UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark One)
| REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the fiscal year ended
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ___________ to ___________
OR
| SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Date of event requiring this shell company report _________________________
Commission
file number:
(Exact Name of Registrant as Specified in Its Charter)
Not Applicable
(Translation of Registrant’s Name Into English)
(Jurisdiction of Incorporation or Organization)
People’s
Republic of
(Address of Principal Executive Offices)
People’s
Republic of
Tel:
Fax:
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange On Which Registered | ||
Securities registered or to be registered pursuant to Section 12(g) of the Act.
None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None
(Title of Class)
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 (December 31, 2022): ordinary shares, no par value
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐
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 ☐
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.
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule
405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer, “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large Accelerated Filer ☐ | Accelerated Filer ☐ | Emerging
growth company |
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.
Indicate
by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered
public accounting firm that prepared or issued its audit report.
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
| International Financial Reporting ☐ | Other ☐ | |||
| Standards as issued by the International | ||||
| Accounting Standards Board |
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ☐ Item 17 ☐ Item 18
If
this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes ☐
Annual Report on Form 20-F
Year Ended December 31, 2022
TABLE OF CONTENTS
| i |
| ii |
INTRODUCTORY NOTES
Use of Certain Defined Terms
Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:
| ● | “Taoping” or “the Company” are to Taoping Inc., a British Virgin Islands business company, which has no business operations of its own; | |
| ● | “We,” “us,” “our” and “our company” are to the combined business of Taoping and its subsidiaries; | |
| ● | “Taoping Holdings” and “THL” are to Taoping Holdings Limited, a BVI subsidiary of Taoping; | |
| ● | “Taoping Group” and “IST HK” are to Taoping Group (China) Ltd., a Hong Kong company; | |
| ● | “TopCloud” are to TopCloud Software Co., Ltd., a PRC company; | |
| ● | “IST” are to Information Security Tech. (China) Co., Ltd., a PRC company; | |
| ● | “ISIOT” are to Information Security IoT Tech. Co., Ltd., a PRC company; | |
| ● | “iASPEC” are to iASPEC Technology Co., Ltd, a PRC company; | |
| ● | “Geo” are to Wuda Geoinformatics Co., Ltd., a PRC company; | |
| ● | “Biznest” are to Biznest Internet Technology Co., Ltd., a PRC company; | |
| ● | “Bocom” are to iASPEC Bocom IoT Technology Co. Ltd., a PRC company; | |
| ● | “BVI” are to the British Virgin Islands; | |
| ● | “BVI Act” are to the British Virgin Islands; | |
| ● | “Hong Kong” are to the Hong Kong Special Administrative Region of the People’s Republic of China; | |
| ● | “PRC” and “China” are to the People’s Republic of China; | |
| ● | “SEC” are to the Securities and Exchange Commission; | |
| ● | “Exchange Act” are to the Securities Exchange Act of 1934, as amended; | |
| ● | “Securities Act” are to the Securities Act of 1933, as amended; | |
| ● | “Renminbi” and “RMB” are to the legal currency of China; and | |
| ● | “U.S. dollars,” “dollars” and “$” are to the legal currency of the United States. |
On July 30, 2020, we completed a share combination of Taoping’s ordinary shares at a ratio of one-for-six. This share combination did not change the maximum number of shares the Company is authorised to issue or the par value of the ordinary shares. Accordingly, except as otherwise indicated, all share and per share information contained in this annual report has been restated to retroactively show the effect of the share combination.
| 1 |
Forward-Looking Information
In addition to historical information, this annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” or “will” or the negative of these terms or other comparable terminology. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; and any statements regarding future economic conditions or performance, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties include, among other things, the effects of the global Covid-19 pandemic, the emergence of additional competing technologies, changes in domestic and foreign laws, regulations and taxes, uncertainties related to China’s legal system and economic, political and social events in China, the volatility of the securities markets; and other risks including, but not limited to, those that we discussed or referred to in Item 3 “Key information—D. Risk Factors” and elsewhere in this annual report.
Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.
| 2 |
PART I
Taoping is not an operating company but rather a holding company incorporated in the British Virgin Islands. Because Taoping has no business operations of its own, we conduct our business through Taoping’s operating subsidiaries, primarily in China. This structure involves unique risks to investors and you may never directly hold equity interests in Taoping’s operating entities. You are specifically cautioned that there are significant legal and operational risks associated with being based in or having the majority of operations in China, including that changes in the legal, political and economic policies of the Chinese government, the relations between China and the United States, or Chinese or United States regulations may materially and adversely affect our business, financial condition, results of operations and the market price of Taoping’s securities. Moreover, the Chinese government may exercise significant oversight and discretion over the conduct of our business and may intervene in or influence our operations at any time, which could result in a material change in our operations and/or the value of Taoping’s securities or could significantly limit or completely hinder our ability to offer or continue to offer Taoping securities to investors and cause the value of such securities to significantly decline or be worthless. For a detailed description of risks related to the holding corporate structure, see Item 3 “Key Information—D. Risk Factors—Risks Related to Doing Business in China”.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
A. Directors and Senior Management
Not applicable.
B. Advisors
Not applicable.
C. Auditors
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
A. Offer Statistics
Not applicable.
B. Method and Expected Timetable
Not applicable.
ITEM 3. KEY INFORMATION
Taoping was incorporated in the British Virgin Islands under the BVI Act on June 18, 2012. Taoping is not an operating company but rather a holding company conducting its operations through Taoping’s operating subsidiaries, primarily in China. This structure involves unique risks to investors and you may never directly hold equity interests in Taoping’s operating entities. Between July 2007 and September 2021, Taoping employed a variable interest entity structure where the operating entities were controlled and consolidated based on contractual agreements, rather than direct ownership, due to restrictions on foreign investment in value-added telecommunication business in China. Taoping dissolved such variable interest entity structure in September 2021 and ceased the e-commerce and related businesses which had constituted an insignificant portion of its consolidated revenue prior to such dissolution. See “—Regulatory Permissions to Operate Business” below for more information. Since then, Taoping has been owning all of the operating entities through one or more subsidiaries. While the variable interest entity structure was in place, Taoping did not experience any difficulty in controlling the operating entities through contractual arrangements and the terms of the contractual agreements relating to the variable interest entity structure had been complied with by the parties of such agreements.
| 3 |
You are specifically cautioned that there are significant legal and operational risks associated with being based in or having the majority of operations in China. Specifically, the PRC government recently initiated a series of regulatory actions and made a number of public statements on the regulation of business operations in China, including cracking down on illegal activities in the securities market, enhancing supervision over China-based companies listed overseas using a variable interest entity structure, adopting new measures to extend the scope of cybersecurity reviews, and expanding efforts in anti-monopoly enforcement. We do not believe that our subsidiaries in China are directly subject to these regulatory actions or statements, as we have not carried out any monopolistic behavior and our business does not involve the collection of personal information or implicate national security. We also dissolved the variable interest entity structure in 2021 as our business does not involve any type of restricted industry.
On February 17, 2023, the China Securities Regulatory Commission (the “CSRC”) promulgated the Trial Administrative Measures of Overseas Securities Offering and Listing by Domestic Companies (the “Trial Measures”) and five supporting guidelines, which came into effect on March 31, 2023. On February 24, 2023, the CSRC, together with the Ministry of Finance, National Administration of State Secrets Protection and National Archives Administration of China, revised the Provisions on Strengthening Confidentiality and Archives Administration for Overseas Securities Offering and Listing (the “Revised Provisions”), which were issued by the CSRC and National Administration of State Secrets Protection and National Archives Administration of China in 2009. The Revised Provisions came into effect on March 31, 2023 together with the Trial Measures. Given the recent nature of the introduction of the above Trial Measures, listing guidelines and Revised Provisions, there remains significant uncertainty as to the enactment, interpretation and implementation of regulatory requirements related to overseas securities offerings and other capital markets activities. Notwithstanding the foregoing, as of the date of this report, we are not aware of any PRC laws or regulations in effect requiring that we obtain permission from any PRC authorities to issue securities to foreign investors, other than the filing requirements under the Trial Measures, and we have not received any inquiry, notice, warning, or sanction from the CSRC or any other PRC authorities that have jurisdiction over our operations. See “—Regulatory Permissions to Operate Business and for the Offering of Securities to Foreign Investors” below.
In addition, pursuant to the Holding Foreign Companies Accountable Act (the “HFCA Act”) enacted in 2020, if the auditor of a U.S. listed company’s financial statements is not subject to Public Company Accounting Oversight Board (the “PCAOB”) inspections for three consecutive “non-inspection” years, the SEC is required to prohibit the securities of such issuer from being traded on a U.S. national securities exchange, such as NYSE and Nasdaq, or in U.S. over-the-counter markets. On June 22, 2021, the U.S. Senate passed the Accelerating Holding Foreign Companies Accountable Act, and on December 29, 2022, legislation entitled “Consolidated Appropriations Act, 2023” (the “Consolidated Appropriations Act”) was signed into law, which contained, among other things, an identical provision to the Accelerating Holding Foreign Companies Accountable Act and amended the HFCA Act by requiring the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchanges or over-the-counter markets if its auditor is not subject to PCAOB inspections for two consecutive years instead of three. On December 16, 2021, the PCAOB issued a Determination Report finding that the PCAOB is unable to inspect or investigate completely registered public accounting firms headquartered in mainland China and Hong Kong because of a position taken by one or more authorities in such jurisdictions, and identified specific registered public accounting firms subject to this determination. Our current registered public accounting firm, PKF Littlejohn LLP (“PKF”), or our former registered public accounting firm, UHY LLP, is not headquartered in mainland China or Hong Kong and was not identified in this report as a firm subject to the PCAOB’s determination. They both are subject to full inspection by the PCAOB and the PCAOB is able to inspect the audit workpapers of our subsidiaries in China, as such workpapers are electronic files possessed by our registered public accounting firms. On August 26, 2022, the China Securities Regulatory Commission (the “CSRC”), the Ministry of Finance of the PRC (the “MOFCOM”), and the PCAOB signed a Statement of Protocol (the “Protocol”) governing inspections and investigations of accounting firms based in mainland China and Hong Kong, taking the first step toward opening access for the PCAOB to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong. Pursuant to the fact sheet with respect to the Protocol disclosed by the SEC, the PCAOB shall have independent discretion to select any issuer audits for inspection or investigation and has the unfettered ability to transfer information to the SEC. On December 15, 2022, the PCAOB made a statement announcing that it was able, in 2022, to inspect and investigate completely issuer audit engagements of PCAOB-registered public accounting firms headquartered in mainland China and Hong Kong. However, uncertainties still exist as to whether the PCAOB will have continued access for complete inspections and investigations in 2023 and beyond. The PCAOB has indicated that it will act immediately to consider the need to issue new determinations under the HFCA Act if needed. If the PCAOB determines in the future that it cannot inspect or fully investigate our auditor at such future time, trading in the Company’s securities would be prohibited under the HFCA Act. See “Risk Factor—Risks Related to Doing Business in China—The recent joint statement by the SEC, proposed rule changes submitted by Nasdaq, and the HFCA Act, all call for additional and more stringent criteria to be applied to U.S.-listed companies with significant operations in China. These developments could add uncertainties to our continued listing, future offerings, business operations share price and reputation.”
| 4 |
Cash is transferred through our organization in the following manner:
| ● | Our equity structure is a direct holding structure, that is, Taoping, the British Virgin Islands entity listed in the U.S., controls its operating subsidiaries in China, through Taoping Holdings, a British Virgin Islands subsidiary of Taoping. See Item 4. “Information of the Company—A. History and Development of the Company—Corporate Structure” for more details. |
| ● | As of the date of this report, neither Taoping nor any of its subsidiaries have paid dividends or made distributions to U.S. investors. |
| ● | Within our direct holding structure, the cross-border transfer of funds from Taoping to its Chinese subsidiaries is legal and compliant with the laws and regulations of China. Taoping is permitted to provide funding to its subsidiaries in mainland China in the form of shareholder loans or capital contributions, subject to satisfaction of applicable government registration, approval and filing requirements of the respective jurisdiction. There are no quantity limits on Taoping’s ability to make capital contributions to its subsidiaries in mainland China under the PRC regulations. Historically, cash proceeds raised from overseas financing activities by Taoping have been first transferred to its BVI subsidiary, Taoping Holdings. Whenever we need to make capital contributions to either of our PRC subsidiaries by contributing any of such net proceeds, and convert the contributed proceeds into RMB, we will need to increase the PRC subsidiary’s registered capital by registering and/or filing the increase with the Ministry of Commerce or one of its local branches, the State Administration of Foreign Exchange (“SAFE”) or one of its local branches, or an authorized bank. If we transfer any of the proceeds to one of our PRC subsidiaries through loans, under current PRC law we will also need to register such loans with the SAFE or one of its local branches, and the amount that we may convert into RMB and loan to one of these entities will be limited by applicable SAFE regulations, in the case of a loan to one of our PRC subsidiaries, to the greater of (i) the difference between the subsidiary’s approved total investment and the subsidiary’s total registered capital and (ii) two times the PRC subsidiary’s net assets. |
| ● | As a holding company, Taoping relies on dividends and other distributions on equity paid by its operating subsidiaries in China for cash requirements, including the funds necessary to pay dividends and other cash distributions to its shareholders or to any service expenses it may incur. For operating subsidiaries in mainland China, they will first transfer funds to Taoping Group in accordance with applicable laws and regulations of China, and then to Taoping through Taoping Holdings. Taoping will then distribute dividends to its shareholders in proportion to their respective shareholding, regardless of whether the shareholders are U.S. investors or investors in other countries or regions. As of the date of this report, none of our subsidiaries has made any transfers, dividends or other distributions to Taoping, the holding company. We intend to retain most, if not all, of our available funds and any future earnings to the development and growth of our business in China and do not expect to pay dividends in the foreseeable future. |
| ● | The ability of our subsidiaries in mainland China to distribute dividends is based upon their distributable earnings. Current PRC regulations permit these subsidiaries to pay dividends to their respective shareholders only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries in mainland China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. These reserves are not distributable as cash dividends. In addition, if any of our operating subsidiaries incurs debt on its own behalf in the future, the instruments governing such debt may restrict its ability to pay dividends to Taoping. We believe, other than above, current PRC regulations do not prohibit or limit using cash generated from one subsidiary to fund another subsidiary’s operations. We currently do not have our own cash management policy and procedures that dictate how funds are transferred. |
| 5 |
The table below presents the cash flows between our subsidiaries for the fiscal years ended December 31, 2022 and 2021.
Years Ended December 31, | ||||||||
| Cash Flows Between Subsidiaries(1) | 2022 | 2021 | ||||||
| Advances between subsidiaries(2) | 3,713,393 | 11,396,890 | ||||||
| Settlement of trade credits between subsidiaries(3) | - | - | ||||||
| Additional paid-in capital by immediate parent company | 2,200,000 | 7,064,437 | ||||||
| Intercompany dividends or other distributions | - | - | ||||||
(1) For ease of comparison over the financial periods presented, the “subsidiaries” in the table above include consolidated VIE entities as to the first nine months of 2021 prior to the dissolution of the VIE structure.
(2) Represent the sum of advances among offshore subsidiaries (including then-existing BVI subsidiary, Hong Kong subsidiaries and Kazakhstan subsidiaries), and between such offshore subsidiaries and PRC subsidiaries in mainland China. These advances were made in the ordinary course of business, payable on demand and interest free.
(3) The trade credits extended between subsidiaries primarily related to provision of technical services, sales of products, and sublease of office between PRC subsidiaries. For the years ended December 31, 2022 and 2021, the trade credits between subsidiaries amounted to $1,287,328 and $323,383, respectively. The Company’s subsidiaries only record but do not settle the trade credits in cash between them, which is allowed under the PRC laws.
Restrictions on Cash Transfers
We face various restrictions and limitations on foreign exchange, our ability to transfer cash between entities, across borders and to U.S. investors, and our ability to distribute earnings from our subsidiaries to Taoping and holders of our ordinary shares. If our subsidiaries 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 PRC subsidiaries 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. Pursuant to laws applicable to entities incorporated in the PRC, our subsidiaries in the PRC must make appropriations from after-tax profit to non-distributable reserve funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the general reserve fund requires an annual appropriation of 10% of after-tax profit (as determined under accounting principles generally accepted in the PRC at each year-end) until the accumulative amount of such reserve fund reaches 50% of its registered capital; the other fund appropriations are at the subsidiaries’ discretion. These reserve funds can only be used for the specific purposes of enterprise expansion, staff bonus and welfare, and are not distributable as cash dividends. Also, due to restrictions on the distribution of share capital from our PRC subsidiaries, the share capital of our PRC subsidiaries, is considered restricted.
Due to various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, we may not be able to obtain the necessary government approvals or complete the necessary government registrations or other procedures on a timely basis, or at all, with respect to future loans or capital contributions by us to our PRC subsidiaries. This may delay or prevent us from using our offshore funds to make loans or capital contribution to our PRC subsidiaries, and thus may restrict our ability to execute our business strategy, and materially and adversely affect our liquidity and our ability to fund and expand our business.
Furthermore, due to restrictions on foreign exchange placed on our PRC subsidiaries by the PRC government under PRC laws and regulations, to the extent cash is located in the PRC or within a PRC domiciled entity and may need to be used to fund our operations outside of the PRC, the funds may not be available due to such limitations unless and until related approvals and registrations are obtained. Under regulations of the State Administration of Foreign Exchange (“SAFE”) of China, the Renminbi is not convertible into foreign currencies for capital account items, such as loans, repatriation of investments and investments outside of China, unless the prior approval of the SAFE is obtained and prior registration with the SAFE is made.
| 6 |
Regulatory Permissions to Operate Business and for the Offering of Securities to Foreign Investors
The establishment, operation and management of corporate entities in mainland China are governed by the Company Law of the People’s Republic of China, or the China Company Law, which was adopted by the Standing Committee of the National People’s Congress (“SCNPC”) in December 1993, implemented in July 1994, and subsequently amended in December 1999, August 2004, October 2005, December 2013 and October 2018. Under the China Company Law, companies are generally classified into two categories: limited liability companies and companies limited by shares. The China Company Law applies to both domestic and foreign-invested companies.
Investment activities in mainland China by foreign investors are governed by the Guiding Foreign Investment Direction, which was promulgated by the State Council on February 11, 2002, and came into effect on April 1, 2002, and the latest Special Administrative Measures (Negative List) for Foreign Investment Access (2022), or the Negative List, which was promulgated by the Ministry of Commerce (“MOFCOM”) and the National Development and Reform Commission (“NDRC”) on March 12, 2022, and took effect on the same date. The Negative List sets out in a unified manner the restrictive measures, such as the requirements on shareholding percentages and management, for the access of foreign investments, and the industries that are prohibited for foreign investment. Any field not falling in the Negative List shall be administered under the principle of equal treatment to domestic and foreign investment.
The Foreign Investment Law of the People’s Republic of China, or the Foreign Investment Law was promulgated by the NPC in March 2019 and become effective in January 2020. The investment activities of foreign natural persons, enterprises or other organizations (hereinafter referred to as foreign investors) directly or indirectly within the territory of mainland China are governed by the Foreign Investment Law, including: 1) establishing by foreign investors of foreign-invested enterprises in mainland China alone or jointly with other investors; 2) acquiring by foreign investors of shares, equity, property shares, or other similar interests of Chinese domestic enterprises; 3) investing by foreign investors in new projects in mainland China alone or jointly with other investors; and 4) other forms of investment prescribed by laws, administrative regulations or the State Council.
In December 2019, the State Council issued the Regulations on Implementing the Foreign Investment Law, which came into effect in January 2020. After the Regulations on Implementing the Foreign Investment Law came into effect, the Regulation on Implementing the Law on Sino-foreign Equity Joint Ventures, Provisional Regulations on the Duration of Sino-Foreign Equity Joint Ventures, the Regulations on Implementing the Law on Wholly Foreign-Owned Enterprises and the Regulations on Implementing the Law on Sino-Foreign Cooperative Joint Ventures have been repealed simultaneously.
In December 2019, the MOFCOM and the State Administration for Market Regulation (“SAMR”) issued the Measures for the Reporting of Foreign Investment Information, which came into effect in January 2020. After the Measures for the Reporting of Foreign Investment Information came into effect, the Interim Measures on the Administration of Filing for Establishment and Change of Foreign Invested Enterprises has been repealed simultaneously. Since January 1, 2020, for foreign investors carrying out investment activities directly or indirectly in mainland China, the foreign investors or foreign-invested enterprises shall submit investment information to the relevant commerce administrative authorities pursuant to these measures.
In light of the above restrictions and requirements, prior to the dissolution of our VIE structure in September 2021, we had conducted our value-added telecommunications businesses through our then consolidated VIEs. As a result of the dissolution of our VIE structure, we ceased the e-commerce and related businesses which had constituted a minor portion of our consolidated revenue. Based on the legal analysis of the Company’s in-house legal counsel, who is a licensed attorney in the PRC, we believe that none of our PRC subsidiaries’ current business is stipulated on the Negative List.
As a result, according to the laws and regulations currently in effect, our PRC subsidiaries are able to conduct their business without being subject to restrictions imposed by the foreign investment laws and regulations of the PRC and none of Taoping or our subsidiaries is required to obtain additional licenses or permits beyond a regular business license for each PRC subsidiary’s operations. Each of our PRC subsidiaries is required to obtain and has obtained such regular business license from the local branch of the SAMR. No application for any such license has been denied.
| 7 |
However, we cannot assure you that our PRC subsidiaries are always able to successfully update or renew the licenses or permits required for the relevant business in a timely manner or that these licenses or permits are sufficient to conduct all of our present or future business. If our PRC subsidiaries (i) do not receive or maintain required permissions or approvals, (ii) inadvertently conclude that such permissions or approvals are not required, or (iii) applicable laws, regulations, or interpretations change and our PRC subsidiaries are required to obtain such permissions or approvals in the future, we could be subject to fines, legal sanctions or an order to suspend our PRC operating subsidiaries’ business, which may materially and adversely affect the business, financial condition and results of operations of us. See “Risk Factors—Risks Related to Doing Business in China—Uncertainties exist with respect to the interpretation and implementation of PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations” on page 27.
In connection with our previous issuance of securities, under current PRC laws, regulations and regulatory rules, as of the date of this annual report, we believe that we and our PRC subsidiaries, (i) are not required to obtain permissions from the CSRC, (ii) are not required to go through cybersecurity review by the Cybersecurity Administration of China (the “CAC”), and (iii) have not received or were denied such requisite permissions by any PRC authority. We cannot guarantee that the regulators will agree with us. As of the date hereof, we have not been involved in any investigations for cybersecurity review made by the CAC, and we have not received any inquiry, notice, warning, or sanctions in such respect.
However, the PRC government has recently indicated an intent to exert more oversight and control over offerings that are conducted overseas and/or foreign investment in China-based issuers. The CSRC published the Trial Measures and Listing Guidelines on February 17, 2023, designed to regulate overseas securities offerings by PRC domestic companies. On February 24, 2023, the CSRC, together with the Ministry of Finance, National Administration of State Secrets Protection and National Archives Administration of China, revised the Provisions on Strengthening Confidentiality and Archives Administration for Overseas Securities Offering and Listing, which were issued by the CSRC and National Administration of State Secrets Protection and National Archives Administration of China in 2009. The Revised Provisions were issued under the title the “Provisions on Strengthening Confidentiality and Archives Administration of Overseas Securities Offering and Listing by Domestic Companies,” and came into effect on March 31, 2023 together with the Trial Measures. See “Risk Factor—Risks Related to Doing Business in China—The PRC government has increasingly strengthened oversight in offerings conducted overseas or on foreign investment in China-based issuers, which could result in a material change in our operations and our ordinary shares could decline in value or become worthless.” on page 19.
Given the recent nature of the introduction of the above Trial Measures, listing guidelines, and Revised Provisions, there remains significant uncertainty as to the enactment, interpretation and implementation of regulatory requirements related to overseas securities offerings and other capital markets activities. Notwithstanding the foregoing, as of the date of this report, other than the filing requirements mandated by the Trial Measures, we are not aware of any PRC laws or regulations in effect requiring that we obtain permission from any PRC authorities to issue securities to foreign investors, and we have not received any inquiry, notice, warning, or sanction from the CSRC, the CAC, or any other PRC authorities that have jurisdiction over our operations.
