ITEM
1A. RISK FACTORS
The
following risk factors apply to the business and operations of the Company. These risk factors are not exhaustive. Investors are
encouraged to perform their own investigation with respect to the business, financial condition and prospects of the Company.
You should carefully consider the following risk factors, as well as the other information included in this Report. In particular,
please refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements.” We may face additional
risks and uncertainties that are not presently known to us, or that we currently deem immaterial, which may also impair our business.
The following discussion should be read in conjunction with the financial statements and notes to the financial statements included
herein. For the purposes of these risk factors, unless otherwise indicated, the term “Borqs” “we,” “us,”
“our” or “the Company” refers to Borqs Technologies, Inc. together with our consolidated subsidiaries
and consolidated affiliated entities.
Risks
Related to our Business and Industry
Our
future capital needs are uncertain and our independent registered public accounting firm has expressed in its report on our 2017
audited financial statements a substantial doubt about our ability to continue as a going concern. Our ability to continue as
a going concern is dependent on our ability to raise additional capital or obtain loans from financial institutions and our operations
could be curtailed if we are unable to obtain the required additional funding when needed. We may not be able to do so when
necessary, and/or the terms of any financings may not be advantageous to us.
Our
financial statements for the year ended December 31, 2017 included in our Annual Report on Form 10-K filed on April 2, 2018, have
been prepared assuming we will continue to operate as a going concern. However, due to our recurring losses from operations,
and working capital deficiency, there is substantial doubt about our ability to continue as a going concern. Because we
continue to experience negative cash flow, our ability to continue as a going concern is subject to our ability to obtain necessary
funding from outside sources, including obtaining additional funding from the sale of our securities, grants or other forms of
financing. Our continued negative cash flow increases the difficulty in completing such sales or securing alternative sources
of funding, and there can be no assurances that we will be able to obtain such funding on favorable terms or at all. If
we are unable to obtain sufficient financing from the sale of our securities or from alternative sources, we may be required to
reduce, defer or discontinue certain of our research and development and operating activities or we may not be able to continue
as a going concern. As a result, our independent registered public accounting firm has expressed in its auditors’
report on the financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 31,
2017, a substantial doubt regarding our ability to continue as a going concern. Our financial statements do not include
any adjustments that might result from the outcome of the uncertainty regarding our ability to continue as a going concern. If
we cannot continue as a going concern, our shareholders may lose their entire investment in our ordinary shares. Future
reports from our independent registered public accounting firm may also contain statements expressing doubt about our ability
to continue as a going concern.
Due
to liquidity concerns arising from our negative cash flow, we anticipate that we will need to raise additional funds to finance
operations.
As
of 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.
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. (“PFG”)
restrict, among other things, our ability to:
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pay dividends or
distributions, repurchase or redeem equity;
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incur or permit
to exist any additional indebtedness or liens;
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guarantee or otherwise
become liable with respect to the obligations of another party or entity;
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acquire any assets,
except in the ordinary course of business, or make any investments; and
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sell all or substantially
all of our assets.
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Our
ability to comply with these provisions may be affected by events beyond our control. We have notified each of SSVB and PFG as
to the transactions with Crave/Colmei, KADI and repurchase of shares from Zhengqi. Additionally, we have notified SSVB and PFG
as to the transaction contemplated by this offering. Although we have not been notified by either lender that they will not permit
such transactions, neither lender has expressly waived such right, and we are in discussions with the lender to confirm their
consent. 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:
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seek additional
financing in the debt or equity markets;
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delay, curtail or
abandon altogether our research & development or investment plans;
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refinance or restructure
all or a portion of our indebtedness; or
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Such
measures might be insufficient to service the indebtedness. In addition, any such financing, refinancing or sale of assets may
not be available on commercially reasonable terms, or at all. If funds are not available when needed, or available on acceptable
terms, we may be required to delay, scale back or eliminate some of our obligations, including with respect to our commitments
in connection with our investments into KADI and Crave/Colmei, the repurchase of our shares from Zhengqi, 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 could result in a substantial loss of our assets.
We
have pledged our assets as collateral under the loan agreements with SSVB and PFG. A failure to repay any of the indebtedness
under such loan agreements as it becomes due or to otherwise comply with the covenants contained in any of the loan agreements
could result in an event of default thereunder. If not cured or waived, an event of default under any of our loan agreements could
enable the lenders thereunder to declare all borrowings outstanding on such debt, together with accrued and unpaid interest and
fees, to be due and payable and terminate all commitments to extend further credit. The lenders could also elect to foreclose
on our assets securing such debt. In such an event, the Company may not be able to refinance or repay all of its indebtedness,
pay dividends or have sufficient liquidity to meet operating and capital expenditure requirements. Any such acceleration could
cause us to lose a substantial portion of our assets and will substantially adversely affect our ability to continue our operations.
We
have in the past failed to comply with financial covenants in certain of our loan documents, which has resulted in potential defaults
under certain of our loan documents. These and similar breaches of our loan documents in the future could adversely affect our
financial condition and our ability to meet our payment obligations on our indebtedness.
We
have in the past breached certain financial covenants under our loan agreements with SSVB and PFG. Specifically, we failed to
meet a monthly cash ratio threshold, under U.S. GAAP basis, for several months in the second, third and fourth quarters of 2017
under the SVB loan agreement and a minimum 3-month trailing EBITDA target under the PFG loan agreement as of the third quarter
of 2017. Such breach would result in acceleration of the repayment according to the contract term. Therefore, the outstanding
balance of $1.515 million was reclassified as current liability as of December 31, 2017. 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 57.8%, 51.5%
and 69.3% of our net revenues in 2015, 2016 and 2017, respectively.
Our
ability to maintain close relationships with our major customers is essential to the growth and profitability of our business.
However, the volume of work performed for a specific customer is likely to vary from year-to-year and project-to-project, especially
since we are generally not the exclusive Android platform software and service solutions provider for our customers, some of our
customers have in-house research and development capabilities and we do not have long-term purchase commitments from any of our
customers. A major customer in one year may not provide the same level of net revenues for us in any subsequent year. The products
we provide to our customers, and the net revenues and income from those products, may decline or vary as the type and quantity
of products changes over time. In addition, reliance on any individual customer for a significant portion of our net revenues
may give that customer a degree of pricing leverage when negotiating contracts and terms of service with us.
In
addition, a number of factors not within our control could cause the loss of, or reduction in, business or revenues from any customer,
and these factors are not predictable. These factors include, among others, a customer’s decision to re-negotiate the royalty
payment of a contract if the volume of unit sales exceeds original expectations, pricing pressure from competitors, a change in
a customer’s business strategy, or failure of a mobile chipset manufacturer or mobile device OEM to develop competitive
products. Our customers may also choose to pursue alternative technologies and develop alternative products in addition to, or
in lieu of, our products, either on their own or in collaboration with others, including our competitors. The loss of any major
customer or key project, or a significant decrease in the volume of customer demand or the price at which we sells our products
to customers, could materially adversely affect our financial condition and results of operations.
We
have limited experience with our current product offerings, which makes it difficult to predict our future operating results.
From
our inception in 2007 through 2014, we focused primarily on providing our Android+ software platform solutions to mobile chipset
manufacturers, mobile device OEMs and mobile operators as well as complete product solutions of mobile connected devices for enterprise
and consumer applications. In 2014, after acquiring Yuantel Investment, we entered into the MVNO business. As we continue to grow
our business and markets, we plan to increase our service product offerings in both our Connected Solutions BU and MVNO BU. However,
the success of these new product offerings will depend on many factors, including timely and successful research and development,
pricing, market and consumer acceptance of such new products and the product offerings of our competitors. If new product offerings
are not successful, our revenue growth will suffer and our results of operations may be harmed. Further, we do not have significant
experience in the MVNO business and cannot be assured that our investments in the development of our MVNO business will result
in increased revenue.
We
provide mobile communication services as a mobile virtual network operator in China. The current license to operate such services
is based on a government issued extension of a trial license that originally would have expired on December 31, 2015. If we cannot
obtain a renewed license or the current extension is terminated, 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.
The
ability of our MVNO to provide mobile communication services in China is based on trial licenses granted by the Ministry of Industry
& 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 are preparing for application
of the official MVNO license. 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 obtain the official MVNO license or maintain such
license once it is received.
If
we cannot obtain the official MVNO license by May 1, 2020 or maintain such license after it is received, 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 Beijing
Big Cloud Century Network Technology Co., Ltd. (“BC-NW”). As all the registered shareholders of BC-NW are PRC citizens
and all other shareholders of the subsidiaries of BC-NW are also PRC citizens or PRC domestic enterprises, BC-NW and our subsidiaries
are therefore considered PRC domestic enterprises under PRC law. The “registered shareholders” of BC-NW refer to those
shareholders who have pledged their equity interest in BC-NW to Borqs Beijing and entered into exclusive option agreements with
Borqs Beijing as part of the contractual arrangements. Our contractual arrangements with BC-NW and the registered shareholders
of BC-NW allow it to have the power to direct the activities of BC-NW and our subsidiaries that most significantly impact economic
performance.
There
are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited
to, the laws and regulations governing the MVNO business, or the enforcement and performance of our contractual arrangements with
BC-NW. These laws and regulations may be subject to change, and their official interpretation and enforcement may involve substantial
uncertainty. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
Although
we believe we are in compliance with current PRC laws and regulations, we cannot assure you that the PRC government would agree
that our contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies
or with requirements or policies that may be adopted in the future. The PRC government has broad discretion in determining penalties
for violations of laws and regulations. If the PRC government determines that we do not comply with applicable law, it could revoke
our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues,
block our websites, require us to restructure our operations, impose additional conditions or requirements with which we may not
be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement
actions against us that could be harmful to our business. Any of these or similar occurrences could significantly disrupt our
business operations or restrict us from conducting a substantial portion of our business operations, which could materially and
adversely affect our business, financial condition and results of operations. If any of these occurrences results in our inability
to direct the activities of any of our consolidated affiliated entities that most significantly impact our economic performance,
and/or our failure to receive the economic benefits from any of our consolidated affiliated entities, we may not be able to consolidate
such entity in our consolidated financial statements in accordance with U.S. GAAP.
Our
MVNO business is dependent upon China Unicom for voice and data service as well as reliability and accessibility of to China’s
telecommunications and Internet infrastructure.
