20-F 1 f20f2018_lianluosmart.htm ANNUAL REPORT

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F

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

OR

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018

OR

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

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

Date of event requiring this shell company report __________

For the transition period from __________ to __________

Commission file number: 001-34661

Lianluo Smart Limited

(Exact name of Registrant as specified in its charter)

British Virgin Islands

(Jurisdiction of incorporation or organization)

Room 2108, 21st Floor,

China Railway Construction Building,

No. 20 Shijingshan Road, 100040, Beijing, China

(Address of principal executive offices)

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

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

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

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

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

As of December 31, 2018, there were 17,806,586 shares of the registrant’s Common Shares outstanding.

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

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

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

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

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

Large accelerated filer ☐ | Accelerated filer ☐ | Non-accelerated filer ☒
|  | ☐ Emerging growth company

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

US GAAP ☒ | International Financial Reporting Standards as issued by the International Accounting Standards Board ☐ | Other ☐

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

TABLE OF CONTENTS

PART I |
Item 1. | Identity of Directors, Senior Management and Advisers | 1
Item 2. | Offer Statistics and Expected Timetable | 1
Item 3. | Key Information | 2
Item 4. | Information on the Company | 27
Item 4A. | Unresolved Staff Comments | 43
Item 5. | Operating and Financial Review and Prospects | 43
Item 6. | Directors, Senior Management and Employees | 64
Item 7. | Major Shareholder and Related Party Transactions | 72
Item 8. | Financial Information | 74
Item 9. | The Offer and Listing | 75
Item 10. | Additional Information | 76
Item 11. | Quantitative and Qualitative Disclosures about Market Risk | 83
Item 12. | Description of Securities Other than Equity Securities | 84
PART II |
Item 13. | Defaults, Dividend Arrearages and Delinquencies | 85
Item 14. | Material Modifications to the Rights of Securities Holders and Use of Proceeds | 85
Item 15. | Controls and Procedures | 85
Item 15T. | Controls and Procedures | 87
Item 16. | [Reserved] | 87
Item 16A. | Audit Committee Financial Expert | 87
Item 16B. | Code of Ethics | 88
Item 16C. | Principal Accountant Fees and Services | 88
Item 16D. | Exemptions from the Listing Standards for Audit Committees | 89
Item 16E. | Purchases of Equity Securities by the Issuer and Affiliated Purchasers | 89
Item 16F. | Change in Registrant’s Certifying Accountant. | 89
Item 16G. | Corporate Governance. | 89
Item 16H. | Mine Safety Disclosure. | 89
PART III |
Item 17. | Financial Statements | 90
Item 18. | Financial Statements | 90
Item 19. | Exhibits | 90

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SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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PART I

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

Item 1. | Identity of Directors, Senior Management and Advisers

Not applicable for annual reports on Form 20-F.

Item 2. | Offer Statistics and Expected Timetable

Not applicable for annual reports on Form 20-F.

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Item 3. | Key Information

| A. | Selected Financial Data

The following table presents the selected consolidated financial information for our company. The selected consolidated statements of income data for the three years ended December 31, 2018, 2017 and 2016 and the consolidated balance sheet data as of 2018 and 2017 have been derived from our audited consolidated financial statements set forth in “Item 18 – Financial Statements”. The selected consolidated statements of comprehensive income data for the years ended December 31, 2015 and 2014 and the selected consolidated balance sheets data as of December 31, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements for the years ended December 31, 2016, 2015 and 2014, which are not included in this annual report. Our historical results do not indicate results expected for any future periods. The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” are shown below. Our audited consolidated financial statements are prepared and presented in accordance with Generally Accepted Accounting Principles in the United States of America, or U.S. GAAP.

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |  |  | 2015 |  |  | 2014 |
Revenues |  | $ | 559,386 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |  |  | $ | 738,301 |  |  | $ | 2,774,241 |
Costs of revenue |  |  | (757,901 | ) |  |  | (1,655,970 | ) |  |  | (17,179,060 | ) |  |  | (1,094,124 | ) |  |  | (1,802,864 | )
Gross loss |  |  | (198,515 | ) |  |  | (773,959 | ) |  |  | (4,116,687 | ) |  |  | (355,823 | ) |  |  | (971,377 | )
Service income |  |  | - |  |  |  | 56,030 |  |  |  | 14,587 |  |  |  | 1,600,012 |  |  |  | 47,665 |
Service expenses |  |  | - |  |  |  | (1,289 | ) |  |  | (21,130 | ) |  |  | (1,234,257 | ) |  |  | (29,022 | )
Selling expenses |  |  | (2,082,829 | ) |  |  | (1,170,378 | ) |  |  | (927,243 | ) |  |  | (2,815,609 | ) |  |  | (138,981 | )
General and administrative expenses |  |  | (3,675,465 | ) |  |  | (3,192,030 | ) |  |  | (4,183,775 | ) |  |  | (4,089,592 | ) |  |  | (1,929,206 | )
(Provision for) recovery from doubtful accounts |  |  | (22,229 | ) |  |  | 23,608 |  |  |  | 150,280 |  |  |  | (8,544 | ) |  |  | (347,891 | )
Impairment loss for intangible assets |  |  | (3,281,779 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Operating loss |  |  | (9,260,817 | ) |  |  | (5,058,018 | ) |  |  | (9,083,968 | ) |  |  | (6,903,813 | ) |  |  | (1,426,058 | )
(Loss) profit before provision for income tax and non-controlling interest |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,704,761 | ) |  |  | (6,710,848 | ) |  |  | 1,327,562 |
Income tax benefit (expense) |  |  | - |  |  |  | - |  |  |  | 95,026 |  |  |  | 11,978 |  |  |  | (357,726 | )
Net (loss) profit from continuing operations |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,609,735 | ) |  |  | (6,698,870 | ) |  |  | 969,836 |
Discontinued operations: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss from operations of discontinued operations, net of taxes |  |  | - |  |  |  | - |  |  |  | (168,574 | ) |  |  | (3,663,465 | ) |  |  | (26,003,708 | )
Loss from disposal of discontinued operations, net of taxes |  |  | - |  |  |  | - |  |  |  | (82,579 | ) |  |  | - |  |  |  | - |
Net loss |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,860,888 | ) |  |  | (10,362,335 | ) |  |  | (25,033,872 | )
Less: net loss attributable to non-controlling interest |  |  | - |  |  |  | - |  |  |  | (129,020 | ) |  |  | (139,205 | ) |  |  | (735,758 | )
Net loss attributable to Lianluo Smart Limited |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,731,868 | ) |  | $ | (10,223,130 | ) |  | $ | (24,298,114 | )
Other comprehensive (loss) income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Foreign currency translation (loss) gain |  |  | (515,477 | ) |  |  | 380,077 |  |  |  | (567,162 | ) |  |  | (461,548 | ) |  |  | (576,891 | )
Comprehensive loss |  |  | (9,425,479 | ) |  |  | (4,756,357 | ) |  |  | (10,428,050 | ) |  |  | (10,823,883 | ) |  |  | (25,610,763 | )
-less comprehensive loss attributable to non-controlling interest |  |  | - |  |  |  | - |  |  |  | (230,838 | ) |  |  | (189,670 | ) |  |  | (762,777 | )
Comprehensive loss attributable to Lianluo Smart Limited |  | $ | (9,425,479 | ) |  | $ | (4,756,357 | ) |  | $ | (10,197,212 | ) |  | $ | (10,634,213 | ) |  | $ | (24,847,986 | )
Weighted average number of common shares used in computation |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
-Basic |  |  | 17,617,416 |  |  |  | 17,312,586 |  |  |  | 10,422,765 |  |  |  | 5,990,552 |  |  |  | 5,510,076 |
-Diluted |  |  | 17,617,416 |  |  |  | 17,312,586 |  |  |  | 10,422,765 |  |  |  | 5,990,552 |  |  |  | 5,597,169 |
Net loss per share of common stock |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
-Basic |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.93 | ) |  | $ | (1.71 | ) |  | $ | (4.41 | )
-Diluted |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.93 | ) |  | $ | (1.71 | ) |  | $ | (4.34 | )

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|  | December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |  |  | 2015 |  |  | 2014 |
Balance Sheet Data: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 477,309 |  |  | $ | 6,809,485 |  |  | $ | 10,792,823 |  |  | $ | 615,517 |  |  | $ | 1,639,746 |
Working capital |  |  | 1,260,558 |  |  |  | 7,152,147 |  |  |  | 10,221,074 |  |  |  | 462,687 |  |  |  | 9,739,149 |
Total current assets |  |  | 2,713,362 |  |  |  | 9,833,029 |  |  |  | 11,336,148 |  |  |  | 6,868,333 |  |  |  | 13,468,644 |
Total assets |  |  | 5,698,670 |  |  |  | 15,563,108 |  |  |  | 16,552,137 |  |  |  | 13,875,247 |  |  |  | 21,321,309 |
Total current liabilities |  |  | 1,452,804 |  |  |  | 2,680,882 |  |  |  | 1,115,074 |  |  |  | 6,405,646 |  |  |  | 3,729,495 |
Non-controlling interest |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 867,826 |  |  |  | 1,057,496 |
Total Lianluo Smart Limited shareholders’ equity |  |  | 3,116,620 |  |  |  | 11,153,115 |  |  |  | 13,937,701 |  |  |  | 6,439,039 |  |  |  | 15,981,258 |
Common shares |  |  | 48,630 |  |  |  | 47,281 |  |  |  | 47,281 |  |  |  | 16,918 |  |  |  | 15,864 |
Total equity |  |  | 3,116,620 |  |  |  | 11,153,115 |  |  |  | 13,937,701 |  |  |  | 7,306,86 |  |  |  | 17,038,754 |

Exchange Rate Information

Our business is primarily conducted in China and all of our revenues are denominated in RMB. However, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using the then current exchange rates, for the convenience of the readers. The conversion of RMB into U.S. dollars in this annual financial report is based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this annual financial report were made at a rate of RMB 6.8755 to US $1.00, the middle exchange rate in effect as of December 31, 2018. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The government of the People’s Republic of China (the “PRC”) imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. The Company does not currently engage in currency hedging transactions. The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated.

|  | Noon Buying Rate |
Period |  | Period-End |  |  | Average (1) |  |  | Low |  |  | High |
|  | (RMB per U.S. dollar) |  |  |  |
2011 |  |  | 6.2939 |  |  |  | 6.4475 |  |  |  | 6.2939 |  |  |  | 6.6364 |
2012 |  |  | 6.2301 |  |  |  | 6.2990 |  |  |  | 6.2221 |  |  |  | 6.3879 |
2013 |  |  | 6.0537 |  |  |  | 6.0738 |  |  |  | 6.0537 |  |  |  | 6.0927 |
2014 |  |  | 6.2046 |  |  |  | 6.1886 |  |  |  | 6.2256 |  |  |  | 6.1490 |
2015 |  |  | 6.4893 |  |  |  | 6.2360 |  |  |  | 6.0775 |  |  |  | 6.4724 |
2016 |  |  | 6.9449 |  |  |  | 6.6445 |  |  |  | 6.4494 |  |  |  | 7.0672 |
2017 |  |  | 6.5074 |  |  |  | 6.7553 |  |  |  | 6.4686 |  |  |  | 6.9535 |
2018 |  |  | 6.8755 |  |  |  | 6.6090 |  |  |  | 6.2649 |  |  |  | 6.9737 |
2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
January |  |  | 6.6958 |  |  |  | 6.7863 |  |  |  | 6.6958 |  |  |  | 6.8708 |
February |  |  | 6.6912 |  |  |  | 6.7367 |  |  |  | 6.6822 |  |  |  | 6.7907 |
March |  |  | 6.7112 |  |  |  | 6.7119 |  |  |  | 6.6916 |  |  |  | 6.7381 |
April |  |  | 6.7347 |  |  |  | 6.7161 |  |  |  | 6.6870 |  |  |  | 6.7418 |
May (through May 10, 2019) |  |  | 6.8217 |  |  |  | 6.7705 |  |  |  | 6.7319 |  |  |  | 6.8256 |

Source: Federal Reserve Statistical Release

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

| B. | Capitalization and Indebtedness

Not applicable for annual reports on Form 20-F.

| C. | Reasons for the Offer and Use of Proceeds

Not applicable for annual reports on Form 20-F.

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| D. | Risk Factors

Risks Related to Our Business

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

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

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

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

New sleep respiratory disorder related technology and relevant regulation could materially affect provision of our OSAS service to hospitals and medical centers. Development of our OSAS service business depends on our ability to decrease OSAS service related device production cost and the relationship with hospital and medical center. It may take an extended period of time for us to decrease the cost of our new devices and to market our new devices. We may be unable to provide service to sufficient hospitals and medical centers, which could adversely affect our financial condition and results of operations and prospects.

We sell our products primarily to distributors, and our technical services are provided to hospitals and check-up centers; our ability to add distributors, hospital and check-up centers will impact our revenue growth. Failure to maintain or expand our distribution network and network of hospital and check-up centers would materially and adversely affect our business.

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

In the OSAS sector, starting from fiscal 2018 we provide technical services in relation to detection and analysis of Obstructive Sleep Apnea Syndrome (“OSAS”). We focused on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in public hospitals and medical centers in China. We sign service agreements with public hospitals usually for a period of 1 to 3 years, and check-up centers usually for a period of one year or less, with the aim of provision of wearable sleep diagnostic products and cloud-based services and we charge a fixed technical service fee on a per user basis when our OSAS diagnostic services are provided to the user at medical centers and public hospitals. Our service revenue is dependent on the number of OSAS tests performed by each hospital/check-up center. The provision of these OSAS diagnosis services is still in its early stage and we may require to invest more marketing efforts in order to build up and consolidate our partnership with hospitals and physical examination centers in China. We may terminate relationships with underperforming hospital/check-up center. The hospital/check-up may also terminate their relationship with us without penalty, and they may not renew their service agreement with us upon expiration.

Any disruption in our distribution network and network of hospital and check-up centers could have negative effects on our ability to market our products and services, which would in turn materially and adversely affect our business, financial condition and results of operations.

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We sell products for some of our competitors, and some of such products compete with our own branded products.

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

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

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

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

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

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

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

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

| ● | political instability;
| ● | economic instability and recessions;
| ● | changes in tariffs;
| ● | difficulties of administering foreign operations generally;
| ● | limited protection for intellectual property rights;
| ● | obligations to comply with a wide variety of foreign laws and other regulatory requirements;
| ● | financial condition, expertise and performance of international distributors;
| ● | export license requirements;
| ● | unauthorized re-export of our branded products;
| ● | inability to purchase our distributed products from international suppliers at competitive prices;
| ● | potentially adverse tax consequences; and
| ● | inability to effectively enforce contractual or legal rights.

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

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

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

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

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

We face direct competition from both domestic and international competitors across all product lines and price points. Our competitors also vary by product. Currently, in China our competitors include publicly traded and privately held multinational companies. As we expand into international markets, we expect that our competitors will primarily be publicly traded and privately held multinational companies. We also expect to face competition in international sales from companies that have local operations in the markets in which we sell our products. Some of our larger competitors may have:

| ● | greater financial and other resources;
| ● | larger variety of products;
| ● | more products that have received regulatory approvals;

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| ● | greater pricing flexibility;
| ● | more extensive research and development and technical capabilities;
| ● | patent portfolios that may present an obstacle to our conduct of business;
| ● | greater knowledge of local market conditions where we seek to increase our international sales;
| ● | stronger brand recognition; and
| ● | larger sales and distribution networks.

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

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

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

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

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

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

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

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

| ● | continued enhancement of our research and development capabilities;

| ● | information technology system enhancement;

| ● | stringent cost controls and sufficient liquidity;

| ● | strengthening of financial and management controls and information technology systems; and

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

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

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

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

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

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

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

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

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

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

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

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

| ● | pay damage awards;

| ● | seek licenses from third parties;

| ● | pay ongoing royalties;

| ● | redesign our branded products; or

| ● | be restricted by injunctions.

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

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We are subject to product liability exposure and currently do not have insurance coverage for product-related liabilities. Any product liability claims or potential safety-related regulatory actions could damage our reputation and materially and adversely affect our business, financial condition and results of operations.

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

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

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

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

| ● | the integration of new operations, services and personnel;
| ● | unforeseen or hidden liabilities;
| ● | the diversion of resources from our existing businesses and technologies; our inability to generate sufficient revenue to offset the costs of acquisitions; and
| ● | potential loss of, or harm to, relationships with employees or customers, any of which could significantly disrupt our ability to manage our business and materially and adversely affect our business, financial condition and results of operations.

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

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

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

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

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

| ● | economic, political and other conditions in China and elsewhere.

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

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

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

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

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

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

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

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

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

We may need additional capital and we may not be able to obtain it.

We believe that our current cash and cash equivalents, cash flow from operations and proceeds from our financing activities will be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. In particular, the recent financial turmoil affecting the financial markets and banking system may significantly restrict our ability to obtain financing in the capital markets or from financial institutions on commercially reasonable terms, or at all.

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

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

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

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

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

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

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Foreign Operational Risks

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

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

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

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

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

Our risk management and internal control systems may not be effective and have deficiencies and material weaknesses

We are subject to the reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), has adopted rules requiring public companies to include a report of management on the effectiveness of such companies’ internal control over financial reporting in their respective annual reports. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting because we are currently a non-accelerated filer and therefore not required to obtain such report.

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Our management has concluded that under the rules of Section 404, our internal control over financial reporting was not effective as of December 31, 2018. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of our company’s financial statements will not be prevented, or detected and corrected on a timely basis. A significant deficiency is a deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. The material weakness we identified is our lack of sufficient qualified accounting personnel with appropriate understanding of U.S. GAAP and SEC reporting requirements commensurate with our financial reporting requirements, which resulted in a number of internal control deficiencies that were identified as being significant. Also, as a small company, we do not have sufficient internal control personnel to set up adequate review functions at each reporting level.

We are in the process of implementing measures to resolve the material weakness and improve our internal and disclosure controls. However, we may not be able to successfully implement the remedial measures. For example, we may not be able to identify and hire suitable personnel with the requisite U.S. GAAP and internal control experience. The implementation of our remedial initiatives may not fully address the material weakness and significant deficiencies in our internal control over financial reporting. In addition, the process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate in satisfying our reporting obligations.

As a result, our business and financial condition, results of operations and prospects, as well as the trading price of our common shares may be materially and adversely affected. Ineffective internal control over financial reporting could also expose us to increased risk of fraud or misuse of corporate assets, In turn, that could subject us to potential delisting from the stock exchange on which our common shares are listed, regulatory investigations or civil or criminal sanctions.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The global financial markets have experienced significant disruptions in the past, including the recent international trade disputes and tariff actions announced by the United States, the PRC and certain other countries. The U.S. administration has imposed significant amount of tariffs on Chinese goods, and the PRC government has imposed tariffs on certain goods manufactured in the United States. There is no assurance that the list of goods impacted by additional tariffs will not be expanded or the tariffs will not be increased materially. It is difficult to predict how PRC or U.S. government policy, in particular, the outbreak of a trade war between the PRC and the United States and the imposition in 2018 of additional tariffs on bilateral imports, may continue to impact the PRC.

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

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

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

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

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

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

We have granted share options to our PRC employees, which may require registration with SAFE. We may also face regulatory uncertainties that could restrict our ability to issue equity compensation to our directors and employees and other parties who are PRC citizens or residents under PRC law.

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 plan in an overseas publicly-listed company are required to register with SAFE or its 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 its 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 have adopted equity compensation plans and have begun to make option grants to some of our key employees, who are PRC citizens. If we or our PRC recipients of such options fail to comply with these regulations, we or our PRC option grantees may be subject to fines and other legal or administrative sanctions. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected.

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

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

Our auditor, like other independent registered public accounting firms operating in China and to the extent their audit clients have operations in China, is not permitted to be inspected by the U.S. Public Company Accounting Oversight Board and, as such, you may be deprived of the benefits of such inspection.

Our independent registered public accounting firm issues the audit report included in this Annual Report filed with the SEC. As auditors of companies that are traded publicly in the U.S., our public accounting firm is registered with the U.S. Public Company Accounting Oversight Board (United States) (the “PCAOB”). It is required by U.S. laws to be regularly inspected by the PCAOB to assess its compliance with the U.S. laws and professional standards.

Our operations, however, are mainly located in the PRC, a jurisdiction where PCAOB is currently not able to conduct inspections without the approval of PRC authorities. Our auditor, like other independent registered public accounting firms operating in China and Hong Kong (to the extent their audit clients have operations in China), is currently not subject to inspection by the PCAOB. In May 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission (“CSRC”) and the PRC 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 CSRC or the PRC Ministry of Finance in the United States and the PRC, respectively. PCAOB continues to be in discussions with the CSRC and the PRC Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with the PCAOB and audit Chinese companies that trade on U.S. exchanges.

Inspections of some other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures. Certain deficiencies revealed in the inspection process can be addressed to improve future audit quality. The inability of the PCAOB to conduct inspections of auditors operating in China makes it difficult to evaluate our auditor’s audit procedures and quality control procedures. As a result, our investors may not receive the benefits of the PCAOB inspections.

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

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

Proceedings instituted by the SEC against five PRC-based accounting firms could result in adverse impact on our business and price of our stock.

In late 2012, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the PRC-based units of five accounting firms. The Rule 102(e) proceedings initiated by the SEC relate to these firms’ failure to produce documents, including audit work papers, in response to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act of 2002, as the auditors located in the PRC are not in a position lawfully to produce documents directly to the SEC because of restrictions under PRC law and specific directives issued by the CSRC. The issues raised by the proceedings are not specific to our auditors or to us, but affect equally all audit firms based in China and all China-based businesses with securities listed in the United States.

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In January 2014, the administrative judge reached an Initial Decision that the PRC-based units of the “big four” accounting firms should be barred from practicing before the SEC for six months. The decision is neither final nor legally effective unless reviewed and approved by the SEC. In February 2014, four of these PRC-based accounting firms appealed to the SEC against this decision. In February 2015, each of the four PRC-based accounting firms agreed to a censure and paid a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. The settlement requires the firms to follow detailed procedures that seek to provide the SEC with access to Chinese firms’ audit documents via the CSRC. If the firms do not follow these procedures, the SEC could impose penalties such as suspensions, or it could restart the administrative proceedings.

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, public companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which may result in SEC’s revocation of the registration of their shares under the Exchange Act, including possible delisting. Moreover, although our independent registered public accounting firm was not named as a defendant in the above SEC administrative proceedings, any negative news about the proceedings against these audit firms may erode investor confidence in China-based, U.S. public companies, including us, and the market price of our shares may be adversely affected.

Risks Related to Our Shares

The trading price of our shares has been and is likely to continue to be volatile, which could result in substantial losses to our shareholders.

The trading price of our shares has been and is likely to continue to be volatile and could fluctuate widely in response to a variety of factors, many of which are beyond our control. In addition, the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes for our shares. Some of these companies have experienced significant volatility. The trading performances of these PRC companies’ securities at the time of or after their offerings may affect the overall investor sentiment towards other PRC companies listed in the United States and consequently may impact the trading performance of our shares. In addition to market and industry factors, the price and trading volume for our shares may be highly volatile for specific business reasons, including:

| ● | variations in our results of operations;

| ● | announcements about our earnings that are not in line with analyst expectations;

| ● | publication of operating or industry metrics by third parties, including government statistical agencies, that differ from expectations of industry or financial analysts;

| ● | changes in financial estimates by securities research analysts;

| ● | announcements made by us or our competitors of new product and service offerings, acquisitions, strategic relationships, joint ventures or capital commitments;

| ● | press and other reports, whether or not true, about our business;

| ● | negative reports published by short sellers, regardless of their veracity or materiality to our company;

| ● | changes or developments in the PRC or global regulatory environment;

| ● | litigation and regulatory allegations or proceedings that involve us;

| ● | changes in pricing we or our competitors adopt;

| ● | conditions in our industries;

| ● | additions to or departures of our management;

| ● | actual or perceived general economic and business conditions and trends in China and globally;

| ● | fluctuations of exchange rates between the Renminbi and the U.S. dollar;

| ● | sales or perceived potential sales or other disposition of existing or additional shares or other equity or equity-linked securities, including by our principal shareholders, directors officers and other affiliates

If we are treated as a passive foreign investment company, the U.S. holder generally will be subject to increased tax liability upon the sale of our common shares or upon the receipt of certain excess distributions.

We believe that we are not a passive foreign investment company for our taxable year ended December 31, 2018. However, because the tests for determining passive foreign investment company status for any taxable year are dependent upon a number of factors, some of which are beyond our control, including the value of our assets, which may be determined by reference to the market price of our common shares (which may be volatile), and the amount and type of our gross income. There can be no assurance that we will not be classified as a passive foreign investment company, which may result in adverse United States federal income tax consequences for United States investors in our common shares.

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We do not expect to pay dividends, so our shareholders will only benefit from an investment in our shares if such shares appreciate in value.