Enforceability of Civil Liabilities
British Virgin Islands
There is no statutory enforcement in the British Virgin Islands of judgments obtained in the U.S., however, the courts of the British Virgin Islands will in certain circumstances recognize such a foreign judgment and treat it as a cause of action in itself which may be sued upon as a debt at common law so that no retrial of the issues would be necessary, provided that:
| ● | the U.S. court issuing the judgment had jurisdiction in the matter and the company either submitted to such jurisdiction or was resident or carrying on business within such jurisdiction and was duly served with process; |
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| ● | the judgment is final and for a liquidated sum; |
| ● | the judgment given by the U.S. court was not in respect of penalties, taxes, fines or similar fiscal or revenue obligations of the company; |
| ● | in obtaining judgment there was no fraud on the part of the person in whose favor judgment was given or on the part of the court; |
| ● | recognition or enforcement of the judgment in the British Virgin Islands would not be contrary to public policy; and |
| ● | the proceedings pursuant to which judgment was obtained were not contrary to natural justice. |
The British Virgin Islands courts are unlikely:
| ● | to recognise or enforce against the Company, judgments of courts of the U.S. predicated upon the civil liability provisions of the securities laws of the U.S.; and | |
| ● | to impose liabilities against the Company, predicated upon the certain civil liability provisions of the securities laws of the U.S. so far as the liabilities imposed by those provisions are penal in nature. |
Substantially all of our assets are located outside the United States. In addition, a majority of our directors and officers are nationals or residents of jurisdictions other than the United States and all or a substantial portion of their assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or these persons.
Hong Kong
Currently judgment of U.S. courts will not be directly enforced in Hong Kong. There are currently no treaties or other arrangements providing for reciprocal enforcement of foreign judgments between Hong Kong and the U.S. However, a judgment of a court in the U.S. predicated upon U.S. federal or state securities laws may be enforced in Hong Kong at common law by bringing an action in a Hong Kong court on that judgment for the amount due thereunder, and then seeking summary judgment on the strength of the foreign judgment, provided that the foreign judgment, among other things, is (1) for a debt or a definite sum of money (not being taxes or similar charges to a foreign government taxing authority or a fine or other penalty) and (2) final and conclusive on the merits of the claim, but not otherwise. Such a judgment may not, in any event, be so enforced in Hong Kong if (a) it was obtained by fraud; (b) the proceedings in which the judgment was obtained were opposed to natural justice; (c) its enforcement or recognition would be contrary to the public policy of Hong Kong; (d) the court of the United States was not jurisdictionally competent; or (e) the judgment was in conflict with a prior Hong Kong judgment.
China
There is uncertainty as to whether the courts of China would (1) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or (2) entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.
The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the jurisdiction where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other form of reciprocity with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States. Under the PRC Civil Procedures Law, foreign shareholders may originate actions based on PRC law against us in the PRC for disputes if they can establish sufficient nexus to the PRC for a PRC court to have jurisdiction, and meet other procedural requirements, including, among others, the plaintiff must have a direct interest in the case, and there must be a concrete claim, a factual basis and a cause for the suit.
Summary of Risk Factors
There are a number of risks that you should consider and understand before making an investment decision regarding our securities. You should carefully consider all of the information set forth in this report and, in particular, the specific factors set forth in the section titled “Risk Factors” below. These risks include, but are not limited to:
| ● | As of the date of this report, based on the legal analysis of the Company’s in-house legal counsel, who is a licensed attorney in the PRC, other than the filing requirements mandated by the Trial Measures, we believe that we are not required to obtain any approval or prior permission to offer securities to foreign investors from the CSRC or any other Chinese regulatory authority under the Chinese laws and regulations currently in effect. If a domestic company fails to complete required filing procedures or conceals any material fact or falsifies any major content in its filing documents, such domestic company may be subject to administrative penalties, such as an order to rectify, warnings, fines, and its controlling shareholders, actual controllers, the person directly in charge, and other directly liable persons may also be subject to administrative penalties, such as warnings and fines. There remains significant uncertainty as to the enactment, interpretation and implementation of regulatory requirements related to overseas securities offerings and other capital markets activities. The risks arising from the legal system in China include risks and uncertainties regarding the enforcement of laws and that rules and regulations in China can change quickly with little, if any, advance notice. As a result, there can be no assurance that we will not be subject to such requirements, approvals or permissions in the future. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Doing Business in China—The PRC government has increasingly strengthened oversight in offerings conducted overseas or on foreign investment in China-based issuers, which could result in a material change in our operations and our ordinary shares could decline in value or become worthless.” on pages 19 and “Key Information—D. Risk Factors—Risks Related to Doing Business in China—The PRC government exerts substantial influence over the manner in which we conduct our business activities. Its oversight and discretion over our business could result in a material adverse change in our operations and the value of our ordinary shares. Changes in laws, regulations and policies in China and uncertainties with respect to the PRC legal system could materially and adversely affect us. In addition, rules and regulations in China can change quickly with little advance notice.” on pages 19. |
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| ● | There are significant legal and operational risks associated with having significant business operations in China, including that changes in the legal, political and economic policies of the Chinese government, the relations between China and the United States, or Chinese or United States regulations may materially and adversely affect our business, financial condition, results of operations and the value of the Company’s securities. Any such changes may take place quickly and with very little notice and as a result, could significantly limit or completely hinder our ability to offer or continue to offer Taoping’s securities to investors, and could cause the value of Taoping’s securities to significantly decline or become worthless. Recent statements made and regulatory actions undertaken by China’s government, such as those related to data security or anti-monopoly concerns and any other future laws and regulations may require us to incur significant expenses and could materially affect our ability to conduct our business or accept foreign investments. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Related to Doing Business in China—Changes in U.S. and Chinese regulations or in relations between the United States and China may adversely impact our business, our operating results, our ability to raise capital and the value of the securities that we are registering. Any such changes may take place quickly and with very little notice” on pages 22. |
| ● | The increased regulatory scrutiny focusing on U.S.-listed companies with significant operations in China in the U.S. could add uncertainties to our business operations, share price and reputation. In recent years, as part of increased regulatory focus in the United States on access to audit information, the United States enacted the HFCA Act in December 2020. On June 22, 2021, the U.S. Senate passed the Accelerating Holding Foreign Companies Accountable Act, and on December 29, 2022, legislation entitled “Consolidated Appropriations Act, 2023” was signed into law, which contained an identical provision to the Accelerating Holding Foreign Companies Accountable Act and amended the HFCA Act by requiring the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchange or over-the-counter markets if its auditor is not subject to PCAOB inspections for two consecutive years instead of three. On December 16, 2021, the PCAOB issued its determination that the PCAOB is unable to inspect or investigate completely PCAOB-registered public accounting firms headquartered in mainland China and Hong Kong, because of positions taken by authorities in the jurisdictions, and the PCAOB included in the report of its determination a list of the accounting firms that are headquartered in mainland China or Hong Kong. Our current registered public accounting firm, PKF, or our former registered public accounting firm, UHY LLP, is not headquartered in mainland China or Hong Kong and was not identified in this report as a firm subject to the PCAOB’s determination. They both are subject to full inspection by the PCAOB and the PCAOB is able to inspect the audit workpapers of our subsidiaries in China, as such workpapers are electronic files possessed by our registered public accounting firms. On August 26, 2022, CSRC, the MOFCOM, and the PCAOB signed the Protocol, governing inspections and investigations of audit firms based in China and Hong Kong. The Protocol remains unpublished and is subject to further explanation and implementation. Pursuant to the fact sheet with respect to the Protocol disclosed by the SEC, the PCAOB shall have independent discretion to select any issuer audits for inspection or investigation and has the unfettered ability to transfer information to the SEC. On December 15, 2022, the PCAOB made a statement announcing that it was able, in 2022, to inspect and investigate completely issuer audit engagements of PCAOB-registered public accounting firms headquartered in China and Hong Kong. However, uncertainties still exist as to whether the PCAOB will have continued access for complete inspections and investigations in 2023 and beyond. When the PCAOB reassesses its determinations in 2023 and beyond, it could still determine that it is unable to inspect and investigate completely accounting firms based in mainland China and Hong Kong. The PCAOB has also indicated that it will act immediately to consider the need to issue new determinations under the HFCA Act if needed. There can be no assurance that we will continue to be able to comply with requirements imposed by U.S. regulators if the PCAOB is not able to fully inspect any component of our auditor’s work papers in the future. Delisting of the Company’s ordinary shares would force holders to sell their shares. The market price of Taoping’s ordinary shares could be adversely affected as a result of anticipated negative impacts of these executive or legislative actions, regardless of whether these executive or legislative actions are implemented and regardless of our actual operating performance. See Item 3 “Key Information—D. Risk Factors—Risks Related to Doing Business in China—The recent joint statement by the SEC, proposed rule changes submitted by Nasdaq, and the HFCA Act, all call for additional and more stringent criteria to be applied to U.S.-listed companies with significant operations in China. These developments could add uncertainties to our continued listing, future offerings, business operations share price and reputation” on page 26. |
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| ● | As of the date of this report, based on the legal analysis of the Company’s in-house legal counsel, who is a licensed attorney in the PRC, we believe, according to the laws and regulations currently in effect, our PRC subsidiaries are able to conduct their business without being subject to restrictions imposed by the foreign investment laws and regulations of the PRC and none of Taoping or our subsidiaries is required to obtain additional licenses or permits beyond a regular business license for each PRC subsidiary’s operations. Each of our PRC subsidiaries is required to obtain and has obtained such regular business license. However, we cannot assure you that our PRC subsidiaries are always able to successfully update or renew the licenses or permits required for the relevant business in a timely manner or that these licenses or permits are sufficient to conduct all of our present or future business. If our PRC subsidiaries (i) do not receive or maintain required permissions or approvals, (ii) inadvertently conclude that such permissions or approvals are not required, or (iii) applicable laws, regulations, or interpretations change and our PRC subsidiaries are required to obtain such permissions or approvals in the future, we could be subject to fines, legal sanctions or an order to suspend our PRC operating subsidiaries’ business, which may materially and adversely affect the business, financial condition and results of operations of us. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Related to Doing Business in China— Uncertainties exist with respect to the interpretation and implementation of PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations” on pages 27. |
| ● | There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations. For additional information. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Related to Doing Business in China—There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations” on pages 22. |
| ● | We have a limited operating history of selling cloud-based products and services and may be unable to achieve or sustain profitability or reasonably predict our future results. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Business—We have a limited operating history of selling cloud-based products and services and may be unable to achieve or sustain profitability or reasonably predict our future results” on page 13. |
| ● | Our independent registered auditors have expressed substantial doubt about our ability to continue as a going concern. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Business—Our independent registered auditors have expressed substantial doubt about our ability to continue as a going concern” on page 14. |
| ● | If we fail to comply with the continued listing requirements of NASDAQ, we would face possible delisting, which would result in a limited public market for our shares and make obtaining future debt or equity financing more difficult for us. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—If we fail to comply with the continued listing requirements of NASDAQ, we would face possible delisting, which would result in a limited public market for our shares and make obtaining future debt or equity financing more difficult for us” on page 33. |
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| ● | The trading price of Taoping’s ordinary shares has been and likely continue to be highly volatile, which could result in significant losses to holders of the ordinary shares. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—The trading price of the Company’s ordinary shares is highly volatile, leading to the possibility of their value being depressed at a time when you want to sell your holdings” on pages 34-35. |
| ● | Because we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of your shares for return on your investment. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—We do not intend to pay dividends for the foreseeable future” on page 36. |
| ● | You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under British Virgin Islands law and a significant majority of our current business operations are conducted in the PRC. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—You may have difficulty enforcing judgments obtained against us or our directors and officers” on page 37 and “Key Information—D. Risk Factors—Risks Relating to Our Securities—As we were incorporated under the laws of the BVI, it may be more difficult for our shareholders to protect their rights than it would be for a shareholder of a corporation incorporated in another jurisdiction” on pages 38. |
| ● | Taoping is a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to U.S. domestic public companies. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—We are a “foreign private issuer” and have disclosure obligations that are different than those of U.S. domestic reporting companies. Therefore, you should not expect to receive the same information about us as a U.S. domestic reporting company may provide. Furthermore, if we lose our status as a foreign private issuer, we would be required to fully comply with the reporting requirements of the Exchange Act applicable to U.S. domestic issuers and incur significant operational, administrative, legal, and accounting costs that we would not incur as a foreign private issuer” on pages 36. |
As a foreign private issuer, Taoping is permitted to rely on exemptions from certain Nasdaq corporate governance standards applicable to domestic U.S. issuers. This may afford less protection to holders of Taoping’s securities. For additional information, see Item 3 “Key Information—D. Risk Factors—Risks Relating to Our Securities—As a foreign private issuer, we are permitted to rely on exemptions from certain NASDAQ corporate governance standards applicable to domestic U.S. issuers. This may afford less protection to holders of the Company’s securities” on page 37.
A. [Reserved]
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
An investment in the Company’s securities involves a high degree of risk. INVESTORS PURCHASING OUR SECURITIES ARE PURCHASING SECURITIES OF TAOPING INC., THE BRITISH VIRGIN ISLANDS HOLDING COMPANY RATHER THAN SECURITIES OF TAOPING INC.’S SUBSIDIARIES THAT HAVE SUBSTANTIVE BUSINESS OPERATIONS IN CHINA AND OTHER COUNTRIES. You should carefully consider the risks described below, together with all of the other information included in this annual report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the value of the Company’s securities could significantly decline or be worthless and you may lose all or part of your investment.
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Risks Relating to our Business
A sustained outbreak of the COVID-19 pandemic could have a material adverse impact on our business, operating results and financial condition.
The COVID-19 outbreak has led governments across the globe to impose a series of measures intended to contain its spread, including border closures, travel bans, quarantine measures, social distancing, and restrictions on business operations and large gatherings. The outbreak of COVID-19 has caused companies like us and our business partners to implement temporary adjustments to work schedules and travel plans, mandating employees to work from home and collaborate remotely. As a result, we may have experienced lower efficiency and productivity, internally and externally, which may adversely affect our service quality. Moreover, our business depends on our employees. If any of our employees has contracted or is suspected of having contracted COVID-19, these employees will be required to be quarantined and they could pass it to other of our employees, potentially resulting in severe disruption to our business.
Most of the restrictive measures previously adopted by the Chinese governments at various levels to control the spread of the COVID-19 virus have been revoked or replaced with more flexible measures since December 2022. The revocation or replacement of the restrictive measures to contain the COVID-19 pandemic could have a positive impact on our normal operations. However, the extent to which the COVID-19 pandemic may continue to impact our results will depend on future developments, which are highly uncertain and cannot be predicted as of the date of this prospectus, including the effectiveness of vaccines and other treatments for COVID-19, and other new information that may emerge concerning the severity of the pandemic and steps taken to contain the pandemic or treat its impact, among others. Given the general slowdown in economic conditions globally, volatility in the capital markets as well as the general negative impact of the COVID-19 outbreak on the global market, we cannot assure you that we will be able to maintain the growth rate we have experienced or projected.
We have a limited operating history of selling cloud-based products and services and may be unable to achieve or sustain profitability or reasonably predict our future results.
In early 2013, we made a strategic decision to transform our business from servicing the public sector to focusing on the private sector. Leveraging our experience and expertise in handling large-scale IT projects for the public sector, we started investing in research and development to develop software products for the private sector. In 2014, continuing our business transition from the public sector to the private sector, we identified and provided cloud-based ecosystem solutions to four core markets including new media, healthcare, education, and residential community management. Underpinning our ecosystems are our industry-specific integrated technology platform, resource exchange, and big data services. In 2014, we predominately sold our cloud-based solutions to the Chinese new media industry. Starting from 2015, we further expanded the customer base of cloud-based solutions to education, government, and residential community management. In 2016, we expanded our business from the industry-specific integrated technology platform, resource exchange, and big data services into the elevator IoT sectors. From May 2017, we have focused our business to provide products and services on Cloud-App-Terminal (CAT) and IoT technology based digital advertising distribution networks and new media resource sharing platforms in the out-of-home adverting market in China. As such, we have a limited operating history of selling our cloud-based products and professional services to the private sector, which makes it difficult to evaluate our current business and future prospects and may increase the risk of your investment. In 2022, 2021 and 2020, we generated approximately $24.0 million, $18.8 million and $10.7 million in revenue, respectively, from our cloud-based technology (CBT) segment for customers in the education, new media, and out-of-home advertising market sectors. We expect to have significant operating expenses in the future to further support and grow our business, including expanding the scope of our customer base, expanding our direct and indirect selling capabilities, pursuing acquisitions of complementary businesses, investing in our data storage and analysis infrastructure, and research and development, and increasing our international presence.
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Our independent registered auditors have expressed substantial doubt about our ability to continue as a going concern.
Our independent auditors have added an explanatory paragraph to their audit opinion issued in connection with our financial statements included in this report which states that the financial statements were prepared assuming that we would continue as a going concern.
Due to the unfavorable macro-economic environment and the slowdown of the out-of-home advertising market in China, we incurred net loss of approximately $18.3 million in 2020, $9.9 million in 2021 and $7.1 million in 2022. However, the Company will aggressively develop domestic and international markets to develop new customers and new product offerings through potential acquisitions and strategic collaborations with our business partners. There can be no assurance that we will be successful in achieving the goals set forth in our new business strategy and business model.
Unfavorable economic conditions may affect the level of the out-of-home advertising and information technology spending by our customers which could cause the demand for our products and services to decline.
The revenue growth and profitability of our business rely on the overall demand by our customers for out-of-home digital advertising, display technology products, and internet related services. Our business is sensitive to the overall economy in China and the economic and business conditions within our respective product and service sectors. If there is an economic downturn, our existing and prospective customers may reassess their decisions to purchase our products and services. China’s economic slowdown or a reduction in out-of-home advertising and information technology spending by our customers could harm our business in many ways, including longer sales cycles and lower prices for our products and services. These events could have a material effect on our future revenues and earnings.
Our periodic operating results are difficult to predict and could fall below investors’ expectations or estimates by securities research analysts, which may cause the trading price of our ordinary shares to decline.
Our revenues and operating results can vary significantly from a filing period to the next due to a number of factors, many of which are beyond our control, such as public health pandemic, fluctuations in the volume of purchase by our customers as a result of changes in their operations, their decisions to purchase our products and services, as well as currency fluctuations. Our revenues and operating results could also be affected by delays or difficulties in expanding our geographical presence and infrastructure, changes to our pricing strategies due to a competitive business environment and underestimates of resources and time required to complete ongoing projects. Our first-quarter revenues may be relatively low compared to that of the other quarters due to the Chinese New Year holiday. Moreover, our operating and financial results may fluctuate as a result of our dependency on our customers’ budgets and spending patterns. Therefore, we may not be able to accurately forecast the demand for our products and services beyond the current calendar year, which could adversely affect our business, operating results, and financial condition. In addition, sales volumes from specific customers are likely to vary from year to year, and a major customer in one year may not remain as a major customer in the subsequent years.
These fluctuations are likely to continue in the future and operating results for any period may not be indicative of our performance in any future period. If our operating results for any filing period fall below investors’ expectations or estimates by securities research analysts, the trading price of our ordinary shares may decline.
We face risks associated with new businesses or assets acquired through mergers or acquisitions, and the acquired companies may not perform to our expectations, which may adversely affect our results of operations.
We face risks when we acquire other businesses. These risks include:
| ● | difficulties in the integration of acquired operations and retention of personnel, | |
| ● | unforeseen or hidden liabilities, | |
| ● | relevant tax, regulatory and accounting matters, and | |
| ● | inability to generate sufficient revenues to offset acquisition costs. |
Acquired companies may not perform to our expectations for various reasons, including the departure of key personnel and loss of customers. Therefore, we may not realize the benefits we have previously anticipated. If we fail to integrate acquired businesses or realize expected benefits, we may not gain anticipated economic returns on investments in these mergers and acquisitions and incur substantial transaction costs, causing our operating results to be materially and adversely affected.
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If we are unable to secure additional financing or identify suitable merger or acquisition targets, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities, or respond to competitive pressures on a timely manner.
Our long-term business plan includes the identification of suitable targets for horizontal or vertical mergers or acquisitions, so as to enhance overall productivity and to benefit from economies of scale. Due to the recent uncertainties in the global economic outlook and financial market stability, we may not be able to secure an adequate level of additional financing, whether through equity financing, debt financing or other sources. To raise additional capital, we may need to issue new securities, which could result in further dilution to our shareholders and significant dilution to our earnings per share. Issuance of new securities with registration rights or covenants through additional financings may be superior to the current ones that would restrict our operations and strategies. If we are unable to raise additional financing, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities, or respond to competitive pressures on a timely basis, if at all. In addition, lack of additional capital could force us to substantially curtail or even cease operations.
We also may not be able to identify merger or acquisition targets. We may not be able to successfully integrate the targeted business or operations with ours after a merger or acquisition. Such failure to execute our long-term business plan likely will negatively impact results of our operations.
We generally do not have exclusive agreements with our customers and we may lose their contracts if they are not satisfied with our products and services or for other reasons.
We generally do not have exclusive agreements with our customers. As a result, we must rely on the quality of our products and services, our reputation in the industry, and favorable pricing terms to attract and retain customers. There is no assurance that we will be able to maintain and retain our relationships with current and or future customers. Our customers may choose to terminate their relationships with us if they are not satisfied with our services or the prices of our competitors’ offerings are lower. If a substantial number of our customers choose not to continue to purchase products and services from us, it would materially and adversely affect on our business and results of operations.
If we are unable to develop and offer competitive new products and services, our future operations could be adversely affected.
Our future revenue stream, to a large degree, depends on our ability to capitalize on our technology strength and capabilities to offer new software applications and services to a broader client base. We must make investments in research and development to continue developing and offering new software applications and internet related products and services, and to enhance our existing software applications and internet related services to maintain market acceptance of our products and services. We may encounter challenges in innovation and introduction of new products and services. Our software applications under development may not be successfully completed or, if developed, may not achieve significant customer acceptance. If we are unable to successfully define, develop, introduce competitive new software applications, and enhance the existing ones, our future operating results would be adversely affected. The timeline for software developments is difficult to predict. Timely launch of new applications and their acceptance by customers are important to our future success. A delay in the development or introduction of new applications could have a significantly adverse impact on our results of operations.
If we are unable to keep abreast with the rapid technological changes in our industry, demand for our products and services could decline and adversely affect our revenue and growth.
Our industry is known for rapid changes in technology, frequent introductions of new applications, quick evolution of industry standards, and changes in customer demands. These conditions require continuous investments in product research and development to enhance existing products, innovate new products, and keep up with the leading-edge technologies. We believe that the timely development of new products and continuous enhancements to the existing products are essential to maintain our competitive position in the marketplace. Our future success depends in part upon customer and market acceptance of our products and innovations. Failure to achieve market acceptance of our existing products and services or to launch new products could materially and adversely affect our business and results of operations.
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Our software applications may contain defects or errors, which could decrease sales, damage our reputation, or delay deliveries of our products.
Our software products are complex and must meet the stringent technical requirements requested by our customers. In order to keep pace with the current technologies and the rapid changes in the industry standards, we must accelerate new product developments and enhancements for our existing products. Because of the complex designs and the expeditious development cycles, we cannot assure that our software products are free of errors, especially for the newly released software applications and the updates for the existing software products. If our software is not free of errors, this could potentially result in litigation, declining sales, increasing product returns, product warranty costs, and damage to our reputation, which would adversely affect our business.
Our technology may become obsolete, which could materially adversely affect our ability to sell our products and services.
If our technology, products and services become obsolete, our business operations would be materially and adversely affected. The market in which we compete is known for rapid changes in technologies, quick evolution of industry standards, fast introductions of new products, and changes in customer demands. These market characteristics can cause the existing products to be obsolete and unmarketable. Our future success depends upon our ability to timely address the increasingly sophisticated requests from our customers to support the existing and new hardware, software, database, and networking platforms. We have to invest in research and development in order to succeed in this competitive industry and timely satisfy market demands. Our research and development expenses from continuing operations were approximately $3.6 million, $4.5 million and $3.9 million for the years ended December 31, 2022, 2021, and 2020, respectively.