We
provide our MVNO services via telecommunications and Internet networks, and therefore our ability to fulfill our contracts and
generate revenue and profits is dependent on those systems remaining available and accessible with minimal disruption or interruption.
Just as we are dependent on the reliability of our software and systems and the telecommunications networks of our customers,
we are also dependent on the operational reliability and capacity of China’s overall telecommunications and Internet infrastructure.
Should this infrastructure or key portions of it be disabled or become nonfunctional, we may not be able to secure alternate means
of communication or alternate means of accessing needed information. Our operational results could suffer as a result.
Through
our subsidiary, Yuantel Investment, we purchase wholesale rates for mobile voice and data services from China Unicom, a PRC state-owned
telecommunications service provider, and repackage the voice and data services into competitive bundles for our Chinese customers.
We purchase bulk voice-per-minute and MB-of-data service from China Unicom at attractive wholesale rates pursuant to a Business
Cooperation Agreement with China Unicom dated as of January 10, 2018. The agreement is for a one year term, ending December
31, 2018. There is no guarantee that the supply of telecommunications resources or competitive rates provided by China
Unicom will be renewed when the contract term ends. If the agreement is not renewed, we will not be able to maintain our
gross margin and will not be able to operate profitably, which may lead us to cease operations of the MVNO BU entirely.
We
operate in multiple rapidly evolving industries. If we fail to keep up with technological developments and changing requirements
of our customers, business, financial condition and results of operations may be materially and adversely affected.
The
mobile industry is rapidly evolving and subject to continuous technological developments. Our success depends on our ability to
keep up with these technological developments and the resulting changes in customers’ demands. There may also be changes
in the industry landscape as different types of platforms compete with one another for market share. If we do not adapt our Android+
software and service platform solutions to such changes in an effective and timely manner as more mobile operating system platforms
become available in the future, we may suffer a loss in market share. Given that we operate in a rapidly evolving industry, we
also need to continuously invest significant resources in research and development in order to enhance our existing products and
to respond to changes in customer preference, new challenges and industry changes in a timely and effective manner. If we fail
to keep up with technological developments and continue to innovate to meet the needs of our customers, our Android+ software
and service platform solutions may become less attractive to customers, which in turn may adversely affect our reputation, competitiveness,
results of operations and prospects.
We
face intense competition from onshore and offshore third party software providers in the Android platform and software market,
and, if we are unable to compete effectively, it may lose customers and our revenues may decline.
The
Android platform and software market is highly fragmented and competitive, and we expect competition to persist and intensify
from both existing competitors and new market entrants. We believe that the principal competitive factors in our industry are
reliability and efficiency, performance, product features and functionality, development complexity and time-to-market, price,
support for multiple architectures and processors, interoperability with other systems, support for emerging industry and customer
standards and protocols and levels of training, technical services and customer support.
Our
business model is to provide a full suite of Android+ software and service platform solutions to a broad range of customers, including
mobile chipset manufacturers, mobile device OEMs and mobile operators. As of the date of this 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.”
In
addition, we face competition from companies seeking to compete with the Android platform by developing their own operating systems,
such as Baidu and Alibaba in China, and major mobile device OEMs, such as Foxconn Technology Group and BYD Electronic (International)
Company Limited, which are able to develop low-level software for mobile chipsets, as well as Huawei, GTE and Xiaomi.
We
believe that we presently compete favorably with respect to each segment identified above. However, the market for Android platform
software and service solutions is still rapidly evolving, and we may not be able to compete successfully against current and potential
competitors in the future. In addition, some of our independent competitors are more focused on one or several particular segments
of the value chain and may deliver better services in those segments than we do. Furthermore, some of our competitors may have
significantly greater financial, technical, marketing, sales and other resources and significantly greater name recognition than
we have. If we are unable to compete successfully on the principal competitive factors described above or otherwise, our business
could be harmed.
As
an MVNO, we face intense competition in the wireless communications market and if we cannot compete effectively our revenues,
profits, cash flows and growth may be adversely affected.
The
wireless communications market is extremely competitive, and competition for customers is increasing. We compete with other MVNOs
such as Snail Mobile, d.Mobile and Soshare. We are one of the top MVNOs in China as measured in terms of registered subscribers,
and we intend to expand our market share organically or by acquiring smaller MVNOs. However, we continue to face intense competition
from the dozens of other MVNOs and we may not be able to compete successfully in the future. In addition, continued consolidation
in the industry creates even large competitors, and such competitors may have greater financial, technical, personnel and marketing
resources and a larger market share than us, and we may not be able to compete successfully against them. If we are unable to
compete successfully on the principal competitive factors described above or otherwise, our MVNO business could be harmed.
We
may undertake acquisitions, investments, joint ventures or other strategic alliances in the future, which could expose us to new
operational, regulatory and market risks. In addition, such future and past undertakings may not be successful, which may adversely
affect our business, results of operations, financial condition and prospects.
We
intend to grow both organically by expanding our current business lines and geographic coverage and through acquisitions, investments,
joint ventures or other strategic alliances if the appropriate opportunities arise. These potential business plans, acquisitions,
investments, joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as
risks associated with additional capital requirements. In addition, we may not be able to identify suitable future acquisition
or investment candidates or joint venture or alliance partners. Even if we identify suitable candidates or partners, we may be
unable to complete an acquisition, investment or alliance on terms commercially acceptable to us. If we fail to identify appropriate
candidates or partners, or complete desired acquisitions, investments or alliances, including but not limited to the proposed
KADI acquisition, we may not be able to implement our strategies effectively or efficiently.
In
addition, our ability to successfully integrate acquired companies and their operations may be adversely affected by a number
of factors, including, among others, the ability to capitalize on anticipated synergies, diversion of resources and management’s
attention, difficulties in retaining personnel of the acquired companies, unanticipated problems or legal liabilities and tax
and accounting issues. If we fail to integrate any acquired company efficiently, our earnings, revenues, gross margins, operating
margins and business operations could be adversely affected. The integration of acquired companies is a complex, time-consuming
and expensive process.
We
are dependent upon the Android platform and, if Google determines to no longer develop the Android platform and our further development
is not taken up by reliable alternative sources, our business could be materially harmed.
Our
business model is dependent upon the Android platform, which is a free and fully open source mobile software platform developed
by Google. The Android platform has been updated frequently since our original release and the development of the Android platform
is an ongoing process which we do not control. If Google determines to no longer develop the Android platform or our further development
is not taken up by reliable alternative sources, such as another third party or the open source community, demand for our Android+
software and service platform solutions could decline significantly and our revenue and financial condition could be materially
harmed.
If
our customers move more research and development work in-house, lower demand for our solutions could reduce our net revenues and
harm our business.
Collaboration
with customers is essential to the growth and profitability of our business. However, our customers may elect to move more research
and development work in-house, and reduce collaboration with us for Android platform projects. There are many factors beyond our
control that could cause our customers to move their work in-house, such as spending reductions due to a challenging economic
environment, corporate restructuring, cost control, pricing pressure and concerns regarding the protection of technology know-how,
trade secrets and other intellectual property rights. If our customers decide to change their strategy by moving more research
and development work in-house, our net revenues may decline, and our business, financial condition and results of operations may
be adversely affected.
Our
quarterly results may fluctuate significantly and may not fully reflect the underlying performance of our business.
Our
quarterly operating results, including the levels of our revenue, gross margin, profitability, cash flow and deferred revenue,
may vary significantly in the future, and period-to-period comparisons of our operating results may not be meaningful. Accordingly,
the results of any one quarter should not be relied upon as an indication of future performance. Our quarterly financial results
may fluctuate as a result of a variety of factors, many of which are outside of our control and, as a result, may not fully reflect
the underlying performance of our business. Fluctuations in quarterly results may negatively impact the value of our ordinary
shares. Factors that may cause fluctuations in our quarterly financial results include, but are not limited to:
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our ability to attract new customers;
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our ability to convert users of our limited
free versions to paying customers;
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the addition or loss of large customers, including
through acquisitions or consolidations;
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our customer retention rate;
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the timing of recognition of revenue;
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the amount and timing of operating expenses
related to the maintenance and expansion of our business, operations and infrastructure;
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network outages or security breaches;
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general economic, industry and market conditions;
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increases or decreases in the number of features
in our services or pricing changes upon any renewals of customer agreements;
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changes in our pricing policies or those of
our competitors;
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the timing and success of new services and service
introductions by us and our competitors or any other change in the competitive dynamics of our industry, including consolidation
among competitors, customers or strategic partners; and
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the timing of expenses related to the development
or acquisition of technologies or businesses and potential future charges for impairment of goodwill from acquired companies.
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If
we fail to effectively manage our technical operations infrastructure, our customers may experience service outages and delays
in the further deployment of our services, which may adversely affect our business.
We
have experienced significant growth in the number of users and the amount of data that our operations infrastructure supports.
We seek to maintain sufficient excess capacity in our operations infrastructure to meet the needs of all of our customers. We
also seek to maintain excess capacity to facilitate the rapid provisioning of new customer deployments and the expansion of existing
customer deployments. In addition, we need to properly manage our technological operations infrastructure in order to support
version control, changes in hardware and software parameters and the evolution of our services. However, the provision of new
hosting infrastructure requires significant lead-time. We have experienced, and may in the future experience, website disruptions,
outages and other performance problems. These problems may be caused by a variety of factors, including infrastructure changes,
human or software errors, viruses, security attacks, fraud, spikes in customer usage and denial of service issues. In some instances,
we may not be able to identify the cause or causes of these performance problems within an acceptable period of time, which may
harm our reputation and operating results. Furthermore, if we do not accurately predict our infrastructure requirements, our existing
customers may experience service outages that may subject us to financial penalties, financial liabilities and customer losses.
If our operations infrastructure fails to keep pace with increased sales, customers may experience delays as we seek to obtain
additional capacity, which could adversely affect our reputation and our revenue.
Most
of our engagements with customers are for a specific project only and do not provide for subsequent engagements. If we are unable
to generate a substantial number of new engagements for projects on a continuing basis, our business and results of operations
will be adversely affected.