Currently, we do not expect to pay dividends to our shareholders. The Board of Directors may determine to pay dividends in the future, depending upon results of operations, financial condition, contractual restrictions, including restrictions in credit agreements, imposed by applicable law, and the laws of China governing dividend payments, currency conversion and loans, and other factors our Board of Directors deems relevant. Accordingly, realizing a gain on shareholders’ investments currently depends on whether the price of our shares appreciates in the securities exchange on which our shares trade. There is no guarantee that our shares will appreciate in value or even maintain the price at which shareholders purchased their shares.

If we become directly subject to the scrutiny involving U.S. listed Chinese companies, we may have to expend significant resources to investigate and/or defend the matter, which could harm our business operations, stock price and reputation.

During the last several years, U.S. public companies that have substantially all of their operations in China have been the subject of intense scrutiny by investors, financial commentators and regulatory agencies. Much of the scrutiny has centered on financial and accounting irregularities and mistakes, lacks of effective internal controls over financial reporting and, in many cases, allegations of fraud. As a result of the scrutiny, the publicly traded stock of many U.S.-listed Chinese companies that have been the subject of such scrutiny has sharply decreased in value.

If we become the subject of any such scrutiny, whether any allegations are true or not, we may have to expend significant resources to investigate such allegations and/or defend the Company. Such investigations or allegations will be costly and time-consuming and distract our management from our normal business and could result in our reputation being harmed. Our stock price could decline because of such allegations, even if the allegations are false.

We may fail to meet continued listing requirements on the NASDAQ Capital Market

Our shares are listed on the NASDAQ Capital Market. We must comply with various NASDAQ Marketplace rules to maintain the listing of our securities. The NASDAQ listing rules require, among other things, that a company’s stock trading to maintain a minimum bid price of $1.00. If a NASDAQ-listed company trades below the minimum bid price requirement for 30 consecutive business days, it will be notified of the deficiency.

To regain compliance with the minimum, bid price requirement, the Company must have a minimum, closing bid price of $1.00 or more for a minimum of ten consecutive business days during a 180-day compliance period. If compliance does not occur within the applicable 180-day compliance period, the Staff will notify the Company that its securities will be delisted from the NASDAQ Capital Market. However, the Company may appeal the Staff’s determination to delist its securities to a Hearing Panel. During any appeal process, the Company’s shares would continue to trade on the NASDAQ Capital Market.

If our securities were to be delisted from NASDAQ, the trading of our securities could possibly be shifted to the OTC Bulletin Board or the Pink Sheets. But, that would make it more difficult to dispose of, or obtain accurate quotations for the price of, our securities. In addition, such a development would likely also reduce the already limited coverage of our Company by security analysts and the news media. Delisting and these other effects could cause the price of our securities to decline further.

As a company incorporated in the British Virgin Islands, we can adopt certain home country practices regarding corporate governance matters that differ significantly from the NASDAQ Stock Market corporate governance listing standards. These practices may provide less protection to shareholders than they would enjoy if we complied fully with the NASDAQ Stock Market corporate governance listing standards.

As a British Virgin Islands company listed on the NASDAQ Stock Market, we are subject to the NASDAQ Stock Market corporate governance listing standards. But, NASDAQ Stock Market rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the British Virgin Islands, which is our home country, may differ significantly from the NASDAQ Stock Market corporate governance listing standards.

For example, BVI laws do not require shareholders’ approval prior to issuance (or potential issuance) of securities (i) equaling 20% or more of the company’s common stock or voting power for less than the greater of market or book value or (ii) resulting in a change of control of the company. Therefore, we could issue above mentioned amount of shares without shareholders’ approval. As such, our shareholders may receive less protection than they otherwise would under the NASDAQ Stock Market corporate governance listing standards applicable to U.S. domestic issuers.

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As a foreign private issuer, we are exempt from certain disclosure requirements under the Exchange Act, which may afford less protection to our shareholders than they would enjoy if we were a domestic U.S. company.

As a foreign private issuer, we are exempt from, among other things, the rules prescribing the furnishing and content of proxy statements under the Exchange Act and the rules relating to selective disclosure of material nonpublic information under Regulation FD. In addition, our executive officers, directors and principal shareholders are exempt from the reporting and short-swing profit and recovery provisions contained in Section 16 of the Exchange Act. We are also not required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as domestic U.S. companies with securities registered under the Exchange Act. As a result, our shareholders may be afforded less protection than they would under the Exchange Act rules applicable to domestic U.S. companies.

As the rights of shareholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as a shareholder.

Our corporate affairs will be governed by our memorandum of association and articles of association, the BVI Business Companies Act, 2004, or the BVI Act, of the British Virgin Islands and the common law of the British Virgin Islands. The rights of shareholders to take legal action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are to a large extent governed by the BVI Act and the common law of the British Virgin Islands. The common law of the British Virgin Islands is derived in part from comparatively limited judicial precedent in the British Virgin Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the British Virgin Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands has a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully developed and judicially interpreted bodies of corporate law.

As a result of all of the above, holders of our shares may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than shareholders of a U.S. company.

British Virgin Islands companies may not be able to initiate shareholder derivative actions, thereby depriving shareholders of the ability to protect their interests.

British Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. The circumstances in which any such action may be brought, and the procedures and defenses that may be available in respect to any such action, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States. Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred. The British Virgin Islands courts are also unlikely to recognize or enforce judgments of courts in the United States based on certain liability provisions of U.S. securities law against us; and to impose liabilities against us, in original actions brought in the British Virgin Islands, based on certain liability provisions of U.S. securities laws that are penal in nature. There is no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the British Virgin Islands will generally recognize and enforce the non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.

The laws of the British Virgin Islands provide little protection to minority shareholders, so minority shareholders will have little or no recourse if the shareholders are dissatisfied with the conduct of our affairs.

Under the law of the British Virgin Islands, there is little statutory law for the protection of minority shareholders other than the provisions of the BVI Act dealing with shareholder remedies. The principal protection under statutory law is that shareholders may bring an action to enforce the constituent documents of the corporation, our memorandum of association and articles of association. Shareholders are entitled to have the affairs of the company conducted in accordance with the general law and the memorandum of association and articles of association.

There are common law rights for the protection of shareholders that may be invoked, largely dependent on English company law, since the common law of the British Virgin Islands is limited. Under the general rule pursuant to English company law known as the rule in Foss v. Harbottle, a court will generally refuse to interfere with the management of a company at the insistence of a minority of its shareholders who express dissatisfaction with the conduct of the company’s affairs by the majority or the board of directors. However, every shareholder is entitled to have the affairs of the company conducted properly according to law and the company’s constituent documents. As such, if those who control the company have persistently disregarded the requirements of company law or the provisions of the company’s memorandum of association and articles of association, then the courts will grant relief. Generally, the areas in which the courts will intervene are the following: (1) an act complained of which is outside the scope of the authorized business or is illegal or not capable of ratification by the majority; (2) acts that constitute fraud on the minority where the wrongdoers control the company; (3) acts that infringe on the personal rights of the shareholders, such as the right to vote; and (4) where the company has not complied with provisions requiring approval of a majority of shareholders, which are more limited than the rights afforded minority shareholders under the laws of many states in the United States.

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Item 4. | Information on the Company

| A. | History and Development of the Company

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

In 2003, in order to continue to grow our business, BTL engaged in a corporate restructuring. As a result of those actions, Lianluo Smart and BDL were established, and we created the holding company structure.

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

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

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

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

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

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

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

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On February 22, 2016, we discontinued part of our medical devices business, including assembly and sales of X-ray machines and anesthesia machines, monitoring devices, general medical products, and oxygen generators.

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

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

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

On June 8, 2017, the Company held the Annual General Meeting to approve the amend and restate the Company’s amended and restated Memorandum and Articles of Association (the “New M&AAs”) in order that the Company’s authorized share capital be re-classified and re-designated into 50,000,000 Common Shares of par value of US$0.002731 each, of which 37,888,889 would be designated as Class A Common Shares of par value of US$0.002731 each (the “Class A Common Shares”) and 12,111,111 be designated as Class B Common Shares of par value of US$0.002731 each (the “Class B Common Shares”).

On November 3, 2017 (the “Effective Date”), the Company completed a purchase of an aggregate of 1,304,348 shares of common stock, par value $0.001 per share (the “Shares”) of Guardion Health Sciences, Inc. (“GHSI” or the “Seller”), at a purchase price of $1.15 per Share (or a purchase price of $1,500,000.20 in the aggregate) in a private placement (the “Private Placement”). The Private Placement occurred pursuant to a Stock Purchase Agreement dated November 3, 2017 (the “Purchase Agreement”) by and among GHSI as Seller and (i) LLIT and (ii) Digital Grid (Hong Kong) Technology Co., Limited (“DGHKT”; and together with LLIT, “Purchasers”), as purchasers of, in aggregate, 4,347,827 Shares for aggregate purchase price of $5,000,001.05.

On January 30, 2019, GHSI effectuated a one-for-two (1:2) reverse stock split of its common stock without any change to its par value. On April 9, 2019, GHSI closed its initial public offering of 1,250,000 shares of its common stock at a public offering price of $4.00 per share for total gross proceeds of $5.0 million, before deducting underwriting discounts and commissions and other offering costs and expenses payable by it. GHSI’s shares began trading on the Nasdaq Capital Market on April 5, 2019 under the symbol “GHSI”.

Relationship among Lianluo Smart, BTL, LCL and BDL

BTL is a PRC company established on July 5, 2001. Lianluo Smart is a BVI company established on July 22, 2003, formerly known as Dehaier Medical Systems Limited. Lianluo Smart and BTL jointly established BDL on September 24, 2003 as a Chinese-foreign equity joint-venture under the PRC laws. Under PRC laws, the shareholders of the equity joint-venture share the profits, risks and losses in proportion to their respective contributions of the equity joint-venture.

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BTL leased its building to BDL from January 1, 2015 through December 31, 2016, and BDL no longer leases this building. On December 18, 2015, BTL’s building was pledged to a bank as collateral for short-term borrowings of RMB 10,000,000 ($1,541,000) by BDL. Pursuant to the terms of the agreement, the line of credit is secured by BTL’s land use right, building and guaranteed by Mr. Ping Chen and another shareholder of BTL. Upon the execution of the VIE Termination, BTL stopped providing its property as collateral for our outstanding borrowings. As of December 31, 2016, we reported no outstanding short-term borrowings.

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

Currently, Lianluo Smart owns 100% of LCL and LCL owns 100% of BDL.

Lianluo’s principal executive office is located at Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China. Our telephone number is +86 010 8860 9850. Our principal website is located at http://lianluosmart.com. The information on our website is not part of this Annual Report. The SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us, which is available free of cost at http://www.sec.gov.

In 2018, we obtained short-term loans of $3.7 million from HLI, which constitutes our main method of financing. For capital expenditure, see Item 5.B. Liquidity and Capital Resources — Capital Expenditures.”

| B. | Business Overview

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

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

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

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

In the OSAS sector, starting from fiscal 2018 the Company is providing examination service to hospitals and medical centers through our developed medical wearable device. Doctors could refer to examination result provided by the device in making diagnosis regarding OSAS.

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

We design, develop and market our own branded medical products and medical components. Since we do not operate any fully scaled manufacturing facilities, we contract some of the medical components to outside manufacturers in China. Most of our branded products require light assembly by us before distribution.

We completed the corporate and business restructuring plan of scaling down and discontinued, as appropriate, our unprofitable medical device business. We aim to concentrate our resources to develop medical wearable devices, smart devices and smart ecosystem platform, as our major business.

Recent Operational Developments

On December 12, 2017, the Company announced that the Chairman of the Board of Directors, Mr. Zhitao He, has notified the Company that he intends to purchase up to $6 million in Lianluo Smart’s Class A Common Shares from time to time within the next twelve months, subject to market conditions. As of December 31, 2018, approximately $1 million common shares had been purchased from the market.

From March 16 to March 17, 2018, we attended the 10th Annual Conference of Beijing Health Management Association in Beijing, and set up booths to display the Company’s products.

From April 7 to April 8, 2018, we attended the “National Academic Forum on Children’s Respiratory and Sleep Disorders” in Wenzhou, China, and set up exhibition booths to display products. Our experts introduced Mofeishi products at the meeting. We also organized doctors to visit the Second Affiliated Hospital of Wenzhou.

From April 20 to April 22, 2018, we attended the 2nd Annual Academic Conference of the Health Check-up and Assessment Committee of Shandong Health Management Association in Jinan, China, and set up a booth to display the Company’s products.

From June 29, 2018 to July 01, 2018, we participated in the 8th Annual Academic Conference of Sleep Medicine Branch of Shandong Medical Association in Qingdao, China and set up exhibition booths to display products. We invited medical experts from Beijing to attend the meeting.

From June 30, 2018 to July 01, 2018, we participated in the Annual Meeting of Health Management Branch of Ningbo Medical Association in Ningbo, China, and set up exhibition booths to display products.

From July 13, 2018 to July 15, 2018, we participated in the Annual Meeting of Sleep Medicine Branch of Chinese Medical Association in Shenyang, China. Medical experts were invited to participate in the meeting and we introduced Mofeishi products at the meeting. We provided the documents of product information during the meeting.

From August 25 to August 26, 2018, we attended the 12th Health Management Academic Conference in Jinan, Shandong Province, China, and set up exhibition booths to display products and introduced Mofeishi products in the meeting.

On October 15, 2018, a “Sleep Health Lecture” was held in Beijing with Ci Ming Aoya, Beijing. The expert from respiratory department of Chaoyang Hospital, named Guo Xiheng, was invited to attend the meeting.

From October 19 to October 20, 2018, we attended the “Hubei Annual Conference of Otolaryngology” in Wuhan, China, and set up exhibition booths to display products. Our experts introduced Mofeishi products in the meeting.

From October 27 to October 28, 2018, we attended the Sixth Shandong Health Forum in Jinan, China, and set up booths to display products, and held satellite meetings. Our experts introduced Mofeishi products in the meeting.

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Our Products

Our Proprietary Products

Our proprietary product is: wearable sleep respiratory devices which are mainly used for hospitals, sleep centers, physical examination centers and for individuals used at-home. Our management believes that our proprietary products, which are generally more convenient and effective and less expensive than products from other competitors, tend to be more attractive to hospitals and healthcare facilities and other end-users for whom effectiveness and price are the significant factors in deciding whether to use our products.

Medical Devices (Including Related Supporting Products)

| ● | Ventilator Air Compressor. We provide two types of air compressors to support medical ventilators in surgery by supplying continuous airflow for the ventilator. Where a facility lacks a central pressured air supply system, our DHR280 air compressors provide a portable source of such pressured air. Our air compressors feature oil-less motors, large locking castors, high flow capacity, and spill-proof switches. We have designed our air compressors to be adaptable for use with any ventilator.
| ● | Abdominal pressure cardiopulmonary resuscitation instrument. We also provide one type of cardiopulmonary resuscitation (“CPR”) instruments.

Mobile Medicine (including Internet Medical and Sleep Diagnosis Products)

| ● | Sleep Apnea Diagnostic Products. We have designed and expect to provide two types of screening and diagnosis products which are portable sleep respiratory recording devices that can be used in a healthcare facility or in a patient’s home to assist physicians in determining whether the patient has obstructive sleep apnea.

Research and Development of Our Proprietary Products

Our success to date has in part resulted from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at competitive prices. Research and development costs from continuing operations were $301,713, $344,575 and $1,192,930 for the years ended December 31, 2018, 2017 and 2016, respectively. No research and development costs from discontinued operations were incurred for the year ended December 31, 2016. Our research and development team in 2018 consisted of 4 engineers, representing 4.1% of our employees.

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

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

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If we deem a new product to be commercially feasible, our research and development team will work closely with our assembly team to move assembly forward. This integrated approach allows us to identify potential difficulties in commercializing our proprietary product or product improvement. Furthermore, it enables us to make adjustments as necessary and develop cost-efficient assembly processes prior to distribution. We believe these abilities can significantly shorten the time it takes to launch a commercialized product.

Assembly of Our Proprietary Products

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

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

BDL maintains a 3,660 square foot product center in Changping District in Beijing. In addition, LCL maintains a 4,689 square foot product center in Changping District as well and is preparing the application of its assembly permit. This product center contains our research and development area and our assembly facilities. Final assembly of our products is currently performed in this facility by our employees in assembly and by some of our external vendors. Currently, the supply and manufacture of many critical components is performed by exclusive third-party vendors in China.

Proprietary Rights for Our Proprietary Products

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

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

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

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

Our Distributed Products

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

We have served as a distributor in China for laryngoscopes from Timesco Healthcare Ltd. (“Timesco”) until February 2019.

Medical Devices

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

Our Relationships with Suppliers of Our Distributed Products

While we develop, assemble, market and sell our proprietary products, we also serve as the distributor for a number of international companies looking to sell their brands of products in China. We have been a distribution agent for some or all products marketed in China by Timesco until February 2019. In this capacity, we are responsible for sales, marketing and after-sale services of these products.

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

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

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Principal Suppliers – Our Proprietary Products

We distribute products designed and manufactured in our facility, which are used in our OSAS service business. We can purchase materials from various suppliers depending on the price, quality and production capacity of each supplier.

Our Services

In the OSAS sector, starting from fiscal 2018 we provide technical services in relation to detection and analysis of Obstructive Sleep Apnea Syndrome (“OSAS”). We focused on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China.

As of the date of this report, we have partnered with 23 hospitals, 22 distributors and 33 check-up centers over 39 cities across China for the provision of OSAS diagnostic services.

We sign service agreements with public hospitals usually for a period of [3 years], and check-up centers usually for a period of [one year or less], with the aim of provision of wearable sleep diagnostic products and cloud-based services and we charge a fixed technical service fee on a per user basis when our OSAS diagnostic services are provided to the user at medical centers and public hospitals.

We seek to partner with more hospitals and check-up centers across China and to enlarge the scope of OSAS diagnostic services that we are able to provide in order to solidify our market position in this area and drive our revenue growth.

Our Service Centers

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

Customers and Suppliers

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

Our distributors. Sales to our distributors make up the substantial majority of our revenues as over 54% of our total revenues are to distributors. Based on the expected use of products sold to distributors, for proprietary products, we estimate that they sell approximately 90% of our products to physical examination centers, and 10% to hospitals; for distributed products, about 100% products are sold to hospitals. We have contractual distribution relationships with approximate 32 independent distributors. We do not own, employ or control these independent distributors.

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

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Dependence on Major Customers. For the years ended December 31, 2018, 2017 and 2016, approximately 29%, 56% and 94% of the Company’s total revenues, respectively, were received from two largest customers for continuing operations.

Dependence on Major Suppliers. For the years ended December 31, 2018, 2017 and 2016, purchases from two largest suppliers for continuing operations were approximately 48%, 63% and 96% of the total purchases, respectively.

Competition

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

Our competitors include publicly traded and privately held multinational companies. We believe that we can continue to compete successfully in China because our established domestic distribution network and customer support and service network allows us significantly better access to China’s small and medium-sized hospitals. In addition, our strong investment in research and development, coupled with our low-cost operating model, allows us to compete effectively for sales to large hospitals.

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

Proprietary Product |  | Primary Competitors in China |  | Lianluo Smart’s Estimated Competitive Position*
DHR280 air compressors |  | Beijing Yi’an, Beijing Shenlu |  | Average
DHR 998* and diagnosis products |  | Foreign companies such as Respironics, ResMed, and Covidien and Chinese company like Tianjin Oranger |  | Greater than average
Timesco laryngoscope |  | Kirchner & Wilhelm (GER), Welch Allyn (USA) |  | Average

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

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

Methods of Sales and Competition

We have a professional sales team of 39 personnel as of December 31, 2018. Our sales team is divided by geographic region and type of customer. Our sales personnel promote our products in various regions by selling our products to distributors and corporate customers. We always deliver our products after receiving payment from distributors and settle with our corporate customers pursuant to the term of contract, which generally ranges from 3 to 7 months. Additionally, we provide sleep respiratory apnea analysis services to hospitals and physical examination centers. We require settlement of these service fees on a monthly basis. We attend conferences held by hospitals and medical organizations in various regions on a regular basis. We also set booths to display and promote our products and services to ensure and improve effectiveness of our sales and marketing activities.

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

We have confidence on the well-established distribution channels and market occupancy. As of the date of this report, we have partnered with 22 dealers and distributors, 23 hospitals, 33 check-up centers over 52 cities across China. We compete with other companies by offering the real effective, convenient and most competitively priced products and services to customers. We provide 24/7 hour service and technical support by phone and wechat to the clients and end-users. We are also continuing our research and development on the sleep respiratory field and continue to look for cooperation and merger and acquisition opportunities with state-of-the-art technologies and products in the worldwide. Furthermore, being a Nasdaq-listed company has helped to build our brand image and reputation with potential customer and business partners.

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Seasonality

We generally experience an increase in revenues and tests from March through May, and September through December. This is because people tend to have physical check-up during these months. Our first quarter performance generally declines as a result of fewer business activities during the Chinese New Year Holiday.

Employees

As of December 31, 2018, we have 98 full-time employees, of which 18 were in middle and high management, 16 are employed in assembly and procurement; 8 were in clinical and technical service; 7 were in regulation and compliance; 4 were in research and development; 6 were in general administration; and 39 were in marketing and sales. As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, and medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses, housing funds and certain reserves of our employees, up to a maximum amount specified by the local government from time to time. We made contributions to employee benefits equal to 31% of employee salaries in 2018.

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

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

Regulations

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

China’s Regulation of Medical Devices

Classification of Medical Devices

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

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

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

Assembly Permit

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

We have a single assembly permit, which covers all products we assemble and is scheduled to expire on January 30, 2023. We are now applying for the renewal of our assembly permit. To renew an assembly permit, a company needs to submit to the provincial level food and drug administration an application to renew the permit, along with required information, six months before the expiration date of the permit. If we are unable to renew the permit before it expires, we could lose our ability to assemble our medical devices until the situation is rectified.

Distribution License

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

Registration Requirement

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

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

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

Medical Devices (Including Related Supporting Products)

Product Type |  | Product Model |  | Registration Expiration
Ventilator Air Compressor |  | DHR280 Air Compressor for Ventilators |  | June 2019
Laryngoscope |  | Timesco Laryngoscope |  | April 2020
Abdominal pressure cardiopulmonary resuscitation instrument |  | CPR-LW1000 |  | December 2020

Respiratory Products

Sleep Apnea Diagnosis and Analysis Systems Morpheus Ox July 2023

Continuing CFDA Regulation

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

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

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

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

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

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

| ● | fines, injunctions and civil penalties;

| ● | recall or seizure of our products;

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

| ● | criminal prosecution.

Other National and Provincial Level Laws and Regulations in China

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

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

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Restriction on Foreign Ownership

The principal regulation governing foreign ownership of medical device businesses in the PRC is the 2017 Foreign Investment Industrial Guidance Catalogue (the “Catalogue”). The Catalogue classifies the various industries into four categories: encouraged, permitted, restricted and prohibited. As confirmed by the government authorities, LCL and BDL are engaged in an encouraged industry. Such a designation offers businesses distinct advantages. For example, businesses engaged in encouraged industries:

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

| ● | provided such company has total investment of less than $1billion, the company is subject to regional (not central) government examination and approval which are generally more efficient and less time-consuming; and

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

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

Regulation of Foreign Currency Exchange

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

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

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Regulation of Dividend Distribution

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

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

Circular 37

In July 2014, SAFE promulgated the Notice of the State Administration of Foreign Exchange on the Administration of Foreign Exchange Involved in Overseas Investment, Financing and Return on Investment Conducted by Residents in China via Special-Purpose Companies, or Circular 37, which replaced the former circular commonly known as Circular 75 promulgated by SAFE in October 2005. 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.” Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as an increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.

In February 2015, SAFE released the Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving the Policies of Foreign Exchange Administration Applicable to Direct Investment, or Circular 13, which has amended Circular 37 by requiring PRC residents or entities to register with qualified banks rather than SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

PRC residents who control our company are required to make registration as mentioned above in connection with their investments in us. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Circular 37 and Circular 13.

Trademark Rights

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

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

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

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

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

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

| C. | Organizational structure

Lianluo Smart is a BVI company established on July 22, 2003. Lianluo Smart now has a direct wholly-owned subsidiary in China—Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd. (“LCL”). Lianluo Smart transferred its ownership of Beijing Dehaier Medical Technology Co., Ltd. (“BDL”) to LCL following a board resolution on October 9, 2017. Thereafter, BDL became a direct wholly-owned subsidiary of LCL.

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| D. | Property, Plants and Equipment

We are headquartered and our principal executive offices are located in Beijing, China. We assemble and test all our branded products at our 3,660 square foot product facility located in the Changping District in Beijing. The following is a description of our properties, which we lease from third-parties:

Office |  | Address |  | Rental Term Expiration |  | Space
Principal Executive Office |  | Lianluo Smart Limited Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China |  | December 31, 2019 |  | 4,417 square feet
Product Centers |  | Room 424, 4th Floor, Building 3, No. 9, Heying Road, Changping District, Beijing, China |  | November 24, 2020 |  | 3,660 square feet
|  | Room 10, Negative Level 1, BeiKong Technology Building, No. 10 Baifuquan Road Changping District, Beijing, China |  | December 16, 2019 |  | 323 square feet
|  | Rooms 611, 612, 618, 619, 6th Floor, BeiKong Technology Building, No. 10 Baifuquan Road, Changping District, Beijing, China |  | November 30, 2019 |  | 4,689 square feet
Office |  | Rooms 1605,1608, 16th Floor, Building 3, No. 10, Wangjing Street, Chaoyang District, Beijing, China |  | June 30, 2019 |  | 2,623 square feet

At our principal executive office, material tangible assets consist of general office equipment. Our product centers consist of office buildings, a manufacturing/assembly base, and a warehouse and administration area. In addition, we have assembly and testing machines at the product centers. We believe that our current facilities are adequate to meet our ongoing needs and that, and we will be able to obtain additional facilities on commercially reasonable terms, if additional space is required.