We face the risk of systems interruptions and capacity constraints, possibly resulting in adverse publicity, revenue loss and erosion of customer trust.
The satisfactory performance, reliability, and availability of our network infrastructure are critical to our reputation and our ability to attract and retain customers and to maintain adequate customer service levels. We may experience temporary service interruptions for a variety of reasons, including telecommunications or power failures, fire, water damage, vandalism, computer bugs, or viruses or hardware failures. We may not be able to correct a problem in a timely manner. Any service interruption that results in the unavailability of our system or reduces its capacity could result in real or perceived public safety issues that may affect customer confidence in our services and afflict negative publicity that could cause us to lose customer accounts or fail to obtain new accounts. Any inability to scale our systems may cause unanticipated system disruptions, slower response times, degradation in quality of customer service, or impaired performance and speed of transaction processing. We are not certain that we will be able to project the rate or timing of increases, if any, in the use of our services to permit us to upgrade and expand our systems effectively or to efficiently integrate any newly developed or purchased modules with our existing systems.
We have a limited history with our pricing models for our CBT products and services and, as a result, we may be forced to change the prices we charge for our applications or the pricing models upon which they are based.
We have limited experience with respect to determining the optimal prices and pricing models for certain of our CBT products and services and certain geographic markets. As the markets for our applications mature, or as competitors introduce products or services that compete with ours, including bundling competing offerings with additional products or services, we may be unable to attract new customers at the same price or based on the same pricing models as we have used historically. As a result, in the future we may be required to reduce our prices, which could adversely affect our financial performance. In addition, we may offer volume price discounts based on the number of products or services purchased by a customer or the number of our applications purchased by a customer, which would effectively reduce the prices we charge for our products and services. Also, we may be unable to renew existing customer agreements or enter into new customer agreements at the same prices or upon the same terms that we have historically, which could have a material and adverse effect on our financial position.
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Security breaches may harm our business.
Our cloud-based applications involve the storage and transmission of our customers’ proprietary and confidential information. Any security breaches, unauthorized access, unauthorized usage, virus or similar breach or disruption could result in loss of confidential information, damage to our reputation, early termination of our contracts, litigation, regulatory investigations, indemnity obligations, or other liabilities. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise and, as a result, someone obtains unauthorized access to customer data, our reputation will be damaged, our business may suffer and we could incur significant liability. Because the techniques used to obtain unauthorized access or sabotage computer systems change frequently, and generally are not identified until they are launched against a target, we may be unable to anticipate these hacking techniques or implement adequate preventative measures. Any or all of these concerns could negatively affect our ability to attract new customers and cause existing customers to elect not to renew or upgrade their subscriptions, or subject us to third-party lawsuits, regulatory fines, or other action or liability, which could adversely affect our operating results.
If we are not able to adequately secure and protect our patents, trademarks and other proprietary rights, our business may be materially affected.
To protect our intellectual properties, we rely on a combination of copyright, trademark, and trade secret laws. We also rely on non-disclosure agreements and other confidentiality procedures and contractual provisions to protect our intellectual property rights. Some of these technologies are critical to our business but are not protected by copyrights or patents. It may be possible for unauthorized third parties to copy or reverse engineer our products, or otherwise obtain and use information that we regard as proprietary. Further, third parties could challenge the scope or enforceability of our copyrights. In certain other jurisdictions, including China where we operate, the laws do not protect our proprietary rights to the same extent as the laws of the United States. Any misappropriation of our intellectual property could have a material and adverse effect on our business and results of operations. We cannot assure you that the measures we take to protect our proprietary rights are adequate.
Claims that we infringe the proprietary rights of third parties could result in significant expenses or restrictions on our ability to sell our products and services.
Third parties may claim that our products or services infringe their proprietary rights. Any infringement claim, with or without merit, would be time-consuming and expensive to litigate or settle and could divert our management’s attention from our core business. In the event of a successful infringement claim against us, we may have to pay significant damages, incur substantial legal fees, develop costly non-infringing technology, or enter into license agreements that require us to pay substantial royalties that may not be available on terms acceptable to us, if at all.
A significant portion of our sales are derived from a limited number of customers or related parties, and results from operations could be adversely affected and shareholder value harmed if we lose any of these customers.
Historically, a significant portion of our revenues have been derived from a limited number of customers or related parties. For the year ended December 31, 2022, we generated about $0.15 million of revenue from related parties. For the years ended December 31, 2022, 2021 and 2020, approximately 24%, 29% and 25%, respectively, of our revenues of continuing operations were derived from our five largest customers, including related parties. The loss of any of these significant customers and related parties would adversely affect our revenues and shareholder value.
The markets for out-of-home digital advertising and digital security systems in China are highly competitive. We may fail to compete successfully, thereby resulting in loss of customers and decline in our revenues.
The markets for out-of-home digital advertising and digital security information systems in China are intensely competitive and are characterized by frequent technological changes, evolving industry standards, and changing in customer demands. We face competition from multiple domestic competitors in each segment. Increased competition may result in price reductions, reduced margins, and inability to gain or hold market share.
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We have limited insurance coverage for our operations in China.
The insurance industry in China is still in the early stage of development. Insurance companies in China offer limited insurance products. We have determined that the risks of disruption or liability from our business, the loss or damage to our property, including our facilities, equipment and office furniture, the cost of insuring these risks, and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, we do not have any business liability, disruption, litigation or property insurance coverage for our operations in China, except for insurance on some company owned vehicles. Any occurrence of uninsured loss or damage to property, or litigation, or business disruption may result in substantial costs and diversion of resources, which could have an adverse effect on our operating results.
We do not have insurance coverage against damages or losses of our products. Defects in our products could result in a loss of customers and decrease in revenue, unexpected expenses and a loss of market share.
We have not purchased product liability insurance to provide against any claims against us based on our product quality. As a result, defects in our products could result in a loss of customers and decrease in revenue, unexpected expenses and a loss of market share, and any of our products are found to have reliability, quality or compatibility problems, we will be required to accept returns, provide replacements, provide refunds, or pay damages. We may be required to incur substantial amounts to indemnify our customers in respect of their product quality claims against us, which would materially and adversely affect the results of our operations and severely damage our reputation.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our future business and results of operations significantly depend upon continuous contributions by key technical and senior management personnel, including Jianghuai Lin, Chairman and Chief Executive Officer, Zhiqiang Zhao, President and Director, Liqiong (Iris) Yan, the Chief Financial Officer, Zhixiong Huang, Chief Operating Officer and Guangzeng Chen, Chief Technology Officer. The success of our business also depends in significant part upon our ability to attract and retain additional qualified management, technical, marketing, sales, and support personnel for our operations. If we lose a key employee, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could largely deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing technical, marketing, and sales aspects of our business, any part of which could be harmed by future turnover.
We may be exposed to potential risks relating to our internal controls over financial reporting.
Companies that file reports with the SEC, including us, are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404. SOX 404 requires management to establish and maintain a system of internal control over financial reporting, and annual reports on Form 10-K or Form 20-F filed under the Exchange Act are required to contain a report by management assessing the effectiveness of a company’s internal control over financial reporting. Separately, under SOX 404, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, public companies that are large accelerated or accelerated filers, other than emerging growth companies or smaller reporting companies, must include in their annual reports on Form 10-K or Form 20-F an attestation report of their auditors’ attesting to and reporting on the management’s assessment of internal control over financial reporting. Non-accelerated filers and emerging growth companies are not required to include an attestation report of their auditors in the annual reports.
A report of our management is included under Item 15 “Controls and Procedures” of this report. We are a non-accelerated filer and not required to include an attestation report of our auditor in this annual report. Management believes that our internal control over financial reporting has continued to improve in 2022 to minimize material weaknesses identified in Item 15 of this report. Although we have made improvements to overcome such concern, we can provide no assurance that these material weaknesses will be entirely remediated in a timely manner. As a result, investors and others may lose confidence in the reliability of our financial statements.
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We face risks associated with maintaining and expanding our international operations, including unfavorable and uncertain regulatory, political, economic, tax and labor conditions.
We are subject to legal and regulatory requirements, political uncertainty and social, environmental and economic conditions in multiple jurisdictions, over which we have little control and which are inherently unpredictable. Our operations in such jurisdictions, particularly as a company based in the PRC, create risks relating to, among others, compliance; organizing local operating entities; establishing, staffing and managing foreign business locations; navigating foreign government taxes, regulations and permit requirements; enforceability of our contractual rights; trade restrictions or exchange controls. Such conditions may increase our costs, impact our operations and business plans and require significant management attention, and may harm our business if we unable to manage them effectively.
Risks Relating to Doing Business in China
The PRC government exerts substantial influence over the manner in which we conduct our business activities. Its oversight and discretion over our business could result in a material adverse change in our operations and the value of our ordinary shares. Changes in laws, regulations and policies in China and uncertainties with respect to the PRC legal system could materially and adversely affect us. In addition, rules and regulations in China can change quickly with little advance notice.
A substantial portion of our operations are conducted in the PRC. Accordingly, our financial condition and results of operations are affected to a significant extent by the economic, political and legal developments in the PRC. The PRC economy differs from the economies of most developed countries in many respects, including the extent of government involvement, level of development, growth rate, and control of foreign exchange and allocation of resources. The PRC government has implemented various measures to encourage economic growth and to guide the allocation of resources. Some of these measures may benefit the overall PRC economy but may also have a negative effect on us. Our financial condition and results of operations could be materially and adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
The Chinese government recently has published new policies that significantly affected certain industries such as the education and internet industries, and we cannot rule out the possibility that it will not in the future release regulations or policies regarding our industry that could require us or our PRC subsidiaries to seek permission from Chinese authorities to continue to operate our business in China, which may adversely affect our business, financial condition and results of operations. Furthermore, recent statements made by the Chinese government have indicated an intent to increase the government’s oversight and control over offerings of companies with significant operations in China that are to be conducted in foreign markets, as well as foreign investment in China-based issuers like us. Any such action, once taken by the Chinese government, could significantly limit or completely hinder our ability to offer our securities, and could cause the value of such securities to significantly decline or become worthless.
For example, in July 2021, the Chinese government provided new guidance on China-based companies raising capital outside of China, including through arrangements via VIEs. In light of such developments, the SEC has imposed enhanced disclosure requirements on China-based companies seeking to register securities with the SEC. Although we dissolved the VIE structure in September 2021 and our business in China currently does not involve any type of restricted industry under Chinese regulations, any future Chinese, U.S. or other rules and regulations that place restrictions on capital raising or other activities by companies with extensive operations in China could adversely affect our business. If the business environment in China deteriorates from the perspective of domestic or international investment, or if relations between China and the United States or other governments deteriorate, the Chinese government may intervene with our operations, and our business in China, as well as the value of our securities, may also be adversely affected.
The PRC government has increasingly strengthened oversight in offerings conducted overseas or on foreign investment in China-based issuers, which could result in a material change in our operations and our ordinary shares could decline in value or become worthless.
The PRC government has recently indicated an intent to take actions to exert more oversight and control over offerings that are conducted overseas and/or foreign investment in China-based issuers. For example, on July 6, 2021, the relevant PRC government authorities made public the Opinions on Strictly Scrutinizing Illegal Securities Activities in Accordance with the Law, or the Opinions. These Opinions emphasized the need to strengthen the administration over illegal securities activities and the supervision of overseas listings by China-based companies and proposed to take effective measures, such as promoting the construction of relevant regulatory systems to deal with the risks and incidents faced by China-based over-seas-listed companies.
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On December 24, 2021, the CSRC issued the Provisions of the State Council on the Administration of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments) and the Administrative Measures for the Filing of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments), collectively the Draft Overseas Listing Regulations, for public comment until January 23, 2022.
Following issuance of the Draft Overseas Listing Regulations, on February 17, 2023, the CSRC issued the Notice on Filing Arrangements for Overseas Securities Offering and Listing by Domestic Companies (the “CSRC Filing Notice”), stating that the CSRC has published the Trial Administrative Measures of Overseas Securities Offering and Listing by Domestic Companies, or the “Trial Measures,” and five supporting guidelines (the “Listing Guidelines”), collectively the Trial Measures and Listing Guidelines. Among others, the Trial Measures and Listing Guidelines provide that overseas offerings and listings by PRC domestic companies shall:
| (i) | require submission of relevant materials that contain a filing report and a legal opinion, providing truthful, accurate and complete information on matters including but not limited to the shareholders of the issuer. Where the filing documents are complete and in compliance with stipulated requirements, the CSRC shall, within 20 working days after receipt of filing documents, conclude the filing procedure and publish filing results on the CSRC website. Where filing documents are incomplete or do not conform to stipulated requirements, the CSRC shall request supplementation and amendment thereto within five working days after receipt of the filing documents. The issuer should then complete supplementation and amendment within 30 working days; |
| (ii) | abide by laws, administrative regulations and relevant state rules concerning foreign investment in China, state-owned asset administration, industry regulation and outbound investment, and shall not disrupt the PRC domestic market order, harm state or public interests or undermine the lawful rights and interests of PRC domestic investors; |
| (iii) | abide by national secrecy laws and relevant provisions. Necessary measures shall be taken to fulfill confidentiality obligations. Divulgence of state secrets or working secrets of government agencies is strictly prohibited. Provision of personal information and important data, etc., to overseas parties in relation to overseas offering and listing of PRC domestic companies shall be in compliance with applicable laws, administrative regulations and relevant state rules; and |
| (iv) | be made in strict compliance with relevant laws, administrative regulations and rules concerning national security in the spheres of foreign investment, cybersecurity, data security, etc., and issuers shall duly fulfill their obligations to protect national security. If the intended overseas offering and listing necessitates a national security review, relevant security review procedures shall be completed according to the law before the application for such offering and listing is sub-mitted to any overseas parties such as securities regulatory agencies and trading venues; |
The Trial Measures came into effect on March 31, 2023. PRC domestic companies seeking to offer and list securities (which, for the purposes of the Trial Measures, are defined thereunder as equity shares, depository receipts, corporate bonds convertible to equity shares, and other equity securities that are offered and listed overseas, either directly or indirectly, by PRC domestic companies) in overseas markets, either via direct or indirect means, must file with the CSRC within three working days after their application for an overseas listing is submitted.
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The Trial Measures provide that where a PRC domestic company seeks to indirectly offer and list securities in overseas markets, the issuer shall designate a major domestic operating entity, which shall, as the domestic entity responsible, file with the CSRC. The Trial Measures stipulate that an overseas listing will be determined as “indirect” if the issuer meets both of the following conditions: (1) 50% or more of any of the issuer’s operating revenue, total profit, total assets or net assets as documented in its audited consolidated financial statements for the most recent accounting year are accounted for by PRC domestic companies (“Condition I”), and (2) the main parts of the issuer’s business activities are conducted in the PRC, or its main places of business are located in the PRC, or the senior managers in charge of its business operations and management are mostly Chinese citizens or domiciled in the PRC (“Condition II”); whether Chinese citizens from Taiwan, Hong Kong, and Macau are included in the foregoing specification is not specified. The determination as to whether or not an overseas offering and listing by PRC domestic companies is indirect shall be made on a “substance over form” basis; the Listing Guidelines further stipulate that if an issuer not satisfying Condition I submits an application for issuance and listing in overseas markets in accordance with relevant non-PRC issuance regulations requiring such issuer to disclose risk factors mainly related to the PRC, the securities firm(s) and the issuer’s PRC counsel should follow the principle of “substance over form” in order to identify and argue whether the issuer should complete a filing under the Trial Measures. Subsequent securities offerings of an issuer in (i) the same overseas market where it has previously offered and listed securities, and (ii) an overseas market other than one where the issuer has previously offered and listed securities shall be filed with the CSRC within three working days after offerings are completed. Additionally, the Trial Measures stipulate that after an issuer has offered and listed securities in an overseas market, the issuer shall submit a report to the CSRC within three working days after the occurrence and public disclosure of (i) a change of control thereof, (ii) investigations of or sanctions imposed on the issuer by overseas securities regulators or relevant competent authorities, (iii) changes of listing status or transfers of listing segment, and (iv) a voluntary or mandatory delisting.
The CSRC Filing Notice states that, beginning from March 31, 2023, PRC domestic enterprises which have already issued and listed securities overseas and fall within the scope of filing under the Trial Measures shall be considered “existing enterprises” (“Existing Listed Enterprises”). Existing Listed Enterprises are not required to complete filings immediately; rather, Existing Listed Enterprises should complete filings if they are subsequently involved in matters require filings, such as follow-on financing activities, in accordance with the Trial Measures.
There is a possibility that we may be deemed as an Existing Listed Enterprise as defined under the CSRC Filing Notice, and that future offerings of listed securities or listings outside China by us may be subject to CSRC filing requirements in accordance with the Trial Measures.
On February 24, 2023, the CSRC, together with the Ministry of Finance, National Administration of State Secrets Protection and National Archives Administration of China, revised the Provisions on Strengthening Confidentiality and Archives Administration for Overseas Securities Offering and Listing, which were issued by the CSRC and National Administration of State Secrets Protection and National Archives Administration of China in 2009, or the “Provisions.” The revised Provisions were issued under the title the “Provisions on Strengthening Confidentiality and Archives Administration of Overseas Securities Offering and Listing by Domestic Companies,” and came into effect on March 31, 2023 together with the Trial Measures. One of the major revisions to the revised Provisions is expanding their application to cover indirect overseas offering and listing, as is consistent with the Trial Measures. The revised Provisions require that, among other things, (a) a domestic company that plans to, either directly or indirectly through its overseas listed entity, publicly disclose or provide to relevant individuals or entities, including securities companies, securities service providers, and overseas regulators, any documents and materials that contain state secrets or working secrets of government agencies, shall first obtain approval from competent authorities according to law, and file with the secrecy administrative department at the same level; and (b) a domestic company that plans to, either directly or indirectly through its overseas listed entity, publicly disclose or provide to relevant individuals and entities, including securities companies, securities service providers, and overseas regulators, any other documents and materials that, if leaked, will be detrimental to national security or public interest, shall strictly fulfill relevant procedures stipulated by applicable national regulations. Any failure or perceived failure by our Company, or our PRC subsidiaries to comply with the above confidentiality and archives administration requirements under the revised Provisions and other PRC laws and regulations may result in the relevant entities being held legally liable by competent authorities, and referred to the judicial organ to be investigated for criminal liability if suspected of committing a crime.
Given that the Trial Measures, Listing Guidelines and Revised Provisions have been introduced recently, and that there remain substantial uncertainties surrounding the enforcement thereof, we cannot assure you that, if required, we would be able to complete the filings and fully comply with the relevant new rules on a timely basis, if at all. Further, as of the date of this report, the aforementioned Provisions of the State Council on the Administration of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments) issued on December 24, 2021 remain in draft form and final and effective versions are yet to be published.
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Changes in U.S. and Chinese regulations or in relations between the United States and China may adversely impact our business, our operating results, our ability to raise capital and the value of the securities that we are registering. Any such changes may take place quickly and with very little notice.
The U.S. government, including the SEC, has made statements and taken certain actions that led to changes to United States and international relations, and will impact companies with connections to the United States or China. The SEC has issued statements primarily focused on companies with significant China-based operations, such as us. For example, on July 30, 2021, Gary Gensler, Chairman of the SEC, issued a Statement on Investor Protection Related to Recent Developments in China, pursuant to which Chairman Gensler stated that he has asked the SEC staff to engage in targeted additional reviews of filings for companies with significant China-based operations. The statement also addressed risks inherent in companies with VIE structures. We have dissolved our VIE structure and are not in any industry that is subject to foreign ownership limitations by China. However, it is possible that the Company’s filings with the SEC may be subject to enhanced review by the SEC and this additional scrutiny could affect our ability to effectively raise capital in the United States.
In response to the SEC’s July 30, 2021 statement, the CSRC announced on August 1, 2021, that “it is our belief that Chinese and U.S. regulators shall continue to enhance communication with the principle of mutual respect and cooperation, and properly address the issues related to the supervision of China-based companies listed in the U.S. so as to form stable policy expectations and create benign rules framework for the market.” While the CSRC will continue to collaborate “closely with different stakeholders including investors, companies, and relevant authorities to further promote transparency and certainty of policies and implementing measures,” it emphasized that it “has always been open to companies’ choices to list their securities on international or domestic markets in compliance with relevant laws and regulations.” If any new legislation, executive orders, laws and/or regulations are implemented, if the U.S. or Chinese governments take retaliatory actions due to the recent U.S.-China tension or if the Chinese government exerts more oversight and control over securities offerings that are conducted in the United States, such changes could have an adverse effect on our business, financial condition and results of operations, our ability to raise capital and the value of the securities that we are registering.
There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations.
A significant portion of our operations are conducted in the PRC, and are governed by PRC laws, rules and regulations. Our PRC subsidiaries are subject to laws, rules and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws, rules and regulations governing economic matters in general. The overall effect of legislation over the past four decades has significantly enhanced the protections afforded to various forms of foreign investment in China. However, China has not developed a fully integrated legal system, and recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degrees of interpretation by PRC regulatory agencies. In particular, because these laws, rules and regulations, especially those relating to the internet, are relatively new, and because of the limited number of published decisions and the nonbinding nature of such decisions, and because the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and enforcement of these laws, rules and regulations involve uncertainties and can be inconsistent and unpredictable. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation. Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention.
Our business is subject to complex and evolving laws and regulations regarding privacy and data protection. Compliance with China’s new Data Security Law, Cybersecurity Review Measures, Personal Information Protection Law, Regulations on Network Data Security (draft for public comments), as well as additional laws, regulations and guidelines that the Chinese government promulgates in the future may entail significant expenses and could materially affect our business.
Regulatory authorities in China have implemented and are considering further legislative and regulatory proposals concerning data protection. China’s new Data Security Law went into effect on September 1, 2021. The Data Security Law provides that the data processing activities must be conducted based on “data classification and hierarchical protection system” for the purpose of data protection and prohibits entities in China from transferring data stored in China to foreign law enforcement agencies or judicial authorities without prior approval by the Chinese government. The Data Security Law sets forth the legal liabilities of entities and individuals found to be in violation of their data protection obligations, including rectification order, warning, fines of up to RMB5 million, suspension of relevant business, and revocation of business permits or licenses. On July 7, 2022, CAC promulgated the Security Assessment Measures for Outbound Data Transfers, or the “Measures,” which became effective on September 1, 2022. The Measures applies to the security assessment of critical data and personal information collected and generated by a data processor in its operation in the PRC, which are to be provided abroad. Article 4 of the Measures stipulates that a data processor shall declare security assessment for its outbound data transfer to the CAC through the local cyberspace administration at the provincial level if the data processor provide data abroad under any of the following circumstances: (i) where a data processor provides critical data abroad; (ii) where a critical information infrastructure operator or a data processor processing the personal information of more than one million people provides personal information abroad; (iii) where a data processor has provided personal information of 100,000 people or sensitive personal information of 10,000 people in total abroad since January 1 of the previous year; and (iv) other circumstances prescribed by the CAC for which declaration for security assessment for outbound data transfers is required.
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On November 7, 2016, the SCNPC promulgated the Cybersecurity Law of the PRC which came into effect on June 1, 2017 and applies to the construction, operation, maintenance and use of networks as well as the supervision and administration of cybersecurity in China. The PRC Cybersecurity Law defines “network operators” as owners and administrators of networks and network service providers, are subject to various security protection-related obligations, including: (i) complying with security protection obligations under graded system for cybersecurity protection requirements, which include formulating internal security management rules and operating instructions, appointing cybersecurity responsible personnel and their duties, adopting technical measures to prevent computer viruses, cyber-attack, cyber-intrusion and other activities endangering cybersecurity, adopting technical measures to monitor and record network operation status and cybersecurity events; (ii) formulating a emergency plan and promptly responding and handling security risks, initiating the emergency plans, taking appropriate remedial measures and reporting to regulatory authorities in the event comprising cybersecurity threats; and (iii) providing technical assistance and support to public security and national security authorities for protection of national security and criminal investigations in accordance with the law.