Our
customers generally retain us on project-by-project basis in connection with specific projects rather than on a recurring basis
under long-term contracts. Historically, a significant portion of our net revenues has been comprised of software fees, relating
to one-time research and engineering work performed for customers. For 2015, 2016 and 2017, our net revenues from software fees
were $22.5 million, $14.9 million and $11.2 million, respectively, representing 29.9%, 12.4% and 7.3% of total net revenues. Although
a significant amount of our net revenues are generated from repeat business, which we define as revenues from a customer who also
contributed to our revenues during the prior fiscal year, our engagements with our customers are typically for individual projects
that are often on a non-exclusive, project-by-project basis. In addition, a majority of our customer contracts from which we generate
product fees can be terminated by customers with or without cause. There are many factors outside of our control that might lead
customers to terminate a contract or project with us, including, among others:
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financial difficulties for our customers;
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business going to our competitors or remaining
in-house;
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unsuccessful launch of a product;
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disclosure of core technology by a third party;
and
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mergers and acquisitions or significant corporate
restructurings by our customers.
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Furthermore,
some of our customer contracts specify that if a change of control occurs during the term of the contract, the customer has the
right to terminate the contract upon advance notice. If our customers terminate our contracts before completion or choose not
to renew their contracts, our business, financial condition and results of operations may be materially and adversely affected.
Therefore,
we have to continuously seek new engagements while our current engagements are being performed or are completed or terminated,
and we are constantly seeking to expand our business with existing customers and secure new customers. If we are unable to generate
a substantial number of new engagements on a continuing basis, our business and results of operations will be adversely affected.
Because
of the characteristics of open source software, there may be fewer technology barriers to entry in the Android platform and software
market in which we compete, and it may be relatively easy for competitors, some of which may have greater resources than we have,
to enter our markets and compete with us.
One
of the characteristics of open source software is that anyone can modify and redistribute the existing open source software and
use it to compete against us. Such competition can develop without the degree of overhead and lead time required by traditional
proprietary software companies. It is possible for new competitors with greater resources than us to develop their own Android
platform software and service solutions, potentially reducing the demand for, and putting pricing pressure on, our Android+ software
and service platform solutions. In addition, some competitors make their open source software available for free download and
use on an
ad hoc
basis, or may position their open source software as a loss leader in order to win customers. There can
be no assurance that we will be able to compete successfully against current and future competitors or that competitive pressure
and/or the availability of open source software will not result in price reductions, reduced operating margins and loss of market
share, any of which could seriously harm our business.
Security
and privacy breaches may expose us to liability and harm our reputation and business.
As
part of our business we receive and process information about our employees, customers and partners, and we may store (or contract
with third parties to store) our customers’ data. While we take security measures relating to our Android+ software and
service platform solutions, specifically, and our operations, generally, those measures may not prevent security breaches that
could harm our business. Advances in computer capabilities, inadequate technology or facility security measures or other factors
may result in a compromise or breach of our systems and the data we store and process. Our security measures may be breached as
a result of actions by third parties or employee error or malfeasance. A party who is able to circumvent our security measures
or exploit inadequacies in our security measures, could, among other things, misappropriate proprietary information (including
information about our employees, customers and partners and our customers’ information), cause the loss or disclosure of
some or all of this information, cause interruptions in our operations or our customers’ or expose our customers to computer
viruses or other disruptions or vulnerabilities. Any compromise of our systems or the data it stores or processes could result
in a loss of confidence in the security of our Android+ software and service platform solutions, damage our reputation, disrupt
our business, lead to legal liability and adversely affect our financial condition and results of operations. Moreover, a compromise
of our systems could remain undetected for an extended period of time, exacerbating the impact of that compromise. Actual or perceived
vulnerabilities may lead to claims against us by our customers, partners or other third parties, which could be material. While
our customer agreements typically contain provisions that seek to limit our liability, there is no assurance these provisions
will be enforceable and effective under applicable law. In addition, the cost and operational consequences of implementing further
data protection measures could be significant.
We
are vulnerable to technology infrastructure failures, which could harm our reputation and business.
We
rely on our technology infrastructure for many functions, including selling our Android+ software and service platform solutions,
supporting our customers and billing, collecting and making payments. We also rely on our own technology infrastructure, which
is located on a third-party site, as well as the technology infrastructure of third parties, to provide some of our back-end services.
This technology infrastructure may be vulnerable to damage or interruption from natural disasters, power loss, telecommunication
failures, terrorist attacks, computer intrusions and viruses, software errors, computer denial-of-service attacks and other events.
A significant number of the systems making up this infrastructure are not redundant, and our disaster recovery planning is not
sufficient for every eventuality. This technology infrastructure is also subject to break-ins, sabotage and intentional acts of
vandalism by internal employees, contractors and third parties. Despite any precautions we or our third-party partners may take,
such problems could result in, among other consequences, interruptions in our services and loss of data, which could harm our
reputation, business and financial condition. We do not carry business interruption insurance sufficient to protect us from all
losses that may result from interruptions in our services as a result of technology infrastructure failures or to cover all contingencies.
Any interruption in the availability of our websites and on-line interactions with customers and partners would create a large
volume of questions and complaints that would need to be addressed by our support personnel. If our support personnel cannot meet
this demand, customer and partner satisfaction levels may fall, which in turn could cause additional claims, reduced revenue,
reputation damage or loss of customers.
We
may not be able to continue to use or adequately protect our intellectual property rights, which could harm our business reputation
and competitive position.
Although
Android is an open source mobile software platform for mobile devices, we are not required to share the source code for our Android
software, which we have invested significant resources to develop. Accordingly, we believe that patents, trademarks, trade secrets,
copyright, software registration and other intellectual property we use are important to our business. We rely on a combination
of patent, trademark, copyright, software registration and trade secret protection laws in China and other jurisdictions, as well
as confidentiality procedures and contractual provisions to protect our intellectual property and brand name. Any failure by us
to maintain or protect our intellectual property rights, including any unauthorized use of our intellectual property by third
parties or use of “Borqs” as a company name to conduct software or services business, may adversely affect our current
and future revenues and our reputation.
In
addition, the validity, enforceability and scope of protection available under intellectual property laws with respect to the
mobile and Internet industries in China, where a significant part of our business and operations are located, are uncertain and
still evolving. Implementation and enforcement of PRC intellectual property-related laws have historically been deficient, ineffective
and hampered by corruption and local protectionism. Accordingly, protection of intellectual property rights in China may not be
as effective as in the United States or other countries. Furthermore, policing unauthorized use of proprietary technology is difficult
and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability,
scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation,
if any, could result in substantial costs and diversion of resources and management attention, which could harm our business and
competitive position.
We
also may be required to enter into license agreements with certain third parties to use their intellectual property for our business
operations. If such third parties fail to perform under these license agreements or if the agreements are terminated for any reason,
our business and results of operations may be negatively impacted. Furthermore, if we are deemed to be using third parties’
intellectual property without due authorization, we may become subject to legal proceedings or sanctions, which may be time-consuming
and costly to defend, divert management attention and resources or require us to enter into licensing agreements, which may not
be available on commercial terms, or at all.
The
international nature of our business exposes it to risks that could adversely affect our financial condition and results of operations.
We
conduct our business throughout the world in multiple locations. Our corporate structure also spans multiple jurisdictions, with
our parent holding company incorporated in the British Virgin Islands and intermediate and operating subsidiaries incorporated
in China, Hong Kong, India, Brazil, Japan and South Korea. In addition, one of our growth strategies is to further expand our
business in Europe and into the United States. As a result, we are exposed to risks typically associated with conducting business
internationally, many of which are beyond our control. These risks include, among others:
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significant currency fluctuations between the
Renminbi and the U.S. dollar and other currencies in which we transact business;
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difficulty in identifying appropriate mobile
chipset manufacturers, mobile device OEMs, mobile operators and/or joint venture partners, and establishing and maintaining
good relationships with them;
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legal uncertainty owing to the overlap and inconsistencies
of different legal regimes, problems in asserting contractual or other rights across international borders and the burden
and expense of complying with the laws and regulations of various jurisdictions;
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potentially adverse tax consequences, such as
scrutiny of transfer pricing arrangements by authorities in the countries in which we operate;
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adverse effect of inflation and increase in
labor costs;
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current and future tariffs and other trade barriers,
including restrictions on technology and data transfers;
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general global economic downturn;
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unexpected changes in political environment
and regulatory requirements; and
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terrorist attacks and other acts of violence
or war.
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The
occurrence of any of these events could have a material adverse effect on our results of operations and financial condition.
Furthermore,
we are in the process of implementing policies and procedures designed to facilitate compliance with laws and regulations in various
jurisdictions applicable to us, but there can be no assurance that our employees, contractors or agents will not violate such
laws and regulations or our policies. Any such violations could, individually or in the aggregate, materially and adversely affect
our financial condition and operating results.
We
may not be able to manage our anticipated growth and our current and planned resources may not be adequate to support our expanding
operations; consequently, our business, results of operations and prospects may be materially and adversely affected.
We
have experienced rapid growth since we commenced operations. Our rapid expansion may expose us to new challenges and risks. To
manage the further expansion of our business and the growth of our operations and personnel, we need to continuously expand and
enhance our infrastructure and technology, and improve our operational and financial systems and procedures and controls. For
example, we currently manage all of our human resources functions manually and expect that we will need to upgrade our current
system as we continue to increase our headcount. We also need to expand, train and manage our growing employee base. In addition,
our management will be required to obtain, maintain or expand relationships with mobile chipset manufacturers, mobile device OEMs
and mobile operators, as well as other third-party business partners. We cannot assure you that our current and planned personnel,
infrastructure, systems, procedures and controls will be adequate to support our expanding operations. If we fail to manage our
expansion effectively, our business, results of operations and prospects may be materially and adversely affected.
Due
to intense competition for highly skilled personnel, we may fail to attract and retain qualified personnel to support our research
and development operations; as a result, our ability to bid for and obtain new projects may be adversely affected and our net
revenues could decline.
The
mobile industry relies on the talents and efforts of highly skilled personnel, and our success depends to a significant extent
on our ability to recruit, train, develop, retain and motivate qualified personnel for all areas of our organization. The mobile
industry in China has experienced significant levels of employee attrition. Our attrition rates were 19% in 2014, 18% in 2015,
12% in 2016 and 14% in 2017. We may encounter higher attrition rates in the future, particularly if the mobile industry continues
to experience strong growth.