Item 4A. | Unresolved Staff Comments

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

Item 5. | Operating and Financial Review and Prospects

| A. | Operating Results

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

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Overview

Our Company’s business of product sales is divided into two parts: (i) medical products (including supporting products such as operating room products, ventilators, medical emergency products and medical air compressor products); (ii) mobile medicine (including wearable sleep respiratory solution for Obstructive Sleep Apnea Syndrome (“OSAS”)). For the years ended December 31, 2018, 2017 and 2016, our total revenues from product sales from continuing operations amounted to approximately $0.34 million, $0.88 million and $13.1 million respectively.

During 2018, we started to earn service revenue from provision of technical services in relation to detection and analysis of Obstructive Sleep Apnea Syndrome (“OSAS”). We focused on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China. For the year ended December 31, 2018, our total service revenues generated from provision of OSAS diagnostic services amounted to approximately $0.22 million.

Our revenues are subject to value added tax (“VAT”), sales returns and trade discounts. We deduct these amounts from our gross revenue to arrive at our total revenue. Our net loss attributable to the Company for the years ended December 31, 2018, 2017 and 2016 was approximately $8.91 million, $5.14 million and $9.73 million respectively.

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

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

Although our sleep respiratory business is still in its early stages, we anticipate that it can be a key growth driver for our Company in the foreseeable future. During the year 2018, we have intensified our efforts to launch our wearable solutions and products for OSAS in public hospitals and private physical examination centers throughout China, which has developed our distribution channels. Steady progress has been made for our wearable diagnosis and analysis systems for OSAS in public hospitals and private physical examination centers throughout China.

We have continued to establish relationships with pilot hospitals to deliver our wearable solutions and products for OSAS, driving the market growth in the hospitals in the regions where the pilot hospitals located, which helped to push forward our strategic market expansion for public hospitals. So far, wearable diagnosis and analysis systems for OSAS have been successfully delivered to most of major hospitals throughout China. We aim to intensify usage of our system in those hospitals and other institutions where we have already successfully launched. Our target is to gradually promote our business from sleep centers, respiratory departments, and Ear/Nose/Throat (E.N.T.) departments to other hospital departments with strong demand for sleep monitoring including those accommodating patients seeking care (inpatient and outpatient) for key chronic diseases, such as hypertension, heart disease, diabetes and strokes.

We have also targeted the private physical examination centers market. Our wearable OSAS diagnosis and analysis system has been successively launched in Ciming Aoya Hospital and Sonqao’s high-end physical examination center and multiple outpatient departments of Health 100 Group and IKang Healthcare Group in tier 1 cities, tier 2 cities and tier 3 cities. The number of customers for sleep diagnostic services has been growing and our products and services have been well appreciated.

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

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Our revenues for 2018 decreased $0.3 million compared to 2017. In 2018, we redirected our operations from unprofitable product sales of medical products and mobile medicines to marketing and expanding OSAS diagnosis services in hospitals and physical examination centers. However, the provision of these OSAS diagnosis services is still in its early stage and we may require to invest more marketing efforts in order to build up and consolidate our partnership with hospitals and physical examination centers in China.

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Revenues |  | $ | 559,386 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |
Costs of revenue |  |  | (757,901 | ) |  |  | (1,655,970 | ) |  |  | (17,179,060 | )
Gross loss |  |  | (198,515 | ) |  |  | (773,959 | ) |  |  | (4,116,687 | )
Service income |  |  | - |  |  |  | 56,030 |  |  |  | 14,587 |
Service expenses |  |  | - |  |  |  | (1,289 | ) |  |  | (21,130 | )
Selling expenses |  |  | (2,082,829 | ) |  |  | (1,170,378 | ) |  |  | (927,243 | )
General and administrative expenses |  |  | (3,675,465 | ) |  |  | (3,192,030 | ) |  |  | (4,183,775 | )
(Provision for) recovery from doubtful accounts |  |  | (22,229 | ) |  |  | 23,608 |  |  |  | 150,280 |
Impairment loss for intangible assets |  |  | (3,281,779 | ) |  |  | - |  |  |  | - |
Operating loss |  |  | (9,260,817 | ) |  |  | (5,058,018 | ) |  |  | (9,083,968 | )
Net loss from continuing operations |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,609,735 | )
Net loss from discontinued operations |  |  | - |  |  |  | - |  |  |  | (251,153 | )
Net loss |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,860,888 | )
Net loss attributable to Lianluo Smart Limited |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,731,868 | )
Comprehensive loss attributable to Lianluo Smart Limited |  | $ | (9,425,479 | ) |  | $ | (4,756,357 | ) |  | $ | (10,197,212 | )

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Factors Affecting Our Results of Operations – Generally

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

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

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

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

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

| ● | our ability to attract and retain distributors and key customers;

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

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

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

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

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Our income statements are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against RMB, the translation of these foreign currency-denominated transactions results in reduced revenues, operating expenses and net income for our non-U.S. operations. Similarly, to the extent the U.S. dollar weakens against RMB, the translation of RMB transactions results in increased revenues, operating expenses and net income for our non-U.S. operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements into U.S. dollars in consolidation.

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

Our business is primarily conducted in China and all of our revenues are denominated in RMB. However, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using the then current exchange rates, for the convenience of the readers. The conversion of RMB into U.S. dollars in this annual financial report is based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this annual financial report were made at a rate of RMB 6.8755 to US $1.00, the middle exchange rate in effect as of December 31, 2018. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The government of the People’s Republic of China (the “PRC”) imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. The Company does not currently engage in currency hedging transactions.

Components of Results of Operations

The following table sets forth the components of our results of operations both in U.S. dollar amounts (in thousands) and as a percentage of total revenues for the years indicated.

| For the years ended December 31, |  |  | Changes |  |  | Changes |
| 2018 |  |  | 2017 |  |  | 2016 |  |  | 2018 vs. 2017 |  |  | 2017 vs. 2016 |
| USD |  |  |  |  |  | USD |  |  |  |  |  | USD |  |  |  |  |  | USD |  |  |  |  |  | USD |  |  |  |
| (’000) |  |  | % |  |  | (’000) |  |  | % |  |  | (’000) |  |  | % |  |  | (’000) |  |  | % |  |  | (’000) |  |  | % |
Revenues |  | 559 |  |  |  | 100 |  |  |  | 882 |  |  |  | 100 |  |  |  | 13,062 |  |  |  | 100 |  |  |  | (323 | ) |  |  | (37 | ) |  |  | (12,180 | ) |  |  | (93 | )
Cost of revenues |  | (758 | ) |  |  | (136 | ) |  |  | (1,656 | ) |  |  | (188 | ) |  |  | (17,179 | ) |  |  | (132 | ) |  |  | 898 |  |  |  | 54 |  |  |  | 15,523 |  |  |  | 90 |
Gross loss |  | (199 | ) |  |  | (36 | ) |  |  | (774 | ) |  |  | (88 | ) |  |  | (4,117 | ) |  |  | (32 | ) |  |  | 575 |  |  |  | 74 |  |  |  | 3,343 |  |  |  | 81 |
Service incomes |  | - |  |  |  | - |  |  |  | 56 |  |  |  | 6 |  |  |  | 15 |  |  |  | 0 |  |  |  | (56 | ) |  |  | (100 | ) |  |  | 41 |  |  |  | 273 |
Service expenses |  | - |  |  |  | - |  |  |  | (1 | ) |  |  | 0 |  |  |  | (21 | ) |  |  | 0 |  |  |  | 1 |  |  |  | 100 |  |  |  | 20 |  |  |  | 95 |
Selling expenses |  | (2,083 | ) |  |  | (373 | ) |  |  | (1,170 | ) |  |  | (132 | ) |  |  | (927 | ) |  |  | (7 | ) |  |  | (913 | ) |  |  | (78 | ) |  |  | (243 | ) |  |  | (26 | )
General and administrative expenses |  | (3,675 | ) |  |  | (657 | ) |  |  | (3,192 | ) |  |  | (362 | ) |  |  | (4,184 | ) |  |  | (32 | ) |  |  | (483 | ) |  |  | (15 | ) |  |  | 992 |  |  |  | 24 |
(Provision for) recovery from doubtful accounts |  | (22 | ) |  |  | (4 | ) |  |  | 23 |  |  |  | 3 |  |  |  | 150 |  |  |  | 1 |  |  |  | (45 | ) |  |  | (196 | ) |  |  | (127 | ) |  |  | (84 | )
Impairment loss for intangible assets |  | (3,282 | ) |  |  | (587 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (3,282 | ) |  |  | - |  |  |  | - |  |  |  | - |
Operating loss |  | (9,261 | ) |  |  | (1,657 | ) |  |  | (5,058 | ) |  |  | (573 | ) |  |  | (9,084 | ) |  |  | (70 | ) |  |  | (4,203 | ) |  |  | (83 | ) |  |  | 4,026 |  |  |  | 44 |
Net loss from continuing operations |  | (8,910 | ) |  |  | (1,594 | ) |  |  | (5,136 | ) |  |  | (582 | ) |  |  | (9,610 | ) |  |  | (74 | ) |  |  | (3,774 | ) |  |  | (73 | ) |  |  | 4,474 |  |  |  | 47 |
Net loss from discontinued operations |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (251 | ) |  |  | (2 | ) |  |  | - |  |  |  | - |  |  |  | 251 |  |  |  | 100 |
Net loss |  | (8,910 | ) |  |  | (1,594 | ) |  |  | (5,136 | ) |  |  | (582 | ) |  |  | (9,861 | ) |  |  | (76 | ) |  |  | (3,774 | ) |  |  | (73 | ) |  |  | 4,725 |  |  |  | 48 |

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Revenues

Our total revenues are derived from our medical devices and sleep respiratory business. In 2018, our total revenues from continuing operations decreased by 37%, mainly due to the decrease in revenue from product sales by $0.5 million, partially offset by service revenue from the provision of OSAS diagnostic services of $0.22 million. In 2018, we redirected our operations from unprofitable product sales of medical products and mobile medicines to marketing and expanding OSAS diagnosis services in hospitals and physical examination centers.

To capture market share and the execution of the strategy of sales promotion, we suffered a loss from the sleep respiratory solutions business. Our management believes that we will be able to improve our product margins of sleep respiratory solutions and will make the relevant products and service become an important growth factor of the Company in the following years.

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

We derive revenues in our medical devices product line from the sale of general hospital products and related supporting products and medical compressor. We continue to strategically reduce our sales of traditional medical devices, and to fully realize our business focus shift from traditional medical equipment distribution to the market exploration of medical products and services based on the technology of the mobile internet, including delivering comprehensive sleep respiratory solution for OSAS patient care management other medical products. Our sale of proprietary and distributed products business accounted for 61% of the total revenue for the year 2018.

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

OSAS service (analysis and detection)

We will derive revenues in our sleep respiratory line from sales of OSAS test and service. We anticipate that, on a percentage basis, revenues from OSAS analysis and detection business line will increase more rapidly in the near term as we introduce new and more advanced equipment and services. focus on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese leading private preventive healthcare companies in China. We strongly believe in the tremendous growth potential of this business in the coming years. During the past year, the sleep respiratory business has achieved more progress in which we have continued to expand to public hospitals and physical examination centers. In 2018, management focused on introducing more advanced products and penetrating the market for sleep respiratory business. We have broadened and differentiated our target markets by cooperating with different types of medical institutions and individual customers across China. We plan to expand our product portfolio through continued investment in research and development and pursuing attractive opportunities to acquire complementary products and technologies and strategic collaboration with partners. We will continue to pursue sustainable growth by enhancing our capability of delivering the systems to more medical institutions and by promoting application of sleep respiratory systems we delivered. We will also continue to focus on the development of the sleep respiratory systems in private physical examination chains and life insurance companies which we believe to have large quantities of potential customers for sleep diagnosis.

We continue to devote proactive efforts to develop the wearable OSAS solution systems by marketing and expanding OSAS diagnosis, CPAP products and post-treatment evaluation services in hospitals and private medical examination centers nationwide, leveraging our well-established distribution network resources. Our portable sleep diagnostics devices business accounted for 39% of the total revenue for the year 2018.

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The following represents the revenues by categories, all derived from China:

(In U.S. dollars)

|  | For the years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Categories |  |  |  |  |  |  |  |  |
Product sales |  |  |  |  |  |  |  |  |
Medical Devices |  | $ | 221,414 |  |  | $ | 827,032 |  |  | $ | 1,305,372 |
Respiratory and Oxygen Homecare |  |  | - |  |  |  | - |  |  |  | 5,956 |
Mobile Medicine (sleep apnea diagnostic products) |  |  | 120,930 |  |  |  | 54,979 |  |  |  | 12,080,164 |
|  |  | 342,344 |  |  |  | 882,011 |  |  |  | 13,391,492 |
OSAS service (analysis and detection) |  |  | 217,042 |  |  |  | - |  |  |  | - |
Total revenues |  |  | 559,386 |  |  |  | 882,011 |  |  |  | 13,391,492 |
Less: revenues from discontinued operations |  |  | - |  |  |  | - |  |  |  | (329,119 | )
Revenues from continuing operations |  | $ | 559,386 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |

Cost of Revenues

Cost of revenues primarily includes costs of our finished goods, parts for assembly, wages, handling charges, depreciation on our productive plant and equipment, amortization of software copyrights and other software related to our products, and other expenses associated with the assembly and distribution of product.

Selling Expenses

Selling expenses consist primarily of salaries and related expenses for personnel engaged in sales, marketing and customer support functions, and costs associated with advertising and other marketing activities, and depreciation expenses related to equipment used for sales and marketing activities.

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

General and Administrative Expenses

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

We expect that in the near future, our general and administrative expenses will be lower than the current level in order to improve profitability of our operations.

Results of Operations

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

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Fiscal Year Ended December 31, 2018 Compared to Fiscal Year Ended December 31, 2017

Revenues

Our total revenues from continuing operations decreased by 37% from $0.88 million for the fiscal year ended December 31, 2017 to $0.56 million for the fiscal year ended December 31, 2018. The decrease in revenue was caused by a reduction of product sales by $0.54 million, partially offset by service revenue from the provision of OSAS diagnostic services of $0.22 million. In 2018, we redirected our operations from unprofitable product sales of medical products and mobile medicines to marketing and expanding OSAS diagnosis services in hospitals and physical examination centers.

Cost of Revenues

Our cost of revenues from continuing operations decreased by 54% from $1.66 million for the fiscal year ended December 31, 2017 to $0.76 million for the fiscal year ended December 31, 2018. The decrease in cost of revenues was generally in line with the decrease of revenues.

Gross Loss

Our gross loss from continuing operations decreased from $0.77 million in 2017 to $0.20 million in 2018. Gross loss as a percentage of income decreased from 88% in 2017 to 36% in 2018. We incurred significant amounts of relatively fixed costs of revenues, in particular depreciation and amortization of our long-lived assets related to our product and service revenues, in 2018 and 2017, resulting in a high gross loss both in dollar terms and in percentage terms.

Service Income

Our service income dropped from $0.06 million in 2017 to $0 in 2018. Service income represents the income of repair service and technical service.

Selling Expenses

Our selling expenses from continuing operations increased by 78% from $1.17 million for the year ended December 31, 2017 to $2.08 million for the year ended December 31, 2018. The increase in selling expenses was mainly due to devoting more resources in market development for the sleep respiratory business, such as employing more salesmen and participating in more medical device exhibitions during 2018.

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General and Administrative Expenses

Our general and administration expenses from continuing operations increased by 15% from $3.19 million for the year ended December 31, 2017 to $3.68 million for the year ended December 31, 2018. The increase is mainly due to stock based compensation to non-employees of $0.94 million incurred in 2018 for management consulting, merger and acquisition planning and strategy implementation, partially offset by a decrease in stock based compensation to employees by $0.43 million in 2018, as compared to 2017. Research and development expenses from continuing operations were $301,703 and $344,575 for the years ended December 31, 2018 and 2017, respectively. We expect that in the near future, our general and administrative expenses will be lower than the current level in order to improve profitability of our operations.

(Provision for) Recovery from Doubtful Accounts

Our provision for doubtful accounts was $22,229 for the year ended December 31, 2018, as compared to a recovery from doubtful accounts from continuing operations of $23,608 for the year ended December 31, 2017. A reserve for doubtful accounts on our accounts receivable, if required, is based on a combination of historical experience, aging analysis, and an evaluation of the collectability of specific accounts. Management considers that receivables over 1 year to be past due. Accounts receivable balances are charged off against the reserve after all means of collection have been exhausted and the potential for recovery is considered remote.

Impairment Loss for Intangible Assets

We recorded impairment on our intangible assets from our continuing operations of $3,281,779 and $0 for the years ended December 31, 2018 and 2017. During the year ended December 31, 2018, as a result of our lower-than-expected revenue performance, we determined not to further update and maintain our software copyright and patent for the therapy products of sleep respiratory business. The unamortized software copyright and patent and others of $3,281,779 were fully impaired.

Operating Loss

As a result of the foregoing, we incurred an operating loss of approximately $9.26 million in 2018, compared to approximately $5.06 million in 2017, representing an increase of 83%.

Change in Fair Value of Warrants Liability

For the year ended December 31, 2018, the fair value gain on warrants issued to our major shareholder, Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“HLI”) was $0.60 million, compared to a fair value loss of $0.23 million, relating to the warrants issued to HLI and other investors and placement agents in 2016. The warrants, together with restricted common shares, were issued pursuant to a securities purchase agreement with HLI in August 2016. The warrants issued to other investors and placement agents were redeemed during 2016.

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Taxation

We had no income tax expense in 2018 and 2017 as we incurred taxable loss in both years.

Net Loss from Continuing Operations

As a result of the foregoing, we had net loss from continuing operations of approximately $8.91 million in 2018, compared to approximately $5.14 million in 2017.

Net Loss and Net Loss Attributable to Lianluo Smart Limited

As a result of the foregoing, we had net loss and net loss attributable to the Company of approximately $8.91 million in 2018, compared to approximately $5.14 million in 2017.

Fiscal Year Ended December 31, 2017 Compared to Fiscal Year Ended December 31, 2016

Revenues

Our total revenues from continuing operations decreased by 93% from $13.06 million for the fiscal year ended December 31, 2016 to $0.88 million for the fiscal year ended December 31, 2017. The decrease of revenues is mainly due to the significantly decreased revenue from production of sleep respiratory solutions with lower margin in 2017.

Cost of Revenues

Our cost of revenues from continuing operations decreased by 90% from $17.18 million for the fiscal year ended December 31, 2016 to $1.66 million for the fiscal year ended December 31, 2017. The decrease in cost of revenues was in line with the decrease of revenues. The decreasing cost of revenue was also due to the disposal of inventories $2.45 million since all the disposed inventories have been replaced by new products for the improvement of technology in 2016. Before our factory and warehouse moved to the new location in the end of 2016, we had cleaned up and disposed of slow moving inventories, which were one-time expenses in 2016.

Gross Loss

Our gross loss from continuing operations decreased from $4.12 million in 2016 to $0.77 million in 2017. Gross loss as a percentage of revenues increased from 32% in 2016 to 88% in 2017. We incurred significant amounts of relatively fixed costs of revenues, in particular depreciation and amortization of our long-lived assets related to our products, in 2017 and 2016, resulting in a high gross loss both in dollar terms and in percentage terms.

Service Incomes

Our service income increased from $0.01 million in 2016 to $0.06 million in 2017. Service income represents the income of repair service and technical service.

Service Expense

Our service expense decreased from $0.02 million in 2016 to $0.001 million in 2017. Service expense mainly represents costs of spare parts incurred in provision of repair services.

Selling Expenses

Our selling expenses from continuing operations increased by 26% from $0.93 million for the year ended December 31, 2016 to $1.17 million for the year ended December 31, 2017. The increase in selling expenses was mainly because the Company invested more resources and energy in market development for the sleep respiratory business, such as employing more sales staff and attending more medical device exhibitions, in 2017 than it did in 2016.

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General and Administrative Expenses

Our general and administration expenses from continuing operations decreased by 24% from $4.18 million for the year ended December 31, 2016 to $3.19 million for the year ended December 31, 2017. This decrease was mainly due to the development of production that has been nearly completed in 2016. As a result, the investment in research and development activities of sleep respiratory business decreased in 2017. Research and development costs from continuing operations were $344,575 and $1,192,930 for the years ended December 31, 2017 and 2016, respectively.

Recovery from Doubtful Accounts

Our recovery from doubtful accounts from continuing operations decreased from $150,280 for the year ended December 31, 2016 to $23,608 for the year ended December 31, 2017. A reserve for doubtful accounts on our accounts receivable, if required, is based on a combination of historical experience, aging analysis, and an evaluation of the collectability of specific accounts. Management considers that receivables over 1 year to be past due. Accounts receivable balances are charged off against the reserve after all means of collection have been exhausted and the potential for recovery is considered remote.

Operating Loss

As a result of the foregoing, we incurred an operating loss of approximately $5.06 million in 2017, compared to approximately $9.08 million in 2016, representing a decrease of 44%.

Change in Fair Value of Warrants Liability

For the year ended December 31, 2017, the fair value loss on warrants issued to our major shareholder, Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“HLI”) was $0.23 million, compared to a fair value gain of $0.53 million related to relating to the warrants issued to HLI and other investors and placement agents in 2016. The warrants, together with restricted common shares, were issued pursuant to a securities purchase agreement with HLI in August 2016. The warrants issued to other investors and placement agents were redeemed during 2016.

Loss from Warrant Redemption

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

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Taxation

Our income tax benefit was approximately $0 in 2017, compared to approximately $95,026 in 2016. We incurred taxable loss in both 2017 and 2016.

Net Loss from Continuing Operations

As a result of the foregoing, we had net loss from continuing operations of approximately $5.14 million in 2017, compared to approximately $9.61 million in 2016.

Net Loss from Discontinued Operations

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

Net Loss and Net Loss Attributable to Lianluo Smart Limited

As a result of the foregoing, we had net loss of approximately $5.14 million in 2017, compared to a net loss of approximately $9.86 million in 2016. After deduction of non-controlling interest in loss of BTL, net loss attributable to the Company was approximately $5.14 million and $9.73 million in 2017 and 2016, respectively.

| B. | Liquidity and Capital Resources

Cash Flows and Working Capital

As of December 31, 2018, we had $0.48 million in cash and cash equivalents, decreased from $6.81 million at December 31, 2017. Our principal sources of liquidity have been proceeds from issuances of equity securities, and loans from banks and related parties. We believe that our current cash and cash equivalents and our anticipated cash flows from operations will be sufficient to meet our anticipated working capital requirements and capital expenditures for the next 12 months. We may, however, decide to enhance our liquidity position or increase our cash reserve for future investments or operations through additional capital, and finance funding from banks and/or related parties. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations.

The following table sets forth a summary of our cash flows for the periods indicated:

(In U.S. dollars)

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Net cash used in operating activities |  |  | (3,629,567 | ) |  |  | (5,408,997 | ) |  |  | (2,775,158 | )
Net cash used in investing activities |  |  | (6,225,827 | ) |  |  | (1,686,855 | ) |  |  | (636,130 | )
Net cash provided by financing activities |  |  | 3,700,493 |  |  |  | 2,972,858 |  |  |  | 13,675,808 |
Cash and cash equivalents at beginning of year |  |  | 6,809,485 |  |  |  | 10,792,823 |  |  |  | 624,724 |
Cash and cash equivalents at end of year |  |  | 477,309 |  |  |  | 6,809,485 |  |  |  | 10,792,823 |

Operating Activities

Net cash used in operating activities was $3,629,567 for the year ended December 31, 2018, compared to $5,408,997 for the same period in 2017. The reasons for this change are mainly due to decreasing cash outflows from an increase in inventory (including inventory obsolescence and loss from disposal of inventories) by $1.9 million, from $2,007,026 in 2017 to $137,464 in 2018, and increasing cash inflows from advance to suppliers by $0.4 million, from an increase in advances to suppliers of $147,465 in 2017 to a decrease of $233,490 in 2018; partially offset by an increase in cash outflows from net loss from continuing operations (excluding non-cash stock-based compensation, depreciation and amortization, change in fair value of warrants and impairment loss for intangible assets) of $4.2 million in 2018, an increase of approximately $1.1 million from $3.1 million for the same period of 2017.

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Investing Activities

Net cash used in investing activities for the year ended December 31, 2018 was $6,225,827 compared to $1,686,855 for the same period of 2017, an increase of $4.5 million. The cash used in investing activities in 2018 was mainly attributable to our capital expenditures of $0.8 million and a $5.4 million loan, net of repayment, to a related party,. The cash used in investing activities in 2017 was mainly attributable to our purchases of non-marketable equity investments of $1.5 million.