On July 10, 2021, the CAC issued the Cybersecurity Review Measures (revised draft for public comments), which took effect on February 15, 2022. The revised Cybersecurity Review Measures authorize the CAC to conduct cybersecurity review on a range of activities that affect or may affect national security. The PRC National Security Law defines various types of national security, including technology security and information security. The revised Cybersecurity Review Measures expands the cybersecurity review to data processing operators in possession of personal information of over 1 million users if the operators intend to list their securities in a foreign country. Under the revised Cybersecurity Review Measures, the scope of entities required to undergo cybersecurity review to assess national security risks that arise from data processing activities would be expanded to include all critical information infrastructure operators who purchase network products and services and all data processors carrying out data processing activities that affect or may affect national security. In addition, the revised Cybersecurity Review Measures provide that all such entities that maintain or store the personal information of more than 1 million users and undertake a public listing of securities in a foreign country would be required to pass cybersecurity review, which would focus on the potential risk of core data, important data, or a large amount of personal information being stolen, leaked, destroyed, illegally used or exported out of China, or critical information infrastructure being affected, controlled or maliciously used by foreign governments after such a listing. An operator that violates these Measures shall be dealt with in accordance with the provisions of the PRC Cybersecurity Law and the PRC Data Security Law.
On November 14, 2021, the CAC released the Regulations on Network Data Security (draft for public comments) and accepted public comments until December 13, 2021. The draft Regulations on Network Data Security provide more detailed guidance on how to implement the general legal requirements under legislations such as the Cybersecurity Law, Data Security Law and the Personal Information Protection Law. The draft Regulations on Network Data Security follow the principle that the state will regulate based on a data classification and multi-level protection scheme, under which data is largely classified into three categories: general data, important data and core data. Personal data and important data will be subject to “key” protection and core data to “strict” protection. We believe that the data we access falls within the category of “general data,” because such data is data of our member merchants, does not involve personal information and is not large in volume. Further, when we conduct advertising data collection and analysis, such data is only related to the placement and delivery of ads, which does not involve any personal information. However, we may constitute an online platform operator under the draft Regulations on Network Data Security, which is defined as a platform that provides information publishing, social network, online transaction, online payment and online audio/video services, because our PRC subsidiary Biznest is operating a smart cloud platform that publishes commercial ads of our advertiser clients. Online platform operator under the draft Regulations will be required, among other things, to disclose terms and privacy policies and the algorithms they use. Where there are any changes that would result in significant impacts on users’ rights and interests, online platform operators will be required to seek public comments for at least 30 business days and publish how the public comments have been considered and incorporated into the final versions and why other comments are rejected. The draft Regulations also set forth procedures for reporting data breach incidents. In the event that a data breach incident has caused harm to any individuals or organizations, a data processor should notify the relevant individuals and organizations within 3 business days, unless such notices are not required under applicable laws or regulations. Additionally, if we are deemed as a data processor listed overseas under the draft Regulations, we will be required to carry out an annual data security assessment on our own or by engaging a third party data security services institution and submit a data security assessment report for the prior year to the local cyberspace affairs administration department before January 31 of each year. The Regulations on Network Data Security (draft for public comments) were released for public comments and subject to further changes.
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On August 20, 2021, the Standing Committee of the National People’s Congress of China promulgated the Personal Information Protection Law which became effective on November 1, 2021. The Personal Information Protection Law provides a comprehensive set of data privacy and protection requirements that apply to the processing of personal information and expands data protection compliance obligations to cover the processing of personal information of persons by organizations and individuals in China, and the processing of personal information of persons in China outside of China if such processing is for purposes of providing products and services to, or analyzing and evaluating the behavior of, persons in China. The Personal Information Protection Law also provides that critical information infrastructure operators and personal information processing entities who process personal information meeting a volume threshold to be set by Chinese cyberspace regulators are also required to store in China personal information generated or collected in China, and to pass a security assessment administered by Chinese cyberspace regulators for any export of such personal information. Lastly, the Personal Information Protection Law contains proposals for significant fines for serious violations of up to RMB 50 million or 5% of annual revenues from the prior year and may also be ordered to suspend any related activity by competent authorities.
As our smart cloud platform is engaged in the advertising business, the advertising industry is not subject to any foreign investment restrictions and our smart cloud platform does not collect any personal information, we believe that we will be able to comply with the requirements of the PRC Cybersecurity Law, the PRC Data Security Law and related implementing regulations. However, interpretation, application and enforcement of these laws, rules and regulations evolve from time to time and their scope may continually change, through new legislation, amendments to existing legislation or changes in enforcement. Compliance with the PRC Cybersecurity Law and the PRC Data Security Law could increase the cost to us in providing our services, require changes to our operations or may prevent us from providing certain services.
PRC laws and regulations establish complex procedures in connection with certain acquisitions of China-based companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions or mergers in China.
On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the State-Owned Assets Supervision and Administration Commission, the State Administration of Taxation, the State Administration for Industry and Commerce, the CSRC, and the State Administration of Foreign Exchange, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which came into effect on September 8, 2006 and were amended on June 22, 2009. The M&A Rules include, among other things, provisions that purport to require that an offshore special purpose vehicle formed for the purpose of an overseas listing of securities of a PRC company obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings through special purpose vehicles. However, substantial uncertainty remains regarding the scope and applicability of the M&A Rules to offshore special purpose vehicles.
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The regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the MOFCOM be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies.
Moreover, according to the Anti-Monopoly Law of the People’s Republic of China promulgated on August 30, 2007 and the Provisions on Thresholds for Reporting of Concentrations of Undertakings (the “Prior Reporting Rules”) issued by the State Council in August 2008 and amended in September 2018, the concentration of business undertakings by way of mergers, acquisitions or contractual arrangements that allow one market player to take control of or to exert decisive impact on another market player must also be notified in advance to the anti-monopoly enforcement agency of the State Council when the applicable threshold is crossed and such concentration shall not be implemented without the clearance of prior reporting. In addition, the Regulations on Implementation of Security Review System for the Merger and Acquisition of Domestic Enterprise by Foreign Investors (the “Security Review Rules”) issued by the MOFCOM that became effective in September 2011 specify that mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass a security review by structuring the transaction through, among other things, trusts, entrustment or contractual control arrangements.
We may grow our business in part by acquiring other companies operating in our industry. Compliance with the requirements of the regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent Taoping from making additional capital contributions or loans to its PRC subsidiaries.
Taoping, as an offshore holding company, is permitted under PRC laws and regulations to provide funding to its PRC subsidiaries through loans or capital contributions. However, loans by Taoping to its PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the local counterpart of the State Administration of Foreign Exchange and capital contributions to its PRC subsidiaries are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System, and registration with other governmental authorities in China.
The State Administration of Foreign Exchange promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or Circular 19, effective on June 1, 2015, in replacement of the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign- Invested Enterprises, the Notice from the State Administration of Foreign Exchange on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses, and the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses. According to Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of bank loans that have been transferred to a third party. Although Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to be used for equity investments within the PRC, it also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether the State Administration of Foreign Exchange will permit such capital to be used for equity investments in the PRC in actual practice. The State Administration of Foreign Exchange promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to grant loans to non-associated enterprises. Violations of Circular 19 and Circular 16 could result in administrative penalties. Circular 19 and Circular 16 may significantly limit our ability to transfer any foreign currency Taoping holds to its PRC subsidiaries, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.
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In light of the various requirements imposed by PRC regulations on loans to, and direct investment in, PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans or future capital contributions by us to our PRC subsidiaries. As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiaries when needed. If we fail to complete such registrations or obtain such approvals, our ability to use foreign currency and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.
The recent joint statement by the SEC, proposed rule changes submitted by Nasdaq, and the HFCA Act, all call for additional and more stringent criteria to be applied to U.S.-listed companies with significant operations in China. These developments could add uncertainties to our continued listing, future offerings, business operations share price and reputation.
U.S. public companies that have substantially all of their operations in China have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered on financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud.
On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting the continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in HK SAR. On April 21, 2020, SEC Chairman Jay Clayton and PCAOB Chairman William D. Duhnke III, along with other senior SEC staff, released a joint statement highlighting the risks associated with investing in companies based in or have substantial operations in emerging markets including HK SAR, reiterating past SEC and PCAOB statements on matters including the difficulty associated with inspecting accounting firms and audit work papers in HK SAR and higher risks of fraud in emerging markets and the difficulty of bringing and enforcing SEC, Department of Justice and other U.S. regulatory actions, including in instances of fraud, in emerging markets generally.
On May 20, 2020, the U.S. Senate passed the HFCA Act requiring a foreign company to certify it is not owned or controlled by a foreign government if the PCAOB is unable to audit specified reports because the company uses a foreign auditor not subject to PCAOB inspection. In addition, if the PCAOB is unable to inspect the company’s auditors for three consecutive years, the issuer’s securities are prohibited to trade on a national exchange. On December 2, 2020, the U.S. House of Representatives approved the HFCA Act and it was signed into law on December 18, 2020.
On May 21, 2021, Nasdaq filed three proposals with the SEC to (i) apply minimum offering size requirement for companies primarily operating in a “Restrictive Market”, (ii) prohibit Restrictive Market companies from directly listing on Nasdaq Capital Market, and only permit them to list on Nasdaq Global Select or Nasdaq Global Market in connection with a direct listing and (iii) apply additional and more stringent criteria to an applicant or listed company based on the qualifications of the company’s auditors.
On June 22, 2021, the U.S. Senate passed the Accelerating Holding Foreign Companies Accountable Act, and on December 29, 2022, legislation entitled “Consolidated Appropriations Act, 2023” was signed into law, which contained, among other things, an identical provision to the Accelerating Holding Foreign Companies Accountable Act and amended the HFCA Act by requiring the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchanges or over-the-counter markets if its auditor is not subject to PCAOB inspections for two consecutive years instead of three.
On September 22, 2021, the PCAOB adopted a final rule implementing the HFCA Act, which provides a framework for the PCAOB to use when determining, as contemplated under the HFCA Act, whether the PCAOB is unable to inspect or investigate completely registered public accounting firms located in a foreign jurisdiction because of a position taken by one or more authorities in that jurisdiction.
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On December 2, 2021, the SEC adopted amendments to finalize rules implementing the submission and disclosure requirements in the HFCA Act. The rules apply to registrants the SEC identifies as having filed an annual report with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB is unable to inspect or investigate (“Commission-Identified Issuers”). The final amendments require Commission-Identified Issuers to submit documentation to the SEC establishing that, if true, it is not owned or controlled by a governmental entity in the public accounting firm’s foreign jurisdiction. The amendments also require that a Commission-Identified Issuer that is a “foreign issuer,” as defined in Exchange Act Rule 3b-4, provide certain additional disclosures in its annual report for itself and any of its consolidated foreign operating entities. A Commission-Identified Issuer will be required to comply with the submission and disclosure requirements in the annual report for each year in which it was identified.
On December 16, 2021, pursuant to the HFCA Act, the PCAOB issued a Determination Report which found that the PCAOB is unable to inspect or investigate completely registered public accounting firms headquartered in mainland China of the People’s Republic of China and Hong Kong, a Special Administrative Region and dependency of the PRC, because of a position taken by one or more authorities in such jurisdictions. In addition, the PCAOB’s report identified specific registered public accounting firms which are subject to these determinations. Our current registered public accounting firm, PKF, or our former registered public accounting firm, UHY LLP, is not headquartered in mainland China or Hong Kong and was not identified in this report as a firm subject to the PCAOB’s determination. Our current auditor, PKF, is a UK-based accounting firm that is registered with the PCAOB and can be inspected by the PCAOB. We have no current intention of engaging any auditor not subject to regular inspection by the PCAOB. Furthermore, the PCAOB is able to inspect the audit workpapers of our PRC subsidiaries, as such workpapers are electronic files possessed by our registered public accounting firms. However, if the PCAOB determines in the future that it cannot inspect or fully investigate our auditor at such future time, trading in our securities would be prohibited under the HFCA Act.
On August 26, 2022, CSRC, the MOFCOM, and the PCAOB signed the Protocol, governing inspections and investigations of audit firms based in China and Hong Kong. The Protocol remains unpublished and is subject to further explanation and implementation. Pursuant to the fact sheet with respect to the Protocol disclosed by the SEC, the PCAOB shall have independent discretion to select any issuer audits for inspection or investigation and has the unfettered ability to transfer information to the SEC. On December 15, 2022, the PCAOB made a statement announcing that it was able, in 2022, to inspect and investigate completely issuer audit engagements of PCAOB-registered public accounting firms headquartered in China and Hong Kong. However, uncertainties still exist as to whether the PCAOB will have continued access for complete inspections and investigations in 2023 and beyond. When the PCAOB reassesses its determinations in 2023 and beyond, it could still determine that it is unable to inspect and investigate completely accounting firms based in mainland China and Hong Kong. The PCAOB has also indicated that it will act immediately to consider the need to issue new determinations under the HFCA Act if needed. There can be no assurance that we will continue to be able to comply with requirements imposed by U.S. regulators if the PCAOB is not able to fully inspect any component of our auditor’s work papers in the future. Delisting of the Company’s ordinary shares would force holders to sell their shares. The market price of Taoping’s ordinary shares could be adversely affected as a result of anticipated negative impacts of these executive or legislative actions, regardless of whether these executive or legislative actions are implemented and regardless of our actual operating performance.
Uncertainties exist with respect to the interpretation and implementation of PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.
On March 15, 2019, the National People’s Congress approved the Foreign Investment Law, which took effect on January 1, 2020. The Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic invested enterprises in China. The Foreign Investment Law establishes the basic framework for the access to, and the promotion, protection and administration of foreign investments in view of investment protection and fair competition.
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According to the Foreign Investment Law, the State Council will publish or approve to publish a “negative list” for special administrative measures concerning foreign investment. The latest Negative List, which was promulgated by the MOFCOM and the NDRC on March 12, 2022, and took effect on the same date. The Negative List set out in a unified manner the restrictive measures, such as the requirements on shareholding percentages and management, for the access of foreign investments, and the industries that are prohibited for foreign investment. Any field not falling in the Negative List shall be administered under the principle of equal treatment to domestic and foreign investment.
Based on the legal analysis of the Company’s in-house legal counsel, who is a licensed attorney in the PRC, we believe that none of our PRC subsidiaries’ current business is stipulated on the Negative List. As a result, according to the laws and regulations currently in effect, our PRC subsidiaries are able to conduct their business without being subject to restrictions imposed by the foreign investment laws and regulations of the PRC and none of Taoping or our subsidiaries is required to obtain additional licenses or permits beyond a regular business license for each PRC subsidiary’s operations. Each of our PRC subsidiaries is required to obtain and has obtained such regular business license from the local branch of the SAMR. No application for any such license has been denied.
However, we cannot assure you that our current operations or any newly-developed business in the future will still deemed to be “permitted” in the “negative list”, which may be promulgated or be amended from time to time by the MOFCOM and the NDRC. As a result, we cannot assure you that our PRC subsidiaries are always able to successfully update or renew the licenses or permits required for the relevant business in a timely manner or that these licenses or permits are sufficient to conduct all of our present or future business. If our PRC subsidiaries (i) do not receive or maintain required permissions or approvals, (ii) inadvertently conclude that such permissions or approvals are not required, or (iii) applicable laws, regulations, or interpretations change and our PRC subsidiaries are required to obtain such permissions or approvals in the future, we could be subject to fines, legal sanctions or an order to suspend our PRC operating subsidiaries’ business, which may materially and adversely affect the business, financial condition and results of operations of us.
Future inflation in China may inhibit our ability to conduct business in China.
According to the National Bureau of Statistics of China, in January 2023, the national Consumer Price Index (“CPI” increased by 2.1 percent year-on-year while in January 2022, the national CPI rose by 0.9 percent year on year. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation in China. For example, certain operating costs and expenses, such as employee salaries and office operating expenses may increase as a result of higher inflation. Additionally, since a substantial portion of our assets consists of cash and cash equivalents, high inflation could significantly reduce the value and purchasing power of these assets.
Restrictions on currency exchange may limit our ability to receive and use our income effectively.
The majority of our sales will be settled in RMB, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside of China or to make dividend or other payments in U.S. dollars. Although the conversion of RMB into foreign currency for current account transactions, such as interest payments, profit distributions, and trade or service related transactions, can be made without prior governmental approval, significant restrictions still remain, including primarily the restriction that FIEs may only buy, sell, or remit foreign currencies after providing valid commercial documents to certain banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, are subject to governmental approval in China, and requires companies to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our ordinary shares will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB, and between the two currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from any U.S. dollar-denominated investments we make in the future.
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Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to the exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited. We may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.
Substantially all of our revenues are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent companies. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said reserve fund reach 50% of the company’s registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiary to liability or penalties, limit our ability to inject capital into our PRC subsidiary or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.
The State Administration of Foreign Exchange (SAFE) promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of the 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 SAFE Circular 37 as a “special purpose vehicle.” SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. 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. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. According to the Notice on Further Simplifying and Improving Policies for the Foreign Exchange Administration of Direct Investment released on February 13, 2015 by SAFE, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment registration, under SAFE Circular 37 from June 1, 2015.
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According to SAFE Circular 37, our shareholders or beneficial owners, who are PRC residents, are subject to SAFE Circular 37 or other foreign exchange administrative regulations in respect of their investment in our company. We have notified substantial beneficial owners of ordinary shares who we know are PRC residents of their filing obligations. Nevertheless, we may not be aware of the identities of all of our beneficial owners who are PRC residents. We do not have control over our beneficial owners and there can be no assurance that all of our PRC-resident beneficial owners will comply with SAFE Circular 37 and subsequent implementation rules, and there is no assurance that the registration under SAFE Circular 37 and any amendment will be completed in a timely manner, or will be completed at all. The failure of our beneficial owners who are PRC residents to register or amend their foreign exchange registrations in a timely manner pursuant to SAFE Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in SAFE Circular 37 and subsequent implementation rules, may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Such failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to us. These risks may have a material adverse effect on our business, financial condition and results of operations.
Furthermore, it is uncertain how SAFE Circular 37, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, and we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to us. These risks could in the future have a material adverse effect on our business, financial condition and results of operations.
Any failure to comply with PRC regulations regarding employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.
Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In the meantime, directors, executive officers and other employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions, and who have been granted restricted shares, options or restricted share units, or RSUs may follow the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, issued by SAFE in February 2012, to apply for the foreign exchange registration. According to those regulations, employees, directors and other management members participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, subject to limited exceptions, are required to register with SAFE through a domestic qualified agent, which may be a PRC subsidiary of the overseas listed company, and complete certain other procedures. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit their ability to make payment under the relevant equity incentive plans or receive dividends or sales proceeds related thereto in foreign currencies, or our ability to contribute additional capital into our subsidiaries in China and limit our PRC subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties under PRC law that could restrict our ability to adopt additional equity incentive plans for our directors, officers and employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions.
In addition, the State Administration of Taxation has issued circulars concerning employee share options, restricted shares or RSUs. Under these circulars, employees working in the PRC who exercise share options, or whose restricted shares or RSUs vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options, restricted shares or RSUs. Although we currently withhold income tax from our PRC employees in connection with their exercise of options and the vesting of their restricted shares and RSUs, if the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities.
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Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC shareholders.
On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the EIT Law. On November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises, or the Notice, also referred to as SAT Circular 82. The Notice further interprets the application of the EIT Law and its implementation rules to non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management habitually reside in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10%, when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise controlled by Chinese natural persons. It is unclear how tax authorities will determine tax residency based on the facts of each case.
We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for the PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations, which would materially reduce our net income. Second, although, under the EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued a guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for the PRC enterprise income tax purposes. It is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation, where a 10% withholding tax is imposed on dividends we pay to our shareholders that are non-resident enterprises and with respect to gains derived by said shareholders from transferring our shares. Finally, if we are deemed a PRC resident enterprise, dividends paid to our non-PRC individual shareholders and any gain realized on the transfer of our shares by such shareholders may be subject to PRC tax at a rate of 20%, if such income is deemed to be from PRC sources.
If we were treated as a “resident enterprise” by the PRC tax authorities, we would be subject to taxation in both the U.S. and China, and we may not be able to claim our PRC tax as a credit to reduce our U.S. tax.
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We and our shareholders face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises or other assets attributed to a Chinese establishment of a non-Chinese company, or immovable properties located in China owned by non-Chinese companies.
In October 2017, the State Administration of Taxation issued the Bulletin on Issues Concerning the Withholding of Non-PRC Resident Enterprise Income Tax at Source, or Bulletin 37, which replaced the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued by the State Administration of Taxation on December 10, 2009, and partially replaced and supplemented rules under the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or Bulletin 7, issued by the State Administration of Taxation on February 3, 2015. Pursuant to Bulletin 7, an “indirect transfer” of PRC assets, including a transfer of equity interests in an unlisted non-PRC holding company of a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of the underlying PRC assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. According to Bulletin 7, “PRC taxable assets” include assets attributed to an establishment in China, immoveable properties located in China, and equity investments in PRC resident enterprises and any gains from the transfer of such asset by a direct holder, who is a non-PRC resident enterprise, would be subject to PRC enterprise income taxes. When determining whether there is a “reasonable commercial purpose” of the transaction arrangement, factors to be taken into consideration include: whether the main value of the equity interest of the relevant offshore enterprise derives from PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consists of direct or indirect investment in China or if its income mainly derives from China; whether the offshore enterprise and its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature which is evidenced by their actual function and risk exposure; the duration of existence of the business model and organizational structure; the replicability of the transaction by direct transfer of PRC taxable assets; and the tax situation of such indirect transfer and applicable tax treaties or similar arrangements. In the case of an indirect offshore transfer of assets of a PRC establishment, the resulting gain is to be included with the enterprise income tax filing of the PRC establishment or place of business being transferred, and may consequently be subject to PRC enterprise income tax at a rate of 25%. Where the underlying transfer relates to immoveable properties located in China or to equity investments in a PRC resident enterprise, which is not related to a PRC establishment or place of business of a non-resident enterprise, a PRC enterprise income tax of 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is obligated to make the transfer payments has the withholding obligation. Pursuant to Bulletin 37, the withholding agent shall declare and pay the withheld tax to the competent tax authority in the place where such withholding agent is located within 7 days from the date of occurrence of the withholding obligation, while the transferor is required to declare and pay such tax to the competent tax authority within the statutory time limit according to Bulletin 7. Late payment of applicable tax will subject the transferor to default interest charges. Both Bulletin 37 and Bulletin 7 do not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired from a transaction through a public stock exchange.
There is uncertainty as to the application of Bulletin 37 or previous rules under Bulletin 7. We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries or investments. Our company may be subject to filing obligations or taxes if our company is transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions, under Bulletin 37 and Bulletin 7. For transfer of shares in our company by investors that are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under Bulletin 37 and Bulletin 7. As a result, we may be required to expend valuable resources to comply with Bulletin 37 and Bulletin 7 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition and results of operations.
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company to government officials or political parties, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for FCPA violations committed by companies in which we invest or that we acquire.
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If we become directly subject to the scrutiny, criticism, and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter, which could harm our business operations, stock price, and reputation. It could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
In the past few years, U.S. publicly traded companies that have substantially all of their operations in China, particularly companies like us have been the subject of intense scrutiny, criticism, and negative publicity by investors, financial commentators, and regulatory agencies, such as the SEC. Much of the scrutiny, criticism, and negative publicity has centered around financial and accounting irregularities and mistakes, lack of effective internal controls over financial accounting, inadequate corporate governance policies or lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism, and negative publicity, the publicly traded stocks of many U.S. listed Chinese companies have sharply decreased in value and, in some cases, have become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions, and are conducting internal and external investigations into the allegations. It is not clear the effect of this sector-wide scrutiny, criticism, and negative publicity will have on our Company, our business, and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations defending our Company. This situation will be costly, time consuming, and distract our management from growing our company.
Risks Relating to Our Securities
If we fail to comply with the continued listing requirements of NASDAQ, we would face possible delisting, which would result in a limited public market for our shares and make obtaining future debt or equity financing more difficult for us.
