Securities Registration Statement (s-1/a)

Date : 10/02/2018 @ 10:32PM
Source : Edgar (US Regulatory)
Stock : Borqs Technologies - Ordinary Shares (BRQS)
Quote : 2.5527  -0.4272 (-14.34%) @ 8:59PM

Securities Registration Statement (s-1/a)

As filed with the Securities and Exchange Commission on October 2, 2018

Registration No. 333-223034

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

AMENDMENT NO. 8 TO

FORM S-1 REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

 

 

 

BORQS TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

British Virgin Islands

 

7373

 

N/A

(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

 

Building B23-A,
Universal Business Park
No. 10 Jiuxianqiao Road
Chaoyang District, Beijing 100015,
China
(86) 10-5975-6336

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

 

Pat Sek Yuen Chan

Chief Executive Officer

Borqs Technologies, Inc.

Building B23-A,

Universal Business Park

No. 10 Jiuxianqiao Road

Chaoyang District, Beijing 100015
China
(86) 10-5975-6336

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

 

Copies to

 

Barry I. Grossman

Ellenoff, Grossman & Schole LLP

1345 Avenue of the Americas

New York, NY 10105

(212) 370-1300

Mitchell S. Nussbaum

Loeb & Loeb LLP

345 Park Avenue

New York, NY 10154

(212) 407-4000

 

 

 

Approximate date of commencement of proposed sale to the public : As soon as practicable after the effective date of this Registration Statement.

 

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. ☒

 

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐

 

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐

 

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐

 

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

 

Large accelerated filer ☐ Accelerated filer  ☐
Non-accelerated filer ☒ (Do not check if a smaller reporting company) Smaller reporting company ☐
  Emerging growth company ☒

 

If an emerging growth company, 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 7(a)(2)(B) of the Securities Act. ☐

 

 

 

 

CALCULATION OF REGISTRATION FEE

 

Title Of Each Class Of Securities To Be Registered   Amount to be Registered     Proposed Maximum Offering Price per Share     Proposed Maximum Aggregate Offering
Price (1)(2)
    Amount Of Registration Fee  
Ordinary shares, no par value per share     -       -     $ 11,500,000.00     $ 1,431.75  
Representative’s warrants (3)                 -               -       -       -  
Ordinary shares underlying representative’s warrants (2)(4)(5)     -       -     $ 552,000.00     $ 68.72  
Total     -       -     $ 12,052,000.00     $ 1,500.47 (6)

 

(1) Includes the aggregate offering price of up to additional shares (equivalent to 15% of the total number of ordinary shares sold in this offering) that the underwriters have the option to purchase to cover over-allotments, if any.
   
(2) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended (the “Securities Act”).
   
(3) In accordance with Rule 457(g) under the Securities Act, because the ordinary shares underlying the Representative’s warrants are registered hereby, no separate registration fee is required with respect to the warrants registered hereby.
   
(4) Pursuant to Rule 416 under the Securities Act, the securities being registered hereunder include such indeterminate number of additional ordinary shares as may be issued after the date hereof as a result of stock splits, stock dividends or similar transactions.
   
(5) Estimated solely for the purposes of calculating the registration fee pursuant to Rule 457(g) under the Securities Act. The warrants to be issued to the representative of the underwriters are exercisable at a per share exercise price equal to 120% of the public offering price. As estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(g) under the Securities Act, the proposed maximum aggregate offering price of the ordinary shares underlying the representative’s warrants is $552,000 (which is equal to 120% of $ 460,000 (4% of $11,500,000)).
   
(6) Previously paid.

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

 

 

 

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

 

Dated October 2, 2018 

 

2,666,667 Ordinary Shares

 

 

Borqs Technologies, Inc. is offering 2,666,667 of its ordinary shares, at a public offering price of US$                 .

 

 

 

Our ordinary shares are listed on The Nasdaq Capital Market under the symbol “BRQS.” On October 1, 2018, the last reported sale price of our ordinary shares on The Nasdaq Capital Market was US$4.80 per ordinary share. We have assumed a public offering price of $3.75 per ordinary share. The public offering price will be determined between us, the underwriters and investors based on market conditions at the time of pricing and may be at a discount of up to 20% of the assumed $3.75 offering price.

 

 

 

We are an “emerging growth company” as defined under the federal securities laws. Investing in our ordinary shares involves risks. See “ Risk Factors ” beginning on page 11.

 

 

 

PRICE US$       PER ORDINARY SHARE

 

 

 

   

Price to
Public

 

Underwriting
Discounts and
Commissions (1)

 

Proceeds to
Borqs Technologies, Inc.

 
Per Share   US$   US$   US$  
Total   US$   US$   US$  

 

 

(1) In addition to the underwriting discount, we have agreed to issue to the representative of the underwriters warrants to purchase a number of ordinary shares equal to 4% of the total number of ordinary shares being sold in the offering, including the over-allotments, if any, and to reimburse the underwriters for expenses incurred by it. See the section titled “Underwriters” for a description of the total compensation payable to the underwriters.

 

Borqs Technologies, Inc. has granted the underwriters the right to purchase up to an additional 400,000 ordinary shares (equivalent to 15% of the total number of ordinary shares sold in this offering) at the public offering price less underwriting discount.

 

The Securities and Exchange Commission and state regulators have not approved or disapproved of these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The underwriters expect to deliver the ordinary shares to purchasers on or about       , 2018.

 

Sole Book-Running Manager

 

Maxim Group LLC

 

Co-Manager

 

The Benchmark Company

 

       , 2018

 

 

 

 

TABLE OF CONTENTS

 

 

Page

Prospectus Summary 1
The Offering 7
Summary Consolidated Financial Data 8
Risk Factors 11
Market, Industry and Other Data 46
Use of Proceeds 46
Market Price of Our Ordinary Shares 46
Dividend Policy 47
Capitalization 47
Dilution 48
Selected Consolidated Financial Data 49
Management’s Discussion and Analysis of Financial Condition and Results of Operations 51
Special Note Regarding Forward-Looking Statements 51
Business 70
Management 84
Executive Compensation 89
Certain Relationships and Related Person Transactions 94
Principal Shareholders 97
Description of Securities 99
Taxation 104
Underwriters 113
Legal Matters 116
Experts 116
Where You Can Find Additional Information 116
Index to Consolidated Financial Statements F-1

 

 

 

Neither we nor any of the underwriters have authorized anyone to provide you with additional information or information that is different from or to make any representations other than those contained in this prospectus or in any free-writing prospectus prepared by or on behalf of us to which we may have referred you in connection with this offering. We and the underwriters take no responsibility for, and can provide no assurances as to the reliability of, any other information that others may give you. We are offering to sell, and seeking offers to buy, our ordinary shares only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ordinary shares. Our business, financial condition, results of operations and future growth prospects may have changed since that date.

 

Unless the context requires otherwise, the words “we,” “us,” “our,” “the Company” and “Borqs” refer to Borqs Technologies, Inc. and its subsidiaries and consolidated affiliated entities taken as a whole. For purposes of this prospectus, unless the context otherwise requires, the term “shareholders” shall refer to the holders of our ordinary shares.

 

For investors outside the United States, neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus and any such free-writing prospectus outside the United States.

 

i

 

PROSPECTUS SUMMARY

 

This summary highlights information contained in greater detail elsewhere in this prospectus. This summary is not complete and does not contain all of the information you should consider in making your investment decision. You should read the entire prospectus carefully before making an investment in our ordinary shares. You should carefully consider, among other things, our consolidated financial statements and related notes and the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

BORQS TECHNOLOGIES, INC.

 

Overview

 

Borqs Technologies, Inc. (“we”, “the Company” or “Borqs”) is 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 Original Equipment Manufacturers (“OEMs”) and mobile operators, as well as complete product solutions of mobile connected devices for enterprise and consumer applications.

 

Our Connected Solutions Business Unit (“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. In recent years, we have been awarded significant business contracts from Intel and Qualcomm, leading global chipset manufacturers. 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 activities with Intel have reduced over the last two years due to Intel’s strategy to exit the mobile industry, and there are no material agreements with Intel on which we are substantially dependent. For the year 2017, Intel was no longer a customer of the Company. However, our activities with Qualcomm have increased over the last two years, including developmental work on chipsets for mobile devices and wearable products.

 

Our Mobile Virtual Network Operator (“MVNO”) BU 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.

 

The Connected Solutions BU represented 73.4%, 70.9% and 79.2% of our net revenues in the year ended December 31, 2015, 2016 and 2017, respectively. In the year ended December 31, 2015, 2016 and 2017, Borqs generated 85%, 93% and 86% of its net revenues from customers headquartered outside of China and 15%, 7% and 14% of its net revenues from customers headquartered within China. As of June 30, 2018, Borqs had collaborated with 6 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 14 million units worldwide.

 

Borqs has dedicated significant resources to research and development, and has research and development centers in Beijing, China and Bangalore, India. As of June 30, 2018, 350 of our 509 employees were technical professionals dedicated to platform research and development and product specific customization.

 

Borqs has achieved significant growth since inception in 2007. Net revenues increased from $75.1 million in 2015 to $120.6 million in 2016, to $154.3 million in 2017. We recorded net income of $0.8 million and $2.6 million in the years 2015 and 2016 respectively. For 2017, we had a net loss of $12.4 million which included non-cash merger related costs of $14.5 million; excluding such non-cash merger related costs would result in non-GAAP adjusted net income of $2.1 million for 2017 as compared to a net income of $2.6 million for 2016. We recorded a net income of $2.0 million in the three months ended June 30, 2018 and a net income of $3.4 million in the six months ended June 30, 2018, as compared with a net loss of $965, 000 in the three months ended June 30, 2017 and a net loss of $947, 000 in the six months ended June 30, 2017.

 

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Recent Developments

 

Potential acquisition of Shanghai KADI Technologies Co., Ltd.  On January 8, 2018, we entered into a letter of intent to acquire a 60% equity interest in Shanghai KADI Technologies Co., Ltd (“KADI”), a Chinese company that develops software and hardware solutions for electric vehicle control modules, such as charging, battery management and vehicle controls. Pursuant to the letter of intent, and as is being negotiated in a definitive agreement, we intend to pay $11.7 million in cash to KADI and $3.3 million in our ordinary shares to the selling shareholders of KADI based on achievement of net income targets for the years 2018, 2019 and 2020. KADI is not a customer or supplier of Borqs. In accordance with the letter of intent, we have made four scheduled cash advances to KADI totaling $600,000 which will be deducted from our initial cash payments to KADI under the definitive agreement being negotiated. If the transaction is not consummated within nine months after the signing of the letter of intent, the advance payments will be converted into shares representing five percent of the outstanding capital stock of KADI. There are no termination fees or penalties under the letter of intent. Assuming the parties reach a definitive agreement and proceed to closing, part of the proceeds from this offering as contemplated herewith will be used to support the funding of the potential acquisition of KADI. See “Use of Proceeds.”

 

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 has been awarded a RMB320 million (US$50 million) multi-year supply contract for its core electric control modules from Shenzhen Espirit Technology Co., Ltd. (“Espirit”), which is a key automotive contractor in China. Borqs believes that KADI’s products will complement Borqs’ existing automobile in-vehicle-infotainment (IVI) solutions, in terms of sales and distribution, and research and development. Borqs anticipates that the experience of its software engineers will enhance KADI’s capabilities while Borqs’ supply chain management team will ensure efficient delivery of hardware products. Assuming the acquisition of KADI is completed, Borqs expects to provide $7.7 million to KADI in 2018 to service the Espirit supply contract, of which approximately $4 million is anticipated to be used for capital expenditures, and $3.7 million is anticipated to be used for working capital needs. We are in discussions with KADI to negotiate a modified payment schedule in light of the fact that the proceeds raised in this offering are insufficient to fund the acquisition of KADI.

 

Beginning in May 2018, KADI will deliver certain control modules, including steering control, air conditioning and for other electric bus functions, to Dong Feng Motor Group’s Super Dragon Electric Bus Program. Such products represent approximately 10% of the Espirit supply contract.

 

Upon the completion of our acquisition of 60% of KADI, we will have an exclusive option, valid until December 31, 2021, to purchase the remaining 40% of KADI at a 9% premium to the consideration paid for the first 60%.

 

Repurchase of Shares from Zhengqi. On January 10, 2018, we entered into a stock repurchase agreement (“Stock Repurchase Agreement”) with Zhengqi International Holding Limited (“Zhengqi”), pursuant to which we agreed to repurchase 966,136 of our ordinary shares that were originally issued and sold to Zhengqi on August 18, 2017, at an aggregate purchase price of approximately $10 million, or $10.40 per share. In addition, Zhengqi agreed to forfeit all of its rights to 1,278,776 shares held in escrow. The Stock Repurchase Agreement provides that those shares will be treated in the following manner: transfer 51,151 shares (4% of the total) to the indemnity escrow account; and deliver 1,227,625 shares to the former Borqs International shareholders based on their respective proportionate interests in the merger consideration. We and Zhengqi are currently making arrangements for the completion of this transaction, which we anticipate will be within 2018. As of August 3, 2018, the 1,278,776 escrow shares were forfeited and released from escrow and the Company had obtained the consent of its existing lenders with respect to the transaction. The return and cancellation of the 966,136 shares remain in process. Proceeds from this offering will not be used to repurchase the shares from Zhengqi.

 

  2  

  

Investment in Shenzhen Crave Communication Co., Ltd. On January 18, 2018, we entered into an agreement with Shenzhen Crave Communication Co., Ltd (“Crave”) and Colmei Technology International Ltd. (“Colmei”), along with the shareholders of Crave and Colmei (“CC Selling Shareholders”), pursuant to which we agreed to acquire 13.8% of the outstanding shares of Crave and 13.8% of the outstanding shares of Colmei from the CC Selling Shareholders. The transaction closed on March 22, 2018, and under the agreement, the purchase consideration consists of ordinary shares and cash. On the closing, we issued 473,717 ordinary shares to the order of the CC Selling Shareholders and agreed to pay cash in the amount of $10.0 million to be paid to the CC Selling Shareholders over a period of 36 months. In addition, subject to Board approval, we agreed to issue 183,342 additional shares to the CC Selling Shareholders if the aggregate value of the ordinary shares initially issued at the closing to the CC Selling Shareholders under this agreement was less than $3.0 million on August 18, 2018 (the “Calculation Date”). We are currently in discussions with the CC Selling Shareholders to extend the Calculation Date to a mutually agreed date. No proceeds from this offering will be used to pay any of the $10.0 million cash consideration to the CC Selling Shareholders.

 

Crave is a manufacturer of mobile terminal devices located in Shenzhen China. With multiple high speed SMT lines, assembly lines and packaging lines, its annual capacity reaches over 10 million units in its Shenzhen facility. Crave exports final products for customers in South America, India, Indonesia, the Philippines and Vietnam. Colmei, which is under common ownership with Crave, is a sales entity located in Hong Kong that has established relationships with international banks to facilitate transactions with its global clients. Crave is one of our material suppliers from which we source necessary components for our customers, and we believe our investments in Colmei and Crave provide us with indirect access to supply chain financing, competitive component pricing and prioritized production capacity. Prior to this investment, we have contracted Crave and Colmei for multiple projects related to manufacturing our products, including a large variety of phone models and releases.

 

Award of MVNO License to Yuantel Telecom . On July 23, 2018, the Ministry of Industry and Information Technology of China (the “MIIT”) awarded the official commercial MVNO license to Yuantel Telecom, our subsidiary that runs our mobile virtual network operator or MVNO business.  The license is valid from July 12, 2018 to July 12, 2023.

 

Risks Related to Our Business and Investment in Our Ordinary Shares

 

Investing in our ordinary shares involves a high degree of risk. You should carefully consider the risks highlighted in the section titled “Risk Factors” immediately following this prospectus summary before making an investment decision. We may be unable for many reasons, including those that are beyond our control, to implement our business strategy successfully. These risks include:

 

  Our future capital needs are uncertain and our independent registered public accounting firm has expressed in its report on our 2017 audited financial statements a substantial doubt about our ability to continue as a going concern;

 

  We generate a significant portion of our net revenues from a small number of major customers and key projects;

 

  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 control of our VIEs is based upon contract rather than equity;

 

  We face potential risks associated with our ability to fund our expansion plans, including acquisitions, and our operations due to fund restrictions both from currency transfer and conversion restrictions placed on us by the PRC government; and

 

  The current license to operate our services in the PRC is based on an MVNO license issued to us in July 2018 by the MIIT, which is valid until July 12, 2023. If we cannot maintain the license, we will need to cease operating as a MVNO and our total revenues will be significantly reduced.

 

The risks and uncertainties related to our business and our industry also include, but are not limited to:

 

  Our ability to manage our business expansion and increasingly complicated operations effectively;

 

  Our ability to use, protect and enhance our brands;

 

  Our ability to compete effectively in the marketplace;

 

  Our ability to remediate our material weakness and maintain an effective system of internal controls; and

 

  Our ability to make acquisitions, including our potential acquisition of KADI, and to successfully integrate these acquisitions and establish and maintain strategic relationships.

 

  3  

 

See “Risk factors” for a more detailed discussion of these and other risks and uncertainties that we may face.

 

If we are unable to adequately address these and other risks we face, our business, financial condition, operating results and prospects may be adversely affected.

 

Corporate History and Information

 

We were incorporated in the British Virgin Islands on July 1, 2015 as a blank check company, formed for the purpose of acquiring, engaging in a share exchange, share reconstruction and amalgamation with, purchasing all or substantially all of the assets of, entering into contractual arrangements with, or engaging in any other similar business combination with one or more businesses or entities. As a result of a merger on August 18, 2017 of one of our subsidiaries (which we formed for this purpose) with and into Borqs International Holding Corp (“Borqs International”), a company incorporated in the Cayman Islands in 2007, we acquired the entire issued share capital of Borqs International, which became our wholly-owned subsidiary, and we ceased to be a shell company. We conduct our business principally through BORQS Beijing Ltd. (“Borqs Beijing”), which is our wholly-owned Chinese subsidiary. In addition, we conduct parts of our operations through subsidiaries in China, India, Hong Kong and South Korea.

 

As of June 30, 2018, we were authorized to issue an unlimited number of shares and our share capital consisted of 31,307,522 issued and 31,303,350 outstanding ordinary shares, and we had issued 5,750,000 public warrants, 531,875 private warrants, and 417,166 assumed warrants. Our ordinary shares and public warrants began trading on The Nasdaq Capital Market (“Nasdaq”) under the symbols “BRQS” and “BRQSW,” respectively, on or around August 21, 2017. On October 12, 2017, we were notified by Nasdaq that we were not in compliance with Nasdaq Listing Rules 5505(a)(3) and 5515(a)(4), given that our ordinary shares and public warrants did not meet the minimum initial listing requirements of 300 round lot holders of ordinary shares and 400 round lot holders of public warrants. On December 11, 2017, we were notified that our request for continued listing of our ordinary shares on Nasdaq was granted, subject to providing an update regarding the status of our efforts to evidence compliance with the minimum 300 round lot shareholder requirement on or before February 14, 2018, and full compliance with that requirement by no later than April 10, 2018. The Panel also advised the Company that it had determined to delist our warrants. To regain compliance with Nasdaq’s listing requirement of 300 round lot holders of ordinary shares, we implemented a restricted ordinary shares purchase program with eligible employees of our wholly-owned subsidiary in India, Borqs Software Solutions Private Ltd. Pursuant to the program, 222 employees purchased an aggregate of 29,170 ordinary shares at a purchase price of $9.40 per share, which was deducted from their regular compensation on March 23, 2018. On April 12, 2018, we were notified by the Panel 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. Our public warrants have been trading on the OTC Markets system under the symbol “BRQSW” since October 23, 2017.

 

Our principal executive offices are located at Building B23-A, Universal Business Park, No. 10 Jiuxianqiao Road, Chaoyang District, Beijing, 100015 China. Our telephone number is +86 10-5975-6336. Our website address is www.borqs.com . The information contained on our website is not incorporated by reference into this prospectus.

 

  4  

 

The following diagram illustrates our current corporate structure of each of our material subsidiaries, consolidated VIEs and the subsidiaries of the VIEs.