Financing Activities

Net cash provided by financing activities in 2018 was $3,700,493, which was mainly a result of obtaining short-term loans of $3.7 million from HLI.

Net cash provided by financing activities in 2017 was $2,972,858, which was mainly a result of: (i) obtaining short-term loans of $1.5 million from HLI, and (ii) collecting the remaining outstanding subscription receivable balance of $1.5 million from HLI in 2017.

Contractual Obligations and Commercial Commitments

The following table sets forth our contractual obligations as of December 31, 2018:

|  | Payments due by period |
Contractual obligations |  | Total |  |  | Less than 1 year |  |  | 1-3 years |  |  | More than 3 years |
Operating lease obligations |  | $ | 104,706 |  |  | $ | 104,706 |  |  | $ | - |  |  | $ | - |
Total |  | $ | 104,706 |  |  | $ | 104,706 |  |  | $ | - |  |  | $ | - |

The leased properties are principally located in the PRC, and we use such properties for product centers, administration and warehouse facilities. The leases are renewable subject to negotiation.

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Capital Expenditures

We made capital expenditures of approximately $0.78 million, $0.04 million and $0.64 million in 2018, 2017 and 2016, respectively.

Critical Accounting Policies

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

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. For further information on our significant accounting policies, see Note 2 to our consolidated financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Basis of Consolidation

The consolidated financial statements include the accounts of Lianluo Smart and its wholly-owned subsidiaries and variable interest entity for which the Company is the primary beneficiary (“VIE”) (collectively, the “Company”). All inter-company transactions and balances are eliminated in consolidation. The results of subsidiaries and consolidated VIEs acquired or disposed of are recorded in the consolidated statements of operations and comprehensive loss from the effective date of acquisition or up to the effective date of disposal, as appropriate.

A group of shareholders, including the Chief Executive Officer, originally held more than 50% of the voting ownership interest of Lianluo Smart, BDL and BTL. Before July 31, 2016, BTL’s building was pledged as collateral for BDL’s bank loans. In exchange, BDL loaned money to BTL to finance its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. In accordance, BDL is the primary beneficiary of BTL, as the entity that was most closely associated with BTL. BTL was considered a variable interest entity of BDL. Upon execution of the VIE Termination on July 31, 2016, BTL was deconsolidated from Lianluo Smart and its subsidiaries. The results of BTL’s operations were reflected in the Company’s consolidated financial statements as discontinued operations.

For our majority-owned subsidiaries and consolidated VIEs, a noncontrolling interest is recognized to reflect the portion of their equity which is not attributable, directly or indirectly, to us.

Accounts Receivable

Accounts receivable are initially recorded at invoiced amount. We generally require 100% prepayment before delivering our products to individual clients. Our contract terms general require 10%-30% prepayment for our hospital and healthcare center clients, and the trade receivable term in contracts for those clients is generally between 60 and 90 days. Our contract terms general require 10% prepayment from our distributor clients, and the trade receivable term in contracts for those clients is generally between 60 and 180 days. With the exception of the prepayments we require in some cases, we generally do not require collateral or other security to support accounts receivable. A reserve, if required, is based on a combination of historical experience, aging analysis, and an evaluation of the collectability of specific accounts. Management considers that receivables over 1 year to be past due. Accounts receivable balances are charged off against the reserve after all means of collection have been exhausted and the potential for recovery is considered remote.

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Other Receivables ad Prepayments, net

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

Advances to Suppliers, net

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

Warrant Liability

For warrants that are not indexed to our stock, we record the fair value of the issued warrants as a liability at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the consolidated statement of operations and comprehensive income. The warrant liability is recognized in the balance sheet at the fair value (level 3). The fair values of these warrants have been determined using the Black-Scholes pricing mode. The Black-Scholes pricing model provides for assumptions regarding volatility, call and put features and risk-free interest rates within the total period to maturity.

Inventories

Inventories are stated at the lower of cost or net realizable value and consist of assembled and unassembled parts relating to medical devices. Cost is determined on a weighted-average basis. We compare the cost of inventories with the net realizable value and write down their inventories to net realizable value, if lower. Net realizable value is based on estimated selling prices in the ordinary course of business less cost to sell. These estimates are based on the current market and economic condition and the historical experience of selling products of similar nature. It could change significantly as a result of changes in customer taste and competitor actions in response to any industry downturn. We reassess the estimations at the end of each reporting period.

Property and Equipment

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

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

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Estimated useful lives of property and equipment after July 31, 2016 were shortened and depreciation thereafter is calculated on a straight-line basis over the following estimated useful lives:

Leasehold improvements | Shorter of the useful lives or the lease term
Machinery and equipment | 2-3 years
Furniture and office equipment | 3-5 years
Motor vehicles | 5 years

Intangible Assets

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

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

Impairment of Long-Lived Assets

We review the long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we compare the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable.

Non-marketable equity securities

Our non-marketable equity securities represent our investments in a privately held company.

Prior to January 1, 2018, we accounted for our non-marketable equity securities at cost and only adjusted for other-than-temporary declines in fair value and distributions of earnings. An impairment loss was recognized in the consolidated statements of operations equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment was made. The fair value would then become the new cost basis of investment.

On January 1, 2018, we adopted ASU 2016-01 which changed the way we account for non-marketable securities. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in non-operating other income (expenses). As we did not identify any accounting changes that impacted the amount with respect to non-marketable equity securities, no adjustment to accumulated deficit was required upon adoption.

Revenue Recognition

In May 2014 the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”), which supersedes all existing revenue recognition requirements, including most industry specific guidance. This new standard requires a company to recognize revenues when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The FASB subsequently issued the following amendments to ASU No. 2014-09 that have the same effective date and transition date: ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations; ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients; and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. We adopted these amendments with ASU 2014-09 (collectively, the new revenue standards).

The new revenue standards became effective for us on January 1, 2018, and were adopted using the modified retrospective method. The adoption of the new revenue standards as of January 1, 2018 did not change our revenue recognition as the majority of its revenues continue to be recognized when the customer takes control of our product or services. As we did not identify any accounting changes that impacted the amount of reported revenues with respect to our product revenues, no adjustment to accumulated deficit was required upon adoption.

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Under the new revenue standards, we recognize revenues when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods. We recognize revenues following the five step model prescribed under ASU No. 2014-09: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenues when (or as) we satisfy the performance obligation.

The following is a description of principal activities from which we generate revenue and related revenue recognition policies:

| 1. | Sale of medical equipment

We distribute and provide after-sale services for medical equipment, such as sleep apnea machines, ventilator air compressors, laryngoscope, in China. We typically sell our branded products with warranty terms covering 12 months after purchase. The warranty requires us to repair all mechanical malfunctions and, if necessary, replace defective components. Control of products sold transfers to customers upon shipment from our facilities, and our performance obligations are satisfied at that time. Shipping and handling activities are performed before the customer obtains control of the goods and therefore represent a fulfillment activity rather than a promised service to the customer.

We evaluate our arrangements with distributors and determines that we are primarily obligated in the sales of distributed products, are subject to inventory risk, have latitude in establishing prices, and assume credit risk for the amount billed to the customer, or have several but not all of these indicators. In accordance with ASC 606, we determine that it is appropriate to record the gross amount of product sales and related costs. As we are a principal and we obtain control of the specified goods before they are transferred to the customers, the revenues should be recognized in the gross amount of consideration to which we expect to be entitled in exchange for the specified goods transferred.

| 2. | Provision of sleep diagnostic services

During 2018, we started to earn service revenue from provision of technical services in relation to detection and analysis of Obstructive Sleep Apnea Syndrome (“OSAS”). We are focused on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China. Revenue is recognized when all of the revenue recognition criteria are met, which is generally when our diagnostic services are provided to the user at medical centers and public hospitals.

In the PRC, value added tax (“VAT”) of 16% of the invoice amount is collected in respect of the sales of goods on behalf of tax authorities. The VAT collected is not our revenue; instead, the amount is recorded as a liability on the balance sheet until such VAT is paid to the authorities.

Practical expedients and exemptions

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income.

We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

Foreign Currency Transaction

The accounts of Lianluo Smart, BDL, LCL, are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The accompanying consolidated financial statements are presented in US dollars.

Foreign currency transactions are transferred into US dollars using fixed exchange rates in effect at the time of the transaction. Generally, foreign exchange gains and losses resulting from the settlement of such transactions are recognized in the consolidated statements of income and comprehensive income. The financial statements of our foreign operations are transferred into US dollars in accordance with ASC 830-10, “Foreign Currency Matters”. Assets and liabilities are transferred at applicable exchange rates quoted by the People’s Bank of China at the balance sheet dates and revenues, expenses and cash flow items are transferred at average exchange rates in effect during the periods. Equity is transferred at the historical rate of exchange at the date of capital contribution. Resulting transfer adjustments are recorded as other comprehensive income (loss) and accumulated as a separate component of equity.

Income Taxes

We use the asset and liability method of accounting for income taxes in accordance with ASC 740-10, “Accounting for Income Taxes.” Under this method, income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year; and, (ii) deferred tax consequences of temporary differences resulting from matters that have been recognized in an entity’s financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation reserve is provided to reduce the deferred tax assets reported if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

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ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return. Under ASC 740-10, a tax benefit from an uncertain tax position taken or expected to be taken may be recognized only if it is “more likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying position under ASC 740-10 would equal the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all the relevant information. A liability (including interest and penalties, if applicable) is established in the financial statements to the extent a current benefit has been recognized on a tax return for matters that are considered contingent upon the outcome of an uncertain tax position. Related interest and penalties, if any, are included as components of income tax expense and income taxes payable.

Stock-Based Compensation

We account for stock-based share-based compensation awards to employees at fair value on the grant date and recognize the expense over the employee’s requisite service period. Our expected volatility assumption is based on the historical volatility of our stock or the expected volatility of similar entities. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend is based on our current and expected dividend policy.

Share-based compensation expenses for stock-based share-based compensation awards granted to non-employees are measured at fair value at the earlier of the performance commitment date or the date service is completed, and recognized over the period during which the service is provided. We apply the guidance in ASC 505-50 to measure share options and restricted shares granted to non-employees based on the then-current fair value at each reporting date.

Segment Information

Our segments are business units that offer different products and services and are reviewed separately by the chief operating decision maker (the “CODM”), or the decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. During fiscal 2016 and 2017, there was only one segment, which is the business of developing, commercializing and distribution of medical equipment, such as sleep apnea machines, ventilator air compressors, and laryngoscope. During 2018, we started to earn service revenue from provision of technical services in relation to diagnosis of Obstructive Sleep Apnea Syndrome (“OSAS”). We are focused on the promotion of sleep respiratory solutions and service in public hospitals. Our wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China.

Holding Company Structure

Lianluo Smart is a holding company with no material operations of its own. We conduct all of our operations through our PRC subsidiaries. As a result, our ability to pay dividends depends significantly upon dividends paid by our PRC subsidiaries. If our existing PRC subsidiaries or any newly formed ones incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our wholly foreign-owned subsidiaries in China are permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our subsidiaries is required to set aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds reach 50% of its registered capital. In addition, each of our wholly foreign-owned subsidiaries in China may allocate a portion of its after-tax profits based on PRC accounting standards to enterprise expansion funds, staff bonuses and welfare funds at its discretion. The statutory reserve funds and the discretionary funds are not distributable as cash dividends. Remittance of dividends by a wholly foreign-owned company out of China is subject to examination by the banks designated by the SAFE. Our PRC subsidiaries have not paid dividends and will not be able to pay dividends until they generate accumulated profits and meet the requirements for statutory reserve funds.

| C. | Research and Development

Our success to date has in part resulted from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at competitive prices. Research and development costs from continuing operations were $301,703, $344,575 and $1,192,930 for the years ended December 31, 2018, 2017 and 2016, respectively. There were no research and development costs from the discontinued operations incurred for the year ended December 31, 2016. Our research and development team consists of 4 engineers, representing 4.1% of our employees as of December 31, 2018.

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The information provided under Item 4.B, “Business Overview” details the Company’s research and development activities.

| D. | Trend Information

Global wearable medical device market is expected to reach $27.8 billion by 2022, according to a new report by Grand View Research, Inc. the rising prevalence of conditions such as obesity and hypertension, as a result of sedentary lifestyle is anticipated to boost the demand for wearable medical devices. Moreover, increasing health awareness is further expected to augment the demand for these devices. Additionally, growing incidences of chronic conditions, such as diabetes, which require round-the-clock monitoring, are expected to increase the demand for wearable technology. Technological innovation is projected to be vital for growth of this industry over the forecast period.

The 2016 Blue Book on the Development of China’s Medical Device Industry shows that the total size of the medical device market in China in 2016 was approximately 370 billion yuan (approximately $57 billion), an increase of 62 billion yuan (approximately $9.54 billion) from 308 billion yuan (approximately $47.39 billion) in 2015. Among them, the medical device market was about 269 billion yuan (approximately $41.39 billion), accounting for about 72.70%; the home medical device market exceeded 100 billion yuan, about 101 billion yuan (approximately $15.54 billion), accounting for 27.30%.

In May 2015, the highly anticipated “Made in China 2025” plan was formally announced. The trend of the medical device market promoted ten major industries such as biomedicine and high-performance medical devices as national strategies, and officially proposed to improve the innovation capability and industry of medical devices. At the level of development, it focuses on the development of high-performance medical equipment such as imaging equipment and medical robots, high-value medical consumables such as degradable blood vessel stents, and mobile medical products such as wearable and remote medical treatment. Industry analysts said that the policy is a huge driving force for the development of China’s medical device industry and will help boost the development of China’s medical device industry.

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In 2014, per capita medical expenditure in China was 419 US dollars, while Americans spent an average of 9402.5 US dollars in the same period, which is 22.4 times than that of China. Current medical device purchases by individuals in China are also much lower than they are in Europe and the U.S. As China’s population continues to age, our management expects a rapid increase in demand for medical devices, and, as a result, growth in China’s medical device industry.

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

In summary, as a vital component of China’s current health system reform, the medical device industry has been incorporated into the national strategic development plan. In 2019, we anticipate new opportunities, and combined with favorable government policies, we anticipate being in a position for continued growth in the medical device industry.

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

Meanwhile, medical wearable devices are expected to be the most favorable industry in the whole wearable devices market. Nowadays, many companies are positively distributing in the medical industry through acquisition or release of related medical wearable devices to enlarge their market shares in the medical industry. The rapid development in the size of the medical wearable device industry has drawn great attention. Many leading companies, as well as medium and small sized innovative companies, entrepreneurs and investors are entering the medical wearable device industry. According to statistics on Huaxia Medical Industry website, the scale of Chinese medical wearable device market has grown from more than $300 million (RMB 1.86 billion) in 2012 to about $1.95 billion (RMB 12.5 billion) in 2017, and it is estimated that the scale will continue to increase in 2018.

After rapid growth in 2017, the smart device market is expected to continue to increase in 2018. The scale of the market broke $7.9 billion (RMB 55.2 billion) in 2016 from $6 billion (RMB 42.4 billion) in 2015, and is estimated to reach $15.3 billion (RMB 98 billion) in 2018.

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

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

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The ultimate value of smart product is to serve users. To integrate advantages of other industries and join smart devices up with more third-party service is the key point of service expansion. With cooperation from traditional enterprises, smart devices will rapidly reach out to customers from concept, and bring smart life to consumers.

| E. | Off-Balance Sheet Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

| F. | Tabular Disclosure of Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2018:

|  | Payments due by period |
Contractual obligations |  | Total |  |  | Less than 1 year |  |  | 1-3 years |  |  | More than 3 years |
Operating lease obligations |  | $ | 104,706 |  |  | $ | 104,706 |  |  | $ | - |  |  | $ | - |
Total |  | $ | 104,706 |  |  | $ | 104,706 |  |  | $ | - |  |  | $ | - |

Item 6. | Directors, Senior Management and Employees

| A. | Directors and Senior Management

The following table sets forth our executive officers and directors, their ages and the positions held by them as of April 30, 2019:

Name |  | Age |  | Position Held
Zhitao He |  | 37 |  | Chairman and Director
Ping Chen(1)(2) |  | 56 |  | Chief Executive Officer and Director
Yingmei Yang |  | 49 |  | Interim Chief Financial Officer
Richard Zhiqiang Chang(1)(3)(4)(5)(6) |  | 56 |  | Independent Director
Bin Pan(1)(4)(5)(6)(7) |  | 46 |  | Independent Director
Xiaogang Tong(1)(4)(5)(6)(7) |  | 41 |  | Independent Director

| (1) | The individual’s business address is Room 2108, 21th Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China.

| (2) | Class III director whose term expires in 2019.

| (3) | Class II director whose term expires in 2021.

| (4) | Member of audit committee.

| (5) | Member of compensation committee.

| (6) | Member of nominating committee.

| (7) | Class I director whose term expires in 2020.

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Zhitao He. Mr. He has served as the Company chairman and director since October 2016. Mr. Zhitao He is also the Chairman of the Board of Lianluo Interactive, a China-listed company and a major shareholder of the Company. Mr. Zhitao He successfully led Lianluo Interactive to list on China’s A share market (ticker: 002280). Mr. Zhitao He was named one of the “10 Top Entrepreneurs of Post-1980s” by Hurun Report and “Top Ten Entrepreneurial Leader of Listed Companies” by Securities Times. In the past two years, under his leadership, Lianluo Interactive has moved into the field of smart hardware, including the purchase of American electronics online retailer Newegg(http://www.newegg.com), investments in American virtual reality (“VR”) device manufacturer Avegant(www.avegant.com) and hardware corporation Razer(http://www.razerzone.com), and promotion of the world’s biggest VR Operating System OSVR in China together with Razer. This investment plan has allowed Lianluo Interactive to become a closed loop of “Software and Hardware + Platform + Channels”. Mr. He received his master degree from Beijing University of Posts and Telecommunications. Mr. He founded Lianluo Interactive in 2007 which was known as Beijing Digital Grid Technology Co. The Board believes that Mr. He’s vision, leadership and extensive knowledge of the industry is essential to the development of the Company.

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

Yingmei Yang. Ms. Yang has served as our interim Chief Financial Officer since March 15, 2018. Ms. Yang has served as the Vice President of Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“Lianluo Interactive”), a major shareholder of the Company since February, 2018. From January, 2015 to February, 2018, Ms. Yang has served as Chief Financial Officer and Vice President of Lianluo Interactive. From February, 2013 to January, 2015, Ms. Yang was the Chief Financial Officer and Secretary of Board of Beijing Digit Horizon Technology Limited, the predecessor of Lianluo Interactive.

Richard Zhiqiang Chang. Mr. Chang has served as our independent director since 2016. Mr. Richard Chang has been CEO of Beijing Zhineng Technology Co., Ltd. in Beijing China since October 2015. Prior to that position, he served as a Key Account Manager and Business VP at AREVA Inc. in Beijing, China from 2013 through October 2015 and Chief Representative and Regional VP at Ventyx Inc. in Atlanta, Georgia from July 2009 to July 2013. Mr. Chang earned a master’s degree in computer science in 1997 from the University of Texas as Dallas, a master’s degree in automation in 1990 from Shanghai Jiaotong University and a bachelor’s degree in automation in 1985 from the same school. The Board believes that Mr. Chang’s strong experience in business and management is important to the success of the Company.

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

Xiaogang Tong. Mr. Tong has been appointed by the Company’s Board of Directors to serve as an independent member of the Company’s Board of Directors to fill the vacant seat resulting from the resignation of Mingwei Zhang, and to serve on the Company’s Audit Committee since August 23, 2018. Mr. Tong has extensive knowledge and experience in accounting. From December 2014 till now, Mr. Tong served as Chief Financial Officer of Talant Optronics (Suzhou) Co., Ltd.. From August 2008 to December 2014, Mr. Tong was a Partner in Zhong Xin Zi Cheng Financial Consulting Co., Ltd., providing financial consulting, financial due diligence, as well as financial analysis services to pre-IPO companies. From July 2001 to July 2008, Mr. Tong worked in Deloitte Touche Tohmatsu CPA Firm, serving as Auditing Manager (from July 2006 to July 2008) and Senior Auditor (from July 2001 to July 2006). Mr. Tong received a Bachelor’s degree in Accounting from Capital University of Economics and Business. Mr. Tong is a Certified Public Accountant of China (CPA). Mr. Tong has been chosen as a director because of his financial experience.

| B. | Compensation

Executive Compensation

The following table shows the annual compensation paid by us for the year ended December 31, 2018 to Ping Chen, our principal executive officer, and Yingmei Yang, our Interim Chief Financial Officer.

Summary Executive Compensation Table

Name and principal position |  | Salary |  |  | Bonus |  |  | Option Awards |  |  | All Other Compensation |  |  | Total |
Ping Chen, Principal Executive Officer |  | $ | 28,956 |  |  | $ | 2,300 |  |  | $ | - | (1)(2)(3)(4) |  | $ | - |  |  | $ | 31,256 |
Yingmei Yang Interim Chief Financial Officer (since March 15, 2018) |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | - |

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

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

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

| (4) | On March 21, 2016, 210,867 share options were awarded to Mr. Chen, which vest over a period of two years. The expiration date of the options is March 21, 2026. The options’ exercise price is the market price of our shares on March 21, 2016, the date the options were granted. The grant date fair value of the options was $1.88 per underlying share and is not reflected in the Summary Executive Compensation Table.

Director Compensation

All directors hold office until the next annual meeting of shareholders at which their respective class of directors is re-elected or until their successors have been duly elected and qualified. There are no family relationships among our directors or executive officers. Officers are elected by and serve at the discretion of the Board of Directors. We do not separately set aside any amounts for pensions, retirement or other benefits for our executive officers, other than pursuant to relevant statutory requirements. Employee directors do not receive any compensation for their services as directors. Non-employee directors are entitled to receive payment for serving as directors and may receive option grants from our company. For service on our Board of Directors, Mr. Xiaogong Tong receives $4,000 per year, and Mr. Richard Zhiqiang Chang and Mr. Bin Pan receive $8,000 annually. The following table shows the annual compensation we need to pay for the year ended December 31, 2018 to our directors.

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Summary Director Compensation Table

Name |  | Fees earned or paid in cash |  |  | Stock-based Compensation |  |  | Total(1) |
Zhitao He |  | $ | N/A |  |  | $ | N/A |  |  | $ | N/A |
Ping Chen(1) |  | $ | N/A |  |  | $ | N/A |  |  | $ | N/A |
Xiaogong Tong |  | $ | 4,000 |  |  | $ | N/A |  |  | $ | 4,000 |
Bin Pan |  | $ | 8,000 |  |  | $ | N/A |  |  | $ | 8,000 |
Richard Zhiqiang Chang |  | $ | 8,000 |  |  | $ | N/A |  |  | $ | 8,000 |

| (1) | Mr. Ping Chen received compensation in his capacity as officer of our company and/or subsidiaries/affiliates but did not receive any compensation for serving as director of our company.

| C. | Board Practices

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

Board of Directors and Board Committees

Our board of directors currently consists of 5 directors. There are no family relationships between any of our executive officers and directors. The directors are divided into three classes. Class I directors shall face re-election at our annual general meeting of shareholders in 2020 and every three years thereafter. Class II directors shall face re-election at our annual general meeting of shareholders in 2018 and every three years thereafter. Class III directors shall face re-election at our annual general meeting of shareholders in 2019 and every three years thereafter.

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

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

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

Board Committees

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

Duties of Directors

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

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

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

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

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

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

Limitation of Director and Officer Liability

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

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

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

Involvement in Certain Legal Proceedings

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

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

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

| D. | Employees

As of December 31, 2018, we had 98 employees, all of whom were full-time employees and were based in China. We believe that our relations with our employees are good. We have never had a work stoppage, and our employees are not subject to a collective bargaining agreement. As of December 31, 2018, 2017 and 2016, we had 98, 129 and 66 employees, respectively.

|  | December 31, |
|  | 2016 |  |  | 2017 |  |  | 2018 |
Total |  |  | 66 |  |  |  | 129 |  |  |  | 98 |
Mid and high level Manager |  |  | 25 |  |  |  | 14 |  |  |  | 18 |
Sales, Marketing and General management |  |  | 22 |  |  |  | 77 |  |  |  | 45 |
R&D and Compliance |  |  | 5 |  |  |  | 8 |  |  |  | 11 |
Assembly, Procurement and Technical Clinical Service |  |  | 14 |  |  |  | 30 |  |  |  | 24 |

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| E. | Share ownership

The following table sets forth information with respect to beneficial ownership of our common shares as of April 30, 2019 by:

| ● | Each of our directors and named executive officers; and

| ● | All directors and named executive officers as a group.

The number and percentage of common shares beneficially owned are based on 17,806,586 common shares outstanding as of April 30 2019. Information with respect to beneficial ownership has been furnished by each director and officer. Beneficial ownership is determined in accordance with the rules of the SEC and generally requires that such person have voting or investment power with respect to securities. In computing the number of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares underlying options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days of April 30, 2019 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons listed have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated in the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China.