Competition
in our industry for qualified employees, especially technical employees, is intense, and our competitors directly target our employees
from time to time. We have also experienced employees leaving us to start competing businesses or to join the in-house research
and development teams of our customers. The loss of the technical knowledge and industry expertise of any of these individuals
could seriously impede our success. Moreover, the loss of these individuals, particularly to a competitor, some of which are in
a position to offer greater compensation, and any resulting loss of customers or trade secrets and technological expertise could
further lead to a reduction in our market share and adversely affect our business. If we are required to increase the compensation
payable to our qualified employees to compete with certain competitors with greater resources than we have or to discourage employees
from leaving us to start competing businesses, our operating expenses will increase which, in turn, will adversely affect our
results or operations.
Our
success depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may
be severely disrupted if we lose their services.
Our
future success heavily depends upon the continued services of our senior executives and other key employees. In particular, we
rely on the expertise, experience, customer relationships and reputation of Pat Chan, our founder, chairman and chief executive
officer. We currently do not maintain key man life insurance for any of the senior members of our management team or other key
employees. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions,
it could disrupt our business operations, and we may not be able to replace them easily or at all. In addition, competition for
senior executives and key employees in our industry is intense, and we may be unable to retain our senior executives and key employees
or attract and retain new senior executive and key employees in the future, in which case our business may be severely disrupted,
and our financial condition and results of operations may be materially and adversely affected.
If
any of our senior executives or key employees joins a competitor or forms a competing company, it may lose customers, know-how
and other key employees and staff members to them. Also, if any of our business development managers, who generally keep a close
relationship with our customers, joins a competitor or forms a competing company, we may lose customers, and our net revenues
may be materially and adversely affected. Additionally, there could be unauthorized disclosure or use of our technical knowledge,
practices or procedures by such employees. All of our executives and key employees have entered into employment agreements with
us that contain non-competition provisions, non-solicitation and nondisclosure covenants. However, if any dispute arises between
our executive officers or key employees and us, such non-competition, non-solicitation and nondisclosure provisions might not
provide effective protection to us, especially in China, where most of these executive officers and key employees reside, in light
of the uncertainties with China’s legal system. See “Risk Factors — Risks Related to Doing Business in China
— Uncertainties with respect to the PRC legal system could harm us.”
A
significant majority of our outstanding ordinary shares are held by a small number of shareholders, which may have significantly
greater influence on us due to the size of their shareholdings relative to other shareholders.
As
of March 31, 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 12.6%, 12.5%,
11.0%, 10.8%, 10.0%, and 8.6% 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 control 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 control over financial reporting, and are in the process of implementing
remedial steps to improve our internal control 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 lost 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 control over financial reporting. Our internal control
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 control 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 control over financial reporting.
Following
the above-mentioned efforts, as of December 31, 2017, based on an assessment performed by our management on the performance of
the remediation measures described above, we determined that the material weakness in providing for effective accruals in internal
control over financial reporting had been remediated. However the material weakness relating to hiring sufficient U.S. GAAP-qualified
accounting personal had not yet been fully remediated. We plan to take additional measures to improve our internal control over
financial reporting, including (i) hiring additional qualified professionals with U.S. GAAP accounting experience in the year
2018; (ii) providing U.S. GAAP and SEC reporting training to our accounting personnel; and (iii) preparing a comprehensive written
accounting policies and procedures manual that can effectively and efficiently guide our finance and accounting personnel in addressing
significant accounting issues and preparing financial statements that are in compliance with U.S. GAAP and SEC requirements. In
addition, we intend to engage an external service provider by the end of 2018 to assist management in evaluating our current internal
control over financial reporting and implementing necessary controls and measures to assist it in preparing for compliance with
internal control reporting.
If
we fail to maintain effective internal control over financial reporting, we may not be able to accurately and timely report our
financial results or prevent fraud, and investor confidence and the market price of our ordinary shares may be adversely impacted.
We
are required to maintain effective disclosure controls and procedures and effective internal control 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 control 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 control 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 control 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. Additionally, such
weaknesses and deficiencies in internal controls have 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
control over financial reporting could also cause 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 formally attest to the effectiveness of our internal control
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 control
over financial reporting is documented, designed, or operating. Failing to maintain effective disclosure controls and internal
control over financial reporting could have a material and adverse effect on our business and operating results and could cause
a decline in the price of our ordinary shares. In addition, if we are unable to continue to meet these requirements, we may not
be able to remain listed on the Nasdaq Stock Market.
We
are subject to various anti-corruption and anti-bribery laws, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery
Act, and PRC and Indian anti-corruption and anti-bribery laws; any determination that we have violated such laws could damage
our business and reputation, limit our ability to bid for certain business opportunities, and subject us to significant criminal
and civil penalties, civil litigation (such as shareholder derivative suits), and commercial liabilities.
We
are subject to anti-corruption and anti-bribery laws in the United States, United Kingdom, China, and India that prohibit certain
improper payments made directly or indirectly to government departments, agencies, and instrumentalities; officials of those government
departments, agencies, and instrumentalities; political parties and their officials; candidates for political office; officials
of public international organizations; persons acting on behalf of the foregoing; and commercial counterparties. These laws include
the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act 2010, the PRC Criminal Law, the PRC Anti-Unfair Competition Law,
the Indian Prevention of Corruption Act 1988, the Indian Penal Code and anti-corruption laws in various Indian states.
We
are engaged in business in a number of countries that are regarded as posing significant risks of corruption. Of particular note,
we conduct operations, have agreements with state-controlled enterprises and other third parties and make sales in the PRC, and
we have research and development activities in India, each of which may be exposed to corruption risk. It is our policy to implement
safeguards and procedures to prohibit these practices by our employees, officers, directors, or by third parties acting on our
behalf. However, we cannot rule out the risk that any of our employees, officers, directors, or third parties acting on our behalf
may engage in breaches of our policies or anti-corruption laws, for which we might be held responsible.
Allegations
of violations of these anti-corruption and anti-bribery laws, and investigation into such allegations, could negatively affect
our reputation, business, operating results, and financial condition. The violation of these laws may result in substantial monetary
and even criminal sanctions, follow-on civil litigation (such as shareholder derivative suits), and monitoring of our compliance
program by the United States or other governments, each of which could negatively affect our reputation, business, operating results,
and financial condition. In addition, the United States or other governments may seek to hold us liable for violations of these
laws committed by companies in which we invest or acquire.
There
can be no assurance that our securities, including our ordinary shares, will continue to be listed on Nasdaq or, if listed, that
we will be able to comply with the continued listing standards of Nasdaq, which could limit investors’ ability to make transactions
in our securities and subject us to additional trading restrictions.
To
continue listing our ordinary shares on The Nasdaq Stock Market, we will be required to demonstrate compliance with Nasdaq’s
continued listing requirements, particularly the requirement to maintain a minimum number of holders (300 round-lot holders).
We were previously not in compliance with Nasdaq’s listing requirement that we have at least 300 round-lot shareholders
but regained compliance with this requirement on April 12, 2018 by implementing a restricted shares purchase program with eligible
employees of Borqs Software Solutions Private Ltd., our wholly-owned subsidiary in India, pursuant to which 222 employees voluntarily
purchased an aggregate of 29,170 ordinary shares at a purchase price of $9.40 per share. Program participants paid for their purchase
of shares by having the purchase amounts deducted from their regular compensation on March 23, 2018. On April 12, 2018, Nasdaq
informed us that we had regained compliance with the listing requirement of 300 round lot holders and that our ordinary shares
would continue to be listed on Nasdaq.
On
December 11, 2017, Nasdaq advised the Company that it had determined to delist the Company’s public warrants. Our public
warrants have been trading on the OTC Markets system under the symbol “BRQSW” since October 23, 2017. Our ordinary
shares have continued to trade on Nasdaq regardless of the Panel’s decision to delist our public warrants.
We
cannot assure you that we will be able to meet Nasdaq’s continued listing requirement or maintain other listing standards.
If our ordinary shares are delisted by Nasdaq, and we are not able to list our securities on another national securities exchange,
we expect our securities could be quoted on an over-the-counter market. If this were to occur, then, as with our public warrants,
which have been delisted from Nasdaq and are trading on the OTC Markets, we could face significant material adverse consequences,
including:
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less liquid trading market for our securities;
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more limited market quotations for our securities;
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determination that our ordinary shares and/or
warrants are a “penny stock” that requires brokers to adhere to more stringent rules and possibly resulting in
a reduced level of trading activity in the secondary trading market for our securities;
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more limited research coverage by stock analysts;
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loss of reputation; and
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more difficult and more expensive equity financings
in the future.
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The
National Securities Markets Improvement Act of 1996, which is a federal statute, prevents or preempts the states from regulating
the sale of certain securities, which are referred to as “covered securities.” If our ordinary shares remain listed
on NASDAQ, our ordinary shares will be covered securities. Although the states are preempted from regulating the sale of our securities,
the federal statute does allow the states to investigate companies if there is a suspicion of fraud, and, if there is a finding
of fraudulent activity, then the states can regulate or bar the sale of covered securities in a particular case. If our securities
were no longer listed on Nasdaq and therefore not “covered securities”, we would be subject to regulation in each
state in which we offer our securities.
Risks
Related to Doing Business in China
China’s
economic, political and social conditions, as well as changes in any government policies, laws and regulations, could have a material
adverse effect on our business.
A
substantial portion of our operations are conducted in China, and a significant portion of our net revenues are derived from customers
where the contracting entity is located in China. Accordingly, our business, financial condition, results of operations, prospects
and certain transactions we may undertake are subject, to a significant extent, to economic, political and legal developments
in China.
China’s
economy differs from the economies of most developed countries in many respects, including the amount of government involvement,
level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced
significant growth in the past two to three decades, growth has been uneven, both geographically and among various sectors of
the economy. Demand for our services and products depends, in large part, on economic conditions in China. Any slowdown in China’s
economic growth may cause our potential customers to delay or cancel their plans to purchase our services and products, which
in turn could reduce our net revenues.
Although
China’s economy has been transitioning from a planned economy to a more market-oriented economy since the late 1970s, the
PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC
government also exercises significant control over China’s economic growth through allocating resources, controlling the
incurrence and payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment
to particular industries or companies. Changes in any of these policies, laws and regulations could adversely affect the economy
in China and could have a material adverse effect on our business.