 

Corporate Organizational Chart

 

 

 

  5  

 

Borqs Subsidiaries and Consolidated Affiliated Entities

 

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

 

Borqs Beijing Ltd. (“Borqs Beijing”), a wholly foreign owned enterprise established under the laws of the PRC in 2007, is our primary operating entity and 100% owned by Borqs Hong Kong Limited;

 

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 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 (“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;

 

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;

 

Beijing Big Cloud Century Network Technology Co., Ltd. (“BC-NW”), a company established under the laws of the PRC in 2014, is the variable interest entity through which Borqs Beijing controls Yuantel Telecom, the entity which operates the MVNO business,

 

Yuantel (Beijing) Telecommunications Technology Co., Ltd. (“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 BC-NW, which is 100% beneficially owned and controlled by Borqs Beijing through contractual control arrangements; and

 

Beijing Tongbaohuida Technology Co., Ltd. (“Tongbaohuida”), a company established under the laws of the PRC in 2012 and is 100% owned by Yuantel Telecom. Tongbaohuida has been inactive for the years 2016 and 2017.

 

Implications of Being an Emerging Growth Company

 

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or “JOBS Act.” We have elected to take advantage of specified reduced reporting and other requirements available to us, as an emerging growth company, that are otherwise applicable to public companies. These provisions include, among other things:

 

  exemption from the auditor attestation requirement in the assessment of our internal controls over financial reporting;

 

  exemption from new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies;

 

  exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board (United States), requiring mandatory audit firm rotation or a supplement to our auditor’s report in which the auditor would be required to provide additional information about the audit and our financial statements;

 

  an exemption from the requirement to seek non-binding advisory votes on executive compensation and golden parachute arrangements; and

 

  reduced disclosure about executive compensation arrangements.

 

We may take advantage of these provisions until October 20, 2020, unless we earlier cease to be an emerging growth company, which would occur if our annual gross revenues exceed $1.0 billion, if we issue more than $1.0 billion in non-convertible debt in a three-year period, or if the market value of our ordinary shares held by non-affiliates exceeds $700.0 million as of any January 1 before that time, in which case we would no longer be an emerging growth company as of the following December 31. Investors may find our ordinary shares less attractive if we rely on the exemptions, which may result in a less active trading market and increased volatility in our stock price. We have taken advantage of the reduced reporting requirement with respect to disclosure regarding our executive compensation arrangements and expect to take advantage of the exemption from auditor attestation on the effectiveness of our internal control over financial reporting. For as long as we take advantage of the reduced reporting obligations, the information that we provide shareholders may be different from information provided by other public companies. We have not elected to “opt out” of the extended transition period relating to the exemption from new or revised financial accounting standards and as a result, we will not necessarily comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.

  6  

 

THE OFFERING

 

Ordinary shares offered by us 2,666,667 shares
   
Option to purchase additional shares exercisable for
45 days from the closing of this offering
400,000 shares (equivalent to 15% of the total number of ordinary shares sold in this offering)
   
Ordinary shares to be outstanding after this offering                     shares (        shares if the option to purchase additional shares is exercised in full)
   
Use of proceeds We estimate that our net proceeds from this offering will be approximately $8.2 million. If the underwriters exercise their option to purchase additional shares in full, we estimate that our net proceeds from this offering will be approximately $9.6 million. We intend to use our net proceeds from this offering to fund our pending acquisition of Shanghai KADI Technologies Co., Ltd. and for general working capital purposes. See “Use of Proceeds.”
   
Representative’s Warrants We have agreed to issue to Maxim Group LLC in connection with this offering a warrant to purchase 4% of the ordinary shares sold in the offering (“Representative’s Warrants”). The Representative’s Warrants will have an exercise price equal to 120% of the offering price of the ordinary shares sold in this offering and may be exercised on a cashless basis. The Representative’s Warrants are exercisable commencing 180 days after the effective date of the registration statement related to this offering, and will be exercisable for three years after the effective date. The Representative’s Warrants are not redeemable by us and have certain demand and “piggyback” registration rights (See “Underwriters — Representative’s Warrants”).
   
Risk factors See “Risk Factors” beginning on page 11 and other information included in this prospectus for a discussion of factors that you should consider carefully before deciding to invest in our ordinary shares.
   
The Nasdaq Capital Market ticker symbol “BRQS”

 

The number of ordinary shares to be outstanding after this offering is based on 31,307,522 issued and 31,303,350 ordinary shares outstanding as of June 30, 2018, and excludes:

 

  2,686,629 ordinary shares issuable upon the exercise of stock options outstanding as of June 30, 2018, with a weighted-average exercise price of $5.12 per share;

 

 

The repurchase and cancellation of 966,136 ordinary shares outstanding as of June 30, 2018 pursuant to our Stock Repurchase Agreement with Zhengqi, executed on January 10, 2018;

 

  3,558,104 ordinary shares issuable upon the exercise of warrants (See “Description of Securities — Warrants”);

 

  3,853,602 ordinary shares reserved for future issuance under our 2017 Equity Incentive Plan, or Incentive Plan, as of June 30, 2018;

 

  7  

 

  640,000 ordinary shares issuable upon the exercise of EarlyBirdCapital, Inc.’s (“EarlyBird Capital”) purchase option (See “Description of Securities — Purchase Option”); and

 

  The number of ordinary shares issuable upon the exercise the Representative’s Warrants. The Representative’s Warrants will have an exercise price equal to 120% of the offering price of the ordinary shares sold in this offering and may be exercised on a cashless basis. The Representative’s Warrants are exercisable commencing 180 days after the effective date of the registration statement related to this offering, and will be exercisable for three years after the effective date. The Representative’s Warrants are not redeemable by us and have certain demand and “piggyback” registration rights (See “Underwriters — Representative’s Warrants”).

 

Our Incentive Plan also provides for automatic annual increases in the number of shares reserved thereunder. See “Executive Compensation — Employee Benefit Plans” for additional information.

 

Except as otherwise indicated, all information in this prospectus assumes:

 

 

no exercise or cancellation of outstanding options or vesting of RSUs subsequent to June 30, 2018; and

 

  no exercise by the underwriters of their overallotment option.

 

SUMMARY CONSOLIDATED FINANCIAL DATA

 

We have derived the summary consolidated statement of operations data for the years ended December 31, 2015, 2016, and 2017 and the summary consolidated balance sheet data as of December 31, 2016 and 2017 from our audited consolidated financial statements included elsewhere in this prospectus. We have derived the summary consolidated statement of operations data for the three months ended June 30, 2017 and 2018 and the summary consolidated balance sheet data as of June 30, 2018 from our unaudited interim consolidated financial statements included elsewhere in this prospectus. Our unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, on the same basis as our audited annual consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal, recurring adjustments, that are necessary for the fair statement of our consolidated financial position as of June 30, 2018 and our consolidated results of operations for the three months ended June 30, 2017 and 2018. You should read the following summary consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results to be expected for any other period in the future.

 

  8  

 

Statement of Operations:

 

   

Year Ended

December 31,

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Net revenues:                                          
Software     22,468       14,912       11,212       3,499       1,624       6,583       3,880  
Hardware     32,647       70,536       111,021       11,122       47,018       32,801       95,136  
MVNO     16,007       29,309       30,118       6,987       7,220       12,919       14,729  
Others     3,950       5,829       1,956       521       477       1,036       850  
                                                         
Total net revenues     75,072       120,586       154,307       22,129       56,339       53,339       114,595  
                                                         
Cost of revenues                                                        
Software     (12,699 )     (7,491 )     (7,247 )     (1,612 )     (668 )     (3,942 )     (1,437 )
Hardware     (26,101 )     (57,452 )     (96,247 )     (10,008 )     (42,535 )     (29,246 )     (85,934 )
MVNO     (16,225 )     (28,784 )     (22,836 )     (4,533 )     (5,247 )     (9,820 )     (10,308 )
Others     (2,980 )     (1,709 )     (811 )     (288 )     (180 )     (488 )     (351 )
Total cost of revenues     (58,005 )     (95,436 )     (127,141 )     (16,441 )     (48,630 )     (43,496 )     (98,030 )
                                                         
Total gross profit     17,067       25,150       27,166       5,688       7,709       9,843       16,565  
                                                         
Operating expenses:                                                        
Sales and marketing expenses     (7,359 )     (5,874 )     (7,952 )     (1,646 )     (1,665 )     (2,985 )     (3,347 )
General and administrative expenses     (4,883 )     (10,042 )     (20,753 )     (2,599 )     (2,260 )     (4,157 )     (5,356 )
Research and development expenses     (7,206 )     (5,742 )     (6,443 )     (1,184 )     (1,452 )     (1,476 )     (2,341 )
  Changes in the fair value of warrant liabilities     -       (12 )     (200 )     -       -       (161 )     -  
                                                         
Total operating expenses     (19,448 )     (21,670 )     (35,348 )     (5,429 )     (5,377 )     (8,779 )     (11,044 )
                                                         
Other operating income     3,094       1,760       272       1       -       267       -  
                                                         
Operating income (loss)     713       5,240       (7,910 )     260       2,332       1,331       5,521  
                                                         
Interest income     61       65       14       8       2       10       8  
Interest expense     (156 )     (797 )     (1,877 )     (524 )     (1,117 )     (1,143 )     (1,362 )

 

  9  

 

    Year Ended
December 31,
    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Other income     208       114       633       51       14       354       53  
Other expense     (35 )     (59 )     (121 )     (158 )     (2 )     (276 )     (47 )
Foreign exchange gain (loss)     855       692       (779 )     (156 )     633       (333 )     259  
                                                         
Profit (Loss) before income taxes     1,646       5,255       (10,040 )     (519 )     1,862       (57 )     4,432  
Income tax (expense) benefit     (851 )     (2,659 )     (2,319 )     (446 )     146       (890 )     (1,037 )
Net income (loss)     795       2,596       (12,359 )     (965 )     2,008       (947 )     3,395  

 

    Year Ended
December 31,
    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Less: net (loss) income attributable to noncontrolling interests     (1,316 )     (632 )     210       197       178       119       366  
Net income (loss) attributable to Borqs Technologies, Inc.     2,111       3,228       (12,569 )     (1,162 )     1,830       (1,066 )     3,029  
Add: accretion to redemption value of Convertible Redeemable Preferred Shares     (2,417 )     (976 )     (6,956 )     (150 )     -       (448 )     -  
Allocation to holders of Preferred Shares     -       (2,252 )     -       -       -       -       -  
Net loss attributable to ordinary shareholders     (306 )     -       (19,525 )     (1,312 )     1,830       (1,514 )     3,029  
                                                         
(Loss) earnings per share:                                                        
Basic     (0.07 )     0.00       (1.52 )     (0.31 )     0.07       (0.36 )     0.11  
Diluted     (0.07 )     0.00       (1.52 )     (0.31 )     0.07       (0.36 )     0.11  
                                                         
Shares used in (loss) earnings per share computation:                                                        
Basic     4,224,090       4,224,725       12,842,671       4,259,898       26,830,514       4,243,964       26,613,800  
Diluted     4,224,090       4,224,725       12,842,671       4,259,898       27,675,005       4,243,964       27,585,851  
Net income (loss)     795       2,596       (12,359 )     (965 )     2,008       (947 )     3,395  
Other comprehensive (loss) income, net of tax of nil:                                                        
Foreign currency translation adjustments, net of tax of nil     (1,491 )     (1,575 )     2,207       546       (2,397 )     851       (1,005 )
Other comprehensive (loss) income, net of tax of nil     (1,491 )     (1,575 )     2,207       546       (2,397 )     851       (1,005 )
Comprehensive (loss) income     (696 )     1,021       (10,152 )     (419 )     (389 )     (96 )     2,390  
Less: comprehensive (loss) income attributable to noncontrolling interest     (1,519 )     (730 )     298       197       100       119       348  
Comprehensive income (loss) attributable to the Borqs Technologies, Inc.     823       1,751       (10,450 )     (616 )     (489 )     (215 )     2,042  

 

Balance Sheet:

 

    December 31,     June 30,  
    2016     2017     2018  
    (US$ in thousands)  
Balance Sheet Data                  
Current assets     58,079       119,531       88,797  
Total assets     78,030       148,732       133,627  
Current liabilities     50,487       92,748       62,235  
Total liabilities     64,519       101,727       80,838  
Shareholders’ (deficit) equity     (55,351 )     47,005       52,789  
Total liabilities and shareholders’ equity     78,030       148,732       133,627  

  

  10  

 

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 prospectus, 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.

 

Risks Related to our Business and Industry

 

Our future capital needs are uncertain and our independent registered public accounting firm has expressed in its report on our 2017 audited financial statements a substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional capital or obtain loans from financial institutions and our operations could be curtailed if we are unable to obtain the required additional funding when needed.  We may not be able to do so when necessary, and/or the terms of any financings may not be advantageous to us.

 

Our financial statements for the year ended December 31, 2017 included in our Annual Report on Form 10-K filed on April 2, 2018, have been prepared assuming we will continue to operate as a going concern.  However, due to our recurring losses from operations, and working capital deficiency, there is substantial doubt about our ability to continue as a going concern.  Because we continue to experience negative cash flow, our ability to continue as a going concern is subject to our ability to obtain necessary funding from outside sources, including obtaining additional funding from the sale of our securities, grants or other forms of financing.  Our continued negative cash flow increases the difficulty in completing such sales or securing alternative sources of funding, and there can be no assurances that we will be able to obtain such funding on favorable terms or at all.  If we are unable to obtain sufficient financing from the sale of our securities or from alternative sources, we may be required to reduce, defer or discontinue certain of our research and development and operating activities or we may not be able to continue as a going concern.  As a result, our independent registered public accounting firm has expressed in its auditors’ report on the financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, a substantial doubt regarding our ability to continue as a going concern.  Our financial statements do not include any adjustments that might result from the outcome of the uncertainty regarding our ability to continue as a going concern. If we cannot continue as a going concern, our shareholders may lose their entire investment in our ordinary shares.  Future reports from our independent registered public accounting firm may also contain statements expressing doubt about our ability to continue as a going concern.

 

Due to liquidity concerns arising from our negative cash flow, we anticipate that we will need to raise additional funds to finance operations.

 

As of June 30, 2018, we had accumulated deficit of $71.482 million, net income of $3.395 million and net cash inflow from operation of $1.552 million for the six month period then ended. As of December 31, 2017, we had accumulated deficit of $74.231 million and suffered net loss of $12.359 million and negative cash flow from operating of $14.939 million for the year then ended. This condition raises substantial doubt about our ability to continue as a going concern.

 

To support our research and development activities and general corporate purposes as well as our pending acquisition of KADI, we will need to raise additional capital to fund our future operations. Our cash needs will depend on numerous factors, including our revenues, completion of our product development activities, our ability to realize synergies from the acquisition with KADI, market acceptance of electric, plug-in electric and fuel cell vehicles, customer and market acceptance and use of our products, and our ability to reduce and control costs. We expect to devote substantial capital resources to, among other things, fund operations, and continue research and development programs in China and in India. If we are unable to secure such additional financing, it will have a material adverse effect on our business and we may have to limit operations in a manner inconsistent with our development and commercialization plans. If additional funds are raised through the issuance of equity securities or convertible debt securities, it will be dilutive to our shareholders and could result in a decrease in our stock price.

 

We have funded our operations primarily with proceeds from public and private offerings of our ordinary shares and secured and unsecured debt instruments. Our negative cash flow and cash uses, our projections of the level of cash that will be required for our operations, the terms of the private placement transactions that we completed in the past, and the restricted availability of credit for emerging industries, may impair our ability to raise capital on terms that we consider reasonable and at the levels that we will require over the coming months. We cannot provide any assurances that we will be able to secure additional funding from public or private offerings on terms acceptable to us, if at all. If we are unable to obtain the requisite amount of financing needed to fund our planned operations, it would have a material adverse effect on our business and ability to continue as a going concern.

 

  11  

 

The agreements governing the loan facilities we currently have contain restrictions and limitations that could significantly affect our ability to operate our business, raise capital, as well as significantly affect our liquidity, and therefore could adversely affect our results of operations.

 

Covenants governing our loan facilities with SPD Silicon Valley Bank Co., Ltd. (“SSVB”) and Partners For Growth IV, L.P. and Partners For Growth V, L.P. (collectively, “PFG”) restrict, among other things, our ability to:

 

  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. Although each of SSVB and PFG have consented to our transactions with Crave/Colmei, KADI, our repurchase of shares from Zhengqi, and as to the transactions contemplated by this offering, such covenants and obligations are ongoing, any the breach of any such covenants or obligations not otherwise waived or cured could result in a default under the applicable debt obligations and could trigger acceleration of those obligations. In addition, the loan agreements with SSVB and PFG requires us to satisfy certain financial covenants, including quarterly EBITDA thresholds. Any defaults under our loan agreements with SSVB and PFG could adversely affect our growth, our financial condition, our results of operations and our ability to make payments on our debt. The ability to make payments of principal and interest on indebtedness will depend on our financial condition, which is subject to general economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which are beyond our control. If sufficient cash flow is not generated from operations to service such debt, we may be required, among other things, to:

 

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 with respect to our commitments in connection with our investments into KADI and Crave/Colmei, the repurchase of our shares from Zhengqi, and this offering. In addition, we may not be able to grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could negatively impact our business, operating results and financial condition.

 

Defaults under our loan agreements with SSVB and PFG and procurement agreement with HHMC Microelectronic Co., Limited could result in a substantial loss of our assets.

 

We have pledged our assets as collateral under the loan agreements with SSVB and PFG. Additionally, pursuant to a procurement agreement with HHMC Microelectronics Co., Limited (“HHMC”), HHMC has the right to take possession of goods purchased on behalf of Borqs to pay off any advances owed.

 

The initial term of the procurement agreement was extended to May 28, 2018. We have not been notified by HHMC that they seek to accelerate the loan payments and we are currently in discussions with HHMC for another extension.  Outstanding loan amounts under revolving loan facilities we have with SSVB mature on February 28, 2019, and if needed, we may either extend or refinance the loans. A failure to repay any of the indebtedness under our agreements with any of our lenders as it becomes due or to otherwise comply with the covenants contained in any of such agreements could result in an event of default thereunder. If not cured or waived, an event of default under any of such agreements could enable the lenders thereunder to declare all borrowings outstanding on such debt, together with accrued and unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit. The lenders could also elect to foreclose on our assets securing such debt. In such an event, the Company may not be able to refinance or repay all of its indebtedness, pay dividends or have sufficient liquidity to meet operating and capital expenditure requirements. Any such acceleration could cause us to lose a substantial portion of our assets and will substantially adversely affect our ability to continue our operations.

 

  12  

 

We have in the past failed to comply with financial covenants in certain of our loan documents, which has resulted in potential defaults under certain of our loan documents. These and similar breaches of our loan documents in the future could adversely affect our financial condition and our ability to meet our payment obligations on our indebtedness.

 

We have in the past breached certain financial covenants under our loan agreements with SSVB and PFG. Specifically, we failed to meet a monthly quick ratio threshold, under U.S. GAAP basis, for several months in the second, third and fourth quarters of 2017 under the SSVB loan agreement and a minimum 3-month trailing EBITDA target under the PFG loan agreement as of the third quarter of 2017.  Such breach could result in acceleration of the repayment according to the contract term. Therefore, the outstanding balance of $3.032 million was reclassified as current liability as of June 30, 2018. We have not been notified by either lender that they seek to accelerate the loan payments because of such breaches and neither lender has expressly waived such breaches and any resulting defaults.  We are currently negotiating with both lenders to make adjustments to the specific financial covenants to more appropriately reflect the business nature of the Company in 2018 and going forward, particularly allowing for the inclusion of inventories while removing certain non-cash stock based compensation in deriving the covenant ratios.  In the event the lenders choose not to make adjustments to the covenant ratios and consider the occurrence of these breaches as events of default under our current loan agreements, the lenders may elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit to us.

 

In the event of the acceleration of our indebtedness or if we are unable to otherwise maintain compliance with covenants set forth in these arrangements or if these arrangements are otherwise terminated for any reason, management may be forced to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible and/or curtail, suspend or cease planned programs or operations generally, which would have a material adverse effect on our business, results of operations, financial position and liquidity.

 

If alternative mobile operating system platforms become more widely used or accepted, or mobile chipset manufacturers, mobile device OEMs and mobile operators do not continue to make product and service offerings compatible with the Android platform, our business could be materially harmed.