Our ordinary shares are traded and listed on the Nasdaq Capital Market under the symbol of “TAOP.” We received a notification from Nasdaq Listing Qualifications on September 16, 2022, as announced in a report with the SEC on a 6-K Form filed on September 16, 2022, that we were not in compliance with the minimum bid price requirements set forth in Nasdaq Listing Rule 5550(a)(2) for continued listing on The Nasdaq Capital Market. Nasdaq Listing Rule 5550(a)(2) requires listed securities to maintain a minimum bid price of $1.00 per share, and Nasdaq Listing Rule 5810(c)(3)(A) provides that a failure to meet the minimum bid price requirement exists if the deficiency continues for a period of 30 consecutive business days. Based on the closing bid price of the Company’s ordinary shares for the 30 consecutive business days prior to the date of the notification letter from Nasdaq, the Company no longer satisfied the minimum bid price requirement. The notification letter provided that the Company had 180 calendar days, or until March 15, 2023, to regain compliance with Nasdaq Listing Rule 5550(a)(2). To regain compliance, the Company’s ordinary shares must have a closing bid price of at least $1.00 per share for a minimum of 10 consecutive business days (Nasdaq may monitor the price for as long as 20 consecutive business days prior to making a final compliance determination). In the event the Company does not regain compliance with the minimum bid price requirement by March 15, 2023, the Company may be eligible for an additional 180 calendar day grace period. On March 16, 2023, we received a second notice from the Nasdaq Listing Qualifications, in which Nasdaq granted us an additional 180 days, or until September 11, 2023, to regain compliance, because the Company met the continued listing requirement for public float and other applicable requirements, except the bid price requirement, and the Company had indicated its intention of curing the deficiency by effecting a reverse stock split, if necessary.
If we fail to cure this deficiency within the time limits, the Company’s ordinary shares may lose their status on NASDAQ Capital Market and they would likely be traded on the over-the-counter markets, including the Pink Sheets market. As a result, selling the Company’s ordinary shares could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and security analysts’ coverage of us may be reduced. In addition, in the event that the Company’s ordinary shares are delisted, broker dealers would bear certain regulatory burdens which may discourage broker dealers from effecting transactions in the Company’s ordinary shares and further limit the liquidity of the Company’s shares. These factors could result in lower prices and larger spreads in the bid and ask prices for the Company’s ordinary shares. Such delisting from NASDAQ and continued or further declines in the Company’s ordinary share price could also greatly impair our ability to raise additional necessary capital through equity or debt financing and could significantly increase the ownership dilution to shareholders caused by the Company’s issuing equity in financing or other transactions.
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If we were delisted from NASDAQ, we may become subject to the trading complications experienced by “Penny Stocks” in the over-the-counter market.
Delisting from NASDAQ may cause the Company’s shares to become subject to the SEC’s “penny stock” rules. The SEC generally defines a penny stock as an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. One such exemption is to be listed on NASDAQ. Therefore, were we to be delisted from NASDAQ, the Company’s ordinary shares may become subject to the SEC’s “penny stock” rules. These rules require, among other things, that any broker engaging in a purchase or sale of the Company’s securities provide its customers with: (i) a risk disclosure document, (ii) disclosure of market quotations, if any, (iii) disclosure of the compensation of the broker and its salespersons in the transaction, and (iv) monthly account statements showing the market values of the Company’s securities held in the customer’s accounts. A broker would be required to provide the bid and offer quotations and compensation information before effecting the transaction. This information must be contained on the customer’s confirmation. Generally, brokers are less willing to effect transactions in penny stocks due to these additional delivery requirements. These requirements may make it more difficult for shareholders to purchase or sell the Company’s ordinary shares. Since the broker, not us, prepares this information, we would not be able to assure that such information is accurate, complete or current.
We have issued convertible note that contains variable conversion prices which could result in substantial dilution to the Company’s existing shareholders.
On September 10, 2020, we and an individual investor entered into a securities purchase agreement, pursuant to which we sold to the investor 222,222 ordinary shares at a purchase price of $2.70 per share, in a registered direct offering. In a concurrent private placement, for a purchase price of $1,400,000, we sold and issued to the investor a convertible promissory note in a principal amount of $1,480,000 and a warrant to purchase 53,333 ordinary shares at $9.00 per share within three years following the issue date. The note carries an original issue discount of $80,000 matures in 12 months from the issue date, bearing interest at a rate of 5.0% per annum. At any time prior to the maturity, the note, at the investor’s option, may be convertible into fully paid ordinary shares at a conversion price of $9.00 per share. At any time after the occurrence of an event of default (as defined in the note), the investor may convert all of the outstanding balance of the note into ordinary shares in an aggregate amount not exceeding 1.0 million shares. At the maturity, the investors may also covert all of the outstanding balance of the note into ordinary shares at a price no less than $2.40 per share. In addition, if the note remains outstanding and due in each of the months of March and June 2021, the investor has a one-time option during the first three weeks in each of March and June 2021, respectively, to convert no more than one half of the then outstanding balance of the note into ordinary shares at a price no less than $2.40 per share.
On July 12, 2021, we and investors entered into a securities purchase agreement, pursuant to which we sold to the investor 1,200,000 ordinary shares at a purchase price of $4.15 per share, in a registered direct offering. In a concurrent private placement, we are also selling to the same investors warrants to purchase an aggregate of up to 360,000 Ordinary Shares at an exercise price of $4.56 per share. The Warrants will be exercisable for a period of three years commencing on the issue date. At any time prior to the maturity, the note, at the investor’s option, may be convertible into fully paid ordinary shares at a conversion price of $4.56 per share.
Therefore, if the investor elects to convert the then-outstanding balance of the note into the Company ordinary shares at or prior to maturity, such conversion may be made at a significant discount to the then market price of the Company’s shares. In the event that the investor converts any or all of the above note, the Company’s existing shareholders will experience immediate dilution in their ownership of the Company’s shares, as a result of the discounted price at which the note may be converted.
The trading price of the Company’s ordinary shares is highly volatile, leading to the possibility of their value being depressed at a time when you want to sell your holdings.
The market price of the Company’s ordinary shares is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of the Company’s ordinary shares to fluctuate significantly. These factors include:
| ● | our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors; | |
| ● | changes in financial estimates by us or by any securities analysts who might cover the Company’s shares; | |
| ● | speculations about our business in the press or the investment community; | |
| ● | significant developments relating to our relationships with our customers or suppliers; | |
| ● | stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in our industries; | |
| ● | customer demand for our products; |
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| ● | investor perceptions of our industry in general and our company in particular; | |
| ● | the operating and stock performance of comparable companies; | |
| ● | general economic conditions and trends; | |
| ● | major catastrophic events; | |
| ● | announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures; | |
| ● | changes in accounting standards, policies, guidance, interpretation or principles; | |
| ● | loss of external funding sources; | |
| ● | sales of the Company’s ordinary shares, including sales by our directors, officers or significant shareholders; and | |
| ● | additions or departures of key personnel. |
In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations, which could harm our results of operations and require us to incur significant expenses to defend the suit. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.
The Company’s outstanding warrants may adversely affect the market price of the Company’s ordinary shares.
As of the date of this report, there are warrants outstanding to purchase 413,333 ordinary shares of the Company. These warrants consist of warrants exercisable for three years for 53,333 ordinary shares at an exercise price of $9.0 per share, warrants exercisable for 360,000 ordinary shares at an exercise price of $4.56 per share. Most of the warrants could be exercised on a cashless basis. The sale or possibility of sale of the shares underlying the warrants could have an adverse effect on the market price of our ordinary shares or our ability to obtain future financing. If and to the extent these warrants are exercised, you may experience dilution to your holdings.
Techniques employed by short sellers may drive down the market price of the Company’s ordinary shares.
Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s interest for the price of the security to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a security short. These short attacks have, in the past, led to selling of shares in the market.
Public companies that have substantially all of their operations in China have been the subject of short selling. Much of the scrutiny and negative publicity has centered on allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result, a number of targets of such efforts are now conducting internal and external investigations into the allegations and, in the interim, are subject to shareholder lawsuits and/or SEC enforcement actions.
If we were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we could have to expend a significant amount of resources to investigate such allegations and/or defend ourselves. While we would vigorously defend against any such short seller attacks, we may be constrained in the manner in which we can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality. Such a situation could be costly and time-consuming, and could distract our management from growing our business. Even if such allegations are ultimately proven to be groundless, allegations against us could severely impact our business operations, and any investment in the Company’s ordinary shares could be greatly reduced or even rendered worthless.
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If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, the market price and trading volume for the Company’s shares could decline.
The trading market for the Company’s ordinary shares will depend in part on the research and reports that securities or industry analysts publish about us or our business. If research analysts do not establish and maintain adequate research coverage or if one or more of the analysts who covers us downgrades the Company’s ordinary shares or publishes inaccurate or unfavorable research about our business, the market price for the Company’s ordinary shares would likely decline. If one or more of these analysts cease coverage of the Company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for the Company’s ordinary shares to decline.
We do not intend to pay dividends for the foreseeable future.
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and do not anticipate paying any cash dividends on the Company’s shares. Accordingly, investors must be prepared to rely on sales of their shares after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase the Company’s shares. Any determination to pay dividends in the future will be made at the discretion of our Board of Directors, and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable laws, and other factors our board deems relevant.
The Company’s outstanding voting securities are concentrated in a few shareholders.
Mr. Jianghuai Lin, our Chairman and Chief Executive Officer, is the beneficial owner of approximately 27.1% of the Company’s outstanding voting securities. As a result, he possesses significant influence, and can elect a majority of our board of directors and authorize or prevent proposed significant corporate transactions. His ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover, or other business combination, or discourage a potential acquirer from making a tender offer.
We are a “foreign private issuer” and have disclosure obligations that are different than those of U.S. domestic reporting companies. Therefore, you should not expect to receive the same information about us as a U.S. domestic reporting company may provide. Furthermore, if we lose our status as a foreign private issuer, we would be required to fully comply with the reporting requirements of the Exchange Act applicable to U.S. domestic issuers and incur significant operational, administrative, legal, and accounting costs that we would not incur as a foreign private issuer.
We are a foreign private issuer. As a result, we are not subject to certain of the requirements imposed upon U.S. domestic issuers by the SEC. For example, we are not required by the SEC or the federal securities laws to issue quarterly reports or file proxy statements with the SEC. We are also allowed to file our annual report with the SEC within four months of our fiscal year end. We are also not required to disclose certain detailed information regarding executive compensation that is required from U.S. domestic issuers. Further, our directors and executive officers are not required to report equity holdings under Section 16 of the Securities Act. As a foreign private issuer, we are also exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, aim to ensure that select groups of investors are not privy to specific information about an issuer before other investors. We are, however, still subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5. Since many of the disclosure obligations required of us as a foreign private issuer are different than those required by U.S. domestic reporting companies, our shareholders should not expect to receive all of the same types of information about us and at the same time as information is received from, or provided by, U.S. domestic reporting companies. We are liable for violations of the rules and regulations of the SEC, which do apply to us as a foreign private issuer. Violations of these rules could affect our business, results of operations, and financial condition.
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As a foreign private issuer, we are permitted to rely on exemptions from certain NASDAQ corporate governance standards applicable to domestic U.S. issuers and are subject to reporting obligations that, to some extent, are more lenient and less frequent than those of a U.S. issuer. This may afford less protection to holders of the Company’s securities.
We are exempted from certain corporate governance requirements of the Nasdaq Capital Market by virtue of being a foreign private issuer. As a foreign private issuer, we are permitted to follow the governance practices of our home country, the BVI in lieu of certain corporate governance requirements of the Nasdaq Capital Market. As a result, the standards applicable to us are considerably different than the standards applied to domestic U.S. issuers. For instance, we are not required to:
| ● | have a majority of the board be independent (although all of the members of the audit committee must be independent under the Exchange Act); | |
| ● | have a compensation committee and a nominating committee to be comprised solely of “independent directors”; and | |
| ● | hold an annual meeting of shareholders no later than one year after the end of the Company’s fiscal year-end. |
The information we are required to file with or furnish to the SEC will be less extensive and less timely as compared to that required to be filed with the SEC by U.S. domestic issuers. Certain corporate governance practices in the British Virgin Islands, which is our home country, may differ significantly from the NASDAQ Capital Market corporate governance listing standards.
As a result, you may not have the same protections afforded to shareholders of companies that are subject to all of the Nasdaq corporate governance requirements.
You may have difficulty enforcing judgments obtained against us or our directors and officers.
Taoping is a BVI company with substantially all of our assets and operations located outside of the United States. In addition, all of Taoping’s directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is also located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon us or these persons. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States. It may also be difficult for you to enforce the U.S. courts judgments obtained in U.S. courts including judgments based on the civil liability provisions of the U.S. federal securities laws against us or our officers and directors. In addition, there is uncertainty as to whether the courts of the BVI or Hong Kong would (i) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States or (ii) entertain original actions brought in the BVI or Hong Kong against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States. The courts of the BVI or Hong Kong may enforce a foreign judgment subject to various conditions, including but not limited to, that the foreign judgment is a final judgment conclusive upon the merits of the claim, the judgment is for a liquidated amount in a civil matter and not in respect of taxes, fines, penalties, or similar charges, the proceedings in which the judgment was obtained were not contrary to natural justice, and the enforcement of the judgment is not contrary to public policy of the BVI or Hong Kong.
The recognition and enforcement of foreign judgments in mainland China are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of reciprocity with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts will not enforce a foreign judgment against us or our director and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.
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We are a BVI company and, because judicial precedent regarding the rights of shareholders is more limited under BVI law than that under U.S. law, you may have less protection for your shareholder rights than you would under U.S. law.
Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, the BVI Act and the common law of the BVI. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under BVI law are to a large extent governed by the common law of the BVI. The common law of the BVI is derived in part from comparatively limited judicial precedent in the BVI as well as that from English common law, which has persuasive, but not binding, authority on a court in the BVI. The rights of our shareholders and the fiduciary responsibilities of our directors under BVI law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the U.S. In particular, the BVI has a less exhaustive body of securities laws than the U.S. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the BVI. There is no statutory recognition in the BVI of judgments obtained in the U.S., although the courts of the BVI will in certain circumstances recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.
Under the laws of most jurisdictions in the United States, majority and controlling shareholders generally have certain fiduciary responsibilities to the minority shareholders. Shareholders’ actions must be taken in good faith and any unreasonable actions by controlling shareholders may be declared null and void. BVI law protecting the interests of minority shareholders may not be as vigorous in all circumstances as the law protecting minority shareholders in United States or other jurisdictions. Although a shareholder of a BVI company may sue the company derivatively, the procedures and defenses available to the company may result in the rights of shareholders of a BVI company being more limited than those of shareholders of a company organized in the United States. Furthermore, our directors have the power to take certain actions without shareholders’ approval, which would require shareholders’ approval under the laws of most United States or other jurisdictions. The directors of a BVI company, subject in certain cases to the court’s approval but without shareholders’ approval, may implement a reorganization, merger or consolidation, or sale of assets, property, business or securities of the company which sale is subject to a limit of up to 50% in total value of the company. The ability of our board of directors to create new classes or series of shares and the rights attached by amending the Company’s memorandum and articles of association could have the effect of delaying, deterring or preventing a change in our control, including a tender offer to purchase the Company’s ordinary shares at a premium over then market prices.
As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as shareholders of a U.S. public company.
General Risk Factors
We are subject to changing law and regulations regarding regulatory matters, corporate governance and public disclosure that have increased both our costs and the risk of non-compliance.
We are subject to rules and regulations by various governing bodies, including, for example, the SEC, which are charged with the protection of investors and the oversight of companies whose securities are publicly traded, and to new and evolving regulatory measures under applicable law, including the laws of the BVI. Our efforts to comply with new and changing laws and regulations have resulted in and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices. If we fail to address and comply with these regulations and any subsequent changes, we may be subject to penalty and our business may be harmed.
Taoping employs a mail forwarding service, which may delay or disrupt our ability to receive mail in a timely manner.
Mail addressed to Taoping and received at its registered office in the BVI will be forwarded unopened to the forwarding address supplied by Taoping to be dealt with. None of Taoping, its directors, officers, advisors or service providers (including the organization which provides registered office services in the BVI) will bear any responsibility for any delay howsoever caused in mail reaching the forwarding address, which may impair your ability to communicate with us.
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Political risks associated with conducting business in Hong Kong.
Our current corporate structure include certain Hong Kong subsidiaries. Accordingly, our business operation could be affected by the political and legal developments in Hong Kong. Hong Kong is a special administrative region of the PRC and the basic policies of the PRC regarding Hong Kong are reflected in the Basic Law, namely, Hong Kong’s constitutional document, which provides Hong Kong with a high degree of autonomy and executive, legislative and independent judicial powers, including that of final adjudication under the principle of “one country, two systems”. However, there is no assurance that there will not be any changes in the economic, political and legal environment in Hong Kong in the future.
Under the Basic Law of the Hong Kong Special Administrative Region of the PRC, Hong Kong is exclusively in charge of its internal affairs and external relations, while the government of the PRC is responsible for its foreign affairs and defense. As a separate customs territory, Hong Kong maintains and develops relations with foreign states and regions. Based on certain recent development including the Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region issued by the Standing Committee of the PRC National People’s Congress in June 2020, the U.S. State Department has indicated that the United States no longer considers Hong Kong to have significant autonomy from PRC and President Trump signed an executive order and Hong Kong Autonomy Act, or HKAA, to remove Hong Kong’s preferential trade status and to authorize the U.S. administration to impose blocking sanctions against individuals and entities who are determined to have materially contributed to the erosion of Hong Kong’s autonomy. The United States may impose the same tariffs and other trade restrictions on exports from Hong Kong that it places on goods from mainland China. These and other recent actions may represent an escalation in political and trade tensions involving the U.S., mainland China and Hong Kong, which could potentially harm our business.
Given the relatively small geographical size of Hong Kong, any of such incidents may have a widespread effect on our business operations, which could in turn adversely and materially affect our business, results of operations and financial condition. It is difficult to predict the full impact of the HKAA on Hong Kong and companies with operations in Hong Kong like us. Furthermore, legislative or administrative actions in respect of China-U.S. relations could cause investor uncertainty for affected issuers, including us, and the market price of the Company’s ordinary shares could be adversely affected.
Adverse developments affecting the financial services industry, such as actual events or concerns involving liquidity, defaults, or non-performance by financial institutions or transactional counterparties, could adversely affect our current and projected business operations and our financial condition and results of operations.
Actual events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, transactional counterparties or other companies in the financial services industry or the financial services industry generally, or concerns or rumors about any events of these kinds or other similar risks, have in the past and may in the future lead to market-wide liquidity problems. For example, on March 10, 2023, Silicon Valley Bank failed and was taken into receivership by the U.S. Federal Deposit Insurance Corporation; on March 12, 2023, Signature Bank and Silvergate Capital Corp. were each swept into receivership; the following week, a syndicate of U.S. banks infused $30 billion in First Republic Bank; and later that same week, the Swiss Central Bank provided $54 billion in covered loan and short-term liquidity facilities to Credit Suisse Group AG, all in an attempt to reassure depositors and calm fears of a banking contagion. Our ability to effectively run our business could be adversely affected by general conditions in the global economy and in the financial services industry. Various macroeconomic factors could adversely affect our business, including fears concerning the banking sector, changes in inflation, interest rates and overall economic conditions and uncertainties. A severe or prolonged economic downturn could result in a variety of risks, including our ability to raise additional funding on a timely basis or on acceptable terms. A weak or declining economy could also impact third parties upon whom we depend to run our business. Increasing concerns over bank failures and bailouts and their potential broader effects and potential systemic risk on the global banking sector generally and its participants may adversely affect our access to capital and our business and operations more generally.
Currently, we do not have a business relationship with any of the banking institutions mentioned above, and our cash, cash equivalents and short term investments that are mostly concentrated in China have been unaffected by the turmoil in the financial industry in the US and Europe; however, we cannot guarantee that the banking institution with which we do business will not face similar circumstances in the future, or that the third parties with whom we do business will not be negatively affected by such circumstances.
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ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
General Information
The current legal and commercial name of the Company is Taoping Inc. Taoping Inc. was incorporated in the BVI under the BVI Act on June 18, 2012. The address of our principal place of business is 21st Floor, Everbright Bank Building, Zhuzilin, Futian District, Shenzhen 518040 Guangdong China. Our telephone number is 86-755-83708333. Taoping’s registered agent in the British Virgin Islands is Maples Corporate Services (BVI) Limited of Kingston Chambers, PO Box 173, Road Town, Tortola, British Virgin Islands.
Corporate History
Taoping Inc.’s predecessor company was originally organized under the laws of the State of Florida on September 19, 1979 under the name Mark Thomas Publishing Inc. On April 29, 2003, we changed our name to Irish Mag, Inc. From our inception through October 8, 2006, we provided consulting services in the offset printing industry, targeting individual retail consumers as well as small to medium sized companies.
On April 7, 2008, we re-incorporated in the State of Nevada by merging into China Information Security Technology, Inc., a subsidiary that we established in Nevada to effect the re-incorporation. As a result, the Company’s name was changed to China Information Security Technology, Inc. and we became a Nevada corporation.
On August 26, 2010, the Company changed its name to China Information Technology, Inc., or CITN.
On October 31, 2012, we completed a corporate reorganization, whereby the Company, which was established as a subsidiary of CITN under the laws of the BVI to effect the reorganization, became the parent company of a publicly held entity. Consequently, CITN became a wholly-owned subsidiary of the Company. In connection with the reorganization, each outstanding share of the common stock of CITN was converted into the right to receive one ordinary share of the Company. The ordinary shares of the Company were listed on the NASDAQ Global Select Market under the trading symbol of “CNIT,” the same symbol under which the common stock of CITN were listed. Prior to the reorganization, shares of CITN’s common stock were registered pursuant to Section 12(b) of the Exchange Act. On October 31, 2012, the Company filed a Form 8-K12B under cover of a Form 6-K to establish the Company as the successor issuer to CITN pursuant to Rule 12g-3 under the Exchange Act. Pursuant to Rule 12g-3(a) under the Exchange Act, the ordinary shares of the Company, as successor issuer, were deemed registered under Section 12(b) of the Exchange Act. On November 13, 2012, CITN filed a Form 15 with the SEC to terminate the registration of the shares of its common stock and suspend its reporting obligations under Sections 13 and 15(d) of the Exchange Act. On November 19, 2012, we changed the name of CITN to China Information Technology (Nevada), Inc., which was liquidated and dissolved in July 2014.
At the Company’s 2017 Annual Meeting of Members, which was held on September 19, 2017, the shareholders of the Company approved an amendment to the Company’s Memorandum and Articles of Association to remove the par value of the Company’s ordinary shares. On October 12, 2017, the Company filed an amended and restated Memorandum and Articles of Association with the Registrar of Corporate Affairs in the British Virgin Islands, pursuant to which the par value per share of the Company’s ordinary shares has been removed.
On May 25, 2018, the Company held its 2018 Annual Meeting of Members and its shareholders approved the change of company name to “Taoping Inc.” and an amendment and restatement of its Memorandum and Articles of Association to reflect such change of name. In connection with the name change, the trading symbol of its ordinary shares was changed to “TAOP,” effective on June 1, 2018.
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On July 30, 2020, Taoping completed a share combination of the Company’s ordinary shares at a ratio of one-for-six, which decreased its outstanding ordinary shares to approximately 7,332,434 shares. This share combination did not change the maximum number of shares Taoping is authorised to issue or the par value of its ordinary shares. Accordingly, except as otherwise indicated, all share and per share information contained in this annual report has been restated to retroactively show the effect of the share combination.
Management Services Agreement
On July 1, 2007, our subsidiary IST entered into a management services agreement, or MSA, with iASPEC and its shareholders. Pursuant to the MSA, iASPEC granted IST an exclusive, royalty-free, transferable, worldwide license to use and install certain iASPEC software, along with copies of source and object codes relating to such software in any manner permitted by applicable laws for ten years. Under the MSA, IST was entitled to receive 100% of the modified net profit of iASPEC, and would reimburse iASPEC for all net losses incurred. In connection with the MSA, IST also entered into a purchase option agreement, or Option Agreement, with iASPEC and its shareholders, effective as of July 1, 2007. Pursuant to the Option Agreement, the iASPEC shareholders granted IST, or its designee(s), an exclusive, irrevocable option to purchase from the iASPEC shareholders, from time to time, all or part of iASPEC’s shares, according to an equity transfer agreement, or to purchase all or part of iASPEC’s assets, according to an asset purchase and transfer agreement. Under the terms of the Option Agreement, the option is immediately exercisable at an exercise price of $1,800,000, in the aggregate, which is subject to regulatory approval.