The
PRC government has implemented various measures to encourage foreign investment and sustainable economic growth and to guide the
allocation of financial and other resources, which have for the most part had a positive effect on our business and growth. However,
we cannot assure you that the PRC government will not repeal or alter these measures or introduce new measures that will have
a negative effect on us. China’s social and political conditions may also not be as stable as those of the United States
and other developed countries. Any sudden changes to China’s political system or the occurrence of widespread social unrest
could have a material adverse effect on our business and results of operations.
Uncertainties
with respect to the PRC legal system could harm us.
Our
operations in China are governed by PRC government laws and regulations. The PRC legal system is a civil law system based on written
statutes. Unlike common law systems, prior court decisions have limited precedential value. Borqs Beijing is generally subject
to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned
enterprises, and our other wholly-owned subsidiaries in China may be subject to certain laws and regulations in connection with
investments made by foreign-invested enterprises.
Since
1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments
in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently
cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because
of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and
regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules
(some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware
of our violation of these policies and rules until sometime after the violation. Moreover, some regulatory requirements issued
by certain PRC government authorities may not be consistently applied by other government authorities, including local government
authorities, thus making strict compliance with all regulatory requirements impractical, or in some circumstances, impossible.
In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management
attention.
Recent
trade policy initiatives announced by the United States administration against the PRC may adversely affect our business.
On
August 14, 2017, the President of the United States issued a memorandum instructing the U.S. Trade Representative (“USTR”)
to determine whether to investigate under section 301 of the U.S. Trade Act of 1974 (Trade Act), laws, policies, practices, or
actions of the PRC government that may be unreasonable or discriminatory and that may be harming U.S. intellectual property rights,
innovation, or technology development. Based on information gathered in that investigation, the USTR published a report on March
22, 2018 on the acts, policies and practices of the PRC government supporting findings that such are unreasonable or discriminatory
and burden or restrict U.S. commerce.
On
March 8, 2018, the President exercised his authority to issue the imposition of significant tariffs on imports of steel and aluminum
from a number of countries, including the PRC. Subsequently, the USTR announced an initial proposed list of 1,300 goods imported
from the PRC that could be subject to additional tariffs and initiated a dispute with the World Trade Organization against the
PRC for alleged unfair trade practices. The President has indicated that his two primary concerns to be addressed by the PRC are
(i) a mandatory $100 billion reduction in the PRC/U.S. trade deficit and (ii) limiting the planned $300 billion PRC government
support for advanced technology industries including artificial intelligence, semiconductors, electric cars and commercial aircraft.
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. The U.S. Treasury Department has until May 21, 2018, to develop these restrictions, which will be in addition
to the restrictions already imposed by the Committee on Foreign Investment in the United States.
This
evolving policy dispute between the PRC and the U.S. is likely to have significant impact on the industries in which we participate,
directly and indirectly, and no assurance can be given that any individual customer or product for whom we develop software solutions,
or significant groups of companies or a particular industry, will not be adversely affected by any governmental actions taken
by either the PRC or the U.S., perhaps materially. In view of the positions of the respective trade representatives, it is not
possible to predict with any certainty the outcome of this dispute or whether it will involve other agencies or entities brought
in to resolve the policy differences of the two countries.
Our
subsidiaries in China are subject to restrictions on making dividends and other payments to it or any other affiliated company.
We
are a holding company and may rely on dividends paid by our PRC subsidiaries for our cash needs, including the funds necessary
to pay dividends and other cash distributions to our shareholders to the extent we choose to do so, to service any debt it may
incur and to pay our operating expenses. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of
their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, each
of our PRC subsidiaries are required to set aside at least 10% of our after-tax profits each year, if any, to fund a statutory
reserve until such reserve reaches 50% of our registered capital. Appropriations to the employee welfare funds are at the discretion
of the board of directors of Borqs Beijing. These reserves are not distributable as cash dividends.
In
addition, under the PRC Enterprise Income Tax Law, or the EIT Law, which became effective on January 1, 2008, dividends paid to
us by our PRC subsidiaries are subject to withholding tax. Currently, the withholding tax rate is 10.0% (subject to reductions
by the relevant tax treaties, if applicable).
Furthermore,
if our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability
to pay dividends or make other payments to us.
To
date, our PRC subsidiaries have not paid dividends to us out of their accumulated profits. In the future, we do not expect to
receive dividends from our PRC subsidiaries because the accumulated profits of these PRC subsidiaries are expected to be used
for their own business or expansions. Any limitation on the ability of our PRC subsidiaries to distribute dividends or other payments
to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our
businesses, pay dividends or otherwise fund and conduct our business.
The
discontinuation of any of the preferential tax treatments currently available to our PRC subsidiaries could materially increase
our tax liabilities.
Preferential
tax treatments and incentives granted to our PRC subsidiaries by PRC governmental authorities are subject to review and may be
adjusted or revoked at any time in the future. The discontinuation or revocation of any preferential tax treatments and incentives
currently available to them will cause their effective tax rate to materially increase, which will decrease our net income and
may adversely affect our financial condition and results of operations.
We
face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.
On
February 3, 2015, the State Administration of Taxation, or the SAT issued a Public Notice Regarding Certain Enterprise Income
Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or Public Notice 7, where a non-resident enterprise
transfers taxable assets, through the offshore transfer of a foreign intermediate holding company, the non-resident enterprise,
being the transferor, maybe subject to PRC enterprise income tax, if the indirect transfer is considered to be an arrangement
which does not have a reasonable commercial purpose to circumvent enterprise income tax payment obligations. In addition, Public
Notice 7 further provides certain criteria on how to assess reasonable commercial purposes and has introduced safe harbors for
internal group restructurings and the purchase and sale of equity through a public securities market. Public Notice 7 also brings
challenges to both the foreign transferor and transferee (or other person who is obligated to pay for the transfer) of the taxable
assets. Where a non-resident enterprise conducts an “indirect transfer” by transferring the taxable assets indirectly
by disposing of the equity interests of an overseas holding company, the non-resident enterprise being the transferor, or the
transferee, or the PRC entity which directly owned the taxable assets may report to the relevant tax authority such indirect transfer.
Using a “substance over form” principle, the PRC tax authority may re-characterize such indirect transfer as a direct
transfer of the equity interests in the PRC tax resident enterprise and other properties in China. As a result, gains derived
from such indirect transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to
pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of up to 10% for the transfer of equity
interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws
if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.
On
October 17, 2017, the SAT issued the Announcement on Issues Relating to Withholding at Source of Income Tax of Non-Resident Enterprises,
or Announcement 37, which became effective on December 1, 2017. The Announcement 37 further clarifies the practice and procedure
of the withholding of non-resident enterprise income tax.
We
face uncertainties with respect to the reporting and consequences of private equity financing transactions, share exchange or
other transactions involving the transfer of our ordinary shares by investors that are non-PRC resident enterprises, or sale or
purchase of shares in other non-PRC resident companies or other taxable assets by us. We and other non-resident enterprises in
our group may be subject to filing obligations or being taxed if we and other non-resident enterprises affiliated with us are
transferors in such transactions, and may be subject to withholding obligations if we and other non-resident enterprises affiliated
with us are transferees in such transactions, under Public Notice 7 and Announcement 37. For the transfer of shares in us by investors
that are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under Public Notice 7 and
Announcement 37. As a result, we may be required to expend valuable resources to comply with Public Notice 7 and Announcement
37 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish
that we and other non-resident enterprises affiliated with us should not be taxed under these circulars. The PRC tax authorities
have the discretion under Public Notice 7 and Announcement 37 to make adjustments to the taxable capital gains based on the difference
between the fair value of the taxable assets transferred and the cost of investment. If the PRC tax authorities make adjustments
to the taxable income of the transactions under Public Notice 7 and Announcement 37, our income tax costs associated with such
transactions will be increased in the event that we are a transferee of such transactions, which may have an adverse effect on
our financial condition and results of operations. Heightened scrutiny over acquisition transactions by the PRC tax authorities
may also have a negative impact on potential acquisitions we may pursue in the future.
It
is unclear whether we will be considered a PRC “resident enterprise” under the EIT Law and, depending on the determination
of our PRC “resident enterprise” status, we may be subject to 25.0% PRC enterprise income tax on our worldwide income,
and holders of our ordinary shares may be subject to PRC withholding tax on dividends paid by us and gains realized on their transfer
of our ordinary shares.
The
EIT Law and our Implementing Regulations, both of which became effective on January 1, 2008, provide that enterprises established
outside of China whose “
de facto
management bodies” are located in China are considered “resident enterprises.”
The Implementing Regulations of the EIT Law define the term “
de facto
management bodies” as a body which
substantially manages, or has control over the business, personnel, finance and assets of an enterprise. On April 22, 2009, the
SAT issued the Notice Regarding Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises
on the Basis of De Facto Management Bodies, or Circular 82, which provides certain specific criteria for determining whether the
“de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. According
to Circular 82, certain PRC-controlled enterprises will be classified as “resident enterprises” if all of the following
conditions are met: (a) the senior management and core management departments in charge of our daily operations function have
their presence mainly in the PRC; (b) our financial and human resources decisions are subject to determination or approval by
persons or bodies in the PRC; (c) our major assets, accounting books, company seals, and minutes and files of our board and shareholders’
meetings are located or kept in the PRC; and (d) more than half of the enterprise’s directors or senior management with
voting rights habitually reside in the PRC. Further, the Administrative Measures of Enterprise Income Tax of Chinese controlled
Offshore Incorporated Resident Enterprises (Trial), or Bulletin No. 45, took effect on September 1, 2011, and provides more guidance
on the implementation of Circular 82. The State Administration of Taxation issued an amendment to Circular 82 delegating the authority
to our provincial branches to determine whether a Chinese-controlled overseas-incorporated enterprise should be considered a PRC
resident enterprise, in January 2014.
Although
Circular 82, our amendment and Bulletin No. 45 only apply to offshore enterprises controlled by PRC enterprises or PRC enterprise
groups, not those controlled by PRC individuals or foreigners, the determining criteria set forth in Circular 82 and Bulletin
No. 45 may reflect the SAT’s general position on how the “de facto management body” text should be applied in
determining the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises
or individuals. Although we do not believe that our legal entities organized outside of the PRC constitute PRC resident enterprises,
it is possible that the PRC tax authorities could reach a different conclusion.