 

The mobile operating system platform industry is intensely competitive and characterized by rapid technological changes, which often result in shifts in market share among the industry’s participants as one operating system may become more widely used than others. For example, in the past the Symbian mobile operating system platform, or Symbian, from Nokia Corporation, or Nokia, dominated market share for consumer products and the BlackBerry mobile operating system platform, or BlackBerry, from Research in Motion Limited, or RIM, dominated market share for enterprise products. In the past five years, with the rise of the iOS mobile operating system platform, or iOS, from Apple Inc., or Apple, and the Android platform, both the Symbian and Blackberry platforms have experienced a substantial decline. There can be no assurance that the Android platform will continue to compete effectively with alternative mobile operating system platforms, such as the iOS platform or Windows Mobile operating system platform, or Windows Mobile, from Microsoft Corporation. If these or other mobile operating system platforms become more widely used or accepted, such as operating system platforms being developed by Baidu, Inc., or Baidu, and Alibaba.com Ltd., or Alibaba, in China, the market appeal of the Android platform and our Android+ software and service platform solutions could be diminished, which could materially adversely affect our business and financial performance.

 

Furthermore, the competitiveness of our Android+ software and service platform solutions is dependent upon the continued compatibility of the Android platform with the offerings of our customers. If these customers choose not to continue to adopt the Android platform or they are unable to retain or increase their market share, the demand for our Android+ software and service platform solutions may be diminished, which could materially adversely affect our business and financial performance.

 

We generate a significant portion of our net revenues from a small number of major customers and key projects and any loss of business from these customers or key projects could reduce our net revenues and significantly harm our business.

 

We have derived, and believe that in the foreseeable future we will continue to derive, a significant portion of our net revenues from a small number of major customers and key projects. Our top five customers in 2015, 2016 and 2017 accounted for 55.3%, 51.7% and 69.3% of our net revenues in 2015, 2016 and 2017, respectively. Our top five customers in the six months ended June 30, 2018 accounted for 95.1% of our net revenues during such period.

 

Our ability to maintain close relationships with our major customers is essential to the growth and profitability of our business. However, the volume of work performed for a specific customer is likely to vary from year-to-year and project-to-project, especially since we are generally not the exclusive Android platform software and service solutions provider for our customers, some of our customers have in-house research and development capabilities and we do not have long-term purchase commitments from any of our customers. A major customer in one year may not provide the same level of net revenues for us in any subsequent year. The products we provide to our customers, and the net revenues and income from those products, may decline or vary as the type and quantity of products changes over time. In addition, reliance on any individual customer for a significant portion of our net revenues may give that customer a degree of pricing leverage when negotiating contracts and terms of service with us.

 

In addition, a number of factors not within our control could cause the loss of, or reduction in, business or revenues from any customer, and these factors are not predictable. These factors include, among others, a customer’s decision to re-negotiate the royalty payment of a contract if the volume of unit sales exceeds original expectations, pricing pressure from competitors, a change in a customer’s business strategy, or failure of a mobile chipset manufacturer or mobile device OEM to develop competitive products. Our customers may also choose to pursue alternative technologies and develop alternative products in addition to, or in lieu of, our products, either on their own or in collaboration with others, including our competitors. The loss of any major customer or key project, or a significant decrease in the volume of customer demand or the price at which we sells our products to customers, could materially adversely affect our financial condition and results of operations.

 

  13  

 

We have limited experience with our current product offerings, which makes it difficult to predict our future operating results.

 

From our inception in 2007 through 2014, we focused primarily on providing our Android+ software platform solutions to mobile chipset manufacturers, mobile device OEMs and mobile operators as well as complete product solutions of mobile connected devices for enterprise and consumer applications. In 2014, after acquiring Yuantel Investment, we entered into the MVNO business. As we continue to grow our business and markets, we plan to increase our service product offerings in both our Connected Solutions BU and MVNO BU. However, the success of these new product offerings will depend on many factors, including timely and successful research and development, pricing, market and consumer acceptance of such new products and the product offerings of our competitors. If new product offerings are not successful, our revenue growth will suffer and our results of operations may be harmed. Further, we do not have significant experience in the MVNO business and cannot be assured that our investments in the development of our MVNO business will result in increased revenue.

 

We provide mobile communication services as a mobile virtual network operator in China. The current license to operate such services is based on an MVNO license issued to us in July 2018 by the MIIT which is valid until July 12, 2023. If we cannot maintain this license we will need to cease operating as a MVNO and our total revenues will be significantly reduced.

 

In 2014, after acquiring Yuantel Investment, we entered into the MVNO business. Our MVNO BU contributed 26.6%, 29.1% and 20.8% of our net revenues in 2015, 2016 and 2017, respectively. Our MVNO BU contributed 13.7% and 13.6% of our net revenues for the three and six months ended June 30, 2018, respectively.

 

The ability of our MVNO to provide mobile communication services in China was based on trial licenses granted by the Ministry of Industry and Information Technology of China (the “MIIT”) under the mobile virtual network trial program initiated by the MIIT in 2013 to implement the Chinese State Council’s encouragement of private investments in various industries, including telecommunication industry. The trial program and all trial licenses issued thereunder, including our own, were originally set to expire as of December 31, 2015. According to the trial program policies issued by the MIIT, the MIIT will work on formalizing commercial policies regarding the operation of MVNO based on the development of the trial program. On December 28, 2015, the MIIT issued a notice stating that while the government is “diligently researching and determining the formal commercial policies regarding the operation of MVNO, the temporary licenses issued continue to allow MVNO enterprises to operate, and the base telecommunication enterprises shall continue to provide cooperation, support and maintenance services”, as translated from the MIIT’s notice. All MVNOs in China, including us, will continue to operate and provide mobile communication services for subscribers based on the trial licenses.

 

The MIIT issued a Notice on the Official Commercial Use of Mobile Communication Resale Business (the “Official Notice”) on April 28, 2018, which took effect on May 1, 2018. The Official Notice requires an enterprise that has obtained a trial license, or the Pilot Enterprise to execute commercial contracts with a basic telecommunications company and apply for the telecommunications business license to replace the trial license. The Pilot Enterprise is allowed to continue to carry out its MVNO business during such application period. According to the Official Notice, the Pilot Enterprise will be ordered to terminate its MVNO business under certain circumstances, including (1) termination of cooperation between the Pilot Enterprise and the basic telecommunications enterprise resulting in Pilot Enterprise’s failure to operate its business; (2) failure to obtain the telecommunications business license within 2 years of the date of promulgation of the Official Notice; (3) occurrence of serious telecommunication fraud cases or malignant group accidents due to the Pilot Enterprise’s malpractice. In addition, the Official Notice requires the MVNO enterprise to establish network security management systems, deploy corresponding management personnel, implement the real-name registration for telephone users, protect users’ personal information, effectively implement the prevention and crackdown of communication information fraud, and standardize its user service agreements and financial management systems. We submitted our application for the official MVNO license. In July 2018, the MIIT has issued the MVNO license to us which will expire on July 12, 2023. However, uncertainties exist with respect to the interpretation and implementation of the newly issued Official Notice, and thus we cannot assure you that we will be able to maintain the MVNO license.

 

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If we cannot maintain the official MVNO license, we will be forced to cease this operation, and our total revenues will be significantly reduced and our investment into this business will be completely lost. We rely on China United Network Communications Group Co., Ltd (“China Unicom”), the incumbent operator, to provide us with attractive and competitive bulk wholesale rates of voice-per-minute and MB-of-data to compete with our competitors. If we are not provided competitive bulk wholesale rates from China Unicom, we will not be able to maintain our gross margin and will not be able to operate profitably, which may lead to shutting down the MVNO BU entirely.

 

Failure to complete real-name registration of all users of our MVNO services could subject us to penalties, damage our reputation and brand, and harm our business and results of operations.

 

Chinese laws require telecommunication business operators to verify and register real names and identification information of users of mobile phones. For example, in September 2016, the MIIT and certain other governmental departments issued the Notice regarding Prevention of and Cracking Down Telecommunication or Online Frauds to emphasize the real-name registration requirements and to further require telecommunication business operators, including MVNOs, to complete the real-name registration for all of their existing users by end of 2016. In August 2016 and February 2017, we were given a warning by the MIIT for our failure to strictly comply with the real-name registration requirement. We have since rectified such failure in accordance with the MIIT’s requirements and have also established internal policies and require all our staff to strictly comply with the real-name registration requirements for new users. However, we cannot assure you that all our staff will strictly implement our internal policies or that all users will provide authentic information to us. If we are found by the authorities not to comply with the real-name registration requirement, we may be subject to penalties, or be required to suspend or terminate our MVNO business. In addition, complying with these laws and regulations could cause us to incur substantial costs.

 

PRC laws and regulations governing our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation, we could be subject to sanctions. In addition, changes in PRC laws and regulations or changes in interpretations thereof may materially and adversely affect our business.

 

The PRC government restricts or imposes conditions on foreign investment in telecommunication business. We and our PRC subsidiaries are considered foreign persons or foreign-invested enterprises under PRC foreign investment related laws. As a result, we are subject to PRC legal restrictions on or conditions for foreign ownership of telecommunication business. Due to these restrictions and conditions, we conduct our MVNO business in China through BC-NW, our variable interest entity and the subsidiaries of BC-NW. As all the registered shareholders of BC-NW are PRC citizens and all other shareholders of the subsidiaries of BC-NW are also PRC citizens or PRC domestic enterprises, BC-NW and our subsidiaries are therefore considered PRC domestic enterprises under PRC law. The “registered shareholders” of BC-NW refer to those shareholders who have pledged their equity interest in BC-NW to Borqs Beijing and entered into exclusive option agreements with Borqs Beijing as part of the contractual arrangements. Our contractual arrangements with BC-NW and the registered shareholders of BC-NW allow it to have the power to direct the activities of BC-NW and our subsidiaries that most significantly impact economic performance.

 

There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing the MVNO business, or the enforcement and performance of our contractual arrangements with BC-NW. These laws and regulations may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.

 

Although we believe we are in compliance with current PRC laws and regulations, we cannot assure you that the PRC government would agree that our contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. The PRC government has broad discretion in determining penalties for violations of laws and regulations. If the PRC government determines that we do not comply with applicable law, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our websites, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business. Any of these or similar occurrences could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations. If any of these occurrences results in our inability to direct the activities of any of our consolidated affiliated entities that most significantly impact our economic performance, and/or our failure to receive the economic benefits from any of our consolidated affiliated entities, we may not be able to consolidate such entity in our consolidated financial statements in accordance with U.S. GAAP.

 

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Our MVNO business is dependent upon China Unicom for voice and data service as well as reliability and accessibility of to China’s telecommunications and Internet infrastructure.

 

We provide our MVNO services via telecommunications and Internet networks, and therefore our ability to fulfill our contracts and generate revenue and profits is dependent on those systems remaining available and accessible with minimal disruption or interruption. Just as we are dependent on the reliability of our software and systems and the telecommunications networks of our customers, we are also dependent on the operational reliability and capacity of China’s overall telecommunications and Internet infrastructure. Should this infrastructure or key portions of it be disabled or become nonfunctional, we may not be able to secure alternate means of communication or alternate means of accessing needed information. Our operational results could suffer as a result.

 

Through our subsidiary, Yuantel Investment, we purchase wholesale rates for mobile voice and data services from China Unicom, a PRC state-owned telecommunications service provider, and repackage the voice and data services into competitive bundles for our Chinese customers.  We purchase bulk voice-per-minute and MB-of-data service from China Unicom at attractive wholesale rates pursuant to a Business Cooperation Agreement with China Unicom dated as of January 10, 2018.  The agreement is for a one year term, ending December 31, 2018.  There is no guarantee that the supply of telecommunications resources or competitive rates provided by China Unicom will be renewed when the contract term ends.  If the agreement is not renewed, we will not be able to maintain our gross margin and will not be able to operate profitably, which may lead us to cease operations of the MVNO BU entirely.

 

We operate in multiple rapidly evolving industries. If we fail to keep up with technological developments and changing requirements of our customers, business, financial condition and results of operations may be materially and adversely affected.

 

The mobile industry is rapidly evolving and subject to continuous technological developments. Our success depends on our ability to keep up with these technological developments and the resulting changes in customers’ demands. There may also be changes in the industry landscape as different types of platforms compete with one another for market share. If we do not adapt our Android+ software and service platform solutions to such changes in an effective and timely manner as more mobile operating system platforms become available in the future, we may suffer a loss in market share. Given that we operate in a rapidly evolving industry, we also need to continuously invest significant resources in research and development in order to enhance our existing products and to respond to changes in customer preference, new challenges and industry changes in a timely and effective manner. If we fail to keep up with technological developments and continue to innovate to meet the needs of our customers, our Android+ software and service platform solutions may become less attractive to customers, which in turn may adversely affect our reputation, competitiveness, results of operations and prospects.

 

We face intense competition from onshore and offshore third party software providers in the Android platform and software market, and, if we are unable to compete effectively, it may lose customers and our revenues may decline.

 

The Android platform and software market is highly fragmented and competitive, and we expect competition to persist and intensify from both existing competitors and new market entrants. We believe that the principal competitive factors in our industry are reliability and efficiency, performance, product features and functionality, development complexity and time-to-market, price, support for multiple architectures and processors, interoperability with other systems, support for emerging industry and customer standards and protocols and levels of training, technical services and customer support.

 

Our business model is to provide a full suite of Android+ software and service platform solutions to a broad range of customers, including mobile chipset manufacturers, mobile device OEMs and mobile operators. As of the date of this prospectus, 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.”

 

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In addition, we face competition from companies seeking to compete with the Android platform by developing their own operating systems, such as Baidu and Alibaba in China, and major mobile device OEMs, such as Foxconn Technology Group and BYD Electronic (International) Company Limited, which are able to develop low-level software for mobile chipsets, as well as Huawei, GTE and Xiaomi.

 

We believe that we presently compete favorably with respect to each segment identified above. However, the market for Android platform software and service solutions is still rapidly evolving, and we may not be able to compete successfully against current and potential competitors in the future. In addition, some of our independent competitors are more focused on one or several particular segments of the value chain and may deliver better services in those segments than we do. Furthermore, some of our competitors may have significantly greater financial, technical, marketing, sales and other resources and significantly greater name recognition than we have. If we are unable to compete successfully on the principal competitive factors described above or otherwise, our business could be harmed.

 

As an MVNO, we face intense competition in the wireless communications market and if we cannot compete effectively our revenues, profits, cash flows and growth may be adversely affected.

 

The wireless communications market is extremely competitive, and competition for customers is increasing. We compete with other MVNOs such as Snail Mobile, d.Mobile and Soshare. We are one of the top MVNOs in China as measured in terms of registered subscribers, and we intend to expand our market share organically or by acquiring smaller MVNOs. However, we continue to face intense competition from the dozens of other MVNOs and we may not be able to compete successfully in the future. In addition, continued consolidation in the industry creates even large competitors, and such competitors may have greater financial, technical, personnel and marketing resources and a larger market share than us, and we may not be able to compete successfully against them. If we are unable to compete successfully on the principal competitive factors described above or otherwise, our MVNO business could be harmed.

 

We may undertake acquisitions, investments, joint ventures or other strategic alliances in the future, which could expose us to new operational, regulatory and market risks. In addition, such future and past undertakings may not be successful, which may adversely affect our business, results of operations, financial condition and prospects.

 

We intend to grow both organically by expanding our current business lines and geographic coverage and through acquisitions, investments, joint ventures or other strategic alliances if the appropriate opportunities arise. These potential business plans, acquisitions, investments, joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements. In addition, we may not be able to identify suitable future acquisition or investment candidates or joint venture or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition, investment or alliance on terms commercially acceptable to us. If we fail to identify appropriate candidates or partners, or complete desired acquisitions, investments or alliances, including but not limited to the proposed KADI acquisition, we may not be able to implement our strategies effectively or efficiently.

 

In addition, our ability to successfully integrate acquired companies and their operations may be adversely affected by a number of factors, including, among others, the ability to capitalize on anticipated synergies, diversion of resources and management’s attention, difficulties in retaining personnel of the acquired companies, unanticipated problems or legal liabilities and tax and accounting issues. If we fail to integrate any acquired company efficiently, our earnings, revenues, gross margins, operating margins and business operations could be adversely affected. The integration of acquired companies is a complex, time-consuming and expensive process.

 

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We are dependent upon the Android platform and, if Google determines to no longer develop the Android platform and our further development is not taken up by reliable alternative sources, our business could be materially harmed.

 

Our business model is dependent upon the Android platform, which is a free and fully open source mobile software platform developed by Google. The Android platform has been updated frequently since our original release and the development of the Android platform is an ongoing process which we do not control. If Google determines to no longer develop the Android platform or our further development is not taken up by reliable alternative sources, such as another third party or the open source community, demand for our Android+ software and service platform solutions could decline significantly and our revenue and financial condition could be materially harmed.

 

If our customers move more research and development work in-house, lower demand for our solutions could reduce our net revenues and harm our business.

 

Collaboration with customers is essential to the growth and profitability of our business. However, our customers may elect to move more research and development work in-house, and reduce collaboration with us for Android platform projects. There are many factors beyond our control that could cause our customers to move their work in-house, such as spending reductions due to a challenging economic environment, corporate restructuring, cost control, pricing pressure and concerns regarding the protection of technology know-how, trade secrets and other intellectual property rights. If our customers decide to change their strategy by moving more research and development work in-house, our net revenues may decline, and our business, financial condition and results of operations may be adversely affected.

 

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

 

Our quarterly operating results, including the levels of our revenue, gross margin, profitability, cash flow and deferred revenue, may vary significantly in the future, and period-to-period comparisons of our operating results may not be meaningful. Accordingly, the results of any one quarter should not be relied upon as an indication of future performance. Our quarterly financial results may fluctuate as a result of a variety of factors, many of which are outside of our control and, as a result, may not fully reflect the underlying performance of our business. Fluctuations in quarterly results may negatively impact the value of our ordinary shares. Factors that may cause fluctuations in our quarterly financial results include, but are not limited to:

 

  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.

 

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If we fail to effectively manage our technical operations infrastructure, our customers may experience service outages and delays in the further deployment of our services, which may adversely affect our business.

 

We have experienced significant growth in the number of users and the amount of data that our operations infrastructure supports. We seek to maintain sufficient excess capacity in our operations infrastructure to meet the needs of all of our customers. We also seek to maintain excess capacity to facilitate the rapid provisioning of new customer deployments and the expansion of existing customer deployments. In addition, we need to properly manage our technological operations infrastructure in order to support version control, changes in hardware and software parameters and the evolution of our services. However, the provision of new hosting infrastructure requires significant lead-time. We have experienced, and may in the future experience, website disruptions, outages and other performance problems. These problems may be caused by a variety of factors, including infrastructure changes, human or software errors, viruses, security attacks, fraud, spikes in customer usage and denial of service issues. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time, which may harm our reputation and operating results. Furthermore, if we do not accurately predict our infrastructure requirements, our existing customers may experience service outages that may subject us to financial penalties, financial liabilities and customer losses. If our operations infrastructure fails to keep pace with increased sales, customers may experience delays as we seek to obtain additional capacity, which could adversely affect our reputation and our revenue.

 

Most of our engagements with customers are for a specific project only and do not provide for subsequent engagements. If we are unable to generate a substantial number of new engagements for projects on a continuing basis, our business and results of operations will be adversely affected.

 

Our customers generally retain us on project-by-project basis in connection with specific projects rather than on a recurring basis under long-term contracts. Historically, a significant portion of our net revenues has been comprised of software fees, relating to one-time research and engineering work performed for customers. For 2015, 2016 and 2017, our net revenues from software fees were $22.5 million, $14.9 million and $11.2 million, respectively, representing 29.9%, 12.4% and 7.3% of total net revenues. For the six months ended June 30, 2018, our net revenues from software fees were $3.9 million, representing 3.4% of total net revenues. Although a significant amount of our net revenues are generated from repeat business, which we define as revenues from a customer who also contributed to our revenues during the prior fiscal year, our engagements with our customers are typically for individual projects that are often on a non-exclusive, project-by-project basis. In addition, a majority of our customer contracts from which we generate product fees can be terminated by customers with or without cause. There are many factors outside of our control that might lead customers to terminate a contract or project with us, including, among others:

 

  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.

 

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Security and privacy breaches may expose us to liability and harm our reputation and business.