As a result of the relationship with iASPEC, iASPEC became a variable interest entity of the Company.
On July 1, 2008, our Chairman and Chief Executive Officer, Mr. Jianghuai Lin, entered into an Equity Transfer Agreement with Mr. Jin Zhu Cai, the owner of a 24% minority interest in iASPEC. Pursuant to the Agreement, Mr. Lin purchased Mr. Cai’s minority interest for a total consideration of RMB 60 million (approximately $8.7 million). As a result of the Equity Transfer Agreement, Mr. Lin holds 100% of the equity interests of iASPEC.
On December 13, 2009, IST, iASPEC and Mr. Lin, as the sole shareholder of iASPEC, amended and restated the MSA, pursuant to which IST would continue to provide management and consulting services to iASPEC.
Dissolution of the Variable Interest Entity Structure
In September 2021, we dissolved the variable interest entity structure by exercising the purchase option under the Option Agreement to purchase all of the equity interests in iASPEC at an aggregate exercise price of $1,800,000. On September 18, 2021, Taoping and IST entered into an equity transfer agreement with iASPEC and iASPEC’s then sole shareholder, Mr. Lin, under which Mr. Lin sold and transferred to IST all of the equity interests in and any and all rights and benefits relating thereto of iASPEC in exchange for 612,245 unregistered ordinary shares of Taoping as determined by dividing $1,800,000 by the volume-weighted average closing price of ordinary shares for the consecutive five (5) trading days immediately prior to September 18, 2021. The parties thereafter completed the equity transfer through applicable PRC governmental registration(s).
Upon the closing of the equity transfer, the Company’s variable interest entity structure was dissolved and iASPEC became a wholly owned indirect subsidiary of the Company. The amended and restated MSA was automatically terminated.
In June 2022, as a result of the Company’s business transformation and its exit from the TIT business, the Company disposed of 100% equity interests of iASPEC (excluding iASPEC’s subsidiaries) which mainly conducted the Company’s TIT business to an unrelated third party for nil consideration.
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Corporate Structure
The following diagram illustrates our corporate structure as of the date of this report.
The Securities and Exchange Commission, or SEC, maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.
Our web site address is http://www.taop.com. Information contained on, or that can be accessed through, our website does not constitute a part of this Annual Report.
Principal Capital Expenditures and Divestitures
For the year ended December 31, 2022, our total capital expenditures and divestitures were $7.2 million and $1.2 million, respectively. For the year ended December 31, 2021, our total capital expenditures and divestitures were $11.3 million and $0 million, respectively. For the year ended December 31, 2020, our total capital expenditures and divestitures were $1.7 million and $0 million, respectively. Such expenditures and divestitures were primarily related to the purchase and sale of long-lived assets and business acquisitions. These capital expenditures were mainly funded by our operating cash flow.
B. Business Overview
General
Executive Offices of the Company are located in Shenzhen, China. As of December 31, 2022, we had approximately 63 full-time employees.
We are a leading provider of cloud-app technologies for Smart City IoT platforms, digital advertising delivery, and other internet-based information distribution systems in China. Our Internet ecosystem enables all participants of the new media community to efficiently promote branding, disseminate information, and exchange resources. In addition, we provide a broad portfolio of software and hardware with fully integrated solutions, including Information Technology infrastructure, Internet-enabled display technologies, and IoT platforms to customers in government, education, residential community management, media, transportation, and other private sectors.
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Prior to 2014, we generated the majority of our revenues through selling our products and services mostly to the public service entities to help them improve their operational efficiency and service quality. Our representative customers included the China Ministry of Public Security, provincial bureaus of public security, fire departments, traffic bureaus, police stations, human resource departments, urban planning boards, civic administrations, land resource administrations, mapping and surveying bureaus, and the Shenzhen General Station of Immigration Frontier Inspection.
Since 2014, we have expanded and diversified our customer base into the private sector as well. Our customers in the private sector include, among others, elevator maintenance companies, residential community management, advertising agencies, auto dealerships, and educational institutes. Our new corporate mission is to make publicity accessible and affordable for businesses of all sizes.
We generated revenues from sales of hardware products, software products, system integration services, and related maintenance and support services. In 2015, with the introduction of our cloud-based software as a service (SaaS) offering, we expected to generate additional recurring monthly revenues from SaaS fees. In 2019 and 2020, only a very small portion of our revenue was generated from SaaS, which is expected to increase in the coming years with the nationwide roll-out of our cloud-based ad display terminal network.
In May 2017, we completed our transformation to a provider of CAT and IoT technology based digital advertising distribution network and new media resource sharing platform, and offered an end-to-end digital advertising solution enabling customers to efficiently and cost-effectively direct advertisements to specific interactive ad display terminals in the out-of-home advertising market across China. In 2017, we became profitable as a result of a successful transition of our business model. We continued to improve our financial position in 2018. However, due to the unfavorable macro-economic environment and the slowdown of the out-of-home advertising market in China, we had net loss of approximately $7.1 million, $9.9 million and $18.3 million respectively in 2022, 2021, and 2020. For years going forward, we intend to continue to execute our business plan and build a nationwide cloud-based ad terminal network by penetrating into more cities throughout China, which is expected to generate recurring service revenue for the Company, in addition to equipment sales.
On June 9, 2021, the Company consummated an acquisition of 100% of the equity interest of Taoping New Media Co., Ltd (“TNM”), a leading media operator in China’s out-of-home digital advertising industry. Mr. Jianghuai Lin, the Chairman and CEO of the Company, who owns approximately 27.1% of total shares outstanding of the Company, owned approximately 51% of TNM. TNM focuses on digital life scenes and mainly engaged in selling out-of-home advertising time slots on its networked smart digital advertising display terminals with artificial intelligence and big data technologies. The acquisition of TNM is expected to enhance the Company’s presence in the new media and advertising sectors.
In 2021, the Company ventured into blockchain related business through the launch of cryptocurrency mining operations and established new subsidiaries in Hong Kong to diversity revenue streams, following a decline in its Traditional Information Technology (TIT) business segment.
In September 2021, the Company and the Company’s wholly owned subsidiary, Information Security Technology (China) Co., Ltd. (“IST”) entered into an equity transfer agreement with Mr. Jianghuai Lin, the sole shareholder of iASPEC. Upon closing of the equity transfer, the Company’s existing variable interest entity structure was dissolved and iASPEC became a wholly owned indirect subsidiary of the Company.
In December 2022, the Company entered into a series of contracts with certain third parties to sell its cryptocurrency mining and related equipment for a total sale price of approximately $1.08 million. The Company also terminated the leases for both the office facility and the storage rooms, which were previously used to house most of its mining machines for its cryptocurrency mining operations, and laid off relevant employees. As a result, the Company had ceased its cryptocurrency mining business by December 31, 2022.
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We report financial and operational information in the following three segments:
| (1) | Cloud-based Technology (CBT) segment — It includes the Company’s cloud-based products, high-end data storage servers and related services sold to private sectors including new media, healthcare, education and residential community management, and among other industries and applications. In this segment, the Company generates revenues from the sales of hardware and software total solutions with proprietary software and content as well as from designing and developing software products specifically customized for private sector customers’ needs for a fixed price. The Company includes the revenue and cost of revenue of high-end data storage servers in the CBT segment. Advertising services is included in the CBT segment, after the Company consummated the acquisition of TNM. Advertisements are delivered to the ads display terminals and vehicular ads display terminals through the Company’s cloud-based new media sharing platform. Incorporation of advertising services complements the Company’s out-of-home advertising business strategy. | |
| (2) | Blockchain Technology (BT) segment — The BT segment is the Company’s newly formed business sector. Cryptocurrency mining is the first initiative implemented in the BT segment. However, due to the decreased output and the highly volatile cryptocurrency market, the Company had ceased the operation of the BT segment by December 2022.
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| (3) | Traditional Information Technology (TIT) segment —The TIT segment includes the Company’s project-based technology products and services sold to the public sector. The solutions the Company has sold primarily include Geographic Information Systems (GIS), Digital Public Security Technology (DPST), and Digital Hospital Information Systems (DHIS). In this segment, the Company generates revenues from sales of hardware and system integration services. As a result of the business transformation, the TIT segment is gradually being phased out in 2021. |
Industry Overview
General
Urbanization is the primary driver for the demand of our Cloud-based solutions for advertising placement and public information dissemination. China’s urbanization rate has accelerated in the past 30 years. The Chinese urban population has grown by over 170 million in the past five years to more than 1 billion in 2020. According to Chinese Social Development Research, approximately 70% of the Chinese population is expected to live in urban areas by 2035. Urban lifestyle revolves around consumption of information, goods, and services that necessitates advertising and public information dissemination. At the same time, urbanization has imposed considerable pressure on land use, environment protection, and municipal infrastructure. Urbanization has also led to increasing demands for equitable treatment for all dwellers in the cities.
In the first quarter of 2014, China’s State Council unveiled a new urbanization plan for the period from 2014 to 2020 in an effort to steer the country onto a more humanistic and environmentally friendly urbanization path. The plan increases the country’s investment in urban infrastructure, public service facilities, and affordable housing constructions. It also calls for closer coordination between urban and rural developments, optimization of city planning, and tighter integration of environmental protection measures into urbanization efforts. The plan also projects new construction of 20,000 to 50,000 skyscrapers around the country, as well as implementation of mass transit systems in more than 170 cities by 2025. In addition, it requires construction of regular railways to connect all medium sized cities of over 200,000 in population and high-speed railways to connect large cities of over 500,000 in population by 2020. Also, it plans to expand the nation’s civil aviation network to cover 90 percent of its total population.
Out-of-Home Digital Advertising Market in China
Rising urbanization has resulted in prevalent traffic congestions throughout China. In medium to large sized cities, people on an average spend 39 minutes of commuting time to work. According to China New-type Urbanization Report (2014-2018), in densely populated tier one cities including Beijing, Guangzhou, and Shanghai, it costs commuters 14, 12, and 11 minutes every day in traffic jams, respectively. In Beijing, a megacity of over 21 million residents, the daily commute takes 45 minutes, the worst of all Chinese cities.
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While traffic jams are a headache for urban commuters and city planners, they present revenue generating opportunities for out-of-home advertisers, who seek attentive audience in high traffic areas. According to China Industry Information Net, the estimated total market size of China’s out-of-home advertising is expected to reach RMB 227 billion in 2021, with a CAGR of 14%. Cosmetics, beverage, and financial service companies are ranked as top spenders consistently. Internet and real estate companies also increased their advertisement spending significantly.
The growth, starting in 2013, can be attributed to three factors: 1) macroeconomic recovery in China has encouraged businesses to increase their advertising spending; 2) industry leaders have led consolidation in the out-of-home advertising market and grown their market share in tier one cities like Beijing, Guangzhou, Shanghai, and Shenzhen; 3) rapid advancement in Internet and mobile technologies has resulted in new O2O (offline-to-online) advertising opportunities.
Over 50% of the advertisers rated commercial buildings and public transportation hubs as the top two prime locations for advertisement placement. There are over 200 million people riding elevators every day in China. The number of advertisers opting for residential buildings also increased considerably. Precision advertisement uses digital technologies, such as internet-based ads management and distribution and big data analysis, to target its audience, and continues to be the advertisers’ focal point, which resulted in the increasing demands for digital advertising.
Market Trends
In addition to urbanization, two technological developments further accelerate the demand for our CBT products and services: 1) offline-to-online migration of display terminals and 2) adoption of Quick Response (QR) codes.
Currently, most of the advertising display terminals in China are not connected to any network. Consequently, updating their media contents requires onsite manual operation through flash drives or other means. They also tend to have low asset utilization rates. Based on our own primary research, we have estimated that offline terminals have an average asset utilization rate of 40% in tier-one cities, 30% in tier-two cities, and 20% in tier-three and smaller cities. In comparison, content on cloud-based terminals can be remotely uploaded, updated, and managed resulting in substantial labor cost savings for terminal operators, i.e. advertising agencies. In addition, cloud-based terminals offer advertising agencies the flexibility of fine-tuning advertisement schedules on the fly and customizing advertisement content at each location as specific as one single office building. More importantly, idle time slots on cloud-based terminals can be discovered and sold on Taoping, an online resource exchange platform of ours that was released in the fourth quarter of 2015 as a module of our Yunfa Net (www.pubds.com), an information distribution and advertising delivery system. Therefore, asset utilization rate of advertising agencies can be greatly improved. As a result, there is a growing demand to convert offline terminals into networked terminals using our CBT products and services. In January 2018, we separated Taoping module from Yunfa Net and officially launched the Taoping Net (www.taoping.cn) and Taoping App. Taoping Net provides an advertising-resources trading service platform which connects screen owners, advertisers and consumers. Taoping Net integrates nationwide high-quality screen resources of Taoping Alliance, a new media operating organization founded by us and Taoping New Media Co., Ltd. (“Taoping New Media”), a company controlled by Mr. Jianghuai Lin. Taoping App, which enables customers to distribute and manage ads from mobile terminals, effectively satisfies the need to distribute fragmented ads. Using Taoping App, anyone can buy and distribute real-time ads to designated terminals.
Furthermore, the wide adoption of QR codes is also positively impacting the demand for our cloud-based products and services. A QR code is a digital barcode that contains merchants’ information. By incentivizing consumers to scan the QR code embedded in advertisement, advertising agencies can analyze the effectiveness of their advertisements and adjust their sales and marketing tactics on a real-time basis. In China, the application of QR codes is permeating from tier-one cities to the rest of the country. Although QR codes have frequently appeared in print ads as well as in digital ads displayed on offline terminals, the codes can be changed only as frequently as the advertisement itself. The data brought in to advertising agencies by the QR codes cannot be segmented by precise locations or time slots, and thus can generate only limited insight into viewer behavior. In contrast, individualized QR codes embedded in advertisement displayed on networked terminals can vary by location and time slot, and offer advertising agencies deeper insights at a much higher precision than offline terminals or print ads. Consequently, the adoption of QR codes is further driving the demand for our cloud-based ad display terminals.
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Our Products and Services
In the CBT segment, we provide cloud-based ecosystem solutions mainly to the new media in out-of-home digital advertising customers. Underpinning our ecosystems are our industry-specific integrated advertisement display terminal product, digital advertising distribution technology platform, resource exchange and sharing, and big data analysis services. In 2014, we sold our cloud-based solutions predominately to the Chinese new media industry. Starting from 2016, we have also focused our efforts in selling IoT ads display terminal hardware and providing digital ads distribution and resource sharing services for out-of-home advertising market. As a result of COVID-19 pandemic in 2020, city lockdowns, travel restrictions, and other preventive measures and persistent outbreaks of infection in regional localities through 2021 had negatively impacted on the China out-of-home advertising business and significantly dampened customers’ demand for ads display terminals. Nevertheless, mandatory home stays and work from remote locations triggered a steep surge in on-line gaming, on-line shopping, on-line entertainment, and electronic communication that created a great demand for high-end data storage servers to accommodate internet information transmission. We have stabilized supply chains for the high-end data storage server to meet market demands supplementing the declining revenue from ads display terminals and included the revenue and cost of revenue of high-end data storage servers in the CBT segment.
For the out-of-home new media industry, we provide our software as a service to automate the entire interactive workflows between advertising agencies and their customers, including, among others, establishing new advertising projects, submitting advertisement proposals, revising and approving advertising proposals, processing payment online, remotely uploading advertisement content, and tracking and analyzing performance data.
Our Technology Platform
The foundation of our product offerings is our proprietary technology platform called Cloud-Application-Terminal (CAT). Its trademark has been registered in PRC. Our CAT platform includes three layers of technology: 1) cloud infrastructure, 2) software application, and 3) high-definition digital display terminals ranging from 18.5 to 84 inches in display size. Bundled together, three layers of technology serve as a turnkey solution for our customers to improve their operational efficiency and maximize their revenue.
Our CAT platform can be accessed from a variety of devices, including networked display terminals, desktop computers, and mobile devices. It can operate in all operating systems, including Windows, Android and iOS. It unifies all access points into one unique user account, through which a user can log onto our cloud system and enjoy all available software features and functions.
Our Resource Exchange and Sharing
Building on top of our CAT platform is our industry-specific resource sharing functionality. For the out-of-home new media industry, in the fourth quarter of 2015, we released a resource exchange called “Taoping” as a module of our proprietary cloud-based information distribution and ad delivery platform - Yunfa Net (www.pubds.com). Taoping in Chinese means “search and select display terminals.” Taoping pairs those who seek, with those who own out-of-home advertisement resources of interactive display terminals, and facilitates their transactions online.
For example, a local advertising agency based in Shenzhen City may need to place advertisement in Guangzhou City, but does not own any display terminals in Guangzhou. Through Taoping, the advertising agency can search available display terminals by location, venue, and time slots, find suitable resources, negotiate rental prices with terminal owners, and process payments online. Then through Taoping, the advertising agency can upload advertisement content onto remote terminals, monitor advertisement performances, make necessary editing to the advertisement, and update advertisement content.
Taoping enables advertising terminal resource owners to improve their asset utilization rates and returns on investments. At the same time, Taoping allows advertisement promoters to leverage available advertising resources in other geographic regions, and cost effectively expand into new business territories.
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Our Big Data Services
Building on top of our resource sharing capability is our big data analysis service. After releasing our resource sharing feature, we have been compiling and analyzing data related to buyer/seller behavioral preferences, so that we can provide value-added services to our customers.
For example, through big data analyses, we are able to make insightful suggestions to advertising resource owners on which specific types of venues being displayed at specific time slots likely garner high rental fees as well as the optimal range of rental fees they could charge for each type of resources they own. For advertising promoters, we are able to provide advice such as the optimal combinations of terminals to rent in order to reach the biggest possible audience they desire, and attain the greatest impact while staying within their advertising budget.
Our Industry-Specific Ecosystems
In combining our proprietary CAT technology platform, resource sharing functionality, and big data services with our industry expertise, we provide integrated ecosystem solutions to the industries of out-of-home digital advertising new media, healthcare, education, and residential community management. As described above, starting from the out-of-home digital advertising new media industry, we have been in the process of rolling out product offerings to all of those four industries.
| ● | New Media Elevator Management – Our New Media Elevator Management solution integrates advertisement placement with safety supervision into one single technology unit. The built-in LED screen of the unit delivers high-definition digital advertisement, while its safety sensors and data collectors transmit operational and technical data of the elevator to the appropriate property managers, safety supervisors, and maintenance crew, so that such staff can efficiently maintain operational safety of the elevator, and instantaneously respond to emergencies. Since our New Media Elevator Management solution combines public safety with media display, property managers view our products as of strategic importance to their daily operations, and they welcome our products better than the ones that are pure advertisement display terminals without safety devices. As a result, we are able to help advertising agencies that purchase our products to attain customers more easily and enter into new markets more cost effectively. In addition, the Elevator Management platform could be sold as a separate product depending on customer needs to facilitate digital elevator maintenance, big data solution for elevator maintenance company, residential management, and government authorities. | |
| ● | New Media Transportation Management – Our New Media Transportation Management solution remotely uploads advertisement content together with critical transportation information — such as arrival and departure schedules, delay or cancellation notifications, gate assignments, and station announcements – into our cloud infrastructure and displays the content on our large-screen terminals strategically placed at high-traffic transportation hubs, including high-speed railway stations, subway stations, airports, and onboard public buses. Because our Transportation New Media Application combines advertisement display with transportation information crucial to commuters, we enable advertising agencies that purchase our products to attain large and attentive audiences at prime locations, which in turn help them achieve good advertisement placement rates and generate high revenue amounts. | |
| ● | New Media Community Management – Our New Media Community Management solution combines advertisement display with dissemination of community information. Placed within various high-rise residential communities, our large screen display terminals serve as a window of information into various resources available to community residents, including community maps, news updates, emergency announcements, safety precautions, health tips, recreational activities, and local commercial promotions. |
Product Warranty
For our TIT segment, we usually offer a one-year or three-year warranty for our system integration services depending on the project. Our warranty includes support services, minimal updates and system maintenance. No rights of return are allowed except for non-conforming products, which have been insignificant based on historical experiences. If nonconforming products are returned due to software issues, we will provide upgrades or additional customization to suit the customers’ needs, which is infrequent with immaterial costs. The original vendors of hardware are ultimately liable for replacement of defective or non-conforming hardware products. In cases where non-conformity is due to the integrated hardware, we return the hardware to the original vendor for replacement. Based on our past experience, the cost of our warranty provision has been immaterial.
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For our CBT segment, we provide a one-year warranty for our digital displays and high-end data servers. The actual warranty service is carried out by our OEM partners, with whom we have obtained a contractual guarantee that they will repair or replace any defective hardware products that we have purchased on behalf of our customers. Our OEM partners ultimately bear and are liable for the costs of product warranty. Consequently, our own cost of warranty for this segment has been minimal.
Sales and Marketing
We develop new businesses by identifying and contacting potential new customers and through referrals, or by direct contacts from new customers as a result of our strong brand recognition and reputation in the industry. We solidify our market presence through various types of marketing campaigns, such as participating in exhibitions, trade shows, and seminars, developing distributors and dealers, and presenting solutions to prospective customers. We founded and played a key role in the Taoping Alliance, a new media operating organization that includes numerous advertising agencies throughout China, which greatly improved our market expansion capability and industry reputation.
Customers and Related Parties
In fiscal year 2022, 2021 and 2020, no single customer represented 10% or more of our total revenue of continuing operations. The following tables provide revenue by our major customers of continuing operations for the years ended December 31, 2022, 2021 and 2020.
Year 2022
| Revenues | % of | |||||||
| (Thousands) | Revenues | |||||||
| Guangzhou Shengzhuo Intelligent Technology Co., Ltd | $ | 1,831 | 8 | % | ||||
| Shenzhen Chuangzhi Tiancheng Technology Co., Ltd | 1,464 | 6 | % | |||||
| Shenzhen Nortel Positive Light Technology Co., Ltd | 949 | 4 | % | |||||
| Shenzhen Dingsheng Huaxun Technology Co., Ltd | 840 | 3 | % | |||||
| Shanghai Easy Net E-commerce Co., Ltd | 835 | 3 | % | |||||
| TOTAL | $ | 5,919 | 24 | % | ||||
Year 2021
| Revenues | % of | |||||||
| (Thousands) | Revenues | |||||||
| Shenzhen Yixing Information Technology Co. Ltd | $ | 1,654 | 9 | % | ||||
| Guangxi Wancang Technology Group Co., Ltd | 1,092 | 6 | % | |||||
| Guangzhou Shengzhuo Intelligent Technology Co., Ltd | 990 | 5 | % | |||||
| Shenzhen Taitao Electronic Technology Co., Ltd | 967 | 5 | % | |||||
| Shenzhen Chuangzhi Tiancheng Technology Co. Ltd | 750 | 4 | % | |||||
| TOTAL | $ | 5,453 | 29 | % | ||||
Year 2020
| Revenues | % of | |||||||
| (Thousands) | Revenues | |||||||
| Quxian Qucheng Science and Technology Development Co. Ltd | $ | 666 | 6 | % | ||||
| Shenzhen Huaqi Technology Co., Ltd | 624 | 6 | % | |||||
| Shenzhen Bite Technology Co., Ltd | 538 | 5 | % | |||||
| Guangzhou Lindian Intelligent Technology Co., Ltd | 459 | 4 | % | |||||
| Hainan Zhiming Culture and Education Development Co. Ltd | 450 | 4 | % | |||||
| TOTAL | $ | 2,737 | 25 | % | ||||
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Competition
In the CBT segment, there are many small IT service companies in China providing one-off software packages to solve one aspect of the problems, but not integrated solutions combining technology platform, resource exchange and sharing, and big data services like ours. For example, in the new media industry, we encounter competition from 56iq.com, Fujian Star-net Communication Co., Ltd, Shanghai View Show Technology Co., Ltd., and Maipu Communications Technology Co., Ltd. After completion of acquisition of Taoping New Media Co., Ltd, we compete with advertising agencies, such as Focus Media, Air Media, and Vision China in some geographic regions in China.