Named Executive Officers and Directors |  | Amount of Beneficial Ownership(1) |  |  | Percentage Ownership(2) |
Ping Chen, CEO, Director |  |  | 2,113,209 | (3) |  |  | 11.87 | %
Zhitao He, Director, Chairman of the Board |  |  | 471,500 | (4) |  |  | 2.65 | %
All officers and directors as a group |  |  | 2,584,709 |  |  |  | 14.52 | %

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

| (2) | We have used 17,806,586 outstanding shares for all calculations in this table and have not increased the number of shares outstanding to account for such shares underlying such securities in calculating percentage ownership.

| (3) | Ping Chen, our Chief Executive Officer and a director, has the sole power to direct the voting and disposition of the 1,613,542 shares held under his name. The number also includes 499,667 shares underlying options, which will have vested within 60 days hereof.

| (4) | Represents 471,500 shares owned by Hyperfinite Galaxy Holding Limited. Hyperfinite Galaxy Holding Limited is controlled by Zhitao He.

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Share Option Plan and Grants

Under our employee stock option plans, our stock options generally expire after ten years from the date of grant.

In 2009, in connection with our initial public offering, we established a pool for share options for our employees (the “2009 Share Incentive Plan”). This pool contains options to purchase up to 450,000 of our common shares. The options will vest at a rate of 20% per year for five years and have an exercise price of the market price of our shares on the date the options are granted. As of the date of this report, we have issued all 450,000 options pursuant to our 2009 Share Incentive Plan, which were issued on December 29, 2011 at an exercise price of $1.45 per share and vest over five years until December 28, 2016.

In 2013, we established our 2013 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 462,000 of our common shares. As of the date of this report, we have issued 131,000 options pursuant to our 2013 Share Incentive Plan, which were issued on August 20, 2014 at an exercise price of $5.31 per share and will vest over five years until August 19, 2019.

In 2014, we established our 2014 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 466,800 of our common shares. As of the date of this report, we have issued 349,000 options pursuant to our 2014 Share Incentive Plan, which were issued on August 7, 2015 at an exercise price of $1.64 per share and vest over two years until August 6, 2017.

In 2015, we established our 2015 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 580,867 of our common shares. As of the date of this report, we have issued 580,867 options pursuant to our 2015 Share Incentive Plan, which were issued on March 21, 2016 at an exercise price of $1.88 per share and vest over two years until March 20, 2018.

On January 12, 2018, the Company registered 1,150,391 shares representing common shares issuable pursuant to the 2014 Plan, either directly or upon exercise of options issued under the 2014 Plan.

Item 7. | Major Shareholder and Related Party Transactions

| A. | Major shareholders

The following table sets forth information with respect to beneficial ownership of our common shares as of April 30, 2019 by each person who is known by us to beneficially own 5% or more of our outstanding common shares. The number and percentage of common shares beneficially owned are based on 17,806,586 common shares outstanding as of April 30, 2019. Information with respect to beneficial ownership has been furnished by each director, officer or beneficial owner of 5% or more of our common shares. Beneficial ownership is determined in accordance with the rules of the SEC and generally requires that such person have voting or investment power with respect to securities. In computing the number of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares underlying options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days of April 24, 2018 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons listed have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated in the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China. During the past three years, our major shareholder, Ping Chen, has increased his shares of stock in the company by way of incentive grants of stock and options, and we have sold 11,111,111 shares to Hangzhou Lianluo Interactive Information Technology Co., Ltd, which has special voting rights.

Shareholder |  | Amount of Beneficial Ownership(1) |  |  | Percentage Ownership(2) |
Chen Ping |  |  | 2,113,209 | (3) |  |  | 11.87 | %
Hangzhou Lianluo Interactive Information Technology Co., Ltd. (4) |  |  | 11,111,111 |  |  |  | 62.40 | %

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

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

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| (3) | Ping Chen, our Chief Executive Officer and a director, has the sole power to direct the voting and disposition of the 1,613,542 shares held under his name. The number also includes 499,667 shares underlying options, which will have vested within 60 days hereof.

| (4) | Zhitao He, our Chairman of the Board, is also the Chairman and Chief Executive Officer of Hangzhou Lianluo Interactive Information Technology Co. Ltd.

As of April 30, 2019 we had 7 shareholders of record and approximately 35.00% of our total outstanding common shares are held under CEDE & CO., a nominee of The Depository Trust Company.

| B. | Related party transactions

a. | Purchase transactions

The Company entered into related party transactions in the fiscal years ended December 31, 2018, 2017 and 2016.

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

During the years ended December 31, 2018, 2017 and 2016, the Company entered into related party transactions as shown below:

|  | December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
|  | $ |  |  | $ |  |  | $ |
Purchases from related parties |  |  | 204 |  |  |  | 3,760 |  |  |  | 497 |
Rental payments under operating lease commitment |  |  | 39,942 |  |  |  | - |  |  |  | - |

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

On March 15, 2018, we entered into a $6 million loan agreement with DGHKT for a term of 12 months, with a fixed annual interest rate 3.5%. On the year ended December 31, 2018, DGHKT repaid in cash totaled $549,192, and we earned interest of $161,384 from DGHKT.

As of December 31, 2018, the remaining loan balance of RMB35.6 million (equivalent to $5.2 million)(including accrued interest) was fully settled (see e. blow).

On February 3, 2019, pursuant to a loan agreement we granted an unsecured loan of $0.06 million to DGHKT for a term of twelve months, with a fixed annual interest rate 3.5%.

e. | Related party transactions with Hangzhou Lianluo Interactive Information Technology Co., Ltd.

During the years ended December 31, 2018, 2017 and 2016, we made inventory purchases of $204, $3,760 and $497 with HLI, respectively.

On July 1, 2018, we leased office premises from HLI for a period of 1 year, with an annual rental of $84,447 (RMB580,788). Rental payments charged as expenses in 2018 were $39,942. As of December 31, 2018, we reported an outstanding rental payable of $42,223 to HLI.

During 2017, we obtained the following unsecured loans from HLI, which bear fixed interest at 5% per annum:

| - | a loan of $296,064 (RMB2,000,000), repayable by August 28, 2018;
| - | a loan of $296,064 (RMB2,000,000), repayable by December 14, 2018;
|  | a loan of $888,192 (RMB6,000,000), repayable by December 27, 2018.

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Pursuant to various loan agreements between HLI and us in 2018, we obtained the following unsecured loans from HLI:

— | a loan of $529,500 (RMB3,500,000), bearing fixed interest of 6% per annum and repayable by January 29, 2019.
— | a loan of $408,510 (RMB2,700,000), bearing fixed interest of 6% per annum and repayable by March 8, 2019.
— | a loan of $408,510 (RMB2,700,000), bearing fixed interest of 6% per annum and repayable by April 3, 2019.
— | a loan of $423,640 (RMB2,800,000), bearing fixed interest of 6% per annum and repayable by May 23, 2019.
— | a loan of $378,250 (RMB2,500,000), bearing fixed interest of 6% per annum and repayable by June 26, 2019.
— | a loan of $499,290 (RMB3,300,000), bearing fixed interest of 8% per annum and repayable by June 26, 2019.
— | a loan of $226,950 (RMB1,500,000), bearing fixed interest of 6% per annum and repayable by September 4, 2019.
— | a loan of $151,300 (RMB1,000,000), bearing fixed interest of 6% per annum and repayable by October 11, 2019.
— | a loan of $30,260 (RMB200,000), bearing fixed interest of 8% per annum and repayable by October 17, 2019.
— | a loan of $151,300 (RMB1,000,000), bearing fixed interest of 8% per annum and repayable by November 11, 2019.
— | a loan of $90,780 (RMB600,000), bearing fixed interest of 8% per annum and repayable by November 25, 2019.
— | a loan of $107,423 (RMB710,000), bearing fixed interest of 8% per annum and repayable by December 3, 2019.
— | a loan of $276,879 (RMB1,830,000), bearing fixed interest of 8% per annum and repayable by December 10, 2019.

We, via LCL owed a total loan amount RMB34,340,000, plus accrued interest of RMB1,229,076, to HLI.

Interest expense on short-term borrowings from HLI amounted to $200,799, $6,246 and $0 for the years ended December 31, 2018, 2017 and 2016, respectively.

Pursuant to an agreement dated December 27, 2018, we, DGHKT, HLI and LCL agreed that the outstanding amount owed by DGHKT to us of RMB35.6 million be repaid by HLI on behalf of DGHKT, to LCL at our instruction. This repayment is agreed to be settled in the form of offset against the amount owed by LCL to HLI of RMB35.6 million (equivalent to $5.2 million). As a result, we, including our subsidiaries, no longer owed or were owed by HLI or DGHKT any amount as of December 31, 2018.

On February 2, 2019, March 7, 2019 and April 8, 2019, we borrowed an aggregate unsecured amount of RMB1.17 million ($0.18 million) from HLI for a term of twelve months, with a fixed annual interest rate 8%.

f. | Interests of experts and counsel

Not applicable for annual reports on Form 20-F.

Item 8. | Financial Information

We have appended consolidated financial statements filed as part of this annual report. See information provided in response to Item 18 below.

Legal Proceedings

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

On January 24, 2019, Shenzhen JustDo Display Technology Co., Ltd. (“Shenzhen JustDo”) initiated an arbitration proceeding against BDL, claiming that BDL’s failure of payment for goods in 2018 constituted a breach of a purchase contract entered into by and between Shenzhen JustDo and BDL. Shenzhen JustDo asserted its claim at RMB513,684 ($74,712), plus interest since August 1, 2018. On February 21, 2019, BDL submitted a statement of defense, claiming that JustDo’s delay in delivery of goods constituted a breach of the purchase agreement, and the amount of purchase price payable to JustDo shall be determined according to the quantity of goods received. We believe the amount of purchase price payable to JustDo should be RMB235,524 ($34,245), and intend to continue to vigorously defend this proceeding. As of December 31, 2018, we had recognized an account payable to Shenzhen JustDo of RMB250,252 ($36,387).

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Dividend Policy

We have never declared or paid any cash dividends on our common shares. We anticipate that we will retain earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions and future prospects and other factors the Board of Directors may deem relevant.

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

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

Significant Changes

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

Item 9. | The Offer and Listing

| A. | Offer and listing details

Our common shares have been listed on the NASDAQ Capital Market since April 22, 2010 under the symbol “DHRM.” There was no significant trading suspension occurred in the prior three years.

| B. | Plan of distribution

Not applicable for annual reports on Form 20-F.

| C. | Markets

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

| D. | Selling shareholders

Not applicable for annual reports on Form 20-F.

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| E. | Dilution

Not applicable for annual reports on Form 20-F.

| F. | Expenses of the issue

Not applicable for annual reports on Form 20-F.

Item 10. | Additional Information

| A. | Share capital

Not applicable for annual reports on Form 20-F.

| B. | Memorandum and articles of association

The information required by this item is incorporated by reference to (a) the material headed “Description of Share Capital” in our Registration Statement on Form S-1, File no. 333-163041, filed with the SEC on November 12, 2009, as amended and (b) our amended and restated articles and memorandum of association filed as Exhibits 3.1 to a current report on Form 6-K filed on March 8, 2018.

| C. | Material contracts

On November 3, 2017 (the “Effective Date”), the Company completed a purchase of an aggregate of 1,304,348 shares of common stock, par value $0.001 per share (the “Shares”) of Guardion Health Sciences, Inc. (“GHSI” or the “Seller”), at a purchase price of $1.15 per Share (or a purchase price of $1,500,000.20 in the aggregate) in a private placement (the “Private Placement”). The Private Placement occurred pursuant to a Stock Purchase Agreement dated November 3, 2017 (the “Purchase Agreement”) by and among GHSI as Seller and (i) LLIT and (ii) Digital Grid (Hong Kong) Technology Co., Limited (“DGHKT”; and together with LLIT, “Purchasers”), as purchasers of, in aggregate, 4,347,827 Shares for aggregate purchase price of $5,000,001.05

Other than the above contract and those contracts described under “Item 4. Information on the Company”, we have not entered into any material contracts outside the ordinary course of our business within the two years preceding the date of this annual report.

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| D. | Exchange controls

Foreign Currency Exchange

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

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

Dividend Distribution

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

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

Circular 37

In July 2014, SAFE promulgated the Notice of the State Administration of Foreign Exchange on the Administration of Foreign Exchange Involved in Overseas Investment, Financing and Return on Investment Conducted by Residents in China via Special-Purpose Companies, or Circular 37, which replaced the former circular commonly known as Circular 75 promulgated by SAFE in October 2005. 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.” Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as an increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.

In February 2015, SAFE released the Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving the Policies of Foreign Exchange Administration Applicable to Direct Investment, or Circular 13, which has amended Circular 37 by requiring PRC residents or entities to register with qualified banks rather than SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

PRC residents who control our company are required to make registration as mentioned above in connection with their investments in us. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Circular 37 and Circular 13.

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New Mergers & Acquisitions Regulations and Overseas Listings

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

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

| E. | Taxation

British Virgin Islands Taxation

We are exempt from all provisions of the Income Tax Act of the British Virgin Islands, including with respect to all dividends, interests, rents, royalties, compensation and other amounts payable by or to persons who are not resident in the British Virgin Islands. Capital gains realized with respect to any of our shares, debt obligations or other securities by persons who are not resident in the British Virgin Islands are also exempt from all provisions of the Income Tax Act of the British Virgin Islands. No estate, inheritance tax succession or gift tax rate, duty, levy or other charge is payable by persons who are not resident in the British Virgin Islands with respect to any of our shares, debt obligations, or other securities. No stamp duty is payable in the British Virgin Islands in relation to a transfer of shares in a British Virgin Islands Business Company.

United States Federal Income Taxation

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

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

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

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

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

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U.S. Holders

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

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

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

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

Taxation of Dividends and Other Distributions on Common shares

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

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

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

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

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

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

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

Taxation of Disposition of Common shares

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

Passive Foreign Investment Company

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Non-U.S. Holders

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

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

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

Information Reporting and Backup Withholding

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

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

| F. | Dividends and paying agents

Not applicable for annual reports on Form 20-F.

| G. | Statement by experts

Not applicable for annual reports on Form 20-F.

| H. | Documents on display

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

| I. | Subsidiary Information

Not applicable.

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Item 11. | Quantitative and Qualitative Disclosures about Market Risk

Foreign Exchange Risk

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

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

Fluctuations in exchange rates may affect our net revenues, costs, operating margins and net income. In 2018, only 9% of our net revenues were generated from sales denominated in currencies of U.S. dollar. We considered the fluctuations in the exchange rates between the U.S. dollar and the Renminbi had immaterial effect on our operating income.

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

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

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

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Interest Rate Risk

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

As of December 31, 2017, short-term borrowings from HLI were interest bearing at a fixed rate, so we had no financial statement impact from changes in interest rates.

As of December 31, 2018, there were no outstanding short-term borrowings.

Inflation

According to the National Bureau of Statistics of China, China’s overall national inflation rate, as represented by the general consumer price index, was approximately 2% in 2016, 1.6% in 2017 and 2.1% in 2018. We have not in the past been materially affected by any such inflation, but we can provide no assurance that we will not be affected in the future.

Item 12. | Description of Securities Other than Equity Securities

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

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PART II

Item 13. | Defaults, Dividend Arrearages and Delinquencies

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

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

Material Modifications to the Rights of Security Holders

The Company has made re-classification and re-designation of its Common Shares in order that the Company’s authorized share capital be re-classified and re-designated into 50,000,000 Common Shares of par value of $0.002731 each, of which 37,888,889 have been designated as Class A Common Shares of par value of $0.002731 each and 12,111,111 be designated as Class B Common Shares of par value of $0.002731 each. Modifications to the rights of our security holders have been descripted in the modified company Memorandum and Articles of Association, see “Item 10. Additional Information — B. Memorandum and Articles of Association — Ordinary Shares”.

Use of Proceeds

Not applicable.

Item 15. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of December 31, 2018 (the “Evaluation Date”), the Company carried out an evaluation, under the supervision of and with the participation of management, including the Company’s chief executive officer and interim chief financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934). Based upon this evaluation, our chief executive officer and interim chief financial officer concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were not effective, due to the material weakness in our internal control over financial reporting as described below.

Disclosure controls and procedures are designed to ensure that all material information required to be included in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to our management, including our chief executive officer and interim chief financial officer, or persons performing similar functions, as appropriate to allow timely decision regarding required disclosure.

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Management’s Annual Report on Internal Control over Financial Reporting

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

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

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

As required by Section 404 of the Sarbanes-Oxley Act and related rules as promulgated by the SEC, the Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2018, using criteria established in the framework in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Based on this evaluation and as a result of the material weakness discussed below, our Chief Executive Officer and Interim Chief Financial Officer concluded that the our internal control over financial reporting was not effective as of December 31, 2018:

| - | We do not have sufficient qualified accounting personnel with level of knowledge, experience and training of U.S. GAAP and SEC reporting requirements commensurate with our financial reporting requirements. Also, as a small company, we do not have sufficient internal control personnel to set up adequate review functions at each reporting level.

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We plan to take steps to remediate the material weaknesses in our internal control over financial reporting as soon as practicable by:

| ● | hiring additional internal staff familiar with US GAAP and SEC reporting; and
| ● | providing training to our accounting personnel on US GAAP, SEC reporting and other regulatory requirements regarding the preparation of financial statements.

This annual report does not include an attestation report of our registered public accounting firm because we are not an accelerated or large accelerated filer and do not otherwise elect to include such an attestation report.

Despite the material weaknesses reported above, our management believes that our consolidated financial statements included in this report fairly present in all material respects our financial position, results of operations and cash flows for the periods presented.

Changes in Internal Control over Financial Reporting

Other than mentioned above, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 15T. | Controls and Procedures

Not applicable.

Item 16. | [Reserved]

Item 16A. | Audit Committee Financial Expert

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

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Item 16B. | Code of Ethics

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

Room 2108, 21st Floor,

China Railway Construction Building,

No. 20 Shijingshan Road, 100040,

Beijing, China

Attention: Secretary

Item 16C. | Principal Accountant Fees and Services

The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by Centurion ZD CPA & Co., our principal external auditors, for the periods indicated.

|  | 2018 |  |  | 2017 |
Audit fees |  | $ | 183,200 |  |  | $ | 350,000 |
Audit-related fees |  |  | 55,000 |  |  |  | - |
Tax fees |  |  | - |  |  |  | - |
Other fees |  |  | - |  |  |  | - |
|  | $ | 238,200 |  |  | $ | 350,000 |

Note:

| (1) | “Audit fees” means the aggregate fees billed for professional services rendered by our principal external auditors for the audits of our annual financial statements and the interim reviews of our condensed consolidated financial information.

| (2) | “Audit-related fees” means fees billed in 2018 for professional services rendered by our principal auditors associated with certain due diligence projects.

| (3) | “Tax fees” means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal external auditors for tax compliance, tax advice, and tax planning.

| (4) | “All other fees” means the aggregate fees billed for professional services rendered by our principal external auditors associated with other advisory services.

Audit Committee Pre-Approval Policies

The policy of our audit committee is to pre-approve all audit and other service provided by our principal external auditors, including audit services, tax services and other services described above, other than those for de minimis services which are approved by the Audit Committee prior to the completion of the audit.

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

Not applicable.

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

Neither the Company nor any affiliated purchaser has purchased any shares or other units of any class of the Company’s equity securities registered by the Company pursuant to Section 12 of the Securities Exchange Act during the fiscal year ended December 31, 2018.

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

On November 17, 2017, the Company’s Audit Committee and Board of Directors approved the proposed appointment of Centurion ZD CPA Limited (“CZD”) as the Company’s independent registered public accounting firm, dismissing the Company’s previous independent auditors, HHC, on the same date.

The disclosure required under this section was previously reported on Form 6-K filed with the Securities and Exchange Commission on November 21, 2017.

Item 16G. | Corporate Governance.

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

Item 16H. | Mine Safety Disclosure.

Not applicable.

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PART III

Item 17. | Financial Statements

See Item 18.

Item 18. | Financial Statements

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

Item 19. | Exhibits

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

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Exhibit |  |
Number |  | Document
13.2 |  | Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(8)
15.1 |  | Consent of Centurion ZD CPA & Co. (successor of Centurion ZD CPA Limited)(8)
101.INS |  | XBRL Instance Document(8)
101.SCH |  | XBRL Taxonomy Extension Schema Document(8)
101.CAL |  | XBRL Taxonomy Extension Calculation Linkbase Document(8)
101.DEF |  | XBRL Taxonomy Extension Definition Linkbase Document(8)
101.LAB |  | XBRL Taxonomy Extension Label Linkbase Document(8)
101.PRE |  | XBRL Taxonomy Extension Presentation Linkbase Document(8)

(1) | Incorporated by reference to the registrant’s registration statement on Form S-1, File no. 333-163041, filed with the Securities and Exchange Commission on November 12, 2009, as amended.
(2) | Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed with the Securities and Exchange Commission on March 8, 2018.
(3) | Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed with the Securities and Exchange Commission on February 21, 2014.
(4) | Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed with the Securities and Exchange Commission on November 29, 2013.
(5) | Incorporated by reference to the registrant’s proxy statement for the registrant’s annual meeting of shareholders for the fiscal year ended December 31, 2013, File no. 001-34661, filed with the Securities and Exchange Commission on July 1, 2014.
(6) | Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed with the Securities and Exchange Commission on April 22, 2016.
(7) | Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed with the Securities and Exchange Commission on June 30, 2016.
(8) | Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the undersigned certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form 20-F and has duly caused this Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 on Form 20-F to be signed on its behalf by the undersigned, thereunto duly authorized, in the People’s Republic of China, on the 15th day of May, 2019.