 

As part of our business we receive and process information about our employees, customers and partners, and we may store (or contract with third parties to store) our customers’ data. There are numerous laws governing privacy and the storage, sharing, use, disclosure and protection of personally identifiable information and user data. Specifically, personally identifiable and other confidential information is increasingly subject to legislation and regulations in numerous domestic and international jurisdictions. The regulatory framework for privacy protection in China and worldwide is currently evolving and is likely to remain uncertain for the foreseeable future. We could be adversely affected if legislation or regulations in China and elsewhere on the world where we have business operations are expanded to require changes in business practices or privacy policies, or if the relevant governmental authorities in China and elsewhere on the world where we have business operations interpret or implement their legislation or regulations in ways that negatively affect our business, financial condition and results of operations. For example, in November 2016, China released the Cybersecurity Law, which took effect in June 2017. The Cybersecurity Law requires network operators to perform certain functions related to cybersecurity protection and the strengthening of network information management. For instance, under the Cybersecurity Law, network operators of key information infrastructure, including network operators of key information infrastructures in public communications and information industry, generally shall, during their operations in the PRC, store the personal information and important data collected and produced within the territory of the PRC and their purchase of network products and services that may affect national securities shall be subject to national cybersecurity review. While we take security measures relating to our Android+ software and service platform solutions, specifically, and our operations (including MVNO business operation), generally, those measures may not prevent security breaches that could harm our business and we cannot assure you that the measures we have taken or will take are adequate under the Cybersecurity Law and other relevant laws and regulations. Advances in computer capabilities, inadequate technology or facility security measures or other factors may result in a compromise or breach of our systems and the data we store and process. Our security measures may be breached as a result of actions by third parties or employee error or malfeasance. A party who is able to circumvent our security measures or exploit inadequacies in our security measures, could, among other things, misappropriate proprietary information (including information about our employees, customers and partners and our customers’ information), cause the loss or disclosure of some or all of this information, cause interruptions in our operations or our customers’ or expose our customers to computer viruses or other disruptions or vulnerabilities. Any compromise of our systems or the data it stores or processes could result in a loss of confidence in the security of our Android+ software and service platform solutions, damage our reputation, disrupt our business, lead to legal liability and adversely affect our financial condition and results of operations. Moreover, a compromise of our systems could remain undetected for an extended period of time, exacerbating the impact of that compromise. Actual or perceived vulnerabilities may lead to claims against us by our customers, partners or other third parties, which could be material. While our customer agreements typically contain provisions that seek to limit our liability, there is no assurance these provisions will be enforceable and effective under applicable law. In addition, the cost and operational consequences of implementing further data protection measures could be significant.

 

We are vulnerable to technology infrastructure failures, which could harm our reputation and business.

 

We rely on our technology infrastructure for many functions, including selling our Android+ software and service platform solutions, supporting our customers and billing, collecting and making payments. We also rely on our own technology infrastructure, which is located on a third-party site, as well as the technology infrastructure of third parties, to provide some of our back-end services. This technology infrastructure may be vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, terrorist attacks, computer intrusions and viruses, software errors, computer denial-of-service attacks and other events. A significant number of the systems making up this infrastructure are not redundant, and our disaster recovery planning is not sufficient for every eventuality. This technology infrastructure is also subject to break-ins, sabotage and intentional acts of vandalism by internal employees, contractors and third parties. Despite any precautions we or our third-party partners may take, such problems could result in, among other consequences, interruptions in our services and loss of data, which could harm our reputation, business and financial condition. We do not carry business interruption insurance sufficient to protect us from all losses that may result from interruptions in our services as a result of technology infrastructure failures or to cover all contingencies. Any interruption in the availability of our websites and on-line interactions with customers and partners would create a large volume of questions and complaints that would need to be addressed by our support personnel. If our support personnel cannot meet this demand, customer and partner satisfaction levels may fall, which in turn could cause additional claims, reduced revenue, reputation damage or loss of customers.

 

We may not be able to continue to use or adequately protect our intellectual property rights, which could harm our business reputation and competitive position.

 

Although Android is an open source mobile software platform for mobile devices, we are not required to share the source code for our Android software, which we have invested significant resources to develop. Accordingly, we believe that patents, trademarks, trade secrets, copyright, software registration and other intellectual property we use are important to our business. We rely on a combination of patent, trademark, copyright, software registration and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and brand name. Any failure by us to maintain or protect our intellectual property rights, including any unauthorized use of our intellectual property by third parties or use of “Borqs” as a company name to conduct software or services business, may adversely affect our current and future revenues and our reputation.

 

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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;

 

  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.

 

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We may not be able to manage our anticipated growth and our current and planned resources may not be adequate to support our expanding operations; consequently, our business, results of operations and prospects may be materially and adversely affected.

 

We have experienced rapid growth since we commenced operations. Our rapid expansion may expose us to new challenges and risks. To manage the further expansion of our business and the growth of our operations and personnel, we need to continuously expand and enhance our infrastructure and technology, and improve our operational and financial systems and procedures and controls. For example, we currently manage all of our human resources functions manually and expect that we will need to upgrade our current system as we continue to increase our headcount. We also need to expand, train and manage our growing employee base. In addition, our management will be required to obtain, maintain or expand relationships with mobile chipset manufacturers, mobile device OEMs and mobile operators, as well as other third-party business partners. We cannot assure you that our current and planned personnel, infrastructure, systems, procedures and controls will be adequate to support our expanding operations. If we fail to manage our expansion effectively, our business, results of operations and prospects may be materially and adversely affected.

 

Due to intense competition for highly skilled personnel, we may fail to attract and retain qualified personnel to support our research and development operations; as a result, our ability to bid for and obtain new projects may be adversely affected and our net revenues could decline.

 

The mobile industry relies on the talents and efforts of highly skilled personnel, and our success depends to a significant extent on our ability to recruit, train, develop, retain and motivate qualified personnel for all areas of our organization. The mobile industry in China has experienced significant levels of employee attrition. Our attrition rates were 18% in 2015, 12% in 2016 and 14% in 2017. We may encounter higher attrition rates in the future, particularly if the mobile industry continues to experience strong growth.

 

Competition in our industry for qualified employees, especially technical employees, is intense, and our competitors directly target our employees from time to time. We have also experienced employees leaving us to start competing businesses or to join the in-house research and development teams of our customers. The loss of the technical knowledge and industry expertise of any of these individuals could seriously impede our success. Moreover, the loss of these individuals, particularly to a competitor, some of which are in a position to offer greater compensation, and any resulting loss of customers or trade secrets and technological expertise could further lead to a reduction in our market share and adversely affect our business. If we are required to increase the compensation payable to our qualified employees to compete with certain competitors with greater resources than we have or to discourage employees from leaving us to start competing businesses, our operating expenses will increase which, in turn, will adversely affect our results or operations.

 

Our success depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.

 

Our future success heavily depends upon the continued services of our senior executives and other key employees. In particular, we rely on the expertise, experience, customer relationships and reputation of Pat Chan, our founder, chairman and chief executive officer. We currently do not maintain key man life insurance for any of the senior members of our management team or other key employees. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions, it could disrupt our business operations, and we may not be able to replace them easily or at all. In addition, competition for senior executives and key employees in our industry is intense, and we may be unable to retain our senior executives and key employees or attract and retain new senior executive and key employees in the future, in which case our business may be severely disrupted, and our financial condition and results of operations may be materially and adversely affected.

 

If any of our senior executives or key employees joins a competitor or forms a competing company, it may lose customers, know-how and other key employees and staff members to them. Also, if any of our business development managers, who generally keep a close relationship with our customers, joins a competitor or forms a competing company, we may lose customers, and our net revenues may be materially and adversely affected. Additionally, there could be unauthorized disclosure or use of our technical knowledge, practices or procedures by such employees. All of our executives and key employees have entered into employment agreements with us that contain non-competition provisions, non-solicitation and nondisclosure covenants. However, if any dispute arises between our executive officers or key employees and us, such non-competition, non-solicitation and nondisclosure provisions might not provide effective protection to us, especially in China, where most of these executive officers and key employees reside, in light of the uncertainties with China’s legal system. See “Risk Factors — Risks Related to Doing Business in China — Uncertainties with respect to the PRC legal system could harm us.”

 

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A significant majority of our outstanding ordinary shares are held by a small number of shareholders, which may have significantly greater influence on us due to the size of their shareholdings relative to other shareholders.

 

As of September 1, 2018, Zhengqi International Holding Limited, Intel Capital Corporation, Norwest Venture Partners X, L.P., Asset Horizon International Limited, Keytone Ventures L.P., and GSR Ventures II and affiliates, beneficially own approximately 11.0%, 12.8%, 11.3%, 11.1%, 10.2%, and 8.8% respectively, of our outstanding ordinary shares. These major shareholders have significant influence in determining the outcome of any corporate transactions or other matters submitted to our shareholders for approval, including mergers, consolidations and schemes of arrangement, election and removal of directors and other significant corporate actions. They may not act in our best interests or our minority shareholders’ interests. In addition, without the consent of these major shareholders, we could be prevented from entering into transactions that could be beneficial to us. This concentration of ownership may also discourage, delay or prevent a change in control, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ordinary shares. These actions may be taken even if they are opposed by our other shareholders.

 

In the course of preparing our consolidated financial statements, we identified material weaknesses, significant deficiencies and other deficiencies in our internal controls over financial reporting.

 

Prior to our acquisition of Borqs International by way of merger, Borqs International was a private company with limited accounting personnel and other resources with which to address our internal controls and procedures for financial reporting. As of December 31, 2017, we identified a material weakness in our internal controls over financial reporting, and are in the process of implementing remedial steps to improve our internal controls over financial reporting. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal control over financial reporting. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important to help prevent fraud. If we fail to maintain effective internal control over financial reporting, investors could lose confidence in the reliability of our financial statements, which could harm our business and the trading price of our ordinary shares. For instance, on September 25, 2017, we received a letter from Zhengqi International Holding Limited (“Zhengqi”), which stated that Zhengqi believed the Company had supplied to it material untrue and falsified financial statement information. Zhengqi also alleged it was damaged by the alleged untrue and falsified financial statement information. We concluded that the allegations by Zhengqi were unfounded, and responded on October 9, 2017, seeking additional information. Zhengqi has not responded to our inquiry. In addition, we anticipate that we will incur considerable costs and devote significant management time and efforts and other resources to our efforts to maintain effective internal control over financial reporting.

 

Our management is responsible for establishing and maintaining adequate internal controls over financial reporting. Our internal controls over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

 

We identified two material weaknesses in internal controls over financial reporting during our preparation of the financial statements for the fiscal year ended December 31, 2016: (i) an insufficient number of financial reporting personnel with an appropriate level of knowledge and experience in U.S. GAAP and SEC reporting requirements and financial reporting programs; and (ii) insufficient controls to ensure that appropriate accruals are made for expenses. Since then, the Company has undertaken or is in the process of undertaking certain remedial steps to improve its internal controls over financial reporting.

 

Following the above-mentioned efforts, as of December 31, 2017, based on an assessment performed by our management on the performance of the remediation measures described above, we determined that the material weakness in providing for effective accruals in internal control over financial reporting had been remediated. However the material weakness relating to hiring sufficient U.S. GAAP-qualified accounting personal had not yet been fully remediated. We plan to take additional measures to improve our internal control over financial reporting, including (i) hiring additional qualified professionals with U.S. GAAP accounting experience in the year 2018; (ii) providing U.S. GAAP and SEC reporting training to our accounting personnel; and (iii) preparing a comprehensive written accounting policies and procedures manual that can effectively and efficiently guide our finance and accounting personnel in addressing significant accounting issues and preparing financial statements that are in compliance with U.S. GAAP and SEC requirements. In addition, we intend to engage an external service provider by the end of 2018 to assist management in evaluating our current internal control over financial reporting and implementing necessary controls and measures to assist it in preparing for compliance with internal control reporting.  

 

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If we fail to maintain effective internal controls over financial reporting, we may not be able to accurately and timely report our financial results and investor confidence and the market price of our ordinary shares may be adversely impacted.

 

We are required to evaluate the effectiveness of disclosure controls and procedures and internal controls over financial reporting. Any failure to develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal controls over financial reporting also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal controls over financial reporting that we will eventually be required to include in our periodic reports that will be filed with the SEC. As described elsewhere in this prospectus, we have identified a material weakness in our internal controls over financial reporting as of December 31, 2017. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Additionally, such weakness in internal controls has adversely affected our disclosure controls and procedures, and as of December 31, 2017, such disclosure controls and procedures were ineffective. Ineffective disclosure controls and procedures and internal controls over financial reporting could also cause material misstatements in our financial statements and investors to lose confidence in our reported financial and other information, which could have a negative effect on the trading price of our ordinary shares.

 

Our independent registered public accounting firm is not required to attest to and report on the effectiveness of our internal controls over financial reporting until after we are no longer an emerging growth company. At that time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our internal controls over financial reporting is documented, designed, or operating. Failing to maintain effective disclosure controls and internal controls over financial reporting could have a material and adverse effect on our business and operating results and could cause a decline in the price of our ordinary shares. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the Nasdaq Stock Market.

 

We are subject to various anti-corruption and anti-bribery laws, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and PRC and Indian anti-corruption and anti-bribery laws; any determination that we have violated such laws could damage our business and reputation, limit our ability to bid for certain business opportunities, and subject us to significant criminal and civil penalties, civil litigation (such as shareholder derivative suits), and commercial liabilities.

 

We are subject to anti-corruption and anti-bribery laws in the United States, United Kingdom, China, and India that prohibit certain improper payments made directly or indirectly to government departments, agencies, and instrumentalities; officials of those government departments, agencies, and instrumentalities; political parties and their officials; candidates for political office; officials of public international organizations; persons acting on behalf of the foregoing; and commercial counterparties. These laws include the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act 2010, the PRC Criminal Law, the PRC Anti-Unfair Competition Law, the Indian Prevention of Corruption Act 1988, the Indian Penal Code and anti-corruption laws in various Indian states.

 

We are engaged in business in a number of countries that are regarded as posing significant risks of corruption. Of particular note, we conduct operations, have agreements with state-controlled enterprises and other third parties and make sales in the PRC, and we have research and development activities in India, each of which may be exposed to corruption risk. It is our policy to implement safeguards and procedures to prohibit these practices by our employees, officers, directors, or by third parties acting on our behalf. However, we cannot rule out the risk that any of our employees, officers, directors, or third parties acting on our behalf may engage in breaches of our policies or anti-corruption laws, for which we might be held responsible.

 

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Allegations of violations of these anti-corruption and anti-bribery laws, and investigation into such allegations, could negatively affect our reputation, business, operating results, and financial condition. The violation of these laws may result in substantial monetary and even criminal sanctions, follow-on civil litigation (such as shareholder derivative suits), and monitoring of our compliance program by the United States or other governments, each of which could negatively affect our reputation, business, operating results, and financial condition. In addition, the United States or other governments may seek to hold us liable for violations of these laws committed by companies in which we invest or acquire.

 

There can be no assurance that our securities, including our ordinary shares, will continue to be listed on Nasdaq or, if listed, that we will be able to comply with the continued listing standards of Nasdaq, which could limit investors’ ability to make transactions in our securities and subject us to additional trading restrictions.

 

To continue listing our ordinary shares on The Nasdaq Stock Market, we will be required to demonstrate compliance with Nasdaq’s continued listing requirements, particularly the requirement to maintain a minimum number of holders (300 round-lot holders). We were previously not in compliance with Nasdaq’s listing requirement that we have at least 300 round-lot shareholders but regained compliance with this requirement on April 12, 2018 by implementing a restricted shares purchase program with eligible employees of Borqs Software Solutions Private Ltd., our wholly-owned subsidiary in India, pursuant to which 222 employees voluntarily purchased an aggregate of 29,170 ordinary shares at a purchase price of $9.40 per share. Program participants paid for their purchase of shares by having the purchase amounts deducted from their regular compensation on March 23, 2018. On April 12, 2018, Nasdaq informed us that we had regained compliance with the listing requirement of 300 round lot holders and that our ordinary shares would continue to be listed on Nasdaq.

 

On December 11, 2017, Nasdaq advised the Company that it had determined to delist the Company’s public warrants. Our public warrants have been trading on the OTC Markets system under the symbol “BRQSW” since October 23, 2017. Our ordinary shares have continued to trade on Nasdaq regardless of the Panel’s decision to delist our public warrants.

 

We cannot assure you that we will be able to meet Nasdaq’s continued listing requirement or maintain other listing standards. If our ordinary shares are delisted by Nasdaq, and we are not able to list our securities on another national securities exchange, we expect our securities could be quoted on an over-the-counter market. If this were to occur, then, as with our public warrants, which have been delisted from Nasdaq and are trading on the OTC Markets, we could face significant material adverse consequences, including:

 

  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;

 

  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. For instance, we are currently in arbitration with Samsung Electronics Co., Ltd. (“Samsung”) to resolve a dispute regarding royalties payable to us under a software license agreement we had with Samsung. Samsung alleges that, for the period starting the fourth quarter of 2010 through mid-2012, we were overpaid royalties in the amount of approximately $1.67 million due to a clerical error in their accounting department that enabled us to receive royalties on sales of Samsung handsets that did not contain our software.  Samsung is seeking repayment of the $1.67 million plus accrued interest of 12% per annum and as well as reimbursements of reasonable fees including attorney fees and arbitration costs. After arbitration hearings that were held in May 2018, the parties are awaiting a ruling from the arbitrator on Samsung’s claim and the result is unpredictable. Any claims, whether with or without merit, could be time consuming, expensive to defend and could divert management’s attention and resources. We may maintain insurance against some, but not all, of these potential claims, and the levels of insurance we do maintain may not be adequate to fully cover any and all losses. Nonetheless, the results of any future litigation or claims are inherently unpredictable, and such outcomes could have a material adverse effect on our results of operations, cash from operating activities or financial condition.

    

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Risks Related to Doing Business in China

 

China’s economic, political and social conditions, as well as changes in any government policies, laws and regulations, could have a material adverse effect on our business.

 

A substantial portion of our operations are conducted in China, and a significant portion of our net revenues are derived from customers where the contracting entity is located in China. Accordingly, our business, financial condition, results of operations, prospects and certain transactions we may undertake are subject, to a significant extent, to economic, political and legal developments in China.

 

China’s economy differs from the economies of most developed countries in many respects, including the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past two to three decades, growth has been uneven, both geographically and among various sectors of the economy. Demand for our services and products depends, in large part, on economic conditions in China. Any slowdown in China’s economic growth may cause our potential customers to delay or cancel their plans to purchase our services and products, which in turn could reduce our net revenues.

 

Although China’s economy has been transitioning from a planned economy to a more market-oriented economy since the late 1970s, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China’s economic growth through allocating resources, controlling the incurrence and payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Changes in any of these policies, laws and regulations could adversely affect the economy in China and could have a material adverse effect on our business.

 

The PRC government has implemented various measures to encourage foreign investment and sustainable economic growth and to guide the allocation of financial and other resources, which have for the most part had a positive effect on our business and growth. However, we cannot assure you that the PRC government will not repeal or alter these measures or introduce new measures that will have a negative effect on us. China’s social and political conditions may also not be as stable as those of the United States and other developed countries. Any sudden changes to China’s political system or the occurrence of widespread social unrest could have a material adverse effect on our business and results of operations.

 

Uncertainties with respect to the PRC legal system could harm us.

 

Our operations in China are governed by PRC government laws and regulations. The PRC legal system is a civil law system based on written statutes. Unlike common law systems, prior court decisions have limited precedential value. Borqs Beijing is generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises, and our other wholly-owned subsidiaries in China may be subject to certain laws and regulations in connection with investments made by foreign-invested enterprises.

 

Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. Moreover, some regulatory requirements issued by certain PRC government authorities may not be consistently applied by other government authorities, including local government authorities, thus making strict compliance with all regulatory requirements impractical, or in some circumstances, impossible. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

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

 

On August 14, 2017, the President of the United States issued a memorandum instructing the U.S. Trade Representative (“USTR”) to determine whether to investigate under section 301 of the U.S. Trade Act of 1974 (Trade Act), laws, policies, practices, or actions of the PRC government that may be unreasonable or discriminatory and that may be harming U.S. intellectual property rights, innovation, or technology development. Based on information gathered in that investigation, the USTR published a report on March 22, 2018 on the acts, policies and practices of the PRC government supporting findings that such are unreasonable or discriminatory and burden or restrict U.S. commerce.