If
we are treated as a PRC “resident enterprise,” we will be subject to PRC enterprise income tax on our worldwide income,
as well as PRC enterprise income tax reporting obligations. Our income such as interest on other non-PRC sourced income may be
subject to PRC enterprise income tax at a rate of 25.0%. In addition, although under the EIT Law and our Implementing Rules dividends
paid to us by our PRC subsidiaries would qualify as “tax-exempt income,” we cannot assure you that such dividends
will not be subject to a 10.0% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding
tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident
enterprises for PRC enterprise income tax purposes.
Furthermore,
if we are considered a PRC resident enterprise under the EIT Law, shareholders who are deemed non-resident enterprises may be
subject to the PRC enterprise income tax at the rate of 10% upon the dividends payable by us or upon any gains realized from the
transfer of our ordinary shares, if such income is deemed derived from China, provided that (i) such foreign enterprise investor
has no establishment or premises in China, or (ii) it has establishment or premises in China but our income derived from China
has no real connection with such establishment or premises. If we are required under the EIT Law to withhold PRC income tax on
our dividends payable to our non-PRC resident enterprise shareholders, or if any gains realized from the transfer of our ordinary
shares by our non-PRC resident enterprise shareholders are subject to the PRC enterprise income tax, your investment in our ordinary
shares could be materially and adversely affected.
In
addition, if we are considered a PRC resident enterprise and relevant PRC tax authorities consider dividends we pay with respect
to our shares and the gains realized from the transfer of our shares to be income derived from sources within the PRC, it is possible
that such dividends and gains earned by non-resident individuals may be subject to PRC individual income tax at a rate of 20%.
If we are required under PRC tax laws to withhold PRC income tax on dividends payable to our non-PRC investors that are non-resident
individuals or if you are required to pay PRC income tax on the transfer of our ordinary shares, the value of your investment
in our ordinary shares may be materially and adversely affected.
We
may not be able to obtain certain treaty benefits on dividends paid by our PRC subsidiary to us through our Hong Kong Subsidiary.
Under
the EIT Law, dividends generated from retained earnings after January 1, 2008 from a PRC company to a foreign parent company are
subject to a withholding tax rate of 10.0% unless the foreign parent’s jurisdiction of incorporation has a tax treaty with
China that provides for a preferential withholding arrangement. Pursuant to the Arrangement between Mainland China and the Hong
Kong Special Administrative Region for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes
on Income or the Hong Kong Tax Treaty, which became effective on August 21, 2006, a company incorporated in Hong Kong, such as
Borqs Hong Kong, will be subject to withholding income tax at a rate of 5% on dividends it receives from our PRC subsidiary if
it holds a 25.0% or more interest in that particular PRC subsidiary at all times within the 12-month period immediately preceding
the distribution of dividends and be a “beneficial owner” of the dividends. In February 2018, the SAT issued the
Announcement
on Issues Relating to Beneficial Owners under Tax Treaties
, or the SAT Announcement 9, which became effective from April 1,
2018 and supersedes the
Notice on Interpretation and Determination of Beneficial Owners under Tax Treaties
issued by the
SAT on October 27, 2009 (or the Circular 601) and the
Announcement Regarding Recognition of Beneficial Owners under Tax Treaties
released by the SAT on June 29, 2012 (or the Announcement 30). Pursuant to Announcement 9, applicants who intend to prove
their status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau according to
the
Announcement on Issuing the Measures for the Administration of Non-Resident Taxpayers’ Enjoyment of the Treatment
under Tax Agreements
and the SAT Announcement 9. “Beneficial Owners” are residents who have ownership and the
right to dispose of the income or the rights and properties giving rise to the income. These rules also set forth certain adverse
factors against the recognition of a “Beneficial Owner”, such as not carrying out substantive business activities.
Whether a non-resident enterprise may obtain tax benefits under the relevant tax treaty will be subject to approval of the relevant
PRC tax authority and will be determined by the PRC tax authority on a case-by-case basis. SAT Announcement 9 further provides
that a comprehensive analysis should be made when determining the beneficial owner status based on various factors that supported
by various types of documents including the articles of association, financial statements, records of cash movements, board meeting
minutes, board resolutions, staffing and materials, relevant expenditures, functions and risk assumption as well as relevant contracts
and other information. In August 2015, the SAT promulgated the Administrative Measures for Non-Resident Taxpayers to Enjoy Treatments
under Tax Treaties, or SAT Circular 60, which became effective on November 1, 2015. SAT Circular 60 provides that non-resident
enterprises are not required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding
tax rate. Instead, non-resident enterprises may, if they determine by self-assessment that the prescribed criteria to enjoy the
tax treaty benefits are met, directly apply for the reduced withholding tax rate, and file necessary forms and supporting documents
when performing tax filings, which will be subject to post-filing examinations by the relevant tax authorities.
As
a result, although our PRC subsidiary, Borqs Beijing, is currently wholly owned by Borqs Hong Kong, we cannot assure you that
we would be entitled to the tax treaty benefits and enjoy the favorable 5.0% rate applicable under the Hong Kong Tax on dividends.
If Borqs Hong Kong cannot be recognized as the beneficial owner of the dividends to be paid by our PRC subsidiaries to us, such
dividends will be subject to a normal withholding tax of 10% as provided by the EIT Law.
Restrictions
on foreign currency may limit our ability to receive and use our revenue effectively.
The
PRC government imposes controls on the conversion of the Renminbi into foreign currencies and, in certain cases, the remittance
of foreign currency out of China. We receive part of our revenue in Renminbi. Under our current corporate structure, our British
Virgin Islands holding company primarily relies on dividend payments from our PRC and Hong Kong subsidiaries to fund any cash
and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including
profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies
without prior approval of SAFE, by complying with certain procedural requirements. Specifically, under the existing exchange restrictions,
without prior approval of SAFE, accumulated after-tax profits generated from the operations of Borqs Beijing in China may be used
to pay dividends to us. However, approval from or registration with appropriate government authorities is required where Renminbi
is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated
in foreign currencies. As a result, we need to obtain approval from SAFE to use cash generated from the operations of our PRC
subsidiaries to pay off any debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure
payments outside China in a currency other than Renminbi. The PRC government may at our discretion restrict access to foreign
currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient
foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders.
Fluctuations
in the value of the RMB may have a material adverse effect on your investment.
The
value of the RMB against the U.S. Dollar and other currencies is affected by, among other things, changes in China’s political
and economic conditions and China’s foreign exchange policies. On July 21, 2005, the PRC government changed its policy of
pegging the value of the Renminbi to the U.S. Dollar, and the RMB appreciated more than 20.0% against the U.S. Dollar over the
following three years. However, the People’s Bank of China regularly intervenes in the foreign exchange market to limit
fluctuations in Renminbi exchange rates and achieve policy goals. During the period between July 2008 and June 2010, the exchange
rate between the RMB and the U.S. Dollar had been stable and traded within a narrow band. However, the Renminbi fluctuated significantly
during that period against other freely traded currencies, in tandem with the U.S. Dollar. Since June 2010, the Renminbi has fluctuated
against the U.S. Dollar, at times significantly and unpredictably, and in recent months the RMB has depreciated significantly
against the U.S. Dollar. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange
rate between the RMB and the U.S. Dollar in the future.
Approximately
half of our revenues and costs are denominated in RMB. Any significant revaluation of RMB may materially and adversely affect
our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ordinary shares
in U.S. dollars. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments
or expenditures more costly to us, to the extent that it needs to convert U.S. dollars into RMB for such purposes. An appreciation
of RMB against the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when
we translate our U.S. dollar denominated financial assets into RMB, as RMB is our reporting currency. Conversely, a significant
depreciation of the RMB against the U.S. dollar may significantly reduce the U.S. dollar equivalent of our earnings, which in
turn could adversely affect the price of our ordinary shares. Furthermore, a significant depreciation of the RMB against the U.S.
dollar may have a material adverse impact on our cash flow in the event we need to convert our RMB into U.S. dollars to repay
our U.S. dollar denominated payment obligations.
PRC
regulations relating to the establishment of offshore holding companies by PRC residents may subject our PRC resident beneficial
owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit
our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely
affect us.
The
SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Round-Trip Investment
Activities of Domestic Residents Conducted via Offshore Special Purpose Companies on October 26, 2005, or Circular 75, requiring
PRC residents, including PRC resident individuals and PRC companies, to register with the local SAFE branch before establishing
or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies owned
by such PRC residents, referred to in the notice as an “offshore special purpose vehicle.” The PRC resident individuals
include not only PRC citizens, but also foreign natural persons who habitually reside in China due to economic interests. SAFE
promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment
and Financing and Roundtrip Investment through Special Purpose Vehicles, or Circular 37, on July 4, 2014, which replaced the Circular
75. Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or
indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally
owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in Circular 37 as a “special
purpose vehicle.” Under Circular 37, a PRC resident who is a foreign nature person is not required to complete the registration
if he/she uses assets outside China or equity interests in offshore entities to special purpose vehicles. The term “control”
under Circular 37 is broadly defined as the operation rights, beneficiary rights or decision-making rights acquired by the PRC
residents in the offshore special purpose vehicles or PRC companies by such means as acquisition, trust, proxy, voting rights,
repurchase, convertible bonds or other arrangements. Circular 37 further requires amendment to the registration in the event of
any changes with respect to the basic information of the special purpose vehicle, such as changes in a PRC resident individual
shareholder, name or operation period; or any significant changes with respect to the special purpose vehicle, such as increase
or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. If
the shareholders of the offshore holding company who are PRC residents do not complete their registration with the local SAFE
branches, the PRC subsidiaries may be prohibited from distributing their profits and proceeds from any reduction in capital, share
transfer or liquidation to the offshore company, and the offshore company may be restricted in our ability to contribute additional
capital to our PRC subsidiaries. Moreover, failure to comply with SAFE registration and amendment requirements described above
could result in liability under PRC law for evasion of applicable foreign exchange restrictions. On February 28, 2015, SAFE promulgated
a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or Circular 13, which
became effective on June 1, 2015. In accordance with Circular 13, entities and individuals are required to apply for foreign exchange
registration of foreign direct investment and overseas direct investment, including those required under the Circular 37, with
qualified banks, instead of SAFE. The qualified banks, under the supervision of SAFE, directly examine the applications and conduct
the registration.