Lianluo Smart Limited |
By: | /s/ Ping Chen |
Name: | Ping Chen |
Title: | Chief Executive Officer |
| Date: 15th day of May, 2019 |

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LIANLUO SMART LIMITED AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

| PAGE
CONSOLIDATED FINANCIAL STATEMENTS |
Report of Independent Registered Public Accounting Firm | F-2
Consolidated Balance Sheets as of December 31, 2018 and 2017 | F-3
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2018, 2017, and 2016 | F-4
Consolidated Statements of Changes in Equity for the Years Ended December 31, 2018, 2017, and 2016 | F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016 | F-7
Notes to the Consolidated Financial Statements | F-9

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of Lianluo Smart Limited

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Lianluo Smart Limited and subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations and comprehensive loss, changes in equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Centurion ZD CPA & Co. |
Centurion ZD CPA & Co. (successor to Centurion ZD CPA Limited) |
We have served as the Company’s auditor since 2017.
Hong Kong, China |
May 15, 2019 |

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In U.S. dollars, except for shares data)

|  | December 31, |  |  | December 31, |
|  | 2018 |  |  | 2017 |
ASSETS |  |  |  |  |  |
CURRENT ASSETS: |  |  |  |  |  |
Cash and cash equivalents |  | $ | 477,309 |  |  | $ | 6,809,485 |
Accounts receivable, net |  |  | 92,149 |  |  |  | 9,705 |
Other receivables and prepayments, net |  |  | 267,781 |  |  |  | 128,423 |
Advances to suppliers |  |  | 152,751 |  |  |  | 386,241 |
Inventories, net |  |  | 1,349,102 |  |  |  | 2,217,802 |
Other taxes receivable |  |  | 374,270 |  |  |  | 281,373 |
Total Current Assets |  |  | 2,713,362 |  |  |  | 9,833,029 |
Property and equipment, net |  |  | 1,261,493 |  |  |  | 531,467 |
Construction in progress |  |  | 223,772 |  |  |  | - |
Intangible assets, net |  |  | - |  |  |  | 3,698,569 |
Non-marketable equity securities |  |  | 1,500,043 |  |  |  | 1,500,043 |
Total Assets |  | $ | 5,698,670 |  |  | $ | 15,563,108 |
LIABILITIES AND EQUITY |  |  |  |  |  |  |  |
CURRENT LIABILITIES: |  |  |  |  |  |  |  |
Accounts payable |  | $ | 234,449 |  |  | $ | 47,888 |
Advances from customers |  |  | 232,565 |  |  |  | 313,167 |
Accrued expenses and other current liabilities |  |  | 977,119 |  |  |  | 762,873 |
Warranty obligation |  |  | 8,671 |  |  |  | 20,234 |
Due to related parties |  |  |  |  |  |  |  |
- short-term borrowings |  |  | - |  |  |  | 1,536,720 |
Total Current Liabilities |  |  | 1,452,804 |  |  |  | 2,680,882 |
OTHER LIABILITIES |  |  |  |  |  |  |  |
Warrants liability |  |  | 1,129,246 |  |  |  | 1,729,111 |
Total Liabilities |  |  | 2,582,050 |  |  |  | 4,409,993 |
Commitments and Contingency |  |  |  |  |  |  |  |
SHAREHOLDERS’ EQUITY |  |  |  |  |  |  |  |
Common shares, $0.002731 par value, 50,000,000 shares authorized, 17,806,586 and 17,312,586, shares issued and outstanding at December 31, 2018 and 2017 respectively |  |  | 48,630 |  |  |  | 47,281 |
Additional paid-in capital |  |  | 40,620,772 |  |  |  | 39,233,137 |
Accumulated deficit |  |  | (40,156,204 | ) |  |  | (31,246,202 | )
Accumulated other comprehensive income |  |  | 2,603,422 |  |  |  | 3,118,899 |
Total Equity |  |  | 3,116,620 |  |  |  | 11,153,115 |
Total liabilities and equity |  | $ | 5,698,670 |  |  | $ | 15,563,108 |

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

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In U.S. dollars, except for shares data)

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Revenues |  | $ | 559,386 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |
Costs of revenue |  |  | (757,901 | ) |  |  | (1,655,970 | ) |  |  | (17,179,060 | )
Gross loss |  |  | (198,515 | ) |  |  | (773,959 | ) |  |  | (4,116,687 | )
Service income |  |  | - |  |  |  | 56,030 |  |  |  | 14,587 |
Service expenses |  |  | - |  |  |  | (1,289 | ) |  |  | (21,130 | )
Selling expenses |  |  | (2,082,829 | ) |  |  | (1,170,378 | ) |  |  | (927,243 | )
General and administrative expenses |  |  | (3,675,465 | ) |  |  | (3,192,030 | ) |  |  | (4,183,775 | )
(Provision for) recovery from doubtful accounts |  |  | (22,229 | ) |  |  | 23,608 |  |  |  | 150,280 |
Impairment loss for intangible assets |  |  | (3,281,779 | ) |  |  | - |  |  |  | - |
Operating loss |  |  | (9,260,817 | ) |  |  | (5,058,018 | ) |  |  | (9,083,968 | )
Financial (expenses) income |  |  | (37,899 | ) |  |  | 57,077 |  |  |  | (125,127 | )
Other income |  |  | 24,708 |  |  |  | 146,623 |  |  |  | 68,436 |
Other expense |  |  | (235,859 | ) |  |  | (52,367 | ) |  |  | - |
Loss from warrant redemption |  |  | - |  |  |  | - |  |  |  | (1,091,719 | )
Change in fair value of warrants liability |  |  | 599,865 |  |  |  | (229,749 | ) |  |  | 527,617 |
Loss before provision for income tax and non-controlling interest |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,704,761 | )
Income tax benefit |  |  | - |  |  |  | - |  |  |  | 95,026 |
Net loss from continuing operations |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,609,735 | )
Discontinued operations: |  |  |  |  |  |  |  |  |  |  |  |
Loss from operations of discontinued operations, net of taxes |  |  | - |  |  |  | - |  |  |  | (168,574 | )
Loss from disposal of discontinued operations, net of taxes |  |  | - |  |  |  | - |  |  |  | (82,579 | )
Net loss |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,860,888 | )
Less: net loss attributable to non-controlling interest |  |  | - |  |  |  | - |  |  |  | (129,020 | )
Net loss attributable to Lianluo Smart Limited |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,731,868 | )
Other comprehensive (loss) income: |  |  |  |  |  |  |  |  |  |  |  |
Foreign currency translation (loss) gain |  |  | (515,477 | ) |  |  | 380,077 |  |  |  | (567,162 | )
Comprehensive loss |  |  | (9,425,479 | ) |  |  | (4,756,357 | ) |  |  | (10,428,050 | )
-less comprehensive loss attributable to non-controlling interest |  |  | - |  |  |  | - |  |  |  | (230,838 | )
Comprehensive loss attributable to Lianluo Smart Limited |  | $ | (9,425,479 | ) |  | $ | (4,756,357 | ) |  | $ | (10,197,212 | )

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

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Continued)

(In U.S. dollars, except for shares data)

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Weighted average number of common shares used in computation |  |  |  |  |  |  |  |  |
-Basic |  |  | 17,617,416 |  |  |  | 17,312,586 |  |  |  | 10,422,765 |
-Diluted |  |  | 17,617,416 |  |  |  | 17,312,586 |  |  |  | 10,422,765 |
Loss from continuing operations per share of common stock |  |  |  |  |  |  |  |  |  |  |  |
-Basic |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.92 | )
-Diluted |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.92 | )
Loss from discontinued operations per share of common stock |  |  |  |  |  |  |  |  |  |  |  |
-Basic |  | $ | - |  |  | $ | - |  |  | $ | (0.01 | )
-Diluted |  | $ | - |  |  | $ | - |  |  | $ | (0.01 | )
Net loss per share of common stock |  |  |  |  |  |  |  |  |  |  |  |
-Basic |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.93 | )
-Diluted |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.93 | )

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

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(In U.S. dollars, except for shares data)

|  | Common Stock |  |  | Additional Paid-in |  |  | Accumulated |  |  | Accumulated Other Comprehensive |  |  | Non-controlling |  |  |  |
|  | Shares |  |  | Amount |  |  | Capital |  |  | Deficit |  |  | Income |  |  | Interests |  |  | Total |
Balance as of January 1, 2016 |  |  | 6,194,475 |  |  | $ | 16,918 |  |  | $ | 19,810,905 |  |  | $ | (16,377,900 | ) |  | $ | 2,989,116 |  |  | $ | 867,826 |  |  | $ | 7,306,865 |
Issuance of shares upon excise of share-based awards |  |  | 7,000 |  |  |  | 19 |  |  |  | 10,131 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 10,150 |
Proceeds from issuance of shares and warrants for capital contribution |  |  | 11,111,111 |  |  |  | 30,344 |  |  |  | 16,492,849 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 16,523,193 |
Stock based compensation |  |  | - |  |  |  | - |  |  |  | 947,481 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 947,481 |
Foreign currency translation |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (465,344 | ) |  |  | (101,818 | ) |  |  | (567,162 | )
Disposal of a subsidiary |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 215,050 |  |  |  | (636,988 | ) |  |  | (421,938 | )
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (9,731,868 | ) |  |  | - |  |  |  | (129,020 | ) |  |  | (9,860,888 | )
Balance as of December 31, 2016 |  |  | 17,312,586 |  |  |  | 47,281 |  |  |  | 37,261,366 |  |  |  | (26,109,768 | ) |  |  | 2,738,822 |  |  |  | - |  |  |  | 13,937,701 |
Settlement of subscription receivable |  |  | - |  |  |  | - |  |  |  | 1,492,538 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,492,538 |
Stock based compensation |  |  | - |  |  |  | - |  |  |  | 479,233 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 479,233 |
Foreign currency translation |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 380,077 |  |  |  | - |  |  |  | 380,077 |
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (5,136,434 | ) |  |  | - |  |  |  | - |  |  |  | (5,136,434 | )
Balance as of December 31, 2017 |  |  | 17,312,586 |  |  |  | 47,281 |  |  |  | 39,233,137 |  |  |  | (31,246,202 | ) |  |  | 3,118,899 |  |  |  | - |  |  |  | 11,153,115 |
Issuance of shares upon excise of share-based awards |  |  | 19,000 |  |  |  | 52 |  |  |  | 17,799 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 17,851 |
Issuance of shares to non-employees |  |  | 475,000 |  |  |  | 1,297 |  |  |  | 1,122,702 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,123,999 |
Stock based compensation |  |  | - |  |  |  | - |  |  |  | 247,134 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 247,134 |
Foreign currency translation |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (515,477 | ) |  |  | - |  |  |  | (515,477 | )
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (8,910,002 | ) |  |  | - |  |  |  | - |  |  |  | (8,910,002 | )
Balance as of December 31, 2018 |  |  | 17,806,586 |  |  | $ | 48,630 |  |  | $ | 40,620,772 |  |  | $ | (40,156,204 | ) |  | $ | 2,603,422 |  |  | $ | - |  |  | $ | 3,116,620 |

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

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In U.S. dollars)

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Cash flows from operating activities |  |  |  |  |  |  |  |  |
Net loss |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,860,888 | )
Net loss from discontinued operations |  |  | - |  |  |  | - |  |  |  | (251,153 | )
Net loss from continuing operations |  |  | (8,910,002 | ) |  |  | (5,136,434 | ) |  |  | (9,609,735 | )
Adjustments to reconcile net loss to net cash used in operating activities: |  |  |  |  |  |  |  |  |  |  |  |
Stock-based compensation |  |  | 1,192,021 |  |  |  | 479,233 |  |  |  | 947,481 |
Depreciation and amortization |  |  | 827,630 |  |  |  | 1,328,403 |  |  |  | 1,232,263 |
Loss from disposal of inventories |  |  | 58,992 |  |  |  | - |  |  |  | 202,297 |
Loss from warrant redemption |  |  | - |  |  |  | - |  |  |  | 1,091,719 |
Change in fair value of warrants liability |  |  | (599,865 | ) |  |  | 229,749 |  |  |  | (527,617 | )
Loss on disposal of equipment and intangible assets |  |  | 232,171 |  |  |  | - |  |  |  | 18,241 |
(Recovery from) provision for doubtful accounts: |  |  |  |  |  |  |  |  |  |  |  |
– accounts receivable |  |  | 5,826 |  |  |  | (46,831 | ) |  |  | (139,716 | )
– other receivables and prepayments |  |  | 16,403 |  |  |  | 32,213 |  |  |  | (41,790 | )
– advances to suppliers – third parties |  |  | - |  |  |  | - |  |  |  | (1,095 | )
Change in warranty obligation |  |  | (10,261 | ) |  |  | (130,885 | ) |  |  | 141,449 |
(Recovery from) provision for inventory obsolescence |  |  | - |  |  |  | (73,860 | ) |  |  | 2,450,213 |
Impairment loss for intangible assets |  |  | 3,281,779 |  |  |  | - |  |  |  | - |
Changes in assets and liabilities: |  |  |  |  |  |  |  |  |  |  |  |
(Increase) decrease in accounts receivable |  |  | (88,270 | ) |  |  | 115,239 |  |  |  | 115,854 |
Decrease (increase) in advances to suppliers |  |  |  |  |  |  |  |  |  |  |  |
– third parties |  |  | 233,490 |  |  |  | (341,776 | ) |  |  | 547,267 |
– related party |  |  | - |  |  |  | 194,311 |  |  |  | 680,733 |
Decrease in other receivables and prepayments |  |  | 23,352 |  |  |  | (71,117 | ) |  |  | 13,272 |
Increase in interest receivable – related party |  |  | (161,384 | ) |  |  | - |  |  |  | - |
(Increase) decrease in inventories |  |  | (137,464 | ) |  |  | (2,007,026 | ) |  |  | 1,185,688 |
Increase in other taxes receivable |  |  | (92,897 | ) |  |  | (281,373 | ) |  |  | - |
Decrease in long-term prepaid expenses |  |  | - |  |  |  | - |  |  |  | 290,036 |
Increase (decrease) in accounts payable |  |  | 186,561 |  |  |  | (24,563 | ) |  |  | 51,579 |
Increase in interest payable- related party |  |  | 178,708 |  |  |  | - |  |  |  | - |
(Decrease) increase in due to related parties – Trade |  |  | - |  |  |  | (475 | ) |  |  | 107,715 |
(Decrease) increase in advances from customers |  |  | (80,602 | ) |  |  | 206,646 |  |  |  | 63,541 |
Increase (decrease) in accrued expenses and other current liabilities |  |  | 214,245 |  |  |  | 119,549 |  |  |  | (1,315,779 | )
Decrease in other taxes payable |  |  | - |  |  |  | - |  |  |  | (113,429 | )
Net cash used in operating activities from continuing operations |  |  | (3,629,567 | ) |  |  | (5,408,997 | ) |  |  | (2,609,813 | )
Net cash used in operating activities from discontinued operations |  |  | - |  |  |  | - |  |  |  | (165,345 | )
Net cash used in operating activities |  |  | (3,629,567 | ) |  |  | (5,408,997 | ) |  |  | (2,775,158 | )

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LIANLUO SMART LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(In U.S. dollars)

|  | For the years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Cash flows from investing activities |  |  |  |  |  |  |  |  |
Proceeds from disposal of equipment |  |  | 1,309 |  |  |  | - |  |  |  | - |
Capital expenditures and other additions |  |  | (776,328 | ) |  |  | (40,780 | ) |  |  | (636,130 | )
Loan to a related party |  |  | (6,000,000 | ) |  |  | (3,000,000 | ) |  |  | (2,000,000 | )
Repayment from a related party |  |  | 549,192 |  |  |  | 3,000,000 |  |  |  | 2,000,000 |
Consideration paid to BTL |  |  | - |  |  |  | (146,032 | ) |  |  | - |
Non-marketable equity investments |  |  | - |  |  |  | (1,500,043 | ) |  |  | - |
Net cash used in investing activities from continuing operations |  |  | (6,225,827 | ) |  |  | (1,686,855 | ) |  |  | (636,130 | )
Net cash used in investing activities from discontinued operations |  |  | - |  |  |  | - |  |  |  | - |
Net cash used in investing activities |  |  | (6,225,827 | ) |  |  | (1,686,855 | ) |  |  | (636,130 | )
Cash flows from financing activities |  |  |  |  |  |  |  |  |  |  |  |
Loans from related parties |  |  | 3,682,642 |  |  |  | 1,480,320 |  |  |  | 733,688 |
Repayments of related party loans |  |  | - |  |  |  | - |  |  |  | (2,858,748 | )
Repayments of bank loans |  |  | - |  |  |  | - |  |  |  | (1,505,000 | )
Net proceeds from option exercises |  |  | 17,851 |  |  |  | - |  |  |  | 10,150 |
Payment of warrant redemption |  |  | - |  |  |  | - |  |  |  | (1,116,744 | )
Net proceeds from issuance of common stock, net of issuance costs |  |  | - |  |  |  | 1,492,538 |  |  |  | 18,412,462 |
Net cash provided by financing activities from continuing operations |  |  | 3,700,493 |  |  |  | 2,972,858 |  |  |  | 13,675,808 |
Net cash provided by financing activities from discontinued operations |  |  | - |  |  |  | - |  |  |  | - |
Net cash provided by financing activities |  |  | 3,700,493 |  |  |  | 2,972,858 |  |  |  | 13,675,808 |
Effect of exchange rate fluctuations on cash and cash equivalents |  |  | (177,275 | ) |  |  | 139,656 |  |  |  | (96,421 | )
Net (decrease) increase in cash and cash equivalents |  |  | (6,332,176 | ) |  |  | (3,983,338 | ) |  |  | 10,168,099 |
Cash and cash equivalents at beginning of year |  |  | 6,809,485 |  |  |  | 10,792,823 |  |  |  | 624,724 |
Cash and cash equivalents at end of year |  |  | 477,309 |  |  |  | 6,809,485 |  |  |  | 10,792,823 |
-less cash and cash equivalents at end of year from discontinued operations |  |  | - |  |  |  | - |  |  |  | - |
Cash and cash equivalents at end of year from continuing operations |  | $ | 477,309 |  |  | $ | 6,809,485 |  |  | $ | 10,792,823 |
Supplemental cash flow information |  |  |  |  |  |  |  |  |  |  |  |
Cash paid during the year for: |  |  |  |  |  |  |  |  |  |  |  |
Income tax |  | $ | - |  |  | $ | - |  |  | $ | - |
Interest |  | $ | 14,840 |  |  | $ | 3,812 |  |  | $ | 128,537 |
Non-cash investing and financing activities: |  |  |  |  |  |  |  |  |  |  |  |
Acquisition of property and equipment and construction in progress by decreasing inventories |  | $ | 947,172 |  |  | $ | - |  |  | $ | - |
Offset short-term borrowings - related party against loans to a related party (including accrued interests) |  | $ | 5,381,589 |  |  | $ | - |  |  | $ | - |

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

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Table of Contents

LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 1. | ORGANIZATION AND PRINCIPAL ACTIVITIES

Lianluo Smart Limited (“Lianluo Smart” or the “Company”) (previously known as “Dehaier Medical Systems Limited”) was incorporated as an international business company under the International Business Companies Act, 1984, in the British Virgin Islands on July 22, 2003. On November 21, 2016, the Company changed its name from Dehaier Medical Systems Limited to Lianluo Smart Limited, and its NASDAQ stock ticker from DHRM to LLIT.

Lianluo Smart distributed and provided after-sale services for medical equipment in China mainly through its wholly-owned subsidiary, Beijing Dehaier Medical Technology Co., Limited (“BDL”). BDL was formed as a joint venture on September 24, 2003 as a joint venture between a Chinese entity, Beijing Dehaier Technology Co., Limited (“BTL”), and a foreign invested enterprise, Lianluo Smart. BDL has been focused on the development and distribution of medical devices since its inception and began developing its respiratory and oxygen homecare business in 2006.

The Company’s founder and chief executive office, Mr. Ping Chen, founded BTL, a PRC company. He previously owned approximately 91% of BTL, and his wife and several former employees of Lianluo Smart Limited own the remaining 9% of BTL. BTL previously leased some of its property to the Company and provided certain transportation and repair services to medical devices for which the Company is not obligated to perform warranty services, either because the warranty is expired or because the product was sold by another company.

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

On November 9, 2011, Lianluo Smart established a wholly-owned subsidiary in the United States, Breathcare LLC (“Breathcare”). Breathcare was dissolved on June 30, 2017.

On February 21, 2014, the Company and certain institutional investors entered into a securities purchase agreement in connection with an offering (Note 15).

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

Mr. Ping Chen ceased to be a shareholder of BTL on September 29, 2017.

On February 1, 2016, Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd. (“LCL”) was formed in Beijing, the PRC, for the business development in the portable health device market.

During the late 2015, BDL intended to discontinue part of its product lines among the traditional medical device business, which has been approved by the Board of Resolution on February 22, 2016. The results of operations of the traditional medical device business were reflected in the Company’s consolidated financial statements as discontinued operations (Note 22).

On April 28, 2016, the Company entered into a definitive securities purchase agreement (the “SPA”) with Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“Lianluo Interactive” or “HLI”) to sell 11,111,111 of its common shares and warrants to purchase common shares to Lianluo Interactive for an aggregate purchase price of $20 million (Note 14).

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

On July 31, 2016, BDL entered into a Loss Absorption Agreement Termination (“VIE Termination”) with the BTL. According to the VIE Termination, the Loss Absorption Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010 was terminated effective July 31, 2016. There is no relationship between BTL and the Company and its other subsidiaries after the effectiveness of the VIE Termination. The results of BTL’s operations were reflected in the Company’s consolidated financial statements as discontinued operations (Note 22).

Currently, Lianluo Smart owns 100% of LCL and LCL owns 100% of BDL.

Lianluo Smart, through its subsidiaries, now distributes branded, proprietary medical equipment, such as sleep apnea machines, ventilator air compressors, and laryngoscope. Standard product registration, product certification and quality management system have been established; ISO13485 industry standard has also already been passed. It also has the distribution rights for a number of international medical equipment suppliers for products including ventilator, laryngoscope, sleep apnea machines and other medical equipment accessories.

“Lianluo Smart” and the “Company” collectively refer to Lianluo Smart, a BVI registered company, and its subsidiaries, BDL and LCL. The “Company” may also from time to time in these Notes include the Company’s former VIE, BTL and former subsidiary, Breathcare.

| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Basis of Consolidation

The consolidated financial statements include the accounts of Lianluo Smart and its wholly-owned subsidiaries and variable interest entity for which the Company is the primary beneficiary (“VIE”) (collectively, the “Company”). All inter-company transactions and balances are eliminated in consolidation. The results of subsidiaries and consolidated VIEs acquired or disposed of are recorded in the consolidated statements of operations and comprehensive loss from the effective date of acquisition or up to the effective date of disposal, as appropriate.

A subsidiary is an entity in which (i) the Company directly or indirectly controls more than 50% of the voting power; or (ii) the Company has the power to appoint or remove the majority of the members of the board of directors or to cast a majority of votes at the meeting of the board of directors or to govern the financial and operating policies of the investee pursuant to a statute or under an agreement among the shareholders or equity holders. A VIE is required to be consolidated by the primary beneficiary of the entity if the equity holders in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

A group of shareholders, including the Chief Executive Officer, originally held more than 50% of the voting ownership interest of Lianluo Smart, Beijing Dehaier Medical Technology Company Limited, a PRC company (“BDL”) and Beijing Dehaier Technology Co., Limited (“BTL”). Before July 31, 2016, BTL’s building was pledged as collateral for BDL’s bank loans. In exchange, BDL loaned money to BTL to finance its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. In accordance, BDL is the primary beneficiary of BTL, as the entity that was most closely associated with BTL. BTL was considered a variable interest entity of BDL. Upon execution of the VIE Termination on July 31, 2016, BTL was deconsolidated from Lianluo Smart and its subsidiaries. The results of BTL’s operations were reflected in the Company’s consolidated financial statements as discontinued operations (Note 22).

For the Company’s majority-owned subsidiaries and consolidated VIEs, a noncontrolling interest is recognized to reflect the portion of their equity which is not attributable, directly or indirectly, to the Company.

Termination of the VIE Agreement with BTL

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

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

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

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

Use of Estimates

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

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Cash and Cash Equivalents

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

Accounts Receivable, net

Accounts receivable are initially recorded at invoiced amount. Accounts receivable terms typically are net 60-180 days from the end of the month in which the services were provided, or when goods were delivered. The Company generally does not require collateral or other security to support accounts receivable. A reserve, if required, is based on a combination of historical experience, aging analysis, and an evaluation of the collectability of specific accounts. Management considers that receivables over 1 year to be past due. Accounts receivable balances are charged off against the reserve after all means of collection have been exhausted and the potential for recovery is considered remote.

Other Receivables and Prepayments, net

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

Advances to Suppliers, net

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

Fair Value of Financial Instruments

ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:

| ● | Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

| ● | Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

| ● | Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The carrying amounts reported in the consolidated financial statements for current assets and current liabilities approximate fair value due to the short-term nature of these financial instruments.

The fair value of warrants was determined using the Black Scholes Model, with level 3 inputs (Note 15).

Warrant Liability

For warrants that are not indexed to the Company’s stock, the Company records the fair value of the issued warrants as a liability at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the consolidated statement of operations and comprehensive income. The warrant liability is recognized in the balance sheet at the fair value (level 3). The fair value of these warrants has been determined using the Black-Scholes pricing mode. The Black-Scholes pricing model provides for assumptions regarding volatility, call and put features and risk-free interest rates within the total period to maturity.

Inventories

Inventories are stated at the lower of cost or net realizable value and consist of assembled and unassembled parts relating to medical devices. Cost is determined on a weighted-average basis. Management compares the cost of inventories with the net realizable value and writes down their inventories to net realizable value, if lower. Net realizable value is based on estimated selling prices in the ordinary course of business less cost to sell. These estimates are based on the current market and economic condition and the historical experience of selling products of similar nature. It could change significantly as a result of changes in customer taste and competitor actions in response to any industry downturn. The management of the Company reassesses the estimations at the end of each reporting period.

Property and Equipment

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

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

Estimated useful lives of property and equipment after July 31, 2016 were shortened and depreciation thereafter is calculated on a straight-line basis over the following estimated useful lives:

Leasehold improvements | Shorter of the useful lives or the lease term
Machinery and equipment | 2 - 3 years
Furniture and office equipment | 3 - 5 years
Motor vehicles | 3 years

Construction in progress represents capital expenditures for direct costs of construction or acquisition, and the interest expenses directly related to the construction. Capitalization of these costs ceases and the construction in progress is transferred to the appropriate category of property, plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. Construction in progress is not depreciated.

Intangible Assets

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

Software copyrights | 20 years
Other software | 5 years

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Impairment of Long-Lived Assets

The Company reviews the long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the Company compares the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable.

Based on its review, the Company believes that, as of December 31, 2018, impairment loss for intangible assets was $3,281,779 and as of December 31, 2017, there was no significant impairment of its long-lived assets.

Non-marketable Equity Securities

The Company’s non-marketable equity securities are investments in a privately held company.

Prior to January 1, 2018, the Company accounted for its non-marketable equity securities at cost and only adjusted for other-than-temporary declines in fair value and distributions of earnings. An impairment loss was recognized in the consolidated statements of operations equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment was made. The fair value would then become the new cost basis of investment.

On January 1, 2018, the Company adopted ASU 2016-01 which changed the way it accounts for non-marketable securities. The carrying value of the Company’s non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in non-operating other income (expenses). As the Company did not identify any accounting changes that impacted the amount with respect to non-marketable equity securities, no adjustment to accumulated deficit was required upon adoption.

Revenue Recognition

In May 2014 the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC 606), which supersedes all existing revenue recognition requirements, including most industry specific guidance. This new standard requires a company to recognize revenues when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The FASB subsequently issued the following amendments to ASU No. 2014-09 that have the same effective date and transition date: ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations; ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients; and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. We adopted these amendments with ASU 2014-09 (collectively, the new revenue standards).

The new revenue standards became effective for the Company on January 1, 2018, and were adopted using the modified retrospective method. The adoption of the new revenue standards as of January 1, 2018 did not change the Company’s revenue recognition as the majority of its revenues continue to be recognized when the customer takes control of its product or services. As the Company did not identify any accounting changes that impacted the amount of reported revenues with respect to its product revenues, no adjustment to accumulated deficit was required upon adoption.