 

On March 8, 2018, the President exercised his authority to issue the imposition of significant tariffs on imports of steel and aluminum from a number of countries, including the PRC. Subsequently, the USTR announced an initial proposed list of 1,300 goods imported from the PRC that could be subject to additional tariffs and initiated a dispute with the World Trade Organization against the PRC for alleged unfair trade practices. The President has indicated that his two primary concerns to be addressed by the PRC are (i) a mandatory $100 billion reduction in the PRC/U.S. trade deficit and (ii) limiting the planned $300 billion PRC government support for advanced technology industries including artificial intelligence, semiconductors, electric cars and commercial aircraft. On June 15, 2018, the President announced that the U.S. would go ahead with tariffs on $50 billion worth of Chinese goods, including agriculture and industrial machinery, which prompted the PRC government to consider imposing tariffs on $50 billion worth of goods from the U.S., including beef, poultry, tobacco and cars. In response to the PRC’s proposed retaliatory measures, the President announced on June 19, 2018 that the U.S. would compile a list of $200 billion in China goods for levies should the PRC move forward with their proposed tariffs. On August 7, 2018, the U.S. announced a tariff of 25% on approximately $16 billion worth of mostly industrial goods from China, including tractors, plastic tubes and antennas, which went into effect on August 23, 2018. In response, on August 8, 2018, China announced a 25% tariff on $16 billion worth of US goods, including large passenger cars, motorcycles, chemical items and diesel fuel, which also went into effect on August 23, 2018. On September 7, 2018, the President warned that he was prepared to impose tariffs on another $267 billion of Chinese goods, which in addition to the other previously announced tariffs, would cover virtually all of China’s imports into the U.S.   Despite a September 12, 2018 invitation by the U.S. to China to restart trade talks, which China has welcomed, the President has instructed his administration to proceed with a 10% tariff on Chinese goods worth $200 billion, which China intends to match with tariffs on $60 billion of US goods.

 

In addition to the proposed retaliatory tariffs, the President has also directed the U.S. Secretary of the Treasury to develop new restrictions on PRC investments in the U.S. aimed at preventing PRC-controlled companies and funds from acquiring U.S. firms with sensitive technologies. Congress is currently considering new legislation, the Foreign Investment Risk Review Modernization Act, to modernize the restrictive powers imposed by the Committee on Foreign Investment in the United States.

 

This evolving policy dispute between the PRC and the U.S. is likely to have significant impact on the industries in which we participate, directly and indirectly, and no assurance can be given that any individual customer or product for whom we develop software solutions, or significant groups of companies or a particular industry, will not be adversely affected by any governmental actions taken by either the PRC or the U.S., perhaps materially. In view of the positions of the respective trade representatives, it is not possible to predict with any certainty the outcome of this dispute or whether it will involve other agencies or entities brought in to resolve the policy differences of the two countries.

 

Our subsidiaries in China are subject to restrictions on making dividends and other payments to it or any other affiliated company.

 

We are a holding company and may rely on dividends paid by our PRC subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders to the extent we choose to do so, to service any debt it may incur and to pay our operating expenses. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, each of our PRC subsidiaries are required to set aside at least 10% of our after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of our registered capital. Appropriations to the employee welfare funds are at the discretion of the board of directors of Borqs Beijing. These reserves are not distributable as cash dividends.

 

In addition, under the PRC Enterprise Income Tax Law, or the EIT Law, which became effective on January 1, 2008, dividends paid to us by our PRC subsidiaries are subject to withholding tax. Currently, the withholding tax rate is 10.0% (subject to reductions by the relevant tax treaties, if applicable).

 

Furthermore, if our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.

 

To date, our PRC subsidiaries have not paid dividends to us out of their accumulated profits. In the future, we do not expect to receive dividends from our PRC subsidiaries because the accumulated profits of these PRC subsidiaries are expected to be used for their own business or expansions. Any limitation on the ability of our PRC subsidiaries to distribute dividends or other payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business.

 

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The discontinuation of any of the preferential tax treatments currently available to our PRC subsidiaries could materially increase our tax liabilities.

 

Preferential tax treatments and incentives granted to our PRC subsidiaries by PRC governmental authorities are subject to review and may be adjusted or revoked at any time in the future. The discontinuation or revocation of any preferential tax treatments and incentives currently available to them will cause their effective tax rate to materially increase, which will decrease our net income and may adversely affect our financial condition and results of operations.

 

We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

 

On February 3, 2015, the State Administration of Taxation, or the SAT issued a Public Notice Regarding Certain Enterprise Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or Public Notice 7, where a non-resident enterprise transfers taxable assets, through the offshore transfer of a foreign intermediate holding company, the non-resident enterprise, being the transferor, maybe subject to PRC enterprise income tax, if the indirect transfer is considered to be an arrangement which does not have a reasonable commercial purpose to circumvent enterprise income tax payment obligations. In addition, Public Notice 7 further provides certain criteria on how to assess reasonable commercial purposes and has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. Public Notice 7 also brings challenges to both the foreign transferor and transferee (or other person who is obligated to pay for the transfer) of the taxable assets. Where a non-resident enterprise conducts an “indirect transfer” by transferring the taxable assets indirectly by disposing of the equity interests of an overseas holding company, the non-resident enterprise being the transferor, or the transferee, or the PRC entity which directly owned the taxable assets may report to the relevant tax authority such indirect transfer. Using a “substance over form” principle, the PRC tax authority may re-characterize such indirect transfer as a direct transfer of the equity interests in the PRC tax resident enterprise and other properties in China. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of up to 10% for the transfer of equity interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

 

On October 17, 2017, the SAT issued the Announcement on Issues Relating to Withholding at Source of Income Tax of Non-Resident Enterprises, or Announcement 37, which became effective on December 1, 2017. The Announcement 37 further clarifies the practice and procedure of the withholding of non-resident enterprise income tax.

 

We face uncertainties with respect to the reporting and consequences of private equity financing transactions, share exchange or other transactions involving the transfer of our ordinary shares by investors that are non-PRC resident enterprises, or sale or purchase of shares in other non-PRC resident companies or other taxable assets by us. We and other non-resident enterprises in our group may be subject to filing obligations or being taxed if we and other non-resident enterprises affiliated with us are transferors in such transactions, and may be subject to withholding obligations if we and other non-resident enterprises affiliated with us are transferees in such transactions, under Public Notice 7 and Announcement 37. For the transfer of shares in us by investors that are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under Public Notice 7 and Announcement 37. As a result, we may be required to expend valuable resources to comply with Public Notice 7 and Announcement 37 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that we and other non-resident enterprises affiliated with us should not be taxed under these circulars. The PRC tax authorities have the discretion under Public Notice 7 and Announcement 37 to make adjustments to the taxable capital gains based on the difference between the fair value of the taxable assets transferred and the cost of investment. If the PRC tax authorities make adjustments to the taxable income of the transactions under Public Notice 7 and Announcement 37, our income tax costs associated with such transactions will be increased in the event that we are a transferee of such transactions, which may have an adverse effect on our financial condition and results of operations. Heightened scrutiny over acquisition transactions by the PRC tax authorities may also have a negative impact on potential acquisitions we may pursue in the future.

 

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It is unclear whether we will be considered a PRC “resident enterprise” under the EIT Law and, depending on the determination of our PRC “resident enterprise” status, we may be subject to 25.0% PRC enterprise income tax on our worldwide income, and holders of our ordinary shares may be subject to PRC withholding tax on dividends paid by us and gains realized on their transfer of our ordinary shares.

 

The EIT Law and our Implementing Regulations, both of which became effective on January 1, 2008, provide that enterprises established outside of China whose “ de facto management bodies” are located in China are considered “resident enterprises.” The Implementing Regulations of the EIT Law define the term “ de facto management bodies” as a body which substantially manages, or has control over the business, personnel, finance and assets of an enterprise. On April 22, 2009, the SAT issued the Notice Regarding Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. According to Circular 82, certain PRC-controlled enterprises will be classified as “resident enterprises” if all of the following conditions are met: (a) the senior management and core management departments in charge of our daily operations function have their presence mainly in the PRC; (b) our financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC; (c) our major assets, accounting books, company seals, and minutes and files of our board and shareholders’ meetings are located or kept in the PRC; and (d) more than half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC. Further, the Administrative Measures of Enterprise Income Tax of Chinese controlled Offshore Incorporated Resident Enterprises (Trial), or Bulletin No. 45, took effect on September 1, 2011, and provides more guidance on the implementation of Circular 82. The State Administration of Taxation issued an amendment to Circular 82 delegating the authority to our provincial branches to determine whether a Chinese-controlled overseas-incorporated enterprise should be considered a PRC resident enterprise, in January 2014.

 

Although Circular 82, our amendment and Bulletin No. 45 only apply to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the determining criteria set forth in Circular 82 and Bulletin No. 45 may reflect the SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals. Although we do not believe that our legal entities organized outside of the PRC constitute PRC resident enterprises, it is possible that the PRC tax authorities could reach a different conclusion.

 

If we are treated as a PRC “resident enterprise,” we will be subject to PRC enterprise income tax on our worldwide income, as well as PRC enterprise income tax reporting obligations. Our income such as interest on other non-PRC sourced income may be subject to PRC enterprise income tax at a rate of 25.0%. In addition, although under the EIT Law and our Implementing Rules dividends paid to us by our PRC subsidiaries would qualify as “tax-exempt income,” we cannot assure you that such dividends will not be subject to a 10.0% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.

 

Furthermore, if we are considered a PRC resident enterprise under the EIT Law, shareholders who are deemed non-resident enterprises may be subject to the PRC enterprise income tax at the rate of 10% upon the dividends payable by us or upon any gains realized from the transfer of our ordinary shares, if such income is deemed derived from China, provided that (i) such foreign enterprise investor has no establishment or premises in China, or (ii) it has establishment or premises in China but our income derived from China has no real connection with such establishment or premises. If we are required under the EIT Law to withhold PRC income tax on our dividends payable to our non-PRC resident enterprise shareholders, or if any gains realized from the transfer of our ordinary shares by our non-PRC resident enterprise shareholders are subject to the PRC enterprise income tax, your investment in our ordinary shares could be materially and adversely affected.

 

In addition, if we are considered a PRC resident enterprise and relevant PRC tax authorities consider dividends we pay with respect to our shares and the gains realized from the transfer of our shares to be income derived from sources within the PRC, it is possible that such dividends and gains earned by non-resident individuals may be subject to PRC individual income tax at a rate of 20%. If we are required under PRC tax laws to withhold PRC income tax on dividends payable to our non-PRC investors that are non-resident individuals or if you are required to pay PRC income tax on the transfer of our ordinary shares, the value of your investment in our ordinary shares may be materially and adversely affected.

 

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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 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 prospectus, 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.

 

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We and our PRC resident employees who participate in our employee stock incentive plans are subject to these regulations. If we or our PRC option grantees fail to comply with these regulations, we or our PRC option grantees may be subject to fines and other legal or administrative sanctions. We plan to process the SAFE application for our ESOP within the year 2018.

 

PRC regulations establish complex procedures for some acquisitions conducted by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

 

The Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, adopted by six PRC regulatory agencies in August 2006 and amended in June 2009, among other things, established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. In addition, the Implementing Rules Concerning Security Review on the Mergers and Acquisitions by Foreign Investors of Domestic Enterprises, issued by the Ministry of Commerce in August 2011, specify that mergers and acquisitions by foreign investors involved in “an industry related to national security” are subject to strict review by the Ministry of Commerce, and prohibit any activities attempting to bypass such security review, including by structuring the transaction through a proxy or contractual control arrangement. We believe that our business is not in an industry related to national security, but it cannot preclude the possibility that the Ministry of Commerce or other government agencies may publish explanations contrary to our understanding or broaden the scope of such security reviews in the future, in which case our future acquisitions in the PRC, including those by way of entering into contractual control arrangements with target entities, may be closely scrutinized or prohibited. Moreover, the Anti-Monopoly Law requires that the Ministry of Commerce be notified in advance of any concentration of undertaking if certain filing thresholds are triggered. We may grow our business in part by directly acquiring complementary businesses in China. Complying with the requirements of the laws and regulations mentioned above and other PRC regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share. Our ability to expand our business or maintain or expand our market share through future acquisitions would as such be materially and adversely affected.

 

Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.

 

The Ministry of Commerce, or the MOFCOM published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law, together with their implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. A draft Foreign Investment Law drafted by the MOFCOM and the National Development and Reform Commission, or the NDRC, has been included in the list of draft laws submitted to the Standing Committee of the National People’s Congress for deliberation under the 2018 Legislation Plan of the State Council. However, it is uncertain when the draft would be signed into law and whether the draft version submitted for deliberation or the final version would have any substantial changes from the draft version published by the MOFCOM. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects.

 

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Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company should be treated as a foreign-invested enterprise, or an FIE. According to the definition set forth in the draft Foreign Investment Law, FIEs refer to enterprises established in China pursuant to PRC law that are solely or partially invested by foreign investors. The draft Foreign Investment Law specifically provides that entities established in China (without direct foreign equity ownership) but “controlled” by foreign investors, through contract or trust for example, will be treated as FIEs. Once an entity falls within the definition of FIE, it may be subject to foreign investment “restrictions” or “prohibitions” set forth in a “negative list” to be separately issued by the State Council later. If an FIE proposes to conduct business in an industry subject to foreign investment “restrictions” in the “negative list,” the FIE must go through a market entry clearance by the Ministry of Commerce before being established. An FIE is prohibited from conducting business in an industry subject to foreign investment “prohibitions” in the “negative list”. However, an FIE, during the market entry clearance process, may apply in writing to be treated as a PRC domestic enterprise if its foreign investor(s) is/are ultimately “controlled” by PRC government authorities and its affiliates and/or PRC citizens. In this connection, “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding 50% or more of the voting rights of the subject entity; (ii) holding less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to exert material influence on the board, the shareholders’ meeting or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations.

 

The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us with respect to our MVNO business, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is included in the “negative list” as restricted industry, the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC government authorities and its affiliates or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal.

 

The draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public on this point. Moreover, it is uncertain whether the telecommunication business, in which our variable interest entity operates, will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. If the enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as Ministry of Commerce market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties as to whether such clearance can be timely obtained, or at all.

 

The draft Foreign Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase our compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs.

 

Aside from investment implementation report and investment amendment report that are required at each investment and alteration of investment specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these information reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.

 

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The enforcement of the labor laws and other labor-related regulations in the PRC may adversely affect our results of operations.

 

On June 29, 2007, the Standing Committee of the National People’s Congress of China enacted the Labor Contract Law, which became effective on January 1, 2008 and revised on December 28, 2012. The Labor Contract Law introduces specific provisions related to fixed-term employment contracts, part-time employment, probation, consultation with labor union and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement of labor laws and regulations. According to the Labor Contract Law, an employer is obliged to sign an unlimited-term labor contract with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unlimited term, with certain exceptions. The employer must pay severance to an employee where a labor contract is terminated or expires, with certain exceptions. In addition, the government has continued to introduce various new labor-related regulations after the effectiveness of the Labor Contract Law. Among other things, it is required that that annual leave ranging from five to 15 days be made available to employees and that the employee be compensated for any untaken annual leave days in the amount of three times of the employee’s daily salary, subject to certain exceptions. As a result of these regulations designed to enhance labor protection and increasing labor costs in China, our labor costs have increased. In addition, as the interpretation and implementation of these new regulations are still evolving, we cannot assure you that our employment practice will at all times be deemed in compliance with the new regulations. If we are subject to severe penalties or incur significant liabilities in connection with labor disputes or investigations, our business and results of operations may be adversely affected.

 

Our failure to make adequate contributions to various employee benefit plans as required by PRC regulations may subject us to penalties.

 

Companies operating in China are required to participate in various government sponsored employee benefit plans, including certain social insurance, housing funds and other welfare-oriented payment obligations. Our failure to make contributions to various employee benefit plans and to comply with applicable PRC labor-related laws may subject us to late payment penalties. If we are subject to such penalties in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.

 

If the custodians or authorized users of our controlling non-tangible assets, including corporate chops and seals, fail to fulfill their responsibilities or misappropriate or misuse those assets, our business and operations could be materially and adversely affected.

 

In China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied by a signature. Under PRC law, legal documents for corporate transactions, including contracts and leases that our business relies upon, are executed using “corporate chops,” which are instruments that contain either the official seal of the signing entity or the signature of a legal representative whose designation is registered and filed with the State Administration for Industry and Commerce, or SAIC.

 

Our PRC subsidiaries generally execute legal documents with corporate chops. One or more of our corporate chops may be used to, among other things, execute commercial sales or purchase contracts, procurement contracts and office leases, open bank accounts, issue checks and to issue invoices. We believe that it has sufficient controls in place over access to and use of the chops. Our chops, or chops, including the chops at headquarters level and of each PRC subsidiary, are kept securely at our legal department under the direction of the executive officers at vice president level or higher. Use of chops requires proper approvals in accordance with our internal control procedures. The custodian at our legal department also maintains a log to keep a detailed record or each use of the chops.

 

However, we cannot assure you that unauthorized access to or use of those chops can be prevented. Our designated employees who hold the corporate chops could abuse their authority by, for example, binding us to contracts against our interests or intentions, which could result in economic harm, disruption or our operations or other damages to them as a result of any contractual obligations, or resulting disputes, that might arise. If the party contracting with us asserted that we did not act in good faith under such circumstances, then we could incur costs to nullify such contracts. Such corporate or legal action could involve significant time and resources, while distracting management from our operations. In addition, we may not be able to recover corporate assets that are sold or transferred out of our control in the event of such a misappropriation if a transferee relies on the apparent authority of the representative and acts in good faith.

 

If a designated employee uses a chop in an effort to obtain control over one or more of our PRC subsidiaries, we would need to take legal action to seek the return of the applicable chop(s), apply for a new chop(s) with the relevant authorities or otherwise seek legal redress for the violation of their duties. During any period where we lose effective control of the corporate activities of one or more of our PRC subsidiaries as a result of such misuse or misappropriation, the business activities of the affected entity could be disrupted and we could lose the economic benefits of that aspect of our business. To the extent those chops are stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised and the operations of those entities could be significantly and adversely impacted.

 

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The financial statements included in this prospectus are audited by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

 

Our independent registered public accounting firm, as auditors of companies that are traded publicly in the United States and a firm registered with the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess our compliance with the laws of the United States and professional standards. Because our auditors are located in the PRC, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB. In May 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the CSRC and the Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by PCAOB, the China Securities Regulatory Commission, or the CSRC, or the Ministry of Finance in the United States and the PRC, respectively. PCAOB continues to be in discussions with the CSRC and the Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges.

 

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and our quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

If additional remedial measures are imposed on China-based accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging those firms’ failure to meet specific criteria with respect to requests for the production of documents, we could be unable to timely file our future financial statements in compliance with the requirements of U.S. securities law.

 

In December 2012, the SEC instituted proceedings against five China-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of China-based companies that are publicly traded in the U.S. The SEC has the authority to deny to any person, temporarily or permanently, the ability to practice before the SEC who is found by to have willfully violated any such laws or rules and regulations. On January 22, 2014, an initial administrative law decision was issued, censuring these accounting firms and suspending four of the five firms from practicing before the SEC for a period of six months. Four of these China-based accounting firms appealed to the SEC against this decision and, on February 6, 2015, each of the four China-based accounting firms agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. These firms’ ability to continue to serve all their respective clients is not affected by the settlement. The settlement requires the firms to follow detailed procedures to seek to provide the SEC with access to the firms’ audit documents via the China Securities Regulatory Commission. If the firms do not follow these procedures, the SEC could impose penalties such as suspensions, or it could restart the administrative proceedings. The settlement did not require the firms to admit to any violation of law and preserves the firms’ legal defenses in the event the administrative proceeding is restarted

 

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, companies listed in the U.S. with major Chinese operations may find it difficult or impossible to retain auditors in respect of their operations in China, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of our ordinary shares may be adversely affected.

 

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If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delay or abandonment of this offering, delisting of our ordinary shares from The Nasdaq Stock Market or deregistration from the SEC, which would substantially reduce or effectively terminate the trading of our ordinary shares in the U.S.

 

Our contractual arrangements may not be as effective in providing control over the variable interest entity as direct ownership.