We
requested all of our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial
owners fall within the ambit of Circular 37 and Circular 13 and to register with the local SAFE branch as required under Circular
37 and Circular 13 as applicable. As of the date of this 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.
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 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. The Ministry of Commerce is currently soliciting
comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation.
The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure,
corporate governance and business operations in many aspects.
Among
other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual
control” in determining whether a company should be treated as a foreign-invested enterprise, or an FIE. According to the
definition set forth in the draft Foreign Investment Law, FIEs refer to enterprises established in China pursuant to PRC law that
are solely or partially invested by foreign investors. The draft Foreign Investment Law specifically provides that entities established
in China (without direct foreign equity ownership) but “controlled” by foreign investors, through contract or trust
for example, will be treated as FIEs. Once an entity falls within the definition of FIE, it may be subject to foreign investment
“restrictions” or “prohibitions” set forth in a “negative list” to be separately issued by
the State Council later. If an FIE proposes to conduct business in an industry subject to foreign investment “restrictions”
in the “negative list,” the FIE must go through a market entry clearance by the Ministry of Commerce before being
established. An FIE is prohibited from conducting business in an industry subject to foreign investment “prohibitions”
in the “negative list”. However, an FIE, during the market entry clearance process, may apply in writing to be treated
as a PRC domestic enterprise if its foreign investor(s) is/are ultimately “controlled” by PRC government authorities
and its affiliates and/or PRC citizens. In this connection, “control” is broadly defined in the draft law to cover
the following summarized categories: (i) holding 50% or more of the voting rights of the subject entity; (ii) holding less
than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other
equivalent decision making bodies, or having the voting power to exert material influence on the board, the shareholders’
meeting or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or
trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations.
The
“variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including
us with respect to our MVNO business, to obtain necessary licenses and permits in the industries that are currently subject to
foreign investment restrictions in China. Under the draft Foreign Investment Law, variable interest entities that are
controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by
foreign investors. Therefore, for any companies with a VIE structure in an industry category that is included in the
“negative list” as restricted industry, the VIE structure may be deemed legitimate only if the ultimate
controlling person(s) is/are of PRC nationality (either PRC government authorities and its affiliates or PRC citizens).
Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be
treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance
may be considered as illegal.
The
draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with
a VIE structure, whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public
on this point. Moreover, it is uncertain whether the telecommunication business, in which our variable interest entity operates,
will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued.
If the enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as
Ministry of Commerce market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties
as to whether such clearance can be timely obtained, or at all.
The
draft Foreign Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase
our compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting
requirements on foreign investors and the applicable FIEs.
Aside
from investment implementation report and investment amendment report that are required at each investment and alteration of investment
specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly
basis. Any company found to be non-compliant with these information reporting obligations may potentially be subject to fines
and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.
The
enforcement of the labor laws and other labor-related regulations in the PRC may adversely affect our results of operations.
On
June 29, 2007, the Standing Committee of the National People’s Congress of China enacted the Labor Contract Law, which became
effective on January 1, 2008 and revised on December 28, 2012. The Labor Contract Law introduces specific provisions related to
fixed-term employment contracts, part-time employment, probation, consultation with labor union and employee assemblies, employment
without a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement
of labor laws and regulations. According to the Labor Contract Law, an employer is obliged to sign an unlimited-term labor contract
with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew
a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unlimited
term, with certain exceptions. The employer must pay severance to an employee where a labor contract is terminated or expires,
with certain exceptions. In addition, the government has continued to introduce various new labor-related regulations after the
effectiveness of the Labor Contract Law. Among other things, it is required that that annual leave ranging from five to 15 days
be made available to employees and that the employee be compensated for any untaken annual leave days in the amount of three times
of the employee’s daily salary, subject to certain exceptions. As a result of these regulations designed to enhance labor
protection and increasing labor costs in China, our labor costs have increased. In addition, as the interpretation and implementation
of these new regulations are still evolving, we cannot assure you that our employment practice will at all times be deemed in
compliance with the new regulations. If we are subject to severe penalties or incur significant liabilities in connection with
labor disputes or investigations, our business and results of operations may be adversely affected.
Our
failure to make adequate contributions to various employee benefit plans as required by PRC regulations may subject us to penalties.
Companies
operating in China are required to participate in various government sponsored employee benefit plans, including certain social
insurance, housing funds and other welfare-oriented payment obligations. Our failure to make contributions to various employee
benefit plans and to comply with applicable PRC labor-related laws may subject us to late payment penalties. If we are subject
to such penalties in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely
affected.
If
the custodians or authorized users of our controlling non-tangible assets, including corporate chops and seals, fail to fulfill
their responsibilities or misappropriate or misuse those assets, our business and operations could be materially and adversely
affected.
In
China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied
by a signature. Under PRC law, legal documents for corporate transactions, including contracts and leases that our business relies
upon, are executed using “corporate chops,” which are instruments that contain either the official seal of the signing
entity or the signature of a legal representative whose designation is registered and filed with the State Administration for
Industry and Commerce, or SAIC.
Our
PRC subsidiaries generally execute legal documents with corporate chops. One or more of our corporate chops may be used to, among
other things, execute commercial sales or purchase contracts, procurement contracts and office leases, open bank accounts, issue
checks and to issue invoices. We believe that it has sufficient controls in place over access to and use of the chops. Our chops,
or chops, including the chops at headquarters level and of each PRC subsidiary, are kept securely at our legal department under
the direction of the executive officers at vice president level or higher. Use of chops requires proper approvals in accordance
with our internal control procedures. The custodian at our legal department also maintains a log to keep a detailed record or
each use of the chops.
However,
we cannot assure you that unauthorized access to or use of those chops can be prevented. Our designated employees who hold the
corporate chops could abuse their authority by, for example, binding us to contracts against our interests or intentions, which
could result in economic harm, disruption or our operations or other damages to them as a result of any contractual obligations,
or resulting disputes, that might arise. If the party contracting with us asserted that we did not act in good faith under such
circumstances, then we could incur costs to nullify such contracts. Such corporate or legal action could involve significant time
and resources, while distracting management from our operations. In addition, we may not be able to recover corporate assets that
are sold or transferred out of our control in the event of such a misappropriation if a transferee relies on the apparent authority
of the representative and acts in good faith.
If
a designated employee uses a chop in an effort to obtain control over one or more of our PRC subsidiaries, we would need to take
legal action to seek the return of the applicable chop(s), apply for a new chop(s) with the relevant authorities or otherwise
seek legal redress for the violation of their duties. During any period where we lose effective control of the corporate activities
of one or more of our PRC subsidiaries as a result of such misuse or misappropriation, the business activities of the affected
entity could be disrupted and we could lose the economic benefits of that aspect of our business. To the extent those chops are
stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely
and adversely compromised and the operations of those entities could be significantly and adversely impacted.
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.
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.
The
above risk factors also apply to our pending acquisition of KADI and our investment transaction into Colmei and Crave. Any of
these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional
risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations.
Our
contractual arrangements may not be as effective in providing control over the variable interest entity as direct ownership.
We
rely on contractual arrangements with our variable interest entity to operate our MVNO business in China. These contractual arrangements may not be as effective as
direct ownership in providing us with control over our variable interest entity and our subsidiaries. If we had direct
ownership of the variable interest entity, we would be able to exercise our rights as an equity holder directly to effect
changes in the board of directors of the variable interest entity, which could effect changes at the management and
operational level. Under our contractual arrangements, we may not be able to directly change the members of the board of
directors of the variable interest entity and would have to rely on the variable interest entity and the variable interest
entity equity holders to perform their obligations in order to exercise control over the variable interest entity. The
variable interest entity equity holders may have conflicts of interest with us or our shareholders, and they may not act in
the best interests of us or may not perform their obligations under these contracts. For example, our variable interest
entity and our respective equity holders could breach their contractual arrangements with them by, among other things,
failing to conduct their operations, including maintaining our websites and using our domain names and trademarks which the
variable interest entity has exclusive rights to use, in an acceptable manner or taking other actions that are detrimental to
our interests. Pursuant to the call option, we may replace the equity holders of the variable interest entity at any time
pursuant to the contractual arrangements. However, if any equity holder is uncooperative and any dispute relating to these
contracts or the replacement of the equity holders remains unresolved, we will have to enforce our rights under the
contractual arrangements through the operations of PRC law and arbitral or judicial agencies, which may be costly and
time-consuming and will be subject to uncertainties in the PRC legal system.
Any
failure by our variable interest entity or our equity holders to perform their obligations under the contractual arrangements
would have a material adverse effect on our business, financial condition and results of operations.
If
our variable interest entity or our equity holders fail to perform their respective obligations under the contractual arrangements,
we may have to incur substantial costs and expend additional resources to enforce such arrangements. Although we have entered
into exclusive option agreements in relation to the variable interest entity, which provide that we may exercise an option to
acquire, or nominate a person to acquire, ownership of the equity in that entity to the extent permitted by applicable PRC laws,
rules and regulations, the exercise of these call options is subject to the review and approval of the relevant PRC governmental
authorities. We have also entered into share pledge agreements with respect to the variable interest entity to secure certain
obligations of the variable interest entity or our equity holders to us under the contractual arrangements. However, the enforcement
of such agreements through arbitral or judicial agencies may be costly and time-consuming and will be subject to uncertainties
in the PRC legal system. Moreover, our remedies under the share pledge agreements are primarily intended to help it collect debts
owed to us by the variable interest entity or the variable interest entity equity holders under the contractual arrangements and
may not help us in acquiring the assets or equity of the variable interest entity.
In
addition, although the terms of the contractual arrangements provide that they will be binding on the successors of the variable
interest entity equity holders, as those successors are not a party to the agreements, it is uncertain whether the successors
in case of the death, bankruptcy or divorce of a variable interest entity equity holder will be subject to or will be willing
to honor the obligations of such variable interest entity equity holder under the contractual arrangements. If the variable interest
entity or our equity holder (or our successor), as applicable, fails to transfer the shares of the variable interest entity according
to the respective exclusive option agreement or share pledge agreement, we would need to enforce our rights under the exclusive
option agreement or share pledge agreement, which may be costly and time-consuming and may not be successful. The contractual
arrangements are governed by PRC law and provide for the resolution of disputes through arbitration or court proceedings in China.
Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance
with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United
States. Moreover, there are very few precedents and little formal guidance as to how contractual arrangements in the context of
a variable interest entity should be interpreted or enforced under PRC law, and as a result it may be difficult to predict how
an arbitration panel or court would view such contractual arrangements. As a result, uncertainties in the PRC legal system could
limit our ability to enforce the contractual arrangements. Under PRC law, if the losing parties fail to carry out the arbitration
awards or court judgments within a prescribed time limit, the prevailing parties may only enforce the arbitration awards or court
judgments in PRC courts, which would require additional expense and delay. In the event we are unable to enforce the contractual
arrangements, we may not be able to exert effective control over the variable interest entity and our subsidiaries, and our ability
to conduct our business, as well as our financial condition and results of operations, may be materially and adversely affected.
We
may lose the ability to use, or otherwise benefit from, the licenses, approvals and assets held by our variable interest entity,
which could severely disrupt our business, render us unable to conduct some or all of our business operations and constrain our
growth.
Although
the significant majority of our revenues are generated, and the significant majority of our operational assets are held, by our
wholly-foreign owned enterprises, which are our subsidiaries, our variable interest entity hold licenses and approvals and assets
that are necessary for our business operations, as well as equity interests in a series of our portfolio companies, to which foreign
investments are typically restricted or prohibited under applicable PRC law. The contractual arrangements contain terms that specifically
obligate variable interest entity equity holders to ensure the valid existence of the variable interest entity and restrict the
disposal of material assets of the variable interest entity. However, in the event the variable interest entity equity holders
breach the terms of these contractual arrangements and voluntarily liquidate the variable interest entity or any of our subsidiary,
or any of these entities declares bankruptcy and all or part of our assets become subject to liens or rights of third-party creditors,
or are otherwise disposed of without our consent, we may be unable to conduct some or all of our business operations or otherwise
benefit from the assets held by the variable interest entity or our subsidiaries, which could have a material adverse effect on
our business, financial condition and results of operations. Furthermore, if our variable interest entity undergoes a voluntary
or involuntary liquidation proceeding, our equity holders or unrelated third-party creditors may claim rights to some or all of
the assets of such variable interest entity, thereby hindering our ability to operate our business as well as constrain our growth.
The
equity holders, directors and executive officers of the variable interest entity, as well as our employees who execute other strategic
initiatives may have potential conflicts of interest with us.
PRC
laws provide that a director and an executive officer owes a fiduciary duty to the company he or she directs or manages. The directors
and executive officers of the variable interest entity must act in good faith and in the best interests of the variable interest
entity and must not use their respective positions for personal gain. We control our variable interest entity through contractual
arrangements and the business and operations of our variable interest entity are closely integrated with the business and operations
of our subsidiaries. Nonetheless, conflicts of interests for these individuals may arise due to dual roles both as directors and
executive officers of the variable interest entity and as our directors or employees, and may also arise due to dual roles both
as variable interest entity equity holders and as our directors or employees. We cannot assure you that these individuals will
always act in our best interests should any conflicts of interest arise, or that any conflicts of interest will always be resolved
in our favor. Moreover, we also cannot assure you that these individuals will ensure that the variable interest entity will not
breach the existing contractual arrangements. If we cannot resolve any such conflicts of interest or any related disputes, we
would have to rely on legal proceedings to resolve these disputes and/or take enforcement action under the contractual arrangements.
There is substantial uncertainty as to the outcome of any such legal proceedings.
The
contractual arrangements with our variable interest entity may be subject to scrutiny by the PRC tax authorities. Any adjustment
of related party transaction pricing could lead to additional taxes, and therefore substantially reduce our consolidated net income
and the value of your investment.
The
tax regime in China is rapidly evolving and there is significant uncertainty for taxpayers in China as PRC tax laws may be interpreted
in significantly different ways. The PRC tax authorities may assert that we or our subsidiaries or the variable interest entity
or their equity holders owe and/or are required to pay additional taxes on previous or future revenue or income. In particular,
under applicable PRC laws, rules and regulations, arrangements and transactions among related parties, such as the contractual
arrangements with our variable interest entity, may be subject to audit or challenge by the PRC tax authorities. If the PRC tax
authorities determine that any contractual arrangements were not entered into on an arm’s length basis and therefore constitute
a favorable transfer pricing, the PRC tax liabilities of the relevant subsidiaries and/or variable interest entity and/or variable
interest entity equity holders could be increased, which could increase our overall tax liabilities. In addition, the PRC tax
authorities may impose late payment interest. Our net income may be materially reduced if our tax liabilities increase.
Risks
Related to the Electric Vehicle Industry
Future
growth is dependent upon consumers’ willingness to adopt electric vehicles.
Due
to our contemplated acquisition of a controlling position of Shanghai KADI Machinery Technology Co., Ltd (“KADI”),
our future prospects are highly dependent upon the timing and pace of consumer adoption of alternative fuel vehicles in general
and electric vehicles in particular. The market for alternative fuel vehicles is relatively new and rapidly evolving, characterized
by rapidly changing technologies, price and product competition, newly-emerging competitors, evolving government regulation and
industry standards, frequent new vehicle announcements and changing consumer demands and behaviors. If the market for electric
vehicles in China does not develop as we expect or develops more slowly than we expect, our business, prospects, financial condition
and operating results will be harmed.
Developments
in alternative technologies or improvements in the internal combustion engine
may materially adversely affect the demand for our
electric vehicle products.
Significant
developments in alternative technologies, such as advanced diesel, ethanol, fuel cells or compressed natural gas, or improvements
in the fuel economy of the internal combustion engine, may materially and adversely affect our business and prospects in ways
we do not currently anticipate. Any failure by us to develop new or enhanced technologies or processes, or to react to changes
in existing technologies, could materially delay our development and introduction of new and enhanced electric vehicle products,
which could result in the loss of competitiveness of our vehicles, decreased revenue and a loss of market share to competitors.
If
we are unable to keep up with advances in electric vehicle technology, we may suffer a decline in our competitive position.
We
may be unable to keep up with changes in electric vehicle technology, and we may suffer a resulting decline in our competitive
position. Any failure to keep up with advances in electric vehicle technology would result in a decline in our competitive position
which would materially and adversely affect our business, prospects, operating results and financial condition. Our research and
development efforts may not be sufficient to adapt to changes in electric vehicle technology.
Extended
periods of low diesel or other petroleum-based fuel prices could adversely affect demand for electric vehicles, which would adversely
affect our business and operating results.
We
believe that much of the present and projected demand for commercial electric vehicles results from concerns about volatility
in the cost of petroleum-based fuel, government regulations and economic incentives promoting fuel efficiency and alternative
forms of energy, as well as the belief that climate change results in part from the burning of fossil fuels. If the cost of petroleum-based
fuel decreased significantly, the government eliminated or modified its regulations or economic incentives related to fuel efficiency
and alternative forms of energy, or if there is a change in the perception that the burning of fossil fuels negatively impacts
the environment, the demand for commercial electric vehicles could be reduced, and our business and revenue could be harmed.
We
may be subject to product liability claims or recalls which could
be expensive, damage our reputation or result in a diversion of management
resources.
We
may be subject to lawsuits resulting from injuries associated with the use of the vehicles in which the modules products of KADI
are involved. We may incur losses relating to these claims or the defense of these claims. There is a risk that claims or liabilities
will exceed our insurance coverage. In addition, we may be unable to retain adequate liability insurance in the future.
We
may also be required to participate in recalls involving vehicles with our products, if any prove to be defective, or we may voluntarily
initiate a recall or make payments related to such claims as a result of various industry or business practices or the need to
maintain good customer relationships. Such a recall would result in a diversion of resources. While we do maintain product liability
insurance, we cannot assure investors that it will be sufficient to cover all product liability claims, that such claims will
not exceed our insurance coverage limits or that such insurance will continue to be available on commercially reasonable terms,
if at all. Any product liability claim brought against us could have a material adverse effect on the results of our operations.
Since
KADI’s products primarily involve the central control mechanism of electric vehicles, defective designs or defective components
parts can cause significant damage or injury, and our liability risks will increase. While we have had no product liability claims
to date, we have relatively little experience with these products, and our insurance coverage may not be sufficient to cover potential
claims in the future.
Changes to
the government subsidy support policies in the PRC and further delays in subsidy payments may
have negative impacts on the electric vehicle market.
The
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 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. We are not aware of any PRC regulations or proposed regulations that will specifically restrict or limit the electric
vehicle related 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 involves transactional and integration risks.
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 three scheduled cash advances to KADI totaling $450,000
as of April 30, 2018 and the fourth and last $150,000 advance shall be made by mid-May 2018. These advances will be deducted from
our initial cash payments to KADI under the definitive agreement being negotiated. We will use a portion of the proceeds from
this offering to fund the acquisition of KADI. As a result, if the offering is not consummated, 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.
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.
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.
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 our largest shareholder, Zhengqi, at the original purchase
price and for an aggregate amount of $10.05 million. The repurchase transaction is not yet completed, and although the
purchase price for the trannsaction 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
are working with Zhengqi to satisfy certain conditions and make necessary arrangements before completing the
repurchase, including confirming the consent of Borqs' existing lenders with respect to the transaction, submitting the
shares to the transfer agent for cancellation, releasing the escrowed earnout shares from escrow and returning such
shares to the former Borqs International shareholders in proportion to their ownership prior to the completion of
the business combination on August 18, 2017. We anticipate closing the transaction within 2018.
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 will not benefit from the expected return of 1,227,625 escrowed earnout shares to
the former Borqs International shareholders, which will occur when the repurchase from Zhengqi closes. 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. Further, if the Zhengqi repurchase transaction is not completed, up to 1,278,776 ordinary shares currently
in escrow may not be timely released to the former Borqs International shareholders based on their respective proportionate interests
in the merger consideration, and they may sue the Company for any damages they suffer as a result. Any such litigation could be
time-consuming and costly, and could materially adversely affect our financial condition and results of operations.
Dependency
on Crave and Colmei and financial risks.
Our
agreement to purchase shares of Crave and Colmei from the shareholders of those companies may lead us to be more dependent on
Crave and Colmei for both components and manufacturing. There is no assurance that Crave and Colmei continue to provide competitive
pricing of components and for manufacturing services. There is no assurance that the value of our ownership of Crave and Colmei
will not decline, potentially causing a material adverse effect on our financial condition.