Under the new revenue standards, the Company recognizes revenues when its customer obtains control of promised goods or services, in an amount that reflects the consideration which it expects to receive in exchange for those goods. The Company recognizes revenues following the five step model prescribed under ASU No. 2014-09: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenues when (or as) the Company satisfies the performance obligation.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

The following is a description of principal activities from which the Company generates revenue and related revenue recognition policies:

| 1. | Sale of medical equipment

The Company distributes and provides after-sale services for medical equipment, such as sleep apnea machines, ventilator air compressors, laryngoscope, in China. The Company typically sells its branded products with warranty terms covering 12 months after purchase. The warranty requires the Company to repair all mechanical malfunctions and, if necessary, replace defective components. Control of products sold transfers to customers upon shipment from the Company’s facilities, and the Company’s performance obligations are satisfied at that time. Shipping and handling activities are performed before the customer obtains control of the goods and therefore represent a fulfillment activity rather than a promised service to the customer.

The Company evaluates its arrangements with distributors and determines that it is primarily obligated in the sales of distributed products, is subject to inventory risk, has latitude in establishing prices, and assumes credit risk for the amount billed to the customer, or has several but not all of these indicators. In accordance with ASC 606, the Company determines that it is appropriate to record the gross amount of product sales and related costs. As the Company is a principal and it obtains control of the specified goods before they are transferred to the customers, the revenues should be recognized in the gross amount of consideration to which it expects to be entitled in exchange for the specified goods transferred.

| 2. | Provision of sleep diagnostic services

During 2018, the Company started to earn service revenue from provision of technical services in relation to detection and analysis of Obstructive Sleep Apnea Syndrome (“OSAS”). The Company is focused on the promotion of sleep respiratory solutions and service in public hospitals. Its wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China. Revenue is recognized when all of the revenue recognition criteria are met, which is generally when the Company’s diagnostic services are provided to the user at medical centers and public hospitals.

In the PRC, value added tax (“VAT”) of 16% of the invoice amount is collected in respect of the sales of goods on behalf of tax authorities. The VAT collected is not revenue of the Company; instead, the amount is recorded as a liability on the balance sheet until such VAT is paid to the authorities.

Practical expedients and exemptions

The Company generally expenses sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within selling expenses on our consolidated statements of operations and comprehensive loss.

The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for services performed.

Cost of Revenues

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

Advertising Expenses

Advertising expenses are expensed as incurred. For the years ended December 31, 2018, 2017 and 2016, advertising and promotional expenses from continuing operations recognized in the consolidated statements of comprehensive loss were $56,259, $76,592 and $56,338 respectively. During the year ended December 31, 2016, there were no advertising expenses from discontinued operations.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Foreign Currency Translation

The accounts of Lianluo Smart, BDL, LCL and Breathcare are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The accompanying consolidated financial statements are presented in US dollars.

Foreign currency transactions are translated into the functional currency using exchange rates in effect at the time of the transaction. Generally, foreign exchange gains and losses resulting from the settlement of such transactions are recognized in the consolidated statements of operations and comprehensive loss. The financial statements of the Company’s foreign operations are translated USD in accordance with ASC 830-10, “Foreign Currency Matters”. Assets and liabilities are translated at applicable exchange rates quoted by the People’s Bank of China at the balance sheet dates and revenues, expenses and cash flow items are translated at average exchange rates in effect during the periods. Equity is translated at the historical exchange rates. Resulting translation adjustments are recorded as other comprehensive income (loss) and accumulated as a separate component of equity

Warranty Costs

The Company typically sells its branded products with warranty terms covering 12 months after purchase. The warranty requires the Company to repair all mechanical malfunctions and, if necessary, replace defective components.

The Company provides for the estimated cost of product warranties at the time revenue is recognized. The Company’s warranty obligation is affected by product failure rates and material usage and service delivery costs incurred in correcting product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, the Company may revise its estimated product warranty liability.

Warranty expense (recovery gain from warranty expense) accrued from continuing operations for the years ended December 31, 2018, 2017 and 2016 was $(10,261), $(130,885), $141,449, respectively. No warranty expense from discontinued operations was incurred for the year ended December 31, 2016.

Research and Development Costs

Research and development costs relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed as incurred, and included in general and administrative expenses. Research and development costs from continuing operations were $301,713, $344,575 and $1,192,930 for the years ended December 31, 2018, 2017 and 2016, respectively. No research and development costs from discontinued operations were incurred for the year ended December 31, 2016.

Government Subsidies

Government subsidies primarily consist of financial subsidies received from provincial and local governments for operating a business in their jurisdictions and compliance with specific policies promoted by the local governments. For certain government subsidies, there are no defined rules and regulations to govern the criteria necessary for companies to receive such benefits, and the amount of government subsidy is determined at the discretion of the relevant government authorities. The government subsidies of non-operating nature with no further conditions to be met are recorded as non-operating income in “Other income” when received. The government subsidies with certain operating conditions are recorded as “deferred income” when received and will be recorded as operating income when the conditions are met. During the years ended December 31, 2018, 2017 and 2016, government subsidies from continuing operations with no further conditions to be met of $0, $17,394 and $0, respectively, were recorded. There were no government subsidies from discontinued operations for the year ended December 31, 2016.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Leases

Leases where substantially all the rewards and risk of assets remain with the leasing company are accounted for as operating leases. Payments made under operating leases are charged to the consolidated statement of operations on a straight-line basis over the shorter of the lease term or estimated economic life of the leased property.

Loss per Share

The Company follows the provisions of ASC 260-10, “Earnings per Share”. Basic loss per share is computed by dividing net loss attributable to holders of common shares by the weighted average number of common shares outstanding during the years. Diluted loss per share reflect the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares. Common stock equivalents having an anti-dilutive effect on earnings per share are excluded from the calculation of diluted loss per share.

Value Added Tax

The Company reports revenues, net of PRC’s value added tax, for all the periods presented in the consolidated statements of income and comprehensive income.

Stock-Based Compensation

The Company accounts for stock-based share-based compensation awards to employees at fair value on the grant date and recognizes the expense over the employee’s requisite service period. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock or the expected volatility of similar entities. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend is based on the Company’s current and expected dividend policy.

Share-based compensation expenses for stock-based share-based compensation awards granted to non-employees are measured at fair value at the earlier of the performance commitment date or the date service is completed, and recognized over the period during which the service is provided. The Company applies the guidance in ASC 505-50 to measure share options and restricted shares granted to non-employees based on the then-current fair value at each reporting date.

Segment Information

The Company’s segments are business units that offer different products and services and are reviewed separately by the chief operating decision maker (the “CODM”), or the decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s CODM is the Company’s Chief Executive Officer. During fiscal 2016 and 2017, there was only one segment, which is the business of developing, commercializing and distribution of medical equipment, such as sleep apnea machines, ventilator air compressors, and laryngoscope. During 2018, the Company started to earn service revenue from provision of technical services in relation to diagnosis of Obstructive Sleep Apnea Syndrome (“OSAS”). The Company is focused on the promotion of sleep respiratory solutions and service in public hospitals. Its wearable sleep diagnostic products and cloud-based service are also available in medical centers of Chinese private preventive healthcare companies in China.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Revenues |  |  |  |  |  |  |  |  |
Sale of medical equipment |  | $ | 342,344 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |
Provision of OSAS diagnostic services |  |  | 217,042 |  |  |  | - |  |  |  | - |
Total net revenues |  |  | 559,386 |  |  |  | 882,011 |  |  |  | 13,062,373 |
Cost of revenue |  |  |  |  |  |  |  |  |  |  |  |
Sale of medical equipment |  |  | (464,918 | ) |  |  | (1,655,970 | ) |  |  | (17,179,060 | )
Provision of OSAS diagnostic services |  |  | (292,983 | ) |  |  | - |  |  |  | - |
|  |  | (757,901 | ) |  |  | (1,655,970 | ) |  |  | (17,179,060 | )
Gross loss |  |  |  |  |  |  |  |  |  |  |  |
Sale of medical equipment |  |  | (122,574 | ) |  |  | (773,959 | ) |  |  | (4,116,687 | )
Provision of OSAS diagnostic services |  |  | (75,941 | ) |  |  | - |  |  |  | - |
|  |  | (198,515 | ) |  |  | (773,959 | ) |  |  | (4,116,687 | )
Depreciation and amortization expense: |  |  |  |  |  |  |  |  |  |  |  |
Sale of medical equipment |  | $ | 535,800 |  |  | $ | 1,328,403 |  |  | $ | 1,232,263 |
Provision of OSAS diagnostic services |  |  | 291,830 |  |  |  | - |  |  |  | - |
|  | $ | 827,630 |  |  | $ | 1,328,403 |  |  | $ | 1,232,263 |
Capital expenditure |  |  |  |  |  |  |  |  |  |  |  |
Sale of medical equipment |  | $ | 16,137 |  |  | $ | 40,780 |  |  | $ | 636,130 |
Provision of OSAS diagnostic services |  |  | 760,191 |  |  |  | - |  |  |  | - |
|  | $ | 776,328 |  |  | $ | 40,780 |  |  | $ | 636,130 |

The total assets for the two reportable segments were shared and indistinguishable for reporting purposes.

Income Taxes

The Company uses the asset and liability method of accounting for income taxes in accordance with ASC 740, “Accounting for Income Taxes.” Under this method, income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year; and, (ii) deferred tax consequences of temporary differences resulting from matters that have been recognized in an entity’s financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation reserve is provided to reduce the deferred tax assets reported if, based on the weight of available positive and negative evidence. Based on management’s estimate, it is more likely than not that all of the deferred tax assets will not be realized.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return. Under ASC 740, a tax benefit from an uncertain tax position taken or expected to be taken may be recognized only if it is “more likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying position under ASC 740 would equal the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all the relevant information. A liability (including interest and penalties, if applicable) is established in the financial statements to the extent a current benefit has been recognized on a tax return for matters that are considered contingent upon the outcome of an uncertain tax position. Related interest and penalties, if any, are included as components of income tax expense and income taxes payable.

The implementation of ASC 740 resulted in no material liability for unrecognized tax benefits. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the statements of income and comprehensive income. During the years ended December 31, 2018, 2017 and 2016, the Company did not incur any interest or penalties.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This update requires lessee to recognize the assets and liability (the lease liability) arising from operating leases on the balance sheet for the lease term. When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. Within a twelve month or less lease term, a lessee is permitted to make an accounting policy election not to recognize lease assets and liabilities. If a lessee makes this election, it should recognize lease expense on a straight-line basis over the lease term. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. Originally, entities were required to adopt ASU 2016-02 using a modified retrospective approach, which required prior periods to be presented under Topic 842. However, in July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which allows entities the option of recognizing the cumulative effect of applying Topic 842 as an adjustment to the opening balance of retained earnings in the year of adoption while continuing to present all prior periods under previous lease accounting guidance. The Company is evaluating the impact of the adoption of ASU 2016-02 on the Company’s financial statement presentation and disclosures and expects the most significant change will be the recognition of right-to-use assets and lease liabilities on its balance sheet for real estate operating lease commitments.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance should be adopted on a prospective basis for the annual or any interim goodwill impairment tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company currently intends to adopt this guidance for the fiscal year beginning January 1, 2020, and does not anticipate that the adoption of this guidance will have a material impact on its financial statements or disclosures because the Company does not currently have any recorded goodwill.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 3. | ACCOUNTS RECEIVABLE, NET

Accounts receivable as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Accounts receivable |  | $ | 118,922 |  |  | $ | 34,021 |
Less: reserve for doubtful accounts |  |  | (26,773 | ) |  |  | (24,316 | )
Accounts receivable, net |  | $ | 92,149 |  |  | $ | 9,705 |

During the years ended December 31, 2018, 2017 and 2016, bad debts (recovery of bad debts) from continuing operations were $5,826, ($46,831) and ($139,716) respectively. During the year ended December 31, 2016, there were no bad debts from discontinued operations.

| 4. | OTHER RECEIVABLES AND PREPAYMENTS, NET

Other receivables and prepayments as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Rental deposits |  | $ | 43,838 |  |  | $ | 33,178 |
Prepaid expenses |  |  | 271,965 |  |  |  | 129,286 |
Advances to employees |  |  | 47 |  |  |  | - |
|  |  | 315,850 |  |  |  | 162,464 |
Less: reserve for doubtful accounts |  |  | (48,069 | ) |  |  | (34,041 | )
Other receivables, net |  | $ | 267,781 |  |  | $ | 128,423 |

During the years ended December 31, 2018, 2017 and 2016, bad debts (recovery of bad debts) on other receivables from continuing operations were $16,403, $32,213 and ($41,790), respectively. During the year ended December 31, 2016, there were no bad debts on other receivables from discontinued operations.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 5. | ADVANCES TO SUPPLIERS

Advances to suppliers as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Advances to suppliers |  | $ | 152,751 |  |  | $ | 386,241 |

During the years ended December 31, 2018, 2017 and 2016, impairment charges (recovery) on advances to suppliers from continuing operations were $0, $0 and $(1,095), respectively. During the year ended December 31, 2016, impairment charges on advances to suppliers from discontinued operations were $32,321.

6. | INVENTORIES

Inventories as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Raw materials |  | $ | 27,638 |  |  | $ | 184,490 |
Work in progress |  |  | 902 |  |  |  | 127,530 |
Finished goods |  |  | 1,320,562 |  |  |  | 1,905,782 |
Total inventories |  | $ | 1,349,102 |  |  | $ | 2,217,802 |

During the years ended December 31, 2018, 2017 and 2016, (reversals of write-downs) and write-downs of inventories to lower of cost or net realizable value of $0, $(73,860) and $2,450,213, respectively, were (credited against) charged to costs of revenue in relation to the Company’s continuing operations. Also, during the years ended December 31, 2018, 2017 and 2016, obsolete inventories were disposed of at a loss of $58,992, $0 and $202,297, respectively, charged to costs of revenue in relation to the Company’s continuing operations.

During the year ended December 31, 2016, there was no write-own of inventories or loss on disposal of obsolete inventories in relation to the Company’s discontinued operations.

| 7. | PROPERTY AND EQUIPMENT, NET

Property and equipment as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Plant and machinery |  | $ | 1,770,626 |  |  | $ | 2,461,719 |
Automobiles |  |  | 139,380 |  |  |  | 147,310 |
Office and computer equipment |  |  | 37,005 |  |  |  | 51,034 |
Total property and equipment |  |  | 1,947,011 |  |  |  | 2,660,063 |
Less: Accumulated depreciation |  |  | (685,518 | ) |  |  | (2,128,596 | )
Property and equipment, net |  | $ | 1,261,493 |  |  | $ | 531,467 |

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Depreciation from the Company’s continuing operations were $467,929, $974,432 and $869,073 for the years ended December 31, 2018, 2017, and 2016 respectively. Depreciation from the Company’s discontinued operations were $51,056 for the year ended December 31, 2016.

The Company did not record any impairment on its property and equipment from its continuing and discontinued operations for the years ended December 31, 2018, 2017 and 2016.

| 8. | CONSTRUCTION IN PROGRESS

Construction in progress as of December 31, 2018 represented equipment pending installation.

| 9. | INTANGIBLE ASSETS, NET

Intangible assets from continuing operations as of December 31, 2018 and 2017 consist of the following:

|  | 2018 |  |  | 2017 |
Software copyright |  | $ | 1,698,359 |  |  | $ | 1,794,981 |
Patent and others |  |  | 3,019,516 |  |  |  | 3,191,300 |
Total intangible assets |  | $ | 4,717,875 |  |  |  | 4,986,281 |
Less: Accumulated amortization |  |  | (1,564,070 | ) |  |  | (1,287,712 | )
Less: Impairment loss |  |  | (3,153,805 | ) |  |  | - |
Intangible assets, net |  | $ | - |  |  | $ | 3,698,569 |

Amortization expense from the Company’s continuing operations was $359,701, $353,971 and $363,190 for the years ended December 31, 2018, 2017, and 2016, respectively. The Company did not record amortization expense from its discontinued operations for the year ended December 31 2016.

The Company recorded impairment on its intangible assets from its continuing operations $3,281,779, $0 and $0 for the years ended December 31, 2018, 2017 and 2016. The Company recorded impairment of $18,447 from its discontinued operations for the year ended December 31, 2016. During the year ended December 31, 2018, as a result of lower-than-expected revenue performance of the Company, management determined not to further update and maintain its software copyright and patent for the therapy products of sleep respiratory business. The unamortized software copyright and patent and others of $3,281,779 were fully impaired.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 10. | NON-MARKETABLE EQUITY SECURITIES

On November 3, 2017 (the “Effective Date”), the Company completed a purchase of an aggregate of 1,304,348 shares of common stock, par value $0.001 per share (the “Shares”) of Guardion Health Sciences, Inc., a Delaware corporation (“GHSI” or the “Seller”), at a purchase price of $1.15 per Share (or a purchase price of $1,500,043 in the aggregate) in a private placement, pursuant to a Stock Purchase Agreement dated November 3, 2017 (the “Purchase Agreement”) by and among GHSI as Seller and (i) LLIT and (ii) Digital Grid (Hong Kong) Technology Co., Limited (“DGHKT”; and together with LLIT, “Purchasers”), as purchasers of, in aggregate, 4,347,827 Shares for aggregate purchase price of $5,000,001.

Until the one year anniversary of the Effective Date, or earlier in the event that the Purchasers hold less than three percent (3%) of the issued and outstanding shares of common stock of the Seller, GHSI may not undertake a reverse stock split or equivalent reclassification of GHSI’s shares of common stock without the prior written consent of the Purchasers holding a majority of the Shares issued pursuant to the Purchase Agreement which are then outstanding.

Pursuant to the Purchase Agreement, each Purchaser will have customary preemptive rights to participate in future equity and equity-linked issuances by the Seller up to the extent necessary to maintain such Purchaser’s pro rata ownership percentage in GHSI’s securities, subject to customary exceptions. The preemptive rights shall terminate at the earlier of (i) 18 months from the Effective Date, (ii) such time as the Purchasers in aggregate hold less than five percent (5%) of the issued and outstanding shares of the Seller’s common stock, or (iii) such time as the shares of common stock of GHSI shall become listed or approved for listing on a national securities exchange.

Additionally, pursuant to the Purchase Agreement, the Seller is obligated to file a registration statement (the “Registration Statement”) with the SEC within thirty (30) days of the Effective Date to register the Shares for resale. The requested Registration Statement was filed on November 30, 2017 and was declared effective on December 27, 2017.

GHSI is specialty health sciences company formed to develop, formulate and distribute condition-specific medical foods with an initial medical food product on the market under the brand name Lumega-Z® that replenishes and restores the macular protective pigment. GSHI has had limited commercial operations to date, and has primarily been engaged in research, development, commercialization, and capital raising. As of December 31, 2018, the Company and DGHKT respectively held 3.17% and 7.40% of GHSI’s outstanding common stock.

On January 30, 2019, GHSI effectuated a one-for-two (1:2) reverse stock split of its common stock without any change to its par value. On April 9, 2019, GHSI closed its initial public offering of 1,250,000 shares of its common stock at a public offering price of $4.00 per share for total gross proceeds of $5.0 million, before deducting underwriting discounts and commissions and other offering costs and expenses payable by it. GHSI’s shares began trading on the Nasdaq Capital Market on April 5, 2019 under the symbol “GHSI”.

| 11. | SHORT-TERM BORROWINGS

|  | December 31, |
|  | 2018 |  |  | 2017 |
Loans from Hangzhou Lianluo Interactive Information Technology Co., Ltd. |  | $ | - |  |  | $ | 1,536,720 |

Interest expense on short-term borrowings amounted to $200,799, $6,246 and $128,537 for the years ended December 31, 2018, 2017 and 2016, respectively.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| (1) | Loans from Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“HLI”)

Pursuant to various loan agreements between the Company and HLI in 2017, the Company obtained the following unsecured loans from HLI, which bear fixed interest at 5% per annum:

| — | a loan of $296,064 (RMB2,000,000), repayable by August 28, 2018;

| — | a loan of $296,064 (RMB2,000,000), repayable by December 14, 2018;

| — | a loan of $888,192 (RMB6,000,000), repayable by December 27, 2018.

Pursuant to various loan agreements between the Company and HLI in 2018, the Company obtained the following unsecured loans from HLI:

| — | a loan of $529,500 (RMB3,500,000), bearing fixed interest of 6% per annum and repayable by January 29, 2019.

| — | a loan of $408,510 (RMB2,700,000), bearing fixed interest of 6% per annum and repayable by March 8, 2019.

| — | a loan of $408,510 (RMB2,700,000), bearing fixed interest of 6% per annum and repayable by April 3, 2019.

| — | a loan of $423,640 (RMB2,800,000), bearing fixed interest of 6% per annum and repayable by May 23, 2019.
| — | a loan of $378,250 (RMB2,500,000), bearing fixed interest of 6% per annum and repayable by June 26, 2019.

| — | a loan of $499,290 (RMB3,300,000), bearing fixed interest of 8% per annum and repayable by June 26, 2019.

| — | a loan of $226,950 (RMB1,500,000), bearing fixed interest of 6% per annum and repayable by September 4, 2019.

| — | a loan of $151,300 (RMB1,000,000), bearing fixed interest of 6% per annum and repayable by October 11, 2019.

| — | a loan of $30,260 (RMB200,000), bearing fixed interest of 8% per annum and repayable by October 17, 2019.

| — | a loan of $151,300 (RMB1,000,000), bearing fixed interest of 8% per annum and repayable by November 11, 2019.

| — | a loan of $90,780 (RMB600,000), bearing fixed interest of 8% per annum and repayable by November 25, 2019.

| — | a loan of $107,423 (RMB710,000), bearing fixed interest of 8% per annum and repayable by December 3, 2019.

| — | a loan of $276,879 (RMB1,830,000), bearing fixed interest of 8% per annum and repayable by December 10, 2019.

The Company, via LCL owed a total loan amount RMB34,340,000, plus accrued interest of RMB1,229,076, to HLI.

Interest expense on short-term borrowings from HLI amounted to $200,799, $6,246 and $0 for the years ended December 31, 2018, 2017 and 2016, respectively.

Pursuant to an agreement dated December 27, 2018, the Company, DGHKT, HLI and LCL agreed that the outstanding amount owed by DGHKT to the Company of RMB35.6 million be repaid by HLI on behalf of DGHKT, to LCL at the instruction of the Company. This repayment is agreed to be settled in the form of offset against the amount owed by LCL to HLI of RMB35.6 million (equivalent to $5.2 million) (Note 18). As a result, the Company, including its subsidiaries, no longer owed or was owed by HLI or DGHKT any amount as of December 31, 2018.

| (2) | Loans from Mr. Ping Chen

On March 27, 2015, the Company entered into a new loan agreement with Mr. Ping Chen (“Mr. Chen), who is During the year ended December 31, 2016, the Company obtained unsecured, interest-free loans from Mr. Ping Chen in an aggregate amount of $718,638 (RMB4,775,000) which had been fully repaid on October 24, 2016.

Interest expense paid to Mr. Ping Chen amounted to $29,207 for the year ended December 31, 2016.

Bank borrowings

On December 18, 2015, the Company entered into a new loan agreement with Nanjing Bank Company Limited (Beijing Branch) in the amount of $1,603,590 (RMB10,000,000) with a fixed interest rate which was 7.20% per annum. The loan had been fully repaid on November 14, 2016.

Interest expense paid on bank borrowings amounted to $99,330 for the year ended December 31, 2016.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 12. | ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Other payables and other current liabilities as of December 31, 2018 and 2017 from continuing operations consist of the following:

|  | 2018 |  |  | 2017 |
Accrued salaries and social welfare |  | $ | 337,599 |  |  | $ | 345,710 |
Accrued expenses |  |  | 388,572 |  |  |  | 291,043 |
Reimbursed employee’s expense |  |  | 50,228 |  |  |  | 34,212 |
Deposits from customers |  |  | 198,907 |  |  |  | 89,382 |
Others |  |  | 1,813 |  |  |  | 2,526 |
Total accrued expenses and other current liabilities |  | $ | 977,119 |  |  | $ | 762,873 |

| 13. | COMMITMENTS AND CONTINGENCY

Leases

The lease commitments are for office premises which are classified as operating leases. These non-cancelable leases have lease terms expiring through November 2020. Future minimum lease payments under these leases as of December 31, 2018 are $104,706 for the twelve months ending December 31, 2019.

Rent expense from continuing operations for the years ended December 31, 2018, 2017 and 2016 was $301,021, $244,860 and $101,012 respectively. There was no rental expense incurred in relation to the Company’s discontinued operations for the year ended December 31, 2016.

Employment Contracts

Under the PRC labor law, all employees have signed employment contracts with the Company. Management employees have employment contracts with terms up to three years and non-management employees have either a three year employment contract renewable on an annual basis or non-fixed term employment contract.

Contingency

The Labor Contract Law of the People’s Republic of China requires employers to assure the liability of the severance payments if employees are terminated and have been working for the employers for at least two years prior to January 1, 2008. The Company has estimated its possible severance payments of approximately $886,049 and $663,069 as of December 31, 2018 and 2017, respectively, which have not been reflected in its consolidated financial statements, because it is more likely than not that this will not be paid or incurred.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 14. | EQUITY

Common Shares

In 2016, the Company issued an aggregate of 7,000 ordinary shares to individuals upon exercise of share-based awards.