 

We rely on contractual arrangements with our variable interest entity to operate our MVNO business in China. These contractual arrangements may not be as effective as direct ownership in providing us with control over our variable interest entity and our subsidiaries. If we had direct ownership of the variable interest entity, we would be able to exercise our rights as an equity holder directly to effect changes in the board of directors of the variable interest entity, which could effect changes at the management and operational level. Under our contractual arrangements, we may not be able to directly change the members of the board of directors of the variable interest entity and would have to rely on the variable interest entity and the variable interest entity equity holders to perform their obligations in order to exercise control over the variable interest entity. The variable interest entity equity holders may have conflicts of interest with us or our shareholders, and they may not act in the best interests of us or may not perform their obligations under these contracts. For example, our variable interest entity and our respective equity holders could breach their contractual arrangements with them by, among other things, failing to conduct their operations, including maintaining our websites and using our domain names and trademarks which the variable interest entity has exclusive rights to use, in an acceptable manner or taking other actions that are detrimental to our interests. Pursuant to the call option, we may replace the equity holders of the variable interest entity at any time pursuant to the contractual arrangements. However, if any equity holder is uncooperative and any dispute relating to these contracts or the replacement of the equity holders remains unresolved, we will have to enforce our rights under the contractual arrangements through the operations of PRC law and arbitral or judicial agencies, which may be costly and time-consuming and will be subject to uncertainties in the PRC legal system.

 

Any failure by our variable interest entity or our equity holders to perform their obligations under the contractual arrangements would have a material adverse effect on our business, financial condition and results of operations.

 

If our variable interest entity or our equity holders fail to perform their respective obligations under the contractual arrangements, we may have to incur substantial costs and expend additional resources to enforce such arrangements. Although we have entered into exclusive option agreements in relation to the variable interest entity, which provide that we may exercise an option to acquire, or nominate a person to acquire, ownership of the equity in that entity to the extent permitted by applicable PRC laws, rules and regulations, the exercise of these call options is subject to the review and approval of the relevant PRC governmental authorities. We have also entered into share pledge agreements with respect to the variable interest entity to secure certain obligations of the variable interest entity or our equity holders to us under the contractual arrangements. However, the enforcement of such agreements through arbitral or judicial agencies may be costly and time-consuming and will be subject to uncertainties in the PRC legal system. Moreover, our remedies under the share pledge agreements are primarily intended to help it collect debts owed to us by the variable interest entity or the variable interest entity equity holders under the contractual arrangements and may not help us in acquiring the assets or equity of the variable interest entity.

 

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In addition, although the terms of the contractual arrangements provide that they will be binding on the successors of the variable interest entity equity holders, as those successors are not a party to the agreements, it is uncertain whether the successors in case of the death, bankruptcy or divorce of a variable interest entity equity holder will be subject to or will be willing to honor the obligations of such variable interest entity equity holder under the contractual arrangements. If the variable interest entity or our equity holder (or our successor), as applicable, fails to transfer the shares of the variable interest entity according to the respective exclusive option agreement or share pledge agreement, we would need to enforce our rights under the exclusive option agreement or share pledge agreement, which may be costly and time-consuming and may not be successful. The contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration or court proceedings in China. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States. Moreover, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a variable interest entity should be interpreted or enforced under PRC law, and as a result it may be difficult to predict how an arbitration panel or court would view such contractual arrangements. As a result, uncertainties in the PRC legal system could limit our ability to enforce the contractual arrangements. Under PRC law, if the losing parties fail to carry out the arbitration awards or court judgments within a prescribed time limit, the prevailing parties may only enforce the arbitration awards or court judgments in PRC courts, which would require additional expense and delay. In the event we are unable to enforce the contractual arrangements, we may not be able to exert effective control over the variable interest entity and our subsidiaries, and our ability to conduct our business, as well as our financial condition and results of operations, may be materially and adversely affected.

 

We may lose the ability to use, or otherwise benefit from, the licenses, approvals and assets held by our variable interest entity, which could severely disrupt our business, render us unable to conduct some or all of our business operations and constrain our growth.

 

Although the significant majority of our revenues are generated, and the significant majority of our operational assets are held, by our wholly-foreign owned enterprises, which are our subsidiaries, our variable interest entity hold licenses and approvals and assets that are necessary for our business operations, as well as equity interests in a series of our portfolio companies, to which foreign investments are typically restricted or prohibited under applicable PRC law. The contractual arrangements contain terms that specifically obligate variable interest entity equity holders to ensure the valid existence of the variable interest entity and restrict the disposal of material assets of the variable interest entity. However, in the event the variable interest entity equity holders breach the terms of these contractual arrangements and voluntarily liquidate the variable interest entity or any of our subsidiary, or any of these entities declares bankruptcy and all or part of our assets become subject to liens or rights of third-party creditors, or are otherwise disposed of without our consent, we may be unable to conduct some or all of our business operations or otherwise benefit from the assets held by the variable interest entity or our subsidiaries, which could have a material adverse effect on our business, financial condition and results of operations. Furthermore, if our variable interest entity undergoes a voluntary or involuntary liquidation proceeding, our equity holders or unrelated third-party creditors may claim rights to some or all of the assets of such variable interest entity, thereby hindering our ability to operate our business as well as constrain our growth.

 

The equity holders, directors and executive officers of the variable interest entity, as well as our employees who execute other strategic initiatives may have potential conflicts of interest with us.

 

PRC laws provide that a director and an executive officer owes a fiduciary duty to the company he or she directs or manages. The directors and executive officers of the variable interest entity must act in good faith and in the best interests of the variable interest entity and must not use their respective positions for personal gain. We control our variable interest entity through contractual arrangements and the business and operations of our variable interest entity are closely integrated with the business and operations of our subsidiaries. Nonetheless, conflicts of interests for these individuals may arise due to dual roles both as directors and executive officers of the variable interest entity and as our directors or employees, and may also arise due to dual roles both as variable interest entity equity holders and as our directors or employees. We cannot assure you that these individuals will always act in our best interests should any conflicts of interest arise, or that any conflicts of interest will always be resolved in our favor. Moreover, we also cannot assure you that these individuals will ensure that the variable interest entity will not breach the existing contractual arrangements. If we cannot resolve any such conflicts of interest or any related disputes, we would have to rely on legal proceedings to resolve these disputes and/or take enforcement action under the contractual arrangements. There is substantial uncertainty as to the outcome of any such legal proceedings.

 

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The contractual arrangements with our variable interest entity may be subject to scrutiny by the PRC tax authorities. Any adjustment of related party transaction pricing could lead to additional taxes, and therefore substantially reduce our consolidated net income and the value of your investment.

 

The tax regime in China is rapidly evolving and there is significant uncertainty for taxpayers in China as PRC tax laws may be interpreted in significantly different ways. The PRC tax authorities may assert that we or our subsidiaries or the variable interest entity or their equity holders owe and/or are required to pay additional taxes on previous or future revenue or income. In particular, under applicable PRC laws, rules and regulations, arrangements and transactions among related parties, such as the contractual arrangements with our variable interest entity, may be subject to audit or challenge by the PRC tax authorities. If the PRC tax authorities determine that any contractual arrangements were not entered into on an arm’s length basis and therefore constitute a favorable transfer pricing, the PRC tax liabilities of the relevant subsidiaries and/or variable interest entity and/or variable interest entity equity holders could be increased, which could increase our overall tax liabilities. In addition, the PRC tax authorities may impose late payment interest. Our net income may be materially reduced if our tax liabilities increase.

 

Risks Related to the Electric Vehicle Industry

 

Future growth is dependent upon consumers’ willingness to adopt electric vehicles.

 

Due to our contemplated acquisition of a controlling position of Shanghai KADI Technologies Co., Ltd (“KADI”), our future prospects are highly dependent upon the timing and pace of consumer adoption of alternative fuel vehicles in general and electric vehicles in particular. The market for alternative fuel vehicles is relatively new and rapidly evolving, characterized by rapidly changing technologies, price and product competition, newly-emerging competitors, evolving government regulation and industry standards, frequent new vehicle announcements and changing consumer demands and behaviors. If the market for electric vehicles in China does not develop as we expect or develops more slowly than we expect, our business, prospects, financial condition and operating results will be harmed.

 

Developments in alternative technologies or improvements in the internal combustion engine may materially adversely affect the demand for our electric vehicle products.

 

Significant developments in alternative technologies, such as advanced diesel, ethanol, fuel cells or compressed natural gas, or improvements in the fuel economy of the internal combustion engine, may materially and adversely affect our business and prospects in ways we do not currently anticipate. Any failure by us to develop new or enhanced technologies or processes, or to react to changes in existing technologies, could materially delay our development and introduction of new and enhanced electric vehicle products, which could result in the loss of competitiveness of our vehicles, decreased revenue and a loss of market share to competitors.

 

If we are unable to keep up with advances in electric vehicle technology, we may suffer a decline in our competitive position.

 

We may be unable to keep up with changes in electric vehicle technology, and we may suffer a resulting decline in our competitive position. Any failure to keep up with advances in electric vehicle technology would result in a decline in our competitive position which would materially and adversely affect our business, prospects, operating results and financial condition. Our research and development efforts may not be sufficient to adapt to changes in electric vehicle technology.

 

Extended periods of low diesel or other petroleum-based fuel prices could adversely affect demand for electric vehicles, which would adversely affect our business and operating results.

 

We believe that much of the present and projected demand for commercial electric vehicles results from concerns about volatility in the cost of petroleum-based fuel, government regulations and economic incentives promoting fuel efficiency and alternative forms of energy, as well as the belief that climate change results in part from the burning of fossil fuels. If the cost of petroleum-based fuel decreased significantly, the government eliminated or modified its regulations or economic incentives related to fuel efficiency and alternative forms of energy, or if there is a change in the perception that the burning of fossil fuels negatively impacts the environment, the demand for commercial electric vehicles could be reduced, and our business and revenue could be harmed.

 

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We may be subject to product liability claims or recalls which could be expensive, damage our reputation or result in a diversion of management resources.

 

We may be subject to lawsuits resulting from injuries associated with the use of the vehicles in which the modules products of KADI are involved. We may incur losses relating to these claims or the defense of these claims. There is a risk that claims or liabilities will exceed our insurance coverage. In addition, we may be unable to retain adequate liability insurance in the future.

 

We may also be required to participate in recalls involving vehicles with our products, if any prove to be defective, or we may voluntarily initiate a recall or make payments related to such claims as a result of various industry or business practices or the need to maintain good customer relationships. Such a recall would result in a diversion of resources. While we do maintain product liability insurance, we cannot assure investors that it will be sufficient to cover all product liability claims, that such claims will not exceed our insurance coverage limits or that such insurance will continue to be available on commercially reasonable terms, if at all. Any product liability claim brought against us could have a material adverse effect on the results of our operations.

 

Since KADI’s products primarily involve the central control mechanism of electric vehicles, defective designs or defective components parts can cause significant damage or injury, and our liability risks will increase. While we have had no product liability claims to date, we have relatively little experience with these products, and our insurance coverage may not be sufficient to cover potential claims in the future.

 

Changes to the government subsidy support policies in the PRC and further delays in subsidy payments may have negative impacts on the electric vehicle market.

 

The subsidy support polices effective as of April 22, 2015 and the newly announced government subsidy support policies available in the PRC effective as of January 1, 2017, call for a 20% of reduction in central government subsidies per car in 2017 from the 2016 level, and a 20% of reduction in the subsidies for purchasers of certain new energy vehicles (except for fuel cell vehicles) in 2019 and 2020 as compared to 2017 subsidies and the total local government subsidy match to be not more than 50% of the total central government subsidies per car. The reduction of subsidies from both the central government and local governments will inevitably increase the costs to the consumers, which may cause temporary pressure for the EV market. The change in subsidy payment methods in 2017 from paid in advance to paid post-sale and any further delay in releasing subsidy payments for the EVs manufactured and sold in the prior years might also cause the adverse effects on the EV market.

 

Any of the above factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors presently not known to us or that we currently deem immaterial may also impair our business or results of operations. Although the production and sales of finished electric vehicles is subject to certain restrictions, we are not aware of any PRC regulations or proposed regulations that will specifically restrict or limit the electric vehicle component business currently conducted by KADI from foreign participation. As a result, we do not currently expect our pending ownership of KADI, or KADI’s relationships within the electric vehicle industry, to be adversely affected by our foreign ownership structure.

 

Risks Related to Our Recent Transactions

 

Our proposed acquisition of KADI may not be completed or may be delayed if we cannot obtain sufficient capital to fund the acquisition.

 

We have entered into a letter of intent to acquire a 60% equity interest in KADI, a Chinese company that develops software and hardware solutions for electric vehicle control modules, such as charging, battery management and vehicle controls. We have not yet finalized a definitive agreement to complete this acquisition, but we have made four scheduled cash advances to KADI totaling $600,000 which will be deducted from our initial cash payments to KADI under the definitive agreement being negotiated. We intend to use a portion of the proceeds from this offering to support the funding of the KADI acquisition. As we will not raise enough funds in this offering to fund the acquisition, we are in discussions with KADI to negotiate a modified payment schedule and may need to find alternative funding sources, or else we will not be able to consummate the acquisition of KADI. If the acquisition is not consummated within nine months after signing of the letter of intent, the advance payments will be converted into shares representing five percent of the outstanding capital stock of KADI. There are no termination fees or penalties under the letter of intent.

 

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If we are unable to sign a definitive agreement and complete the acquisition of KADI, our directors, executive officers and other employees will have expended extensive time and effort and will have experienced significant distractions from their work during the period the transaction was pending and we will have incurred significant third party transaction costs, in each case, without any commensurate benefit. In addition, the current market price of our ordinary shares may reflect a market assumption that the KADI acquisition will occur, and a failure to complete the transaction could result in a negative perception by the market of ours generally and a resulting decline in the market price of our ordinary shares. Any delay in the consummation of the acquisition or any uncertainty about the consummation of the acquisition could also negatively impact our stock price and future business and results of operations.

 

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

 

Our proposed acquisition of KADI involves multiple steps in seeing through the procurement of the supply contract awarded to KADI, and there is no assurance that KADI can satisfy its customer in the delivery of the products at this scale either in time or up to the quality standards acceptable to the customer. Assuming we proceed to enter into a definite agreement with KADI and consummate the proposed acquisition, there is no assurance that we can support KADI with the necessary funds in time for KADI to set up correctly for the manufacturing of the products. These and other factors unforeseen by both the Company and KADI, including but not limited to new competition, can also appear to affect the demand and pricing of the KADI products and ultimately cause our acquisition of KADI to fail. Also, there is no assurance that the management of KADI will successfully integrate with our management team to ensure a smooth operation going forward and to gain the intended benefits of this acquisition.

 

Dependency on key personnel of KADI.

 

There is no assurance that the management of KADI will successfully integrate with our management team to realize the intended benefits of the acquisition transaction. The business of KADI is dependent on Mr. Hu Lin, KADI’s chairman and chief executive. In the event that Mr. Lin were unable or unwilling to dedicate his full time to KADI’s business, or if he were to resign or start a competing business, our business and financial results would be adversely affected. KADI has no “key person” insurance on Mr. Lin or any other employee, and no employment agreement with Mr. Lin.

 

Our repurchase of shares from Zhengqi may adversely affect our liquidity and working capital.

 

We have agreed to repurchase 966,136 of our ordinary shares from one of our largest shareholders, Zhengqi, at the original purchase price and for an aggregate amount of $10.05 million. The repurchase transaction has not yet completed, and although the purchase price for the transaction has been remitted, the 966,136 repurchase shares currently remain outstanding. This repurchase will limit our available cash and may adversely affect our ability to carry out our operations normally due to this reduction in working capital.

 

We have been working with Zhengqi to satisfy certain conditions and make necessary arrangements before completing the repurchase, including submitting the shares to the transfer agent for cancellation. We obtained the consent of our existing lenders with respect to the repurchase and anticipate closing the transaction in 2018.  As of August 3, 2018, the 1,278,776 escrow shares were forfeited and released from escrow, of which 51,151 shares were placed in the indemnity escrow account established in connection with the merger by and among the Company, Borqs International, Zhengqi and other parties, and 1,227,625 shares were distributed to the former Borqs International shareholders in proportion to their ownership prior to the completion of the business combination on August 18, 2017. The return and cancellation of the 966,136 shares remain in process.

 

Our repurchase of shares from Zhengqi may trigger litigation by other shareholders.

 

Our agreement to repurchase shares from Zhengqi was not extended to all investors who purchased shares in the August 2017 private placement. Since we are repurchasing those shares at a premium to current market prices, other purchasers may seek similar treatment. In addition, a minority of our shareholders did not benefit from the return of 1,227,625 escrowed earnout shares to the former Borqs International shareholders on August 3, 2018. Those minority shareholders will receive no direct benefit of proposed repurchase and return, and there is no assurance that those minority holders will not make claims against us. Any such litigation brought by such minority shareholders could be time-consuming and costly, and could materially adversely affect our financial condition and results of operations.

 

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Dependency on Crave and Colmei and financial risks.

 

Our agreement to purchase shares of Crave and Colmei from the shareholders of those companies may lead us to be more dependent on Crave and Colmei for both components and manufacturing. There is no assurance that Crave and Colmei continue to provide competitive pricing of components and for manufacturing services. There is no assurance that the value of our ownership of Crave and Colmei will not decline, potentially causing a material adverse effect on our financial condition.

 

Risks Related to This Offering

 

Since the consummation of our acquisition of Borqs International by way of merger, our ordinary shares have not had an active, liquid trading market, and you may not be able to sell your ordinary shares at or above the public offering price, or at all.

 

Following the consummation of our acquisition of Borqs International by way of merger, there has not been an active, liquid public market for our ordinary shares. An active trading market for shares of our ordinary shares may never develop or be sustained following this offering. If an active trading market does not develop, you may have difficulty selling your shares of ordinary shares at an attractive price, or at all. The public offering price for our ordinary shares will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell your ordinary shares at or above the public offering price or at any other price or at the time that you would like to sell. An inactive market may also impair our ability to raise capital by selling our ordinary shares and may impair our ability to expand our business by using our ordinary shares as consideration in an acquisition.

 

The price of our ordinary shares could be volatile following this offering.

 

The market price of our ordinary shares following this offering may be volatile and could be subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include, among other things:

  actual or anticipated variations in our quarterly results of operations;

 

  recommendations by securities analysts;

 

  operating and stock price performance of other companies that investors deem comparable to us;

 

  news reports relating to trends, concerns and other issues in the financial services industry generally;

 

  perceptions in the marketplace regarding us and/or our competitors;

 

  new technology used, or services offered, by competitors; and

 

  changes in government regulations.

 

In addition, if the market for stocks in our industry, or the stock market in general, experiences a loss of investor confidence, the trading price of our ordinary shares could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

 

Our insiders currently own, in the aggregate, approximately 75% of our outstanding ordinary shares and, as a result, are able to exert significant control over matters submitted to shareholders for approval.

 

After this offering, our officers, directors and shareholders who own more than 5% of our outstanding ordinary shares will, in the aggregate, beneficially own approximately 75% of our outstanding ordinary shares (assuming no exercise by the underwriters of their option to purchase additional shares and that none of such insiders purchase ordinary shares in this offering). As such, our insiders will be able to significantly influence or even unilaterally approve matters requiring approval by our shareholders, including the election of directors, certain decisions relating to our capital structure, amendments to our memorandum and articles of association, and the approval of mergers or other business combination transactions. The interests of these shareholders may not always coincide with the interests of our other shareholders and investors who acquired ordinary shares in this offering may have no effective voice in the management of our company.

 

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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.

 

Failure to maintain effective internal controls over financial reporting could have a material adverse effect on our business and stock price.

 

We are required to comply with the SEC’s rules implementing Sections 302 and 404(a) of the Sarbanes-Oxley Act, which requires management to certify disclosure controls and procedures and, internal controls over financial reporting in our quarterly and annual reports and provide an annual management report on the effectiveness of controls over financial reporting. In particular, we are required to certify our compliance with Section 404(a) of the Sarbanes-Oxley Act, which requires us to furnish annually a report by management on the effectiveness of our internal controls over financial reporting. Furthermore, unless we remain an emerging growth company and elect additional transitional relief available to emerging growth companies, or we qualify as a smaller reporting company under applicable SEC rules, then our independent registered public accounting firm will be required to attest and report on the effectiveness of our internal controls over financial reporting.