Compared with our competitors, we believe we have the following advantages:
| ● | We provide integrated ecosystem solutions that combine technology platform, resource exchange and sharing, and big data services. Our solution not only helps our customers improve their operational efficiency and reduce their labor cost, more importantly, help them maximize their asset utilization rate and increase their revenue. For example, by utilizing our solution, an advertising agency can upload its advertisement content from a centralized location to geographically dispersed display terminals, saving its maintenance staff from traveling to each terminal and updating media content manually. In addition, the advertising agency can list its idle terminal assets on Taoping, our resource exchange platform, and lease display terminals to other agencies by location and time slot, generating additional revenue from their existing assets. | |
| ● | Our solution has high scalability, availability, and flexibility. Because our technology solution is architected from ground up using the latest cloud-computing technology, our system can easily scale up to handle a rapidly increasing amount of data. In addition, as the number of display terminals connected to our network continues to grow, our system is able to handle additional workload and workflows to ensure high availability of each terminal. More importantly, because we own our cloud infrastructure and platform, we have the flexibility of changing or upgrading our software anytime without any constraints. | |
| ● | Our solution has a high level of security guarantee. Because we own the entire stack of technology infrastructure and terminals, we have a solid security fortress to prevent hackers from breaking into our system. In addition, because we have over 10 years of experience providing large-scale information systems to the public entities, such as police stations and public security bureaus, we have a track record of protecting our network from security intrusions or breaches. Lastly, to protect ourselves from national security concerns, we have an operational agreement with China’s Internet Oversight Board to inspect and filter all of our advertisement contents before uploading them onto our display network. | |
| ● | Our solution combines digital network with physical assets, establishing a high barrier to entry than other internet related companies. Our proprietary Cloud-Application-Terminal platform has integrated three layers of technology: cloud storage, application software, and display terminals. Although it is relatively easy for potential competitors to develop software application with technology advancement nowadays, it will take them a considerable amount of time and capital to replicate our nationwide physical network of cloud-based display terminals. |
Business Transformation Efforts
Prior to 2014, we predominately sold large-scale customized IT solutions to the Chinese public service sector through various build-and-transfer projects. Due to changes in policies and regulations in China in 2012, various local governments started postponing IT projects they had previously contracted with us indefinitely. As a result, many of our existing receivables became uncollectable.
In early 2013, our management team made a strategic decision to transition our business from servicing the public sector to focusing on the private sector. We started completing our in-process IT projects and ceased taking on new customers in the public sector. In addition, we wrote off accounts receivable that we deemed no longer collectable. At the same time, we decided to transform our business from a build-and-transfer IT service company into a standardized IT product company. Leveraging our experience and expertise in handling large-scale IT projects for the public sector, we started investing in research and development of our own software products suitable for the private sector.
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In 2014, continuing our transition from the public sector to the private sector, we identified new media, healthcare, education, and residential community management as the four core end markets on which we would focus. After fortifying our own software R&D efforts through our acquisition of Biznest in September 2014, we decided to exit the hardware manufacturing business and complete our transformation into a software company. In November 2014, we initiated the process of closing our own manufacturing facilities and transferring hardware production to our OEM partners. Transferring hardware production to our OEM partners was completed during 2015. As a result, we wrote off a large amount of accounts receivable and took substantial goodwill and identifiable intangible asset impairment charges in 2015 and 2016.
As part of transition from the traditional IT business to the cloud-based business, we sold iASPEC’s 100% equity holding in Zhongtian and 54.89% equity holding in Geo in 2015. Proceeds from these sales totaling $19.5 million have been invested in the development and market expansion of our new cloud-based business, as well as repayment of a portion of our short-term debts.
In 2017, we completed our business transformation to a leading products and services provider of CAT and IoT technology based digital advertising distribution network and new media resource sharing platform in the out-of-home Advertising Market in China. In 2017, we gained profitability as a result of the successful transition of our business model. In 2018, we continued to prove the sustainability of the new business model and increased the net income to be approximately $1.7 million. In 2021, 2020 and 2019, due to the unfavorable macro-economic environment and the slowdown of the out-of-home advertising market in China, we had net loss of approximately $9.9 million, $18.3 million and $3.6 million respectively. For years going forward, we will continue to execute our business plan and build a nationwide cloud-based ad terminal network by penetrating into more cities throughout China, which is expected to generate recurring service revenue for the Company, in addition to equipment sales. In addition, we have been actively exploring other cloud-based solutions including the smart charging pile business throughout China, by leveraging our TAOP smart cloud and the Taoping Alliance national distribution network.
In 2021, we expanded our CAT based new media sharing platform into digital advertising and smart community sectors by acquiring Taoping New Media Co., Ltd. to provide out-of-home digital advertising. Also, we explored business opportunities in blockchain, digital assets, and cryptocurrency mining operations by recruiting seasoned executives, contracting various well-known consulting firms, suppliers, and operators in these areas. In addition, we formed a Blockchain Business Division to manage blockchain development, digital assets NFT (None Fungible Token) and cryptocurrency mining operations, and a Digital Culture Business Division to cover on-line education and digital advertising operations. We generated revenues of $5.5 million from the blockchain business during the year ended December 31, 2021.
However, due to a decrease in output and the highly volatile nature of the cryptocurrency market, in December 2022, the Company entered into a series of contracts with certain third parties to sell its cryptocurrency mining and related equipment for a total sale price of approximately $1.08 million. The Company also terminated the leases for both the office facility and the storage rooms, which were previously used to house most of its mining machines for its cryptocurrency mining operations, and laid off relevant employees. As a result, the Company had ceased its cryptocurrency mining business by December 31, 2022.
Intellectual Property
Our success depends, in part, on our ability to maintain and protect our proprietary technology and to conduct our business without infringing on the proprietary rights of others. We rely primarily on a combination of copyrights, patents, trademarks, and trade secrets, as well as executions of employee and third-party confidentiality agreements, to safeguard our intellectual property.
As of December 31, 2022, through our wholly-owned subsidiaries IST, TopCloud, Biznest, Bocom, and ISIOT, we had 177 registered and copyrighted software products, 528 registered trademarks and held 30 patents. We also own three domain names (http://www.taop.com; http://www.taoping.cn; and http://www.pubds.com).
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We protect our know-how and technologies through confidentiality provisions in the employment contracts we enter into with our employees. In addition, our engineers are generally divided into different project groups, each of which generally handles only a portion of the project. As a result, no one engineer generally has access to the entire design process and documentation for a particular product.
We have funded a vendor to develop vehicular display terminal using our digital new media sharing platform to deliver advertisements. The development of vehicular display terminal was completed in September 2020 and started earning advertising revenue. According to modified contract, we have capitalized the funding as purchased software enjoying the intellectual property of the vehicular display terminal and shared advertising revenue generated from the vehicular display terminal within the four-year modified contract term.
Regulation
Because all of our operating entities are located in the PRC, we are regulated by the national and local laws of the PRC. This section summarizes the major PRC regulations relating to our business.
Permits and Certificates
Through our subsidiaries, we hold the following permits and certificates:
| Name | Expiration Date | Company | ||
| National High-tech Enterprise | Valid till December 22, 2024, subject to renewal every three years. | IST | ||
| National High-tech Enterprise | Valid till December 22, 2024, subject to renewal every three years. | Biznest |
The establishment, operation and management of corporate entities in mainland China are governed by the Company Law of the People’s Republic of China, or the China Company Law, which was adopted by the SCNPC in December 1993, implemented in July 1994, and subsequently amended in December 1999, August 2004, October 2005, December 2013 and October 2018. Under the China Company Law, companies are generally classified into two categories: limited liability companies and companies limited by shares. The China Company Law applies to both domestic and foreign-invested companies.
Investment activities in mainland China by foreign investors are governed by the Guiding Foreign Investment Direction, which was promulgated by the State Council on February 11, 2002, and came into effect on April 1, 2002, and the latest Special Administrative Measures (Negative List) for Foreign Investment Access (2022), or the Negative List, which was promulgated by the MOFCOM and the NDRC on March 12, 2022, and took effect on the same date. The Negative List sets out in a unified manner the restrictive measures, such as the requirements on shareholding percentages and management, for the access of foreign investments, and the industries that are prohibited for foreign investment. Any field not falling in the Negative List shall be administered under the principle of equal treatment to domestic and foreign investment.
The Foreign Investment Law of the People’s Republic of China, or the Foreign Investment Law was promulgated by the NPC in March 2019 and become effective in January 2020. The investment activities of foreign natural persons, enterprises or other organizations (hereinafter referred to as foreign investors) directly or indirectly within the territory of mainland China are governed by the Foreign Investment Law, including: 1) establishing by foreign investors of foreign-invested enterprises in mainland China alone or jointly with other investors; 2) acquiring by foreign investors of shares, equity, property shares, or other similar interests of Chinese domestic enterprises; 3) investing by foreign investors in new projects in mainland China alone or jointly with other investors; and 4) other forms of investment prescribed by laws, administrative regulations or the State Council.
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In December 2019, the State Council issued the Regulations on Implementing the Foreign Investment Law, which came into effect in January 2020. After the Regulations on Implementing the Foreign Investment Law came into effect, the Regulation on Implementing the Law on Sino-foreign Equity Joint Ventures, Provisional Regulations on the Duration of Sino-Foreign Equity Joint Ventures, the Regulations on Implementing the Law on Wholly Foreign-Owned Enterprises and the Regulations on Implementing the Law on Sino-Foreign Cooperative Joint Ventures have been repealed simultaneously.
In December 2019, the MOFCOM and the SAMR issued the Measures for the Reporting of Foreign Investment Information, which came into effect in January 2020. After the Measures for the Reporting of Foreign Investment Information came into effect, the Interim Measures on the Administration of Filing for Establishment and Change of Foreign Invested Enterprises has been repealed simultaneously. Since January 1, 2020, for foreign investors carrying out investment activities directly or indirectly in mainland China, the foreign investors or foreign-invested enterprises shall submit investment information to the relevant commerce administrative authorities pursuant to these measures.
In light of the above restrictions and requirements, prior to the dissolution of our VIE structure in September 2021, we had conducted our value-added telecommunications businesses through our then consolidated VIEs. As a result of the dissolution of our VIE structure, we ceased the e-commerce and related businesses which had constituted a minor portion of our consolidated revenue. Based on the legal analysis of the Company’s in-house legal counsel, who is a licensed attorney in the PRC, we believe that none of our PRC subsidiaries’ current business is stipulated on the Negative List.
As a result, according to the laws and regulations currently in effect, our PRC subsidiaries are able to conduct their business without being subject to restrictions imposed by the foreign investment laws and regulations of the PRC and none of Taoping or our subsidiaries is required to obtain additional licenses or permits beyond a regular business license for each PRC subsidiary’s operations. Each of our PRC subsidiaries is required to obtain and has obtained such regular business license from the local branch of the SAMR. No application for any such license has been denied.
Regulations on Mobile Internet Applications Information Services
Mobile Internet applications and the Internet application store are especially regulated by the Administrative Provisions on Mobile Internet Applications Information Services, or the APP Provisions, which was promulgated by the CAC, on June 28, 2016 and entered into force on August 1, 2016. The APP Provisions regulate the APP information and the APP store service providers, and the CAC and local offices of cyberspace administration are responsible for the supervision and administration of nationwide or local APP information respectively.
The APP information service providers shall acquire relevant qualifications in accordance with laws and regulations and fulfil the information security management obligations as follows: (1) shall authenticate the identity information of the registered users including their mobile telephone number and other identity information under the principle of mandatory real name registration at the back-office end, and voluntary real name display at the front-office end; (2) shall establish and perfect the mechanism for the protection of users’ information, and follow the principle of legality, rightfulness and necessity, indicate expressly the purpose, method and scope of collection and use and obtain the consent of users while collecting and using users’ personal information; (3) shall establish and perfect the mechanism for the examination and management of information content, and in terms of any information content released that violates laws or regulations, take such measures as warning, restricting the functions, suspending the update and closing the accounts as the case may be, keep relevant records and report the same to relevant competent authorities; (4) shall safeguard users’ right to know and to make choices when users are installing or using such applications, and shall neither start such functions as collecting the information of users’ positions, accessing users’ contacts, turning on the camera and recording the sound, or any other function irrelevant to the services, nor forcefully install any other irrelevant applications without prior consent of users when noticed expressly; (5) shall respect and protect the intellectual properties and shall neither produce nor release any application that infringes others’ intellectual properties; and (6) shall record the users’ log information and keep the same for 60 days.
We have established necessary mechanisms and adopted data encryption and protection technology in our mobile application to ensure the collection, protection and storage of user information are in compliance with the requirements of the APP Provisions in all material aspects.
Regulations on Internet Information Security
In 1997, the Ministry of Public Security promulgated measures that prohibit use of the internet in ways which, among other things, result in a leakage of state secrets or a spread of socially destabilizing content. If an internet information service provider violates these measures, the Ministry of Public Security and the local security bureaus may revoke its operating license and shut down its websites.
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Internet information in China is regulated and restricted from a national security standpoint. The Standing Committee of the National People’s Congress, or the SCNPC, has enacted the Decisions on Maintaining Internet Security on December 28, 2000 and further amended on August 27, 2009, which may subject violators to criminal punishment in China for any effort to: (i) gain improper entry into a computer or system of strategic importance; (ii) disseminate politically disruptive information; (iii) leak state secrets; (iv) spread false commercial information; or (v) infringe intellectual property rights.
The PRC Cybersecurity Law was promulgated by the SCNPC on November 7, 2016 and became effective on June 1, 2017. Under this regulation, network operators, including online information service providers, shall comply with laws and regulations and fulfill their obligations to safeguard security of the network when conducting business and providing services, and take all necessary measures pursuant to laws, regulations and compulsory national requirements to safeguard the safe and stable operation of the networks, respond to network security incidents effectively, prevent illegal and criminal activities, and maintain the integrity, confidentiality and usability of network data.
We have, in accordance with relevant provisions on network security of the PRC, established necessary mechanisms to protect information security, including, among others, adopting necessary network security protection technologies such as anti-virus firewalls, intrusion detection and data encryption, keeping record of network logs, and implementing information classification framework.
Regulations on Privacy Protection
The Several Provisions on Regulating the Market Order of Internet Information Services, issued by the MIIT in December 2011, provide that, an internet information service provider may not collect any user personal information or provide any such information to third parties without the consent of a user. An internet information service provider must expressly inform the users of the method, content and purpose of the collection and processing of such user personal information and may only collect such information necessary for the provision of its services. An internet information service provider is also required to properly maintain the user personal information, and in case of any leak or likely leak of the user personal information, online lending service providers must take immediate remedial measures and, in severe circumstances, make an immediate report to the telecommunications regulatory authority.
In addition, pursuant to the Decision on Strengthening the Protection of Online Information issued by the SCNPC in December 2012 and the Order for the Protection of Telecommunication and Internet User Personal Information issued by the MIIT in July 2013, any collection and use of user personal information must be subject to the consent of the user, abide by the principles of legality, rationality and necessity and be within the specified purposes, methods and scopes.
The Guidelines jointly released by ten PRC regulatory agencies in July 2015 aim, among other things, to require service providers to improve technology security standards, and safeguard user and transaction information. The Guidelines also prohibit service providers from illegally selling or disclosing users’ personal information. Pursuant to the Ninth Amendment to the Criminal Law issued by the SCNPC in August 2015, which became effective in November 2015, any Internet service provider that fails to fulfill the obligations related to Internet information security administration as required by applicable laws and refuses to rectify upon orders is subject to criminal penalty for the result of (i) any dissemination of illegal information in large scale; (ii) any severe effect due to the leakage of the client’s information; (iii) any serious loss of criminal evidence; or (iv) other severe situation, and any individual or entity that (i) sells or provides personal information to others in a way violating the applicable law, or (ii) steals or illegally obtain any personal information is subject to criminal penalty in severe situation.
Our Taoping APP is used to facilitate cloud ads and content distribution to the designated terminal in our network, which does not invoice the collection and storage of any personal information.
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Regulations Related to Intellectual Property
The SCNPC and the State Council have promulgated comprehensive laws and regulations to protect trademarks. The Trademark Law of the PRC (2019 revision, effective November 1, 2019) promulgated on August 23, 1982 and subsequently amended on February 22, 1993, October 27, 2001, August 30, 2013 and April 23, 2019 respectively, and the Implementation Regulation of the PRC Trademark Law (2014 revision) issued by the State Council on August 3, 2002 and amended on April 29, 2014, are the main regulations protecting registered trademarks. The Trademark Office under the SAIC administrates the registration of trademarks on a “first-to-file” basis, and grants a term of ten years to registered trademarks.
The PRC Copyright Law, adopted in 1990 and revised in 2001 and 2010 respectively, with its implementation rules adopted on August 8, 2002 and revised in 2011 and 2013 respectively, and the Regulations for the Protection of Computer Software as promulgated on December 20, 2001 and amended in 2011 and 2013 provide protection for copyright of computer software in the PRC. Under these rules and regulations, software owners, licensees and transferees may register their rights in software with the National Copyright Administration Center or its local branches to obtain software copyright registration certificates.
The Patent Law of the PRC was adopted by NPCSC in 1984 and amended in 1992, 2000 and 2008, respectively. A patentable invention, utility model or design must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries, rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds or substances obtained by means of nuclear transformation. The Patent Office under the State Intellectual Property Office is responsible for receiving, examining and approving patent applications. A patent is valid for a term of twenty years for an invention and a term of ten years for a utility model or design, commencing on the application date. Subject to limited exceptions provided by law, any third-party user must obtain consent or a proper license from the patent owner to use the patent, or otherwise the use will constitute an infringement of the rights of the patent holder.
The MIIT, promulgated the Administrative Measures on Internet Domain Name, or the Domain Name Measures, on August 24, 2017 to protect domain names. According to the Domain Name Measures, domain name applicants are required to duly register their domain names with domain name registration service institutions. The applicants will become the holder of such domain names upon the completion of the registration procedure.
We have adopted necessary mechanisms to register, maintain and enforce intellectual property rights in China. However, we cannot assure you that we can prevent our intellectual property from all the unauthorized use by any third party, neither can we promise that none of our intellectual property rights would be challenged any third party.
Regulations Related to Employment
The PRC Labor Law and the Labor Contract Law require that employers execute written employment contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. Violations of the PRC Labor Law and the Labor Contract Law may result in the imposition of fines and other administrative sanctions, and serious violations may constitute criminal offences.
On December 28, 2012, the PRC Labor Contract Law was amended, effective since July 1, 2013 to impose more stringent requirements on labor dispatch. Under such law, dispatched workers are entitled to pay equal to that of full-time employees for equal work, but the number of dispatched workers that an employer hires may not exceed a certain percentage of its total number of employees as determined by the Ministry of Human Resources and Social Security. Additionally, dispatched workers are only permitted to engage in temporary, auxiliary or substitute work. According to the Interim Provisions on Labor Dispatch promulgated by the Ministry of Human Resources and Social Security on January 24, 2014, which became effective on March 1, 2014, the number of dispatched workers hired by an employer shall not exceed 10% of the total number of its employees (including both directly hired employees and dispatched workers). The Interim Provisions on Labor Dispatch require employers not in compliance with the PRC Labor Contract Law in this regard to reduce the number of its dispatched workers to below 10% of the total number of its employees prior to March 1, 2016.
Enterprises in China are required by PRC laws and regulations to participate in certain employee benefit plans, including social insurance funds, namely a pension plan, a medical insurance plan, an unemployment insurance plan, a work-related injury insurance plan and a maternity insurance plan, and a housing provident fund, and contribute to the plans or funds in amounts equal to certain percentages of salaries, including bonuses and allowances, of the employees as specified by the local government from time to time at locations where they operate their businesses or where they are located.
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According to the Interim Regulations on the Collection and Payment of Social Insurance Premiums, the Regulations on Work Injury Insurance, the Regulations on Unemployment Insurance and the Trial Measures on Employee Maternity Insurance of Enterprises, enterprises in the PRC shall provide benefit plans for their employees, which include basic pension insurance, unemployment insurance, maternity insurance, work injury insurance and basic medical insurance. An enterprise must provide social insurance by making social insurance registration with local social insurance agencies, and shall pay or withhold relevant social insurance premiums for and on behalf of employees. The Law on Social Insurance of the PRC, which was promulgated by the SCNPC on October 28, 2010, became effective on July 1, 2011, and was most recently updated on December 29, 2018, has consolidated pertinent provisions for basic pension insurance, unemployment insurance, maternity insurance, work injury insurance and basic medical insurance, and has elaborated in detail the legal obligations and liabilities of employers who do not comply with laws and regulations on social insurance.
According to the Regulations on the Administration of Housing Provident Fund, which was promulgated by the State Counsel and became effective on April 3, 1999, and was amended on March 24, 2002 and was partially revised on March 24, 2019 by the Decision of the State Council on Revising Some Administrative Regulations (Decree No. 710 of the State Council), housing provident fund contributions by an individual employee and housing provident fund contributions by his or her employer shall belong to the individual employee. Registration by PRC companies with the applicable housing provident fund management center is compulsory, and a special housing provident fund account for each of the employees shall be opened at an entrusted bank.
The employer shall timely pay up and deposit housing provident fund contributions in full amount and late or insufficient payments of such contributions are unlawful. The employer shall make the housing provident fund payment and deposit registrations with the housing provident fund administration center. With respect to companies which violate the above regulations and fail to complete housing provident fund payment and deposit registrations or open housing provident fund accounts for their employees, such companies shall be ordered by the housing provident fund administration center to complete such procedures within a designated time limit. Those who fail to complete their registrations within the designated period shall be levied a fine ranging from RMB 10,000 to RMB 50,000. When companies breach these regulations and fail to pay housing provident fund contributions in full amount that are due, the housing provident fund administration center shall order such companies to pay up within a designated period, and may further petition a People’s Court for mandatory enforcement against those who still fail to comply after the expiry of such period.
Regulations on Foreign Currency Exchange
Under the PRC Foreign Currency Administration Rules promulgated on January 29, 1996 and last amended on August 5, 2008 and various regulations issued by SAFE and other relevant PRC government authorities, payment of current account items in foreign currencies, such as trade and service payments, payment of interest and dividends can be made without prior approval from SAFE by following the appropriate procedural requirements. By contrast, the conversion of RMB into foreign currencies and remittance of the converted foreign currency outside the PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investment, requires prior approval from SAFE or its local office.
On February 13, 2015, SAFE promulgated the Circular on Simplifying and Improving the Foreign Currency Management Policy on Direct Investment, effective from June 1, 2015, which cancels the requirement for obtaining approvals of foreign exchange registration of inbound foreign direct investment and outbound overseas direct investment from SAFE. The application for the registration of foreign exchange for the purpose of inbound foreign direct investment and outbound overseas direct investment may be filed with qualified banks, which, under the supervision of SAFE, may review the application and process the registration.
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The Circular of the SAFE on Reforming the Management Approach regarding the Settlement of Foreign Capital of Foreign-invested Enterprise, or SAFE Circular 19, was promulgated on March 30, 2015 and became effective on June 1, 2015. According to SAFE Circular 19, a foreign-invested enterprise may, according to its actual business needs, settle with a bank the portion of the foreign exchange capital in its capital account for which the relevant foreign exchange bureau has confirmed monetary contribution rights and interests (or for which the bank has registered the account-crediting of monetary contribution). For the time being, foreign-invested enterprises are allowed to settle 100% of their foreign exchange capitals on a discretionary basis; a foreign-invested enterprise shall truthfully use its capital for its own operational purposes within the scope of business; where an ordinary foreign-invested enterprise makes domestic equity investment with the amount of foreign exchanges settled, the invested enterprise shall first go through domestic re-investment registration and open a corresponding Account for Foreign Exchange Settlement Pending Payment with the foreign exchange bureau (bank) at the place of registration. The Circular of the SAFE on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular 16, was promulgated and became effective on June 9, 2016. According to SAFE Circular 16, enterprises registered in PRC may also convert their foreign debts from foreign currency into Renminbi at the enterprise’s discretion. SAFE Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) at the enterprise’s discretion, which applies to all enterprises registered in the PRC. SAFE Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope and may not be used for investments in securities or other investment with the exception of bank financial products that can guarantee the principal within the PRC unless otherwise specifically provided. Besides, the converted Renminbi shall not be used to make loans for related enterprises unless it is within the business scope or to build or to purchase any real estate that is not for the enterprise own use with the exception for the real estate enterprise.