On April 28, 2016, the Company entered into a definitive securities purchase agreement with HLI pursuant to which HLI has agreed to purchase 11,111,111 restricted common shares of the Company for an aggregate of $20,000,000. The purchase price is $1.80 per share, which represents a 35% premium to the Company’s closing price of $1.33 on April 27, 2016. In August 2016, the Company closed the securities purchase agreement (the “Securities Purchase Agreement”) with HLI and HLI completed the purchase of $20 million of the Company’s common shares and warrants to purchase common shares (Note 16). As of December 31, 2016, the Company reported a subscription receivable of $1,492,538 from HLI which had been collected on April 13, 2017.

On June 8, 2017, the Company held the Annual General Meeting to approve the amend and restate the Company's amended and restated Memorandum and Articles of Association (the “New M&AAs”) in order that the Company’s authorized share capital be re-classified and re-designated into 50,000,000 Common Shares of par value of $0.002731 each, of which 37,888,889 would be designated as Class A Common Shares of par value of $0.002731 each and 12,111,111 be designated as Class B Common Shares of par value of $0.002731 each.

In 2018, the Company issued an aggregate of 275,000 common shares to a consultant under the Company’s incentive plan for advice and services provided concerning the Company’s merger and acquisition planning, development and strategy implementation. The fair value of the 275,000 common shares was $835,999, which was calculated based on the grant date stock price of $3.18 and $2.90. During the year ended December 31, 2018, the Company amortized $835,999 as consulting expenses.

Also in 2018, the Company issued 200,000 common shares to a consulting firm for management consulting and advisory services to be provided for a period of 12 months up to August 15, 2019. The fair value of these shares on the grant date based on the closing price was approximately $288,000. During the year ended December 31, 2018, the Company amortized $108,888 as consulting expenses.

Statutory Surplus Reserves

A PRC company is required to make appropriations to statutory surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”). Appropriations to the statutory surplus reserve is required to be at least 10% of the after tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entity’s’ registered capital.

The statutory surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of shares currently held by them, provided that the remaining statutory surplus reserve balance after such issue is not less than 25% of the registered capital.

No amount was allocated to the statutory surplus reserve account as both the subsidiaries in China had incurred accumulated losses as of December 31, 2018 and 2017.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Stock Option Plan

Under the employee stock option plan, the Company’s stock options generally expire ten years from the date of grant. On December 29, 2011, the Company entered into five-year agreements with its employees and directors, pursuant to which, the Company issued an aggregate of 450,000 options at an exercise price of $1.45 per share. The options vest in equal annual installments over the five years of the agreements ending December 28, 2016.

On October 7, 2013, pursuant to the Company’s Share Incentive Plan, the Company granted a non-statutory option to acquire 94,000 of the Company’s common shares at an exercise price of $2.30 per share to Mr. Ping Chen, the CEO of the Company. The options vest in equal annual installments over the five years of the agreement ending October 6, 2018.

On August 20, 2014, pursuant to the Company’s Share Incentive Plan, the Company granted additional option to acquire 131,000 of the Company’s common shares at an exercise price of $5.31 per share to Mr. Ping Chen. The options vest in equal annual installments over the five years of the agreement ending August 19, 2019.

On August 7, 2015, the Company entered into two-year agreements with its employees and directors, pursuant to which the Company issued an aggregate of 349,000 options at an exercise price of $1.64 per share. The options vest in equal annual installments over the two years of the agreements ending August 6, 2017.

On March 21, 2016, the Company entered into two-year agreements with its employees and directors, pursuant to which the Company issued an aggregate of 580,867 options at an exercise price of $1.88 per share. The options vest in equal annual installments over the two years of the agreements ending March 20, 2018.

In 2018, 11,000 options were exercised for cash to purchase 11,000 shares of the Company’s common shares for an aggregate consideration of $17,851, and 40,000 options were exercised on a cashless basis to purchase 8,000 common shares of the Company.

As of December 31, 2018, 26,200 options have not been vested.

The Company valued the stock options using the Black-Scholes model with the following assumptions:

Expected Terms (years) |  | Expected Volatility |  | Dividend Yield |  | Risk Free Interest Rate |  | Grant Date Fair Value Per share
10 |  | 126%-228% |  | 0% |  | 0.73%-1.65% |  | $1.22-$5.15

The following is a summary of the option activity:

Stock options |  | Shares |  |  | Weighted average exercise price |  |  | Aggregate intrinsic value (1) |
Outstanding as of January 1, 2017 |  |  | 1,237,867 |  |  | $ | 2.17 |  |  |  |  |
Forfeited |  |  | (221,000 | ) |  |  | - |  |  |  |  |
Outstanding as of December 31, 2017 |  |  | 1,016,867 |  |  | $ | 2.26 |  |  |  |  |
Forfeited |  |  | (84,000 | ) |  |  |  |  |  |  |  |
Exercised |  |  | (51,000 | ) |  |  |  |  |  |  |  |
Outstanding as of December 31, 2018 |  |  | 881,867 |  |  | $ | 2.34 |  |  | $ | - |

| (1) | The intrinsic value of the stock options at December 31, 2018 is the amount by which the market value of the Company’s common stock of $1.13 as of December 31, 2018 exceeds the exercise price of the options.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Following is a summary of the status of options outstanding and exercisable at December 31, 2018:

Outstanding options |  |  | Exercisable options |
Average exercise price |  |  | Number |  |  | Average remaining contractual life (years) |  |  | Average exercise price |  |  | Number |  |  | Average remaining contractual life (years) |
$ | 1.45 |  |  |  | 107,000 |  |  |  | 3.00 |  |  | $ | 1.45 |  |  |  | 107,000 |  |  |  | 3.00 |
$ | 2.30 |  |  |  | 94,000 |  |  |  | 4.77 |  |  | $ | 2.30 |  |  |  | 94,000 |  |  |  | 4.77 |
$ | 5.31 |  |  |  | 131,000 |  |  |  | 5.64 |  |  | $ | 5.31 |  |  |  | 104,800 |  |  |  | 5.64 |
$ | 1.64 |  |  |  | 159,000 |  |  |  | 6.60 |  |  | $ | 1.64 |  |  |  | 159,000 |  |  |  | 6.60 |
$ | 1.88 |  |  |  | 390,867 |  |  |  | 7.22 |  |  | $ | 1.88 |  |  |  | 390,867 |  |  |  | 7.22 |
|  |  |  |  | 881,867 |  |  |  |  |  |  |  |  |  |  |  | 855,667 |  |  |  |  |

For the years ended December 31, 2018, 2017 and 2016, the Company recognized $247,134, $479,233 and $947,481 respectively, as compensation expense under its stock option plan.

As of December 31, 2018, unrecognized share-based compensation expense related to options was $85,754.

| 15. | WARRANTS

On April 21, 2010, the Company issued to Anderson & Strudwick Incorporated (“A&S”) 150,000 warrants, as a portion of the placement commission for the IPO. On the same day, the Company granted a total of 7,500 warrants to Hawk Associates Inc. (“Hawk”), the Company’s investor relations consultancy. On January 10, 2012, the Company issued 100,000 warrants to FirsTrust Group, Inc., (“FirsTrust”), the Company’s financial advisor. The warrants were redeemed at December 31, 2016.

In connection with the stock offering in February 2014, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with certain institutional investors for the sale of 734,700 common shares in a registered offering at the price of $9.12 per common share. In addition, the Company issued 220,410 warrants to the institutional investors aggregately and issued 73,470 warrants to FT Global Capital, Inc. (“FT Global”), as a portion of the placement commission. These warrants will be exercisable immediately as of the date of issuance at an exercise price of $11.86 per common share and expire forty-two months from the date of issuance. The exercise price of the warrants is subject to customary adjustment in the case of future issuances or deemed issuances of common shares, stock splits, stock dividends, combinations of shares and similar recapitalization transactions. On April 21, 2016, the Company signed Warrants Repurchase Agreements with those institutional investors and FT Global who signed the “Securities Purchase Agreement” with the Company in 2014. The Company repurchased the outstanding warrants to purchase in aggregate 293,880 shares of its common shares, and paid an aggregate cash purchase price of $1,116,744 ($3.80 per share underlying the warrants).

On April 28, 2016, the Company signed Share Purchase Agreement (“SPA”) with HLI. In this SPA, HLI is entitled with 1,000,000 warrants to acquire from the Company 1,000,000 common shares at purchase price of $2.20 per share. The new warrants will be exercisable at any time.

There were a total of 1,000,000 warrants issued and outstanding as of December 31, 2018 and 2017.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

The fair value of the outstanding warrants was calculated using the Black Scholes Model with the following assumptions:

|  | December 31, |
Stock options |  | 2018 |  |  | 2017 |  |  | 2016 |
Market price per share (USD/share) |  | $ | 1.13 |  |  | $ | 1.73 |  |  | $ | 1.50 |
Exercise price (USD/share) |  |  | 2.20 |  |  |  | 2.20 |  |  |  | 2.20 |
Risk free rate |  |  | 2.6 | % |  |  | 2.36 | % |  |  | 2.40 | %
Dividend yield |  |  | 0 | % |  |  | 0 | % |  |  | 0 | %
Expected term/Contractual life (years) |  |  | 7.3 |  |  |  | 8.3 |  |  |  | 9.3 |
Expected volatility |  |  | 256.20 | % |  |  | 241.20 | % |  |  | 232.20 | %

The following is a reconciliation of the beginning and ending balances of warrants liability measured at fair value on a recurring basis using Level 3 inputs:

|  | December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Beginning balance |  | $ | 1,729,111 |  |  | $ | 1,499,362 |  |  | $ | 162,736 |
Warrants issued to HLI |  |  | - |  |  |  | - |  |  |  | 1,889,269 |
Warrants redeemed |  |  | - |  |  |  | - |  |  |  | (25,026 | )
Fair value change of the issued warrants included in earnings |  |  | (599,865 | ) |  |  | 229,749 |  |  |  | (527,617 | )
Ending balance |  | $ | 1,129,246 |  |  | $ | 1,729,111 |  |  | $ | 1,499,362 |

The following is a summary of the warrants activity:

|  | Number |  |  | Weighted Average Exercise Price |  |  | Weighted Average Remaining Contractual Life (Years) |
Outstanding as of January 1, 2017 |  |  | 1,000,000 |  |  | $ | 2.20 |  |  |  | 0.49 |
Granted |  |  | - |  |  |  |  |  |  |  |  |
Forfeited |  |  | - |  |  |  |  |  |  |  |  |
Exercised |  |  | - |  |  |  |  |  |  |  |  |
Redeemed |  |  | - |  |  |  |  |  |  |  |  |
Outstanding as of December 31, 2017 |  |  | 1,000,000 |  |  | $ | 2.20 |  |  |  |  |
Granted |  |  | - |  |  |  |  |  |  |  |  |
Forfeited |  |  | - |  |  |  |  |  |  |  |  |
Exercised |  |  | - |  |  |  |  |  |  |  |  |
Redeemed |  |  | - |  |  |  |  |  |  |  |  |
Outstanding as of December 31, 2018 |  |  | 1,000,000 |  |  | $ | 2.20 |  |  |  |  |

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| 16. | LOSS PER SHARE

The following is a reconciliation of the basic and diluted loss per share computation for the years ended December 31, 2018, 2017 and 2016:

|  | Year ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Net loss attributable to the Company’s common shareholders |  |  |  |  |  |  |  |  |
- from continuing operations |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,609,735 | )
- from discontinued operations, net of tax |  |  | - |  |  |  | - |  |  |  | (122,133 | )
Net loss attributable to the Company’s common shareholders |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,731,868 | )
Weighted average shares outstanding – Basic and diluted |  |  | 17,617,416 |  |  |  | 17,312,586 |  |  |  | 10,422,765 |
Loss per share – Basic and diluted |  |  |  |  |  |  |  |  |  |  |  |
- from continuing operations |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.92 | )
- from discontinued operations |  |  | - |  |  |  | - |  |  |  | (0.01 | )
Loss per share – Basic and diluted |  | $ | (0.51 | ) |  | $ | (0.30 | ) |  | $ | (0.93 | )

For the years ended December 31, 2018, 2017 and 2016, all the outstanding warrants and options were anti-dilutive.

| 17. | INCOME TAXES

United States

Breathcare was a limited liability company and was not subject to federal income tax; instead any income would be taxable to Breathcare’s sole owner. Moreover, as of June 30, 2017 (date of dissolution of Breathcare) and December 31, 2016, Breathcare was inactive and generated no revenue.

British Virgin Islands

Lianluo Smart is a tax-exempt company incorporated in the British Virgin Islands.

PRC

PRC enterprise income tax is calculated based on the Enterprise Income Tax Law (the “EIT Law”). Under the EIT Law, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises.

Under the current PRC laws, PRC government grants a preferential income tax rate of 15% to government-certified high technology companies, and under the new standard the period of validity for the certification of high technology companies is three years. In 2009, 2012 and 2015, BDL updated its certification for “high technology” company. Therefore, BDL used a 15% income tax rate to calculate the income tax expense for the years ended December 31, 2017, 2016 and 2015. In 2018, BDL did not pass the certification for “high technology” company, and therefore, is subject to a PRC income tax rate of 25% on its 2018 income.

The tax rate for LCL and BTL is 25%.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Benefit (provision) for income taxes consists of:

|  | Year Ended December 31 |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Current income taxes benefit |  | $ | - |  |  | $ | - |  |  | $ | 95,870 |
Deferred income taxes provision |  |  | - |  |  |  | - |  |  |  | - |
Total benefit for income taxes |  |  | - |  |  |  | - |  |  |  | 95,870 |
Less: provision for income tax expenses from discontinued operations |  |  | - |  |  |  | - |  |  |  | (844 | )
Benefit for income taxes from continuing operations |  | $ | - |  |  | $ | - |  |  | $ | 95,026 |

A reconciliation of the provision for income taxes determined at the statutory income tax rate to the Company’s income taxes is as follows:

|  | Years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Loss before provision for income tax and non-controlling interests |  | $ | (8,910,002 | ) |  | $ | (5,136,434 | ) |  | $ | (9,704,761 | )
PRC corporate income tax rate |  |  | 25 | % |  |  | 25 | % |  |  | 25 | %
Income tax benefit computed at PRC statutory corporate income tax rate |  |  | (2,227,500 | ) |  |  | (1,284,108 | ) |  |  | (2,426,190 | )
Reconciling items: |  |  |  |  |  |  |  |  |  |  |  |
Non-deductible expenses |  |  | 1,063,668 |  |  |  | 597,189 |  |  |  | 691,298 |
Valuation allowance on deferred tax assets |  |  | 1,163,832 |  |  |  | 686,919 |  |  |  | 1,734,892 |
Over-provision in prior years |  |  | - |  |  |  | - |  |  |  | (95,026 | )
Income tax benefit |  | $ | - |  |  | $ | - |  |  | $ | (95,026 | )

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Deferred taxes assets

Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities as of December 31, 2018 and 2017 are presented below:

|  | 2018 |  |  | 2017 |
Deferred tax assets |  |  |  |  |  |
Net operating loss carried forward |  | $ | 3,412,338 |  |  |  | 2,386,069 |
Valuation reserve |  |  | (3,412,338 | ) |  |  | (2,386,069 | )
Deferred tax assets, non-current |  | $ | - |  |  | $ | - |

As of December 31, 2018, the Company’s PRC subsidiaries had net operating loss carry forwards of $13,649,354, which will expire in various years through year 2023. Management believes it is more likely than not that the Company will not realize these potential tax benefits as these operations will not generate any operating profits in the foreseeable future. As a result, a valuation reserve was provided against the full amount of the potential tax benefits.

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or its withholding agent. The statute of limitations extends to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion.

| 18. | RELATED PARTY TRANSACTIONS AND BALANCE

In addition to the transactions and balances disclosed elsewhere in these financial statements, the Company had the following material related party transactions:

| (1) | During the years ended December 31, 2018, 2017 and 2016, the Company purchased inventory of $204, $3,760, and $497 from HLI, respectively.

| (2) | On July 1, 2018, the Company leased office premises from HLI for a period of 1 year, with an annual rental of $84,447 (RMB580,788). Rental payments charged as expenses in 2018 were $39,942. As of December 31, 2018, the Company reported an outstanding rental payable of $42,223 to HLI.

| (3) | On December 20, 2016, the Company entered into a $2 million loan agreement with DGHKT, one of HLI’s subsidiaries, with a fixed annual interest rate 3.5%. On December 30, 2016, the Company received the repayment of the loan and related interest in total of $2,002,110 from DGHKT.

| (4) | On June 13, 2017, the Company entered into a $3 million loan agreement with DGHKT for a term of 6 months and with a fixed annual interest rate of 3.5%. Before December 31, 2017, the Company received the repayment of the loan and the related interest in total of $52,932 from DGHKT.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

| (5) | On June 13, 2018, the Company entered into a $6 million loan agreement with DGHKT for a term of 12 months and with a fixed annual interest rate of 3.5%. During the year ended December 2018, DGHKT repaid in cash totaled $549,192, and the Company earned interest of $161,384 from DGHKT.

As of December 31, 2018, the remaining loan balance of RMB35.6 million (equivalent to $5.2 million)(including accrued interest) was fully settled (Note 11).

| (6) | On January 14, 2016, the Company completed an acquisition of 0.8% equity interest of BDL from BTL, who terminated the VIE relationship with the Company and deconsolidated from the Company’s financial statements on July 31, 2016, for a purchase price of $146,032 or RMB920,000, which was paid in 2017.

| (7) | Before the Company terminated the VIE agreement with BTL on July 31, 2016, the Company had various transactions with BTL. During the year ended December 31, 2016, the Company had the following transactions with BTL:

| 1. | The Company repaid loans of $69,253 or RMB460,151 in total to BTL, including various expenses paid by BTL on behalf of the Company and loans from BTL from prior years. Those loans were no interest free loans.

| 2. | The Company reported a technical support expense of $9,027 or RMB59,981 to BTL for its product maintenance.

| 3. | The Company leased an office space from BTL with an annual rental of $36,120 or RMB240,000. The leasing agreement had been terminated in 2016.

| 20. | CONCENTRATIONS

Major Customers

For the year ended December 31, 2018, two customers each accounted for approximately 16% and 13%, respectively, of the Company’s revenues from continuing operations. For the year ended December 31, 2017, two customers each accounted for approximately 44% and 12%, respectively, of the Company’s revenues from continuing operations. For the year ended December 31, 2016, one customer accounted for approximately 92% of the Company’s revenues from continuing operations.

For the year ended December 31, 2016, one customer accounted for approximately 92% of the Company’s revenues from discontinued operations.

No other customer accounted for more than 10% of the Company’s revenues for the years ended December 31, 2016, 2017 and 2018.

Major Suppliers

For the year ended December 31, 2018, two suppliers each accounted for approximately 31% and 17%, respectively, of the Company’s purchases from continuing operations. For the year ended December 31, 2017, two suppliers each accounted for approximately 40% and 23%, respectively, of the Company’s purchases from continuing operations. For the year ended December 31, 2016, one supplier each accounted for 95% of the Company’s purchases from continuing operations.

For the year ended December 31, 2016, one supplier accounted for 94% of the Company’s purchases from discontinued operations.

No other suppliers accounted for more than 10% of the Company’s purchases for the years ended December 31, 2016, 2017 and 2018.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Revenues by categories

The following represents the revenues by categories, all derived from China:

|  | For the years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Categories |  |  |  |  |  |  |  |  |
Product sales |  |  |  |  |  |  |  |  |
Medical Devices |  | $ | 221,414 |  |  | $ | 827,032 |  |  | $ | 1,305,372 |
Respiratory and Oxygen Homecare |  |  | - |  |  |  | - |  |  |  | 5,956 |
Mobile Medicine (sleep apnea diagnostic products) |  |  | 120,930 |  |  |  | 54,979 |  |  |  | 12,080,164 |
OSAS service (analysis and detection) |  |  | 217,042 |  |  |  | - |  |  |  | - |
Total Revenues |  |  | 559,386 |  |  |  | 882,011 |  |  |  | 13,391,492 |
Less: revenues from discontinued operations |  |  | - |  |  |  | - |  |  |  | (329,119 | )
Revenues from continuing operations |  | $ | 559,386 |  |  | $ | 882,011 |  |  | $ | 13,062,373 |

| 20. | OTHER INCOME

|  | For the years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Gain on settlement of payables (a) |  | $ | 18,736 |  |  | $ | 125,312 |  |  | $ | - |
Government subsidy |  |  | - |  |  |  | 17,394 |  |  |  | - |
Exchange gain |  |  | 5,964 |  |  |  | - |  |  |  | 68,436 |
Others |  |  | 8 |  |  |  | 3,917 |  |  |  | - |
Total other income |  | $ | 24,708 |  |  | $ | 146,623 |  |  | $ | 68,436 |

| (a) | In 2014, the Company entered into a Morpheus software licence agreement with a third-party service provider for a total consideration of $200,000. The service has been provided and charged as selling expenses in 2016. As of December 31, 2016, an amount of $125,000 remained unpaid. In 2017, the service provider has agreed to waive its entitlement to the remaining balance and the accrued amount was written back as other income.

| 21. | OTHER EXPENSE

|  | For the years ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Exchange loss |  | $ | - |  |  | $ | 48,430 |  |  | $ | - |
Loss on disposal of equipment |  |  | 232,171 |  |  |  |  |  |  |  | - |
Others |  |  | 3,688 |  |  |  | 3,937 |  |  |  | - |
Total other expense |  | $ | 235,859 |  |  | $ | 52,367 |  |  | $ | - |

| 22. | DISCONTINUED OPERATIONS

In accordance with ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, a disposal of a component of an entity or a group of components of an entity is required to be reported as discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when the components of an entity meets the criteria in paragraph 205-20-45-1E to be classified as held for sale. When all of the criteria to be classified as held for sale are met, including management, having the authority to approve the action, commits to a plan to sell the entity, the major current assets, other assets, current liabilities, and noncurrent liabilities shall be reported as components of total assets and liabilities separate from those balances of the continuing operations. At the same time, the results of all discontinued operations, less applicable income taxes (benefit), shall be reported as a component of net income (loss) separate from the net income (loss) of continuing operations in accordance with ASC 205-20-45.

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LIANLUO SMART LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016

Reconciliation of the Carrying Amounts of Major Classes of Net Income (Loss) from Operations to be Disposed Classified as discontinued operations in the Consolidated Statements of Operations and Comprehensive Loss.

|  | For the Years Ended December 31, |
|  | 2018 |  |  | 2017 |  |  | 2016 |
Revenues |  | $ | - |  |  | $ | - |  |  | $ | 329,119 |
Costs of revenue |  |  | - |  |  |  | - |  |  |  | (338,110 | )
Gross loss |  |  | - |  |  |  | - |  |  |  | (8,991 | )
Service income |  |  | - |  |  |  | - |  |  |  | 3,244 |
Service expenses |  |  | - |  |  |  | - |  |  |  | (5,497 | )
Selling expenses |  |  | - |  |  |  | - |  |  |  | (63,089 | )
General and administrative expenses |  |  | - |  |  |  | - |  |  |  | (43,703 | )
Provision for doubtful accounts |  |  | - |  |  |  | - |  |  |  | (32,321 | )
Impairment loss on intangible assets |  |  | - |  |  |  | - |  |  |  | (18,447 | )
Financial expenses |  |  | - |  |  |  | - |  |  |  | 88 |
Other income |  |  | - |  |  |  | - |  |  |  | 1,261 |
Other expenses |  |  |  |  |  |  | - |  |  |  | (275 | )
Provision for income tax expense |  |  | - |  |  |  | - |  |  |  | (844 | )
Loss on disposal of discontinued operations |  |  | - |  |  |  | - |  |  |  | (82,579 | )
Net loss from discontinued operations |  | $ | - |  |  | $ | - |  |  | $ | (251,153 | )

| 23. | SUBSEQUENT EVENTS

On January 24, 2019, Shenzhen JustDo Display Technology Co., Ltd. (“Shenzhen JustDo”) initiated an arbitration proceeding against BDL, claiming that BDL’s failure of payment for goods in 2018 constituted a breach of a purchase contract entered into by and between Shenzhen JustDo and BDL. Shenzhen JustDo assessed its claim at RMB513,684 ($74,712), plus interest since August 1, 2018. On February 21, 2019, BDL submitted a statement of defense, claiming that JustDo’s delay in delivery of goods constituted a breach of the purchase agreement, and the amount of purchase price payable to JustDo shall be determined according to the quantity of goods received. The Company believes the amount of purchase price payable to JustDo should be RMB235,524($34,245), and intend to continue to vigorously defend this proceeding.

As of December 31, 2018, the Company had recognized an account payable to Shenzhen JustDo of RMB 250,252 ($36,387).

On February 2, 2019, March 7, 2019 and April 8, 2019, the Company borrowed an aggregate unsecured amount of RMB1.17 million ($0.18 million) from HLI for a term of twelve months, with a fixed annual interest rate 8%.

On February 3, 2019, pursuant to a loan agreement the Company granted an unsecured loan of $0.06 million to DGHKT for a term of twelve months, with a fixed annual interest rate 3.5%.

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