 

As described elsewhere herein, our management identified a material weakness in our internal controls over financial reporting as of December 31, 2017 relating to our lack of sufficient financial reporting, and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to properly address complex U.S. GAAP accounting issues and to prepare and review our consolidated financial statements and related disclosures to comply with U.S. GAAP and SEC financial reporting requirements. If we are unable to remediate this material weakness in our internal controls over financial reporting, or if we identify additional material weaknesses in our internal controls over financial reporting, our management will be unable to assert that our internal controls over financial reporting is effective and investors, counterparties and customers may lose confidence in the accuracy and completeness of our financial statements and reports, which could have an adverse effect on our liquidity, access to capital markets and perceptions of our creditworthiness and/or a decline in the market price of our ordinary shares. In addition, we could become subject to investigations by the stock exchange on which our securities are listed, the SEC, other regulatory authorities, which could require additional financial and management resources. These events could have an adverse effect on our business, financial condition and results of operations.

 

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. Based upon shares outstanding as of September 1, 2018, after this offering, assuming the sale of 2,666,667 ordinary shares by us and no exercise by the underwriters of their option to purchase additional shares, approximately 34 million ordinary shares will be outstanding. Of these shares, the ordinary shares to be sold in this offering will be freely tradable, unless such shares are held by “affiliates,” as that term is defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act.

 

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Certain of our officers, directors and shareholders have entered into lock-up agreements with the underwriters in this offering for a period of 180 days following the date of this prospectus, unless certain conditions are met. An aggregate of 17,087,467 shares held by directors, each such shareholder a beneficial owner of more than 5% of our ordinary shares, which number excludes any shares held by Zhengqi, are not subject to any lock-up in connection with this offering.

 

We have entered into registration rights agreements with holders of approximately 22,668,739 of our ordinary shares which were purchased prior to or in connection with our acquisition of Borqs International, pursuant to which we have agreed, under certain circumstances, to file a registration statement to register the resale of their shares, as well as to cooperate in certain public offerings of such shares. Registration of these shares under the Securities Act would result in such shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of such registration, except for shares purchased or subscribed for by affiliates. We have not registered the resale of these shares in this registration statement, and after the closing of this offering, these holders will continue to be entitled to certain registration rights. As such, upon registration of such shares, a substantial number of our ordinary shares may be sold in the public market, which may cause the trading price of our ordinary shares to 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.

 

Shareholders who exercise their registration rights may be entitled to certain remedies if we fail to register their shares when requested.

 

We have entered into registration rights agreements with holders of approximately 22,668,739 of our ordinary shares which were purchased prior to or in connection with our acquisition of Borqs International, pursuant to which we have agreed, under certain circumstances, to file a registration statement to register the resale of their shares, as well as to cooperate in certain public offerings of such shares. We have not registered the resale of these shares in this registration statement as we do not believe the conditions to register such shares have been met, including a requirement by the underwriters that the holders agree to lock up their shares in connection with this offering. However, such holders are entitled to bring claims against us if we fail to comply with the terms of the registration rights agreements, including our obligation to register the resale of any eligible shares when requested. 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 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 and the amount of cash we raise in this offering, 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, 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.”

 

  44  

 

We are an “emerging growth company,” and the reduced regulatory and reporting requirements applicable to emerging growth companies may make our ordinary shares less attractive to investors.

 

We are an “emerging growth company,” as described in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of reduced regulatory and reporting requirements that are otherwise generally applicable to public companies. These include, without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation, and exemptions from the requirements of holding non-binding advisory votes on executive compensation and golden parachute payments. The JOBS Act also permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies, which we intend to take advantage of.

 

We will remain an “emerging growth company” for up to five years following the acquisition of Borqs International by way of merger unless we earlier cease to be an emerging growth company, which would occur if our annual gross revenues exceed $1.0 billion, if we issue more than $1.0 billion in non-convertible debt in a three-year period, or if the market value of our ordinary shares held by non-affiliates exceeds $700.0 million as of any January 1 before that time, in which case we would no longer be an emerging growth company as of the following December 31. Investors may find our ordinary shares less attractive if we rely on the exemptions, which may result in a less active trading market and increased volatility in our stock price.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus 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 prospectus 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 prospectus 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; 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 prospectus to reflect any new information or future events or circumstances or otherwise, except as required by law. Readers should read this prospectus in conjunction with the discussion under the caption “ Risk Factors ,” our financial statements and the related notes thereto in this prospectus, and other documents which we may file from time to time with the SEC.

 

  45  

 

MARKET, INDUSTRY AND OTHER DATA

 

This prospectus contains estimates and information concerning our industry, our business, and the market for our solutions, including market position, market size and growth rates of the markets in which we participate, that are based on industry publications, surveys and reports. Although we have not independently verified the accuracy or completeness of the data contained in these industry publications, surveys, and reports, we believe the publications, surveys and reports are generally reliable, although such information is inherently subject to uncertainties and imprecise. The industry in which we operate is subject to a high degree of uncertainty and risk due to variety of factors, including those described in the “Risk Factors.” These and other factors could cause results to differ materially from those expressed in these publications and reports.

 

USE OF PROCEEDS

 

We estimate that our gross proceeds from this offering will be approximately $10.0 million based on the sale of 2,666,667 ordinary shares in this offering at an assumed public offering price of $3.75. We estimate that we will receive net proceeds of approximately $8.2 million, or approximately $9.6 million if the underwriter exercises its over-allotment option in full, after deducting the estimated underwriting discount and estimated offering expenses payable by us.

 

A $0.50 increase or decrease in the assumed public offering price of $3.75 per share would increase or decrease the expected net cash proceeds of the offering to us by approximately $1.2 million. An increase or decrease of 500,000 in the assumed number of ordinary shares sold in this offering would increase or decrease the expected net cash proceeds to us by approximately $1.7 million, assuming the public offering price of $3.75 per share.

 

We intend to use part of the net proceeds from this offering for the acquisition of a controlling stake in KADI. Pursuant to our existing letter of intent with KADI, the purchase price for such controlling stake includes a payment of $15.0 million, comprised of $11.7 million in cash to be paid to KADI in 2018 and 2019 for working capital and purchases of equipment, and $3.3 million in Borqs’ ordinary shares to be issued to the selling shareholders of KADI based on achievement of net income targets for the years 2018, 2019 and 2020. For 2018, we had anticipated to provide $7.7 million to KADI to service the Espirit supply contract, of which approximately $4 million is anticipated to be used for capital expenditures, and $3.7 million is anticipated to be used for working capital needs. We are in discussions with KADI to negotiate a modified payment schedule in the event that the proceeds raised in this offering are insufficient to fund the acquisition of KADI. We intend to use part of the net proceeds from this offering to fund research and development activities and for general corporate purposes, including funding for our working capital needs.

 

As of the date of this prospectus and except as explicitly set forth herein, we cannot specify with certainty all of the particular uses of the net proceeds from this offering. Pending use of the net proceeds from this offering as described above, we may invest the net proceeds in short-term interest-bearing investment grade instruments.

 

MARKET PRICE OF OUR ORDINARY SHARES

 

The following table sets forth, for the periods indicated, the high and low intra-day sales prices of our ordinary shares reported on The Nasdaq Stock Market.

 

    Low     High  
Fiscal Year ended December 31, 2016            
First Fiscal Quarter   $ 9.86     $ 10.20  
Second Fiscal Quarter   $ 10.00     $ 10.43  
Third Fiscal Quarter   $ 10.06     $ 11.20  
Fourth Fiscal Quarter   $ 10.20     $ 13.00  
Fiscal Year ended December 31, 2017                
First Fiscal Quarter   $ 10.25     $ 10.40  
Second Fiscal Quarter   $ 10.25     $ 10.50  
Third Fiscal Quarter   $ 5.10     $ 10.50  
Fourth Fiscal Quarter   $ 4.00     $ 6.02  
Fiscal Year ending December 31, 2018                
First Fiscal Quarter   $ 5.41     $ 10.00  
Second Fiscal Quarter   $ 5.20     $ 9.80  

Third Fiscal Quarter (through October 1, 2018)

  $ 4.10     $ 5.60  

 

The last reported sale price for our ordinary shares on Nasdaq on October 1, 2018 was $4.80 per share. As of October 1, 2018, there were approximately 270 holders of record of our ordinary shares, not including any persons who hold their ordinary shares in “street name”.

 

  46  

 

Dividend Policy

 

We have never declared or paid any cash dividends on our shares, and we do not currently intend to pay any cash dividends after the offering or for the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our ordinary shares will be at the discretion of our Board and will depend upon, among other factors, our financial condition, operating results, current and anticipated cash needs, plans for expansion and other factors that our Board may deem relevant.

 

CAPITALIZATION

 

The following table sets forth our cash, cash equivalents, and marketable securities and capitalization as of June 30, 2018 on an:

 

  actual basis; and

 

  as adjusted basis to give effect to the sale of 2,666,667 ordinary shares by us in this offering based upon the receipt by us of the estimated net proceeds from this offering at an assumed public offering price of $3.75 per share, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, assuming the underwriters do not exercise the over-allotment option, and the application of the net proceeds from this offering as described in “Use of Proceeds.”

 

The as adjusted information below is illustrative only, and our cash, cash equivalents, and marketable securities, additional paid-in capital, total shareholders’ equity, and total capitalization following the completion of this offering will be adjusted based on the actual public offering price, the actual number of ordinary shares that we sell in this offering and other terms of the offering determined at the pricing of this offering. You should read this information together with our consolidated financial statements and related notes appearing elsewhere in this prospectus and the information set forth in “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    June 30, 2018  
    Actual     As Adjusted (1)  
    (US$ in thousands)  
Cash and cash equivalents     1,305       9,538  
Shareholders’ equity:                
Ordinary shares, no par value per share; unlimited authorized, 31,307,522 shares issued and 31,303,350 outstanding, actual and 33,974,189 and 33,970,017 shares as adjusted     -     $ -  
Additional paid-in capital     124,058       132,694  
Statutory reserve     2,156       2,156  
Accumulated deficit     (71,482 )     (71,885 )
Accumulated other comprehensive loss     (1,494 )     (1,494 )
Noncontrolling interest     (449 )     (449 )
Total shareholders’ equity     52,789       61,022  
Total capitalization     133,627       141,860  

 

The number of ordinary shares to be outstanding after this offering is based on 31,307,522 issued and 31,303,350 ordinary shares outstanding as of June 30, 2018, and excludes:

 

  2,686,629 ordinary shares issuable upon the exercise of stock options outstanding as of June 30, 2018, with a weighted-average exercise price of $5.12 per share;

 

 

(1) Each $0.50 increase (decrease) in the assumed public offering price of $3.75 per share, would increase (decrease) our cash, cash equivalents and marketable securities, total shareholders’ equity and total capitalization by approximately $1.2 million, assuming that the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions payable by us. Each increase (decrease) of 500,000 shares in the number of shares offered by us would increase (decrease) the amount of our cash, cash equivalents and marketable securities, total shareholders’ equity and total capitalization by approximately $1.7 million, assuming a public offering price of $3.75 per share, after deducting estimated underwriting discounts and commissions payable by us. The as adjusted information discussed above is illustrative only and will adjust based on the actual initial price to the public and other terms of this offering determined at pricing.

  47  

 

  3,558,104 ordinary shares issuable upon the exercise of warrants (See “Description of Securities — Warrants”);

 

  The cancellation of 966,136 shares when the Zhengqi repurchase transaction is completed;

 

  3,757,884 ordinary shares reserved for future issuance under our 2017 Equity Incentive Plan, or Incentive Plan, as of June 30, 2018; and

 

  640,000 ordinary shares issuable upon the exercise of EarlyBirdCapital’s purchase option (See “Description of Securities — Purchase Option”).

 

 

Ordinary shares issuable upon the exercise of a warrant issued to Maxim Group LLC in connection with this offering equal to 4% of the total number of ordinary shares sold in the offering (See “Underwriters — Representative’s Warrants”).

 

Our Incentive Plan also provide for automatic annual increases in the number of shares reserved thereunder. See “Executive Compensation — Employee Benefit Plans” for additional information.

 

Except as otherwise indicated, all information in this prospectus assumes:

 

 

no exercise or cancellation of outstanding options or vesting of RSUs subsequent to June 30, 2018; and

 

  no exercise by the underwriters of their option to purchase up to an additional ordinary shares in this offering (equivalent to 15% of the total ordinary shares sold in this offering).

 

DILUTION

 

If you purchase ordinary shares in this offering, you will experience dilution to the extent of the difference between the price per share you pay in this offering and the net tangible book value per share of our ordinary shares immediately after this offering. The net tangible book value of our ordinary shares on June 30, 2018 was $31.5 million, or $1.01 per share. Net tangible book value per share is equal to the amount of consolidated total assets, less intangible assets, goodwill and consolidated total liabilities, divided by number of ordinary shares outstanding.

 

After giving effect to the assumed sale by us of an aggregate of 2,666,667 ordinary shares in this offering at an assumed public offering price of $3.75 per ordinary share, and after deducting the underwriting discount and estimated offering expenses payable by us, our as adjusted net tangible book value as of June 30, 2018 would have been $39.8 million, or $1.17 per ordinary share.

 

This represents an immediate increase in net tangible book value of $0.16 per share to existing stockholders and an immediate dilution of $2.58 per share to new investors purchasing ordinary shares in this offering. The following table illustrates this per share dilution:

 

Assumed public offering price per share   $ 3.75  
Net tangible book value per share as of June 30, 2018   $ 1.01  
As adjusted net tangible book value per share as of June 30, 2018 after giving effect to this offering   $ 1.17  
Dilution per share to investors participating in this offering   $ 2.58  

 

Each $0.50 increase (decrease) in the assumed public offering price of $3.75 per ordinary share would increase (decrease) our as adjusted net tangible book value after this offering by $1.2 million, or $0.04 per share, and the dilution per share to new investors by $0.04 per share, assuming that the number of ordinary shares offered by us, as set forth above, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. We may also increase or decrease the number of ordinary shares we are offering from the number of ordinary shares set forth above. An increase (decrease) of 500,000 ordinary shares in the number of ordinary shares offered by us from the number of ordinary shares set forth above would increase (decrease) our as adjusted net tangible book value after this offering by $1.7 million, or $0.03 per share, and the dilution per share to new investors by $0.03 per share, assuming that the public offering price remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. The information discussed above is illustrative only and will adjust based on the actual public offering price, the actual number of ordinary shares that we offer in this offering, and other terms of this offering determined at pricing.  

 

The number of ordinary shares reflected in the discussion and table above is based on 31,307,522 ordinary shares issued and 31,303,350 outstanding as of June 30, 2018 and excludes certain shares (See “Capitalization”).

 

  48  

  

SELECTED CONSOLIDATED FINANCIAL DATA

 

The selected consolidated statements of operations data for the years ended December 31, 2015, 2016 and 2017, and the selected consolidated balance sheet data as of December 31, 2016 and 2017, have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated statements of operations data for the three and six months ended June 30, 2017 and 2018, and the selected consolidated balance sheet data as of June 30, 2017 and 2018, have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read the consolidated financial and other data set forth below in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

Statement of Operations:

 

   

Year Ended

December 31,

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Net revenues:                                          
Software     22,468       14,912       11,212       3,499       1,624       6,583       3,880  
Hardware     32,647       70,536       111,021       11,122       47,018       32,801       95,136  
MVNO     16,007       29,309       30,118       6,987       7,220       12,919       14,729  
Others     3,950       5,829       1,956       521       477       1,036       850  
                                                         
Total net revenues     75,072       120,586       154,307       22,129       56,339       53,339       114,595  
                                                         
Cost of revenues                                                        
Software     (12,699 )     (7,491 )     (7,247 )     (1,612 )     (668 )     (3,942 )     (1,437 )
Hardware     (26,101 )     (57,452 )     (96,247 )     (10,008 )     (42,535 )     (29,246 )     (85,934 )
MVNO     (16,225 )     (28,784 )     (22,836 )     (4,533 )     (5,247 )     (9,820 )     (10,308 )
Others     (2,980 )     (1,709 )     (811 )     (288 )     (180 )     (488 )     (351 )
Total cost of revenues     (58,005 )     (95,436 )     (127,141 )     (16,441 )     (48,630 )     (43,496 )     (98,030 )
                                                         
Total gross profit     17,067       25,150       27,166       5,688       7,709       9,843       16,565  
                                                         
Operating expenses:                                                        
Sales and marketing expenses     (7,359 )     (5,874 )     (7,952 )     (1,646 )     (1,665 )     (2,985 )     (3,347 )
General and administrative expenses     (4,883 )     (10,042 )     (20,753 )     (2,599 )     (2,260 )     (4,157 )     (5,356 )
Research and development expenses     (7,206 )     (5,742 )     (6,443 )     (1,184 )     (1,452 )     (1,476 )     (2,341 )
  Changes in the fair value of warrant liabilities     -       (12 )     (200 )     -       -       (161 )     -  
                                                         
Total operating expenses     (19,448 )     (21,670 )     (35,348 )     (5,429 )     (5,377 )     (8,779 )     (11,044 )
                                                         
Other operating income     3,094       1,760       272       1       -       267       -  
                                                         
Operating income (loss)     713       5,240       (7,910 )     260       2,332       1,331       5,521  
                                                         
Interest income     61       65       14       8       2       10       8  
Interest expense     (156 )     (797 )     (1,877 )     (524 )     (1,117 )     (1,143 )     (1,362 )

   

  49  

 

    Year Ended
December 31,
    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Other income     208       114       633       51       14       354       53  
Other expense     (35 )     (59 )     (121 )     (158 )     (2 )     (276 )     (47 )
Foreign exchange gain (loss)     855       692       (779 )     (156 )     633       (333 )     259  
                                                         
Profit (loss) before income taxes     1,646       5,255       (10,040 )     (519 )     1,862       (57 )     4,432  
Income tax (expense) benefit     (851 )     (2,659 )     (2,319 )     (446 )     146       (890 )     (1,037 )
Net income (loss)     795       2,596       (12,359 )     (965 )     2,008       (947 )     3,395  

 

    Year Ended
December 31,
    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2015     2016     2017     2017     2018     2017     2018  
    (US$ in thousands)  
Less: net (loss) income attributable to noncontrolling interests     (1,316 )     (632 )     210       197       178       119       366  
Net income (loss) attributable to Borqs Technologies, Inc.     2,111       3,228       (12,569 )     (1,162 )     1,830       (1,066 )     3,029  
Add: accretion to redemption value of Convertible Redeemable Preferred Shares     (2,417 )     (976 )     (6,956 )     (150 )     -       (448 )     -  
Allocation to holders of Preferred Shares     -       (2,252 )     -       -       -       -       -  
Net loss attributable to ordinary shareholders     (306 )     -       (19,525 )     (1,312 )     1,830       (1,514 )     3,029  
                                                         
(Loss) earnings per share:                                                        
Basic     (0.07 )     0.00       (1.52 )     (0.31 )     0.07       (0.36 )     0.11  
Diluted     (0.07 )     0.00       (1.52 )     (0.31 )     0.07       (0.36 )     0.11  
                                                         
Shares used in (loss) earnings per share computation:                                                        
Basic     4,224,090       4,224,725       12,842,671       4,259,898       26,830,514       4,243,964       26,613,800  
Diluted     4,224,090       4,224,725       12,842,671       4,259,898       27,675,005       4,243,964       27,585,851  
Net income (loss)     795       2,596       (12,359 )     (965 )     2,008       (947 )     3,395  
Other comprehensive (loss) income, net of tax of nil:                                                        
Foreign currency translation adjustments, net of tax of nil     (1,491 )     (1,575 )     2,207       546       (2,397 )     851       (1,005 )
Other comprehensive (loss) income, net of tax of nil     (1,491 )     (1,575 )     2,207       546       (2,397 )     851       (1,005 )
Comprehensive (loss) income     (696 )     1,021       (10,152 )     (419 )     (389 )     (96 )     2,390  
Less: comprehensive (loss) income attributable to noncontrolling interest     (1,519 )     (730 )     298       197       100       119       348  
Comprehensive income (loss) attributable to the Borqs Technologies, Inc.     823       1,751       (10,450 )     (616 )     (489 )     (215 )     2,042  

   

  50  

 

Balance Sheet:

 

    December 31,     June 30,  
    2016     2017     2018  
    (US$ in thousands)  
Balance Sheet Data                  
Current assets     58,079       119,531       88,797  
Total assets     78,030       148,732       133,627  
Current liabilities     50,487       92,748       62,235  
Total liabilities     64,519       101,727       80,838  
Shareholders’ (deficit) equity     (55,351 )     47,005       52,789  
Total liabilities and shareholders’ equity     78,030       148,732       133,627  

 

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

 

References in this prospectus to “we,” “us” or the “Company” refer to Borqs Technologies, Inc. References to our “management” or our “management team” refer 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 prospectus. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.

 

Special Note Regarding Forward-Looking Statements

 

This prospectus 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 prospectus 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 prospectus. 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.

 

Overview

 

Borqs Technologies, Inc. (“we”, “the Company” or “Borqs”) focuses 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.

 

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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 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. In recent years, we have been awarded significant business contracts from Intel and Qualcomm, leading global chipset manufacturers. 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 activities with Intel have reduced over the last two years due to Intel’s strategy to exit the mobile industry, and there are no material agreements with Intel on which we are substantially dependent. For the year 2017, Intel was no longer a customer of the Company. However, our activities with Qualcomm have increased over the last two years, including developmental work on chipsets for mobile devices and wearable products.

 

Our MVNO BU 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.

 

The Connected Solutions BU represented 73.4%, 70.9% and 79.2% of our net revenues in the years ended December 31, 2015, 2016 and 2017, respectively. In the years ended December 31, 2015, 2016 and 2017, Borqs generated 85%, 93% and 86%, respectively, of its net revenues from customers headquartered outside of China and 15%, 7% and 14%, respectively, of its net revenues from customers headquartered within China. As of June 30, 2018, 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 14 million units worldwide.

 

We have dedicated significant resources to research and development, and has research and development centers in Beijing, China and Bangalore, India. As of June 30, 2018, 350 of our 509 employees were technical professionals dedicated to platform research and development and product specific customization.

 

On January 8, 2018, we entered into a letter of intent to acquire a 60% equity interest in Shanghai KADI Technologies Co., Ltd (“KADI”), a Chinese company that develops software and hardware solutions for electric vehicle control modules, such as charging, battery management and vehicle controls. We are currently negotiating a definitive agreement to acquire such equity interest for an aggregate of $11.7 million in cash to be paid to KADI and ordinary shares with an agreed-upon value of $3.3 million to be issued to selling shareholders of KADI based on achievement of net income targets for the years 2018, 2019 and 2020. For 2018, we had anticipated to provide $7.7 million to KADI to service the Espirit supply contract, of which approximately $4 million is anticipated to be used for capital expenditures, and $3.7 million is anticipated to be used for working capital needs. We are in discussions with KADI to negotiate a modified payment schedule in light of the fact that the proceeds raised in this offering are insufficient to fund the acquisition of KADI.

 

KADI is not a customer or a supplier of Borqs. In accordance with the letter of intent, we have made four scheduled cash advances to KADI totaling $600,000 which will be deducted from our initial cash payments to KADI under the definitive agreement being negotiated. If this transaction is not consummated within nine months after signing of the letter of intent, the advance payments will be converted into shares representing five percent of the outstanding capital stock of KADI. There are no termination fees or penalties under the letter of intent.

 

We have achieved significant growth since inception in 2007. Net revenues increased from $75.1 million in 2015 to $120.6 million in 2016 and $154.3 million to 2017. We recorded net income of $0.8 million and $2.6 million in the years 2015 and 2016, respectively. For the year ended December 31, 2017, we had a net loss of $12.4 million, which included non-cash merger related costs of $14.5 million. We recorded a net income of $2.0 million in the three months ended June 30, 2018 and a net income of $3.4 million in the six months ended June 30, 2018, as compared with a net loss of $965, 000 in the three months ended June 30, 2017 and a net loss of $947,000 in the six months ended June 30, 2017.

 

Key Factors Affecting Results of Operations

 

The Connected Solutions BU represented 73.4%, 70.9% and 79.2% of our net revenues for the years ended December 31, 2015, 2016 and 2017, respectively. For the years ended December 31, 2015, 2016 and 2017, we generated 85%, 93% and 86% of our net revenues from customers headquartered outside of China and 15%, 7% and 14% of our net revenues from customers headquartered within China. As of June 30, 2018, we 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 14 million units worldwide.

 

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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 less 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 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. Over time, we expect wholesale rates generally decline due to competition and newer technologies (e.g. 4G, 4.5G, and 4.75G).

 

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 in accordance with ASC 605-50. 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.
     
  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.

 

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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 and the Cayman Islands. 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 June 30, 2018, we held total $1.3 million cash 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. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere or incorporated by reference in this prospectus. The operating results in any period are not necessarily indicative of results that may be expected for any future period.

 

Comparisons of Years Ended December 31, 2015, 2016 and 2017

 

    For the Year Ended December 31,  
Consolidated Statement of Operations Data:   2015     2016     2017  
    (US$ in thousands)  
Net revenues     75,072       120,586       154,307  
Cost of revenues     (58,005 )     (95,436 )     (127,141 )
Gross profit     17,067       25,150       27,166  
                         
Operating expenses     (19,448 )     (21,670 )     (35,348 )
Other operating income     3,094       1,760       272  
Operating income (loss)     713       5,240       (7,910 )
                         
Other income (expense)     933       15       (2,130 )
Profit (loss) before income taxes     1,646       5,255       (10,040 )
                         
Income tax expense     (851 )     (2,659 )     (2,319 )
Net income (loss)     795       2,596       (12,359 )
                         
Less: net (loss) income attributable to noncontrolling interests     (1,316 )     (632 )     210  
Net income (loss) attributable to Borqs Technologies, Inc.     2,111       3,228       (12,569 )

 

Comparisons of Three and Six Months Ended June 30, 2017 and 2018

 

    For Three Months Ended
June 30,
    For Six Months Ended
June 30,
 
Consolidated Statement of Operations Data:   2017     2018     2017     2018  
    (US$ in thousands)  
Net revenues     22,129       56,339       53,339       114,595  
Cost of revenues     (16,441 )     (48,630 )     (43,496 )     (98,030 )
Gross profit     5,688       7,709       9,843       16,565  
                                 
Operating expenses     (5,429 )     (5,377 )     (8,779 )     (11,044 )
Other operating income     1       -       267       -  
Operating income     260       2,332       1,331       5,521  
                                 
Other expenses     (779 )     (470 )     (1,388 )     (1,089 )
(Loss) profit before income taxes     (519 )     1,862       (57 )     4,432  
                                 
Income tax (expense) benefit     (446 )     146       (890 )     (1,037 )
Net (loss) income     (965 )     2,008       (947 )     3,395  
                                 
Less: net income attribute to noncontrolling interests     197       178       119       366  
Net (loss) income attribute to Borqs Technologies, Inc.     (1,162 )     1,830       (1,066 )     3,029  
                                 
Accretion to redemption value of Convertible Redeemable Preferred Shares     (150 )     -       (448 )     -  
Net (loss) income attributable to ordinary shareholders     (1,312 )     1,830       (1,514 )     3,029  

 

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We experienced a net profit of $0.8 million in 2015 and a net profit of $2.6 million in 2016. For 2017, we had a net loss of $12.4 million before deduction for noncontrolling interests, which included non-cash merger related costs of $14.5 million. 

 

We had a net income of $2 million and a net loss of $965,000 for the three months ended June 30, 2017 and 2018, respectively. We had a net income of $3.4 million and a net loss of $947,000 for the six months ended June 30, 2018 and 2017, respectively.

 

We had significant increases in the delivery of connected products for worldwide customers in the first and second quarters of 2018.

 

Net Revenues

 

Our net revenues represent our gross revenues, less business taxes and other deductions. 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.

 

For 2015, Connected Solutions BU net revenues was $55.1 million and MVNO BU net revenues was $19.9 million.

 

For 2016, Connected Solutions BU net revenues was $85.4 million and MVNO BU net revenues was $35.1 million, compared to $55.1 million and $20.0 million in 2015, respectively. Connected Solutions BU net revenues increased 55.0% from 2015 to 2016. MVNO BU net revenue increased 76.1% from 2015 to 2016.

 

For 2017, Connected Solutions BU net revenues was $122.2 million, an increase of 43.0% over 2016, and MVNO BU net revenues was $32.1 million, a decrease of 8.7% from 2016.

 

The following table presents the percentage of total net revenues from Connected Solutions BU and the MVNO BU, respectively, for the years indicated.

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
Connected Solutions BU     55,115       73.4 %     85,448       70.9 %     122,233       79.2 %
MVNO BU     19,957       26.6 %     35,138       29.1 %     32,074       20.8 %
Net revenues     75,072       100.0 %     120,586       100.0 %     154,307       100.0 %

 

For the three months ended June 30, 2018, Connected Solutions BU net revenues were $48.6 million and MVNO BU net revenues were $7.7 million, compared to $14.6 million and $7.5 million, respectively, for the same period in 2017. Connected Solutions BU net revenues increased 232.7% for the three months ended June 30, 2018 from the same period in 2017. MVNO BU net revenues increased 2.5% for the three months ended June 30, 2018 from the same period in 2017. Total net revenues increased 154.6% for the second quarter of 2018 from the corresponding period in 2017.

 

For the six months ended June 30, 2018, Connected Solution BU net revenues were $99.0 million and MVNO BU net revenues were $15.6 million, compared to $39.4 million and $14.0 million, respectively, for the same period in 2017. This represented increase in Connected Solutions BU net revenues of 151% and MVNO BU of 12% in the first six months of 2018 over the same period in 2017.

 

    For Three Months Ended June 30,  
    2017     2018  
    US$     US$     %  
    (US$ in thousands)  
Connected Solutions BU     14,621       48,642       232.7 %
MVNO BU     7,508       7,697       2.5 %
Net revenues     22,129       56,339       154.6 %

 

Within the MVNO BU, the net revenues for the MVNO operation itself, including traditional telephony activities, increased to $7.7 million in the second quarter of 2018 from $7.5 million for the same period in 2017. The Company designed a new security check and activation system that simplified the sales procedure. Using this new activation system within our MVNO services, we were able to overcome the effect from tightened security measures for SIM card activation.

 

Net Revenues — Connected Solutions BU — Years ended December 31, 2015, 2016 and 2017

 

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.

 

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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.

 

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, range from six to 36 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 year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
Software     22,468       40.8 %     14,912       17.5 %     11,212       9.2 %
Hardware     32,647       59.2 %     70,536       82.5 %     111,021       90.8 %
Connected Solutions BU net revenues     55,115       100.0 %     85,448       100.0 %     122,233       100 %

 

Software

 

Software net revenues were $22.5 million, $14.9 million and $11.2 million in 2015, 2016 and 2017, respectively, representing 40.8%, 17.5% and 9.2% of Connected Solutions BU net revenues. The $7.6 million decrease in 2016 over 2015 mainly reflected decreases in software engineering activities completed for customers in 2015 as well as the recognition of PCS delivered during 2016 for projects completed in 2015. We account for software engineering contracts applying the completed contract method, recognizing the entire software project fixed fees ratably over the PCS service periods. PCS service periods are generally 12 months, with ranges from six months to three years, and commences upon completion of customer acceptance of the completed software projects. The $3.7 million decline in software net revenues in 2017 from 2016 was mainly attributable to an overall decrease in software engineering project sales.

 

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Hardware

 

Hardware net revenues were $32.6 million, $70.5 million and $111.0 million in 2015, 2016 and 2017, respectively, representing 59.2%, 82.5% and 90.8% of Connected Solutions BU net revenues. The $37.9 million increase in 2016 and the $40.5 million increase in 2017 reflected the increased volume of sales of products in those periods, particularly in tablets, ruggedized handsets, and high speed data smartphones and home entertainment remote controls.

 

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 products are shipped to the customer. We are not engaged in the marketing and distribution of the hardware products.

 

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 and mobile operators. 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 year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
Mobile device OEMs     38,622       70.1 %     70,536       82.5 %     111,021       90.8 %
Mobile Chipset Vendors     14,491       26.3 %     14,912       17.5 %     11,212       9.2 %
Mobile Operators     2,002       3.6 %     -       0.0 %     -       0.0 %
Connected Solutions BU Net Revenues     55,115       100.0 %     85,448       100.0 %     122,233       100 %

 

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

 

Supplier Concentration

 

For our Connected Solutions BU, we rely on several suppliers for components and materials, and for our MVNO BU, we rely solely on China Unicom for supply of voice calling minutes, texting and data related services. The following table sets forth our purchases from the key suppliers for good and services, both in absolute amount and as a percentage of our direct costs for the periods presented:

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
                                                 
China Unicom     13,745       23.7 %     25,937       27.2 %     17,088       13.4 %
Quanta Computer Inc.     18,489       31.9 %     23,480       24.6 %     12,848       10.1 %
Crave International Holdings     -       0.0 %     -       0.0 %     57,005       44.9 %
China Great Wall Computer (Shenzhen) Co. Ltd     -       0.0 %     14,202       14.9 %     -       0.0 %
SBCK Corp     -       0.0 %     11,325       11.9 %     -       0.0 %
Shenzhen Haihong Tianyuan Microelectronics Co. Ltd     4,021       6.9 %     -       0.0 %     -       0.0 %
Total purchases from key suppliers, and as percentage of direct costs     36,255       62.5 %     74,944       78.6 %     86,941       68.4 %

 

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Other than in the case of Reliance which requires us to fill their orders using components from Qualcomm, we purchase from suppliers on a non-exclusive basis. We are not bound by any minimum purchase commitments or other obligations to our suppliers and are able to source products and services at the most competitive prices available from various suppliers on an as needed basis. The above figures for Crave International Holdings included the value of Qualcomm components.

 

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 year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
China     8,485       15.4 %     6,076       7.1 %     17,687       14.5 %
India     7,949       14.4 %     25,126       29.4 %     70,421       57.6 %
United States     14,978       27.2 %     34,526       40.4 %     23,312       19.1 %
Rest of the world     23,703       43.0 %     19,720       23.1 %     10,813       8.8 %
Net revenues     55,115       100.0 %     85,448       100.0 %     122,233       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 2015 to 2017, revenues from customers with headquarters in China declined slightly, and we engaged a significant new customer in India during the second half of 2016 and this customer continued to place orders with us in 2017.

 

Net Revenues — Connected Solutions BU — Three and Six Months Ended June 30, 2017 and 2018

 

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

 

    For Three Months Ended June 30,  
    2017     2018  
    US$     %     US$     %  
    (US$ in thousands)  
Software     3,499       23.9 %     1,624       3.3 %
Hardware     11,122       76.1 %     47,018       96.7 %
Connected Solutions BU net revenues     14,621       100 %     48,642       100 %

 

Software

 

Software net revenues were $3.5 million and $1.6 million for the three months ended June 30, 2017 and 2018, respectively, representing 23.9% and 3.3% of Connected Solutions BU net revenues in those periods. For the six months ended June 30, 2017 and 2018, software net revenues were $6.6 million and $3.9 million, respectively.

 

The decrease primarily reflected the exit by one of the Company’s major chip manufacturer clients from the Android based product platform.

 

Hardware

 

Hardware net revenues were $11.1 million and $47.0 million for the three months ended June 30, 2017 and 2018, respectively, representing 76.1% and 96.7% of Connected Solutions BU net revenues in those periods. For the six months ended June 30, 2017 and 2018, hardware revenues were $32.8 million and $95.1 million, respectively, representing 83.3% and 96.1% of Connected Solutions BU net revenues in those periods.

 

The 322.7% increase in hardware net revenues in the second quarter of 2018 (which increase accounts for the aggregate of 232.7% increase in overall Connected Solutions BU net revenues) primarily reflects an increase in hardware product orders from the emerging markets in Asia.

 

All hardware sales were made to order in writing. 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 the selection of third-party factories for product assembly. Revenue is recognized when products are shipped to the customer, and payment is generally made within 30 to 60 days after shipment. We are not engaged in the marketing and distribution of the hardware products.

 

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Net Revenues — 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.

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
MVNO     16,007       80.2 %     29,309       83.4 %     30,118       93.9 %
Other     3,950       19.8 %     5,829       16.6 %     1,956       6.1 %
MVNO BU net revenues     19,957       100.0 %     35,138       100.0 %     32,074       100 %

 

We started the MVNO services in late 2014 and experienced significant growth in our MVNO BU net revenues from 2015 to 2016, reflecting increasing sales of bundled services, the minor decrease of net revenue in 2017 as we expect sales of MVNO services to growth at a modest rate in future periods while traditional commercial services revenues will remain stable.

 

    For Three Months Ended
June 30,
 
    2017     2018  
    US$     US$  
    (US$ in thousands)  
MVNO     6,987       7,220  
Other     521       477  
MVNO BU net revenues     7,508       7,697  

 

We expect sales of MVNO services to increase at a modest rate in future periods while traditional commercial services revenues will remain stable. As discussed above, governmental policies requiring heightened security checks for authentication of PRC identification cards at the point of sales of SIM cards continue to have an impact on our subscription activities.

 

For the six months ended June 30, 2017 and 2018, MVNO BU net revenues were $14.0 and $15.6 million, respectively.

 

Cost of Revenues

 

Cost of 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 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:

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    ($ in thousands)  
Connected Solutions BU     38,800       66.9 %     64,943       68.0 %     103,494       81.4 %
MVNO BU     19,205       33.1 %     30,493       32.0 %     23,647       18.6 %
Total cost of revenues     58,005       100.0 %     95,436       100.0 %     127,141       100.0 %

 

Connected Solutions BU cost of revenues increased from $38.8 million in 2015 to $64.9 million in 2016 and $103.5 million in 2017. These increases were attributable to the similar trend of increases in our volume of hardware connected products sales during these years.

 

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Cost of MVNO BU revenues increased from $19.2 million in 2015 to $30.5 million in 2016 and decrease to $23.6 million in 2017, generally in line with the expansion of the MVNO BU over that period from the initiation of the MVNO BU in the second half of 2014. As MVNO BU revenue increases, the cost of revenue of the MVNO BU generally increases as well. MVNO BU revenue decreased to $23.6 million in 2017 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 (“MIIT”) of China.

 

    For Three Months Ended
June 30,
 
    2017     2018  
    US$     US$  
    (US$ in thousands)  
Connected Solutions BU     11,620       43,203  
MVNO BU     4,821       5,427  
Total cost of revenue     16,441       48,630  

 

Connected Solutions BU costs of revenues were $11.6 million and $43.2 million for the three months ended June 30, 2017 and 2018, respectively. These increases were generally in line with the associated revenues. For the six months ended June 30, 2017 and 2018, Connected Solution BU costs of revenues were $33.2 million and $87.4 million, respectively.

 

MVNO BU cost of revenues was $4.8 million and $5.4 million for the three months ended June 30, 2017 and 2018, respectively. MVNO BU costs of revenues were generally proportional to MVNO BU revenues. For the six months ended June 30, 2017 and 2018, MVNO BU cost of revenues were $10.3 million and $10.7 million, respectively.

 

Gross Profit and Gross Margin

 

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

 

Our gross profits were $17.1 million in 2015, $25.2 million in 2016 and $27.2 million in 2017, with the breakdown between the Connected Solutions BU and MVNO BU as follows:

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    (Gross Profit in thousands, Gross Margin in %)  
Connected Solutions BU     16,315       29.6 %     20,505       24.0 %     18,739       15.3 %
MVNO BU     752       3.8 %     4,645       13.2 %     8,427       26.3 %
Total     17,067       22.7 %     25,150       20.9 %     27,166       17.6 %

 

Connected Solutions BU gross margin was 29.6%, 24.0% and 15.3% for 2015, 2016 and 2017, respectively, while MVNO BU gross margin was 3.8%, 13.2% and 26.3% for 2015, 2016 and 2017, respectively. MVNO BU gross margin was on an upward trend through 2017 as the MVNO business gradually gained economic scale after its launch in late 2014.

 

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 profits remained relatively stable from 2015 through 2017, while hardware gross profits increased as customers increasingly demanded a comprehensive solution including software design through final commercial product.

 

    For the year ended December 31,  
    2015     2016     2017  
    $     %     $     %     $     %  
    (Gross Profit in thousands, Gross Margin in %)  
Software     9,769       43.5 %     7,421       49.8 %     3,965       35.4 %
Hardware     6,546       20.1 %     13,084       18.5 %     14,774       13.3 %
Total     16,315       29.7 %     20,505