On January 26, 2017, SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, or SAFE Circular 3, which stipulates several capital control measures with respect to the outbound remittance of profits from domestic entities to offshore entities, including (i) banks must check whether the transaction is genuine by reviewing board resolutions regarding profit distribution, original copies of tax filing records and audited financial statements, and (ii) domestic entities must retain income to account for previous years’ losses before remitting any profits. Moreover, pursuant to SAFE Circular 3, domestic entities must explain in detail the sources of capital and how the capital will be used, and provide board resolutions, contracts and other proof as a part of the registration procedure for outbound investment.
On October 25, 2019, SAFE promulgated the Notice on Further Facilitating Cross-Board Trade and Investment, which became effective on the same date (except for Article 8.2 thereof). The notice removed restrictions on the capital equity investment in China by non-investment foreign-invested enterprises. In addition, restrictions on the use of funds for foreign exchange settlement of domestic accounts for the realization of assets have been removed and restrictions on the use and foreign exchange settlement of foreign investors’ security deposits have been relaxed. Eligible enterprises in the pilot areas are also allowed to use revenues under capital accounts, such as capital funds, foreign debts and overseas listing revenues for domestic payments without providing materials to the bank in advance for authenticity verification on an item by item basis, while the use of funds should be true, in compliance with applicable rules and conforming to the current capital revenue management regulations.
Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents
SAFE issued the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, which became effective in July 2014, to replace the Circular of the State Administration of Foreign Exchange on Issues Concerning the Regulation of Foreign Exchange in Equity Finance and Roundtrip Investments by Domestic Residents through Offshore Special Purpose Vehicles, to regulate foreign exchange matters in relation to the use of special purpose vehicles, or SPVs, by PRC residents or entities to seek offshore investment and financing or conduct round trip investment in China. SAFE Circular 37 defines a SPV as an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate onshore or offshore assets or interests, while “round trip investment” is defined as direct investment in China by PRC residents or entities through SPVs, namely, establishing foreign-invested enterprises to obtain the ownership, control rights and management rights. SAFE Circular 37 stipulates that, prior to making contributions into an SPV, PRC residents or entities be required to complete foreign exchange registration with SAFE or its local branch. In addition, SAFE promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment in February 2015, which amended SAFE Circular 37 and became effective on June 1, 2015, requiring PRC residents or entities to register with qualified banks rather than SAFE in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.
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PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to SPVs but had not obtained registration as required before the implementation of the SAFE Circular 37 must register their ownership interests or control in the SPVs with qualified banks. An amendment to the registration is required if there is a material change with respect to the SPV registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in SAFE Circular 37 and the subsequent notice, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations. See “Risk Factors—Risks Related to Doing Business in China—PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiary to liability or penalties, limit our ability to inject capital into our PRC subsidiary or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.”
Regulations on Stock Incentive Plans
SAFE promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, or the Stock Incentive Plan Notice, in February 2012, replacing the previous rules issued by SAFE in March 2007. Pursuant to the Stock Incentive Plan Notice and other relevant rules and regulations, PRC residents participating in stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and follow certain other procedures. Participants of a stock incentive plan who are PRC residents must conduct the SAFE registration and other procedures with respect to the stock incentive plan through a qualified PRC agent, which could be a PRC subsidiary of the overseas publicly listed company or another qualified institution appointed by the PRC subsidiary. In addition, the PRC agent is required to update the relevant SAFE registration should there be any material change to the stock incentive plan, the PRC agent or other material changes. The PRC agent must, on behalf of the PRC residents who have the right to exercise the employee stock options, apply to SAFE or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC residents from the sale of shares under the stock incentive plans granted and dividends distributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents prior to distribution to such PRC residents.
We have adopted an equity incentive plan, under which we will have the discretion to award incentives and rewards to eligible participants. We have advised the recipients of awards under our equity incentive plan to handle relevant foreign exchange matters in accordance with the Stock Incentive Plan Notice. However, we cannot guarantee that all employees awarded equity-based incentives can successfully register with SAFE in full compliance with the Stock Incentive Plan Notice. See “Risk Factors—Risks Relating to Doing Business in China—Any failure to comply with PRC regulations regarding employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.”
Regulations on Dividend Distribution
Distribution of dividends of foreign investment enterprises are mainly governed by the Foreign Investment Enterprise Law, issued in 1986 and amended in 2000 and 2016 respectively, and the Implementation Rules under the Foreign Investment Enterprise Law, issued in 1990 and amended in 2001 and 2014 respectively. Under these regulations, foreign investment enterprises in the PRC may distribute dividends only out of their accumulative profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, no less than 10% of the accumulated profits of the foreign investment enterprises in the PRC are required to be allocated to fund certain reserve funds each year unless these reserves have reached 50% of the registered capital of the enterprises. A PRC company is not permitted to distribute any profits until any losses from previous fiscal years have been offset. Profits retained from prior fiscal years may be distributed together with distributable profits from the current fiscal year. Under our current corporate structure, our BVI holding company may rely on dividend payments from IST, which is a wholly foreign-owned enterprise incorporated in China, to fund any cash and financing requirements we may have. Limitation on the ability of our consolidated VIEs to make remittance to IST and on the ability of IST to pay dividends to us could limit our ability to access cash generated by the operations of those entities. See “Risk Factors—Risks Relating to Doing Business in China—— Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.”
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Dividend Withholding Tax
In March 2007, the National People’s Congress enacted the Enterprise Income Tax Law which became effective on January 1, 2008 and last amended on December 29, 2018. The PRC State Council promulgated the Implementation Rules of the Enterprise Income Tax Law on December 6, 2007, which became effective on January 1, 2008 and was partially amended on April 23, 2019. According to Enterprise Income Tax Law and its Implementation Rules, dividends payable by a foreign-invested enterprise in China to its foreign enterprise investors are subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a preferential withholding arrangement. Pursuant to the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, issued on January 29, 2008 and supplemented and revised on February 29, 2008, and the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income, which became effective on December 8, 2006 and applicable to income derived in any year of assessment commencing on or after April 1, 2007 in Hong Kong and in any year commencing on or after January 1, 2007 in the PRC, such withholding tax rate may be lowered to 5% if a Hong Kong enterprise is deemed the beneficial owner of any dividend paid by a PRC subsidiary by PRC tax authorities and holds at least 25% of the equity interest in that particular PRC subsidiary at all times within the 12-month period immediately prior to the distribution of the dividends. Furthermore, pursuant to the Announcement on Issues concerning “Beneficial Owners” in Tax Treaties issued on February 3, 2018 by the State Administration of Taxation, when determining the status of “beneficial owners,” a comprehensive analysis may be conducted through materials such as articles of association, financial statements, records of capital flows, minutes of board of directors, resolutions of board of directors, allocation of manpower and material resources, the relevant expenses, functions and risk assumption, loan contracts, royalty contracts or transfer contracts, patent registration certificates and copyright certificates, etc. However, even if an applicant has the status as a “beneficiary owner,” if the competent tax authority finds necessity to apply the principal purpose test clause in the tax treaties or the general anti-tax avoidance rules stipulated in domestic tax laws, the general anti-tax avoidance provisions shall apply.
Enterprise Income Tax
In December 2007, the State Council promulgated the Implementing Rules of the Enterprise Income Tax Law, or the Implementing Rules, which became effective on January 1, 2008. The Enterprise Income Tax Law and its relevant Implementing Rules (i) impose a uniform 25% enterprise income tax rate, which is applicable to both foreign invested enterprises and domestic enterprises (ii) permits companies to continue to enjoy their existing tax incentives, subject to certain transitional phase-out rules and (iii) introduces new tax incentives, subject to various qualification criteria.
The Enterprise Income Tax Law also provides that enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered PRC resident enterprises and therefore be subject to PRC enterprise income tax at the rate of 25% on their worldwide income. The Implementing Rules further define the term “de facto management body” as the management body that exercises substantial and overall management and control over the production and operations, personnel, accounts and properties of an enterprise. If an enterprise organized under the laws of jurisdiction outside China is considered a PRC resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, it would be subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. Second, a 10% withholding tax would be imposed on dividends it pays to its non-PRC enterprise shareholders and with respect to gains derived by its non-PRC enterprise shareholders from transfer of its shares. Dividends paid to non-PRC individual shareholders and any gain realized on the transfer of equity by such shareholders may be subject to PRC tax at a rate of 20%, if such income is deemed to be from PRC sources. See “Risk Factors—Risks Relating to Doing Business in China—Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC shareholders.”
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On October 17, 2017, the State Administration of Taxation issued the Bulletin on Issues Concerning the Withholding of Non-PRC Resident Enterprise Income Tax at Source, or Bulletin 37, which replaced the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued by the State Administration of Taxation on December 10, 2009, and partially replaced and supplemented rules under the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or Bulletin 7, issued by the State Administration of Taxation on February 3, 2015. Under Bulletin 7, an “indirect transfer” of assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. In respect of an indirect offshore transfer of assets of a PRC establishment, the relevant gain is to be regarded as effectively connected with the PRC establishment and therefore included in its enterprise income tax filing, and would consequently be subject to PRC enterprise income tax at a rate of 25%. Where the underlying transfer relates to the immoveable properties in China or to equity investments in a PRC resident enterprise, which is not effectively connected to a PRC establishment of a non-resident enterprise, a PRC enterprise income tax at 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is obligated to make the transfer payments has the withholding obligation. Pursuant to Bulletin 37, the withholding party shall declare and pay the withheld tax to the competent tax authority in the place where such withholding party is located within 7 days from the date of occurrence of the withholding obligation. Both Bulletin 37 and Bulletin 7 do not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired from a transaction through a public stock exchange. See “Risk Factors—Risks Relating to Doing Business in China—We and our shareholders face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises or other assets attributed to a Chinese establishment of a non-Chinese company, or immovable properties located in China owned by non-Chinese companies.”
Value-Added Tax
Pursuant to the Provisional Regulations on Value-Added Tax of the PRC, or the VAT Regulations, which were promulgated by the State Council on December 13, 1993, and took effect on January 1, 1994, and were amended on November 10, 2008, February 6, 2016, and November 19, 2017, respectively, and the Rules for the Implementation of the Provisional Regulations on Value Added Tax of the PRC, which were promulgated by the Ministry of Finance, on December 25, 1993, and were amended on December 15, 2008, and October 28, 2011, respectively, entities and individuals that sell goods or labor services of processing, repair or replacement, sell services, intangible assets, or immovables, or import goods within the territory of the People’s Republic of China are taxpayers of value-added tax. The VAT rate is 17% for taxpayers selling goods, labor services, or tangible movable property leasing services or importing goods, except otherwise specified; 11% for taxpayers selling goods, labor services, or tangible movable property leasing services or importing goods, except otherwise specified; 6% for taxpayers selling services or intangible assets.
According to Provisions in the Notice on Adjusting the Value added Tax Rates, or the Notice, issued by the State Administration of Taxation and the Ministry of Finance, where taxpayers make VAT taxable sales or import goods, the applicable tax rates shall be adjusted from 17% to 16% and from 11% to 10%, respectively. The Notice took effect on May 1, 2018, and the adjusted VAT rates took effect at the same time. Pursuant to the Notice of the Ministry of Finance, the State Administration of Taxation and the General Administration of Customs of the PRC on Relevant Policies for Deepening the Value-Added Tax Reform, which was promulgated on March 20, 2019 and became effective on April 1, 2019, the tax rate of 16% applicable to the VAT taxable sale or import of goods by a general VAT taxpayer shall be adjusted to 13%, and the tax rate of 10% applicable thereto shall be adjusted to 9%.
In November 2011, the Ministry of Finance and the State Administration of Taxation promulgated the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax, or the Pilot Plan. The Notice of the Ministry of Finance and the State Administration of Taxation on Implementing the Pilot Plan of Replacing Business Tax with Value-Added Tax in an All-round Manner, issued on March 23, 2016, took effect on May 1, 2016. Pursuant to the Pilot Plan and the subsequent Notice, VAT at a rate of 6% is applied nationwide to revenue generated from the provision of certain modern services in lieu of the prior Business Tax.
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New Overseas Listing Rules issued by the Chinese Government
The PRC government has recently indicated an intent to take actions to exert more oversight and control over offerings that are conducted overseas and/or foreign investment in China-based issuers. For example, on July 6, 2021, the relevant PRC government authorities made public the Opinions on Strictly Scrutinizing Illegal Securities Activities in Accordance with the Law, or the Opinions. These Opinions emphasized the need to strengthen the administration over illegal securities activities and the supervision of overseas listings by China-based companies and proposed to take effective measures, such as promoting the construction of relevant regulatory systems to deal with the risks and incidents faced by China-based overseas-listed companies.
On December 24, 2021, the CSRC issued the Provisions of the State Council on the Administration of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments) and the Administrative Measures for the Filing of Overseas Securities Offering and Listing by Domestic Companies (Draft for Comments), collectively the Draft Overseas Listing Regulations, for public comment until January 23, 2022.
Following issuance of the Draft Overseas Listing Regulations, on February 17, 2023, the CSRC issued the Notice on Filing Arrangements for Overseas Securities Offering and Listing by Domestic Companies (the “CSRC Filing Notice”), stating that the CSRC has published the Trial Administrative Measures of Overseas Securities Offering and Listing by Domestic Companies (the “Trial Measures”) and five supporting guidelines (the “Listing Guidelines”), collectively the Trial Measures and Listing Guidelines or the Oversea Listing Rules. Among others, the Oversea Listing Rules provide that overseas offerings and listings by PRC domestic companies shall:
(i) require submission of relevant materials that contain a filing report and a legal opinion, providing truthful, accurate and complete information on matters including but not limited to the shareholders of the issuer. Where the filing documents are complete and in compliance with stipulated requirements, the CSRC shall, within 20 working days after receipt of filing documents, conclude the filing procedure and publish filing results on the CSRC website. Where filing documents are incomplete or do not conform to stipulated requirements, the CSRC shall request supplementation and amendment thereto within five working days after receipt of the filing documents. The issuer should then complete supplementation and amendment within 30 working days;
(ii) abide by laws, administrative regulations and relevant state rules concerning foreign investment in China, state-owned asset administration, industry regulation and outbound investment, and shall not disrupt the PRC domestic market order, harm state or public interests or undermine the lawful rights and interests of PRC domestic investors;
(iii) abide by national secrecy laws and relevant provisions. Necessary measures shall be taken to fulfill confidentiality obligations. Divulgence of state secrets or working secrets of government agencies is strictly prohibited. Provision of personal information and important data, etc., to overseas parties in relation to overseas offering and listing of PRC domestic companies shall be in compliance with applicable laws, administrative regulations and relevant state rules; and
(iv) be made in strict compliance with relevant laws, administrative regulations and rules concerning national security in the spheres of foreign investment, cybersecurity, data security, etc., and issuers shall duly fulfill their obligations to protect national security. If the intended overseas offering and listing necessitates a national security review, relevant security review procedures shall be completed according to the law before the application for such offering and listing is submitted to any overseas parties such as securities regulatory agencies and trading venues;
The Trial Measures came into effect on March 31, 2023. PRC domestic companies seeking to offer and list securities (which, for the purposes of the Trial Measures, are defined thereunder as equity shares, depository receipts, corporate bonds convertible to equity shares, and other equity securities that are offered and listed overseas, either directly or indirectly, by PRC domestic companies) in overseas markets, either via direct or indirect means, must file with the CSRC within three working days after their application for an overseas listing is submitted.
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The Trial Measures provide that where a PRC domestic company seeks to indirectly offer and list securities in overseas markets, the issuer shall designate a major domestic operating entity, which shall, as the domestic entity responsible, file with the CSRC. The Trial Measures stipulate that an overseas listing will be determined as “indirect” if the issuer meets both of the following conditions: (1) 50% or more of any of the issuer’s operating revenue, total profit, total assets or net assets as documented in its audited consolidated financial statements for the most recent accounting year are accounted for by PRC domestic companies (“Condition I”), and (2) the main parts of the issuer’s business activities are conducted in the PRC, or its main places of business are located in the PRC, or the senior managers in charge of its business operations and management are mostly Chinese citizens or domiciled in the PRC (“Condition II”); whether Chinese citizens from Taiwan, Hong Kong, and Macau are included in the foregoing specification is not specified. The determination as to whether or not an overseas offering and listing by PRC domestic companies is indirect shall be made on a ‘substance over form’ basis; the Listing Guidelines further stipulate that if an issuer not satisfying Condition I submits an application for issuance and listing in overseas markets in accordance with relevant non-PRC issuance regulations requiring such issuer to disclose risk factors mainly related to the PRC, the securities firm(s) and the issuer’s PRC counsel should follow the principle of “substance over form” in order to identify and argue whether the issuer should complete a filing under the Trial Measures. Subsequent securities offerings of an issuer in (i) the same overseas market where it has previously offered and listed securities, and (ii) an overseas market other than one where the issuer has previously offered and listed securities shall be filed with the CSRC within three working days after offerings are completed. Additionally, the Trial Measures stipulate that after an issuer has offered and listed securities in an overseas market, the issuer shall submit a report to the CSRC within three working days after the occurrence and public disclosure of (i) a change of control thereof, (ii) investigations of or sanctions imposed on the issuer by overseas securities regulators or relevant competent authorities, (iii) changes of listing status or transfers of listing segment, and (iv) a voluntary or mandatory delisting.
The CSRC Filing Notice states that, beginning from March 31, 2023, PRC domestic enterprises which have already issued and listed securities overseas and fall within the scope of filing under the Trial Measures shall be considered “existing enterprises” (“Existing Listed Enterprises”). Existing Listed Enterprises are not required to complete filings immediately; rather, Existing Listed Enterprises should complete filings if they are subsequently involved in matters require filings, such as follow-on financing activities, in accordance with the Trial Measures.
There is a possibility that we may be deemed as an Existing Listed Enterprise as defined under the CSRC Filing Notice, and that future offerings of listed securities or listings outside China by us may be subject to CSRC filing requirements in accordance with the Trial Measures.
Seasonality
The first quarter of the calendar year is typically the slowest season of the year due to the Chinese New Year holiday. During this period, accounts receivable collection is very slow and we also need to prepare for upcoming busier seasons by making payments for inventory.
C. Organizational Structure
See “A. History and Development of the Company—Corporate Structure” above for details of our current organizational structure.
D. Property, Plant and Equipment
All land in China is owned by the state or local governments. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a period of 50 years. This period may be renewed at the expiration of the initial and any subsequent terms according to the relevant Chinese laws. Granted land use rights are transferable and may be used as collateral for borrowings and other obligations.
Our current executive offices are located at 21st Floor, Everbright Bank Building, Zhuzilin, Futian District, Shenzhen, Guangdong, 518040, China, of which IST currently has property use rights. This office facility property consists of approximately 1,200 square meters and is currently being used as collateral for certain of our short-term bank loans. Our other properties primarily consist of media display equipment, computer equipment, servers, licensed software, furniture and fixtures. We currently do not have any intention to make large scale improvements or developments with respect to these properties.
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We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.
ITEM 4A. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements. Our actual results may differ materially from those anticipated in these forward-looking statements because of various factors, including those set forth under Item 3 “Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F. See also “Introductory Notes—Forward-looking Information.”
A. Operating Results
Overview
We are a leading provider of integrated cloud-based platform, resource sharing functionality, and big data solutions to the Chinese new media, education residential community management, and elevator IoT industries. Our Internet ecosystem enables all participants of the new media community to efficiently promote brands, disseminate information, and share resources. In addition, we provide a broad portfolio of software, hardware and fully integrated solutions, including information technology infrastructure and Internet-enabled display technologies to customers in government, education, healthcare, media, transportation, and other private sectors. In 2021, we ventured into the blockchain related business through the launch of cryptocurrency mining operations but had discontinued such business by December 2022.
We were founded in 1993. As of December 31, 2022, we had approximately 63 full-time employees.
Prior to 2014, we generated majority of our revenues through selling our products to public service entities to help improve their operational efficiency and service quality. Our representative customers included China Ministry of Public Security, provincial bureaus of public security, fire departments, traffic bureaus, police stations, human resource departments, urban planning boards, civic administrations, land resource administrations, mapping and surveying bureaus, and the Shenzhen General Station of Exit and Entry Frontier Inspection.
In 2014, we generated revenues from sales of hardware products, software products, system integration services, and related maintenance and supporting services. Starting in 2015, with the introduction of our cloud-based software as a service (SaaS) offering, we generated additional recurring monthly revenues from SaaS fees. The revenue from SaaS was still small in 2018 and 2019, which is expected to pick up in future years along with the large-scale roll-out of our cloud-based new media terminals.
In May 2017, we completed the business transformation and rolled out CAT and IoT technology based digital ads distribution network and new media resource sharing platform in the out-of-home advertising market. In 2017, 2018 and 2019, we generated most revenue from selling fully integrated ads display terminals. In 2020, we have a portion of revenue generated from the sale of cloud severs as part of our CBT business. The revenue generated from SaaS and other software products and services remained small.
In 2021, we ventured into the blockchain related business through the launch of cryptocurrency mining operations. However, in December 2022, the Company entered into a series of contracts with certain third parties to sell its cryptocurrency mining and related equipment for a total sale price of approximately $1.08 million. The Company also terminated the leases for both the office facility and storage rooms, which were previously used to house most of its mining machines for its cryptocurrency mining operations, and laid off relevant employees. As a result, the Company had ceased its cryptocurrency mining business by December 31, 2022.
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Recent Developments
In March and April 2023, the Company entered into two long-term strategic cooperation agreements (the “Agreements”) with Zhaoyuan City, Shandong Province and Wuxuan County, Guangxi Province, respectively. Under the Agreements, the Company will provide Taoping’s cloud-based intelligent product solutions, including its IoT Smart Rest Station, fully autonomous street sweeper, smart large screen displays, and Blue Box off-grid wastewater treatment solution. Zhaoyuan City and Wuxuan County will provide the Company with multiple channels of support and preferential policies. As part of the Agreements, both parties will also work together on low-carbon environmental protection, urban renewal, rural ecological revitalization, and other related projects.
Leveraging its strong technological reserves and advanced supporting technologies such as AI and IoT, the Company will provide Zhaoyuan City and Wuxuan County with smart city renewal solutions and technical support, and implement environmental governance projects such as wastewater, waste gas, and garbage treatment. Based on the concept of efficient and low-carbon environmental governance, the Company has combined its digital and intelligent innovative technology products, including its IoT Smart Rest Station with fully autonomous street sweeper and its new off-grid wastewater treatment solution, which will effectively improve the overall public service and environmental protection level for both urban and rural areas.
The above collaborations are expected to bring significant revenue streams for the Company in 2023 and beyond.
Principal Factors Affecting Our Financial Performance
Demand for Software Products and Services, Advertising, and High-End Server
The revenue growth and profitability of our business depend on the overall market demand for software products and related services, high-end data servers, and out-of-home advertising. The demand for our CBT products is attributable to rapid urbanization and rising living standards in China. As a result of migration to the cities, individuals’ disposable income and consumptions of information to assist their purchases of goods and services increase as well. Consequently, our CBT products become increasingly receptive to advertisements displayed at public locations. Meanwhile, rising competition has driven merchants and service providers to seek advertisements as a way to make their brands visible and memorable that drives up the demand for innovative advertising technology like our cloud-based software and services. COVID-19 pandemic has changed landscape of business operations and resulted in significant increase in working from remote locations, on-line shopping, on-line education, on-line entertainment, and other on-line business transactions creating high demand for high-end data storage servers to accommodate the surging internet information transmission.
The demand for our TIT products is attributable to digitization of public services in China. Due to changes in policies and regulations in China in 2012, various local governments started postponing IT projects they had previously contracted with us indefinitely. As a result, many of our existing receivables became uncollectable. Starting 2013, we made a strategic decision to transition our business from servicing the public sector to focusing on the private sector. We started completing our in-process IT projects and ceased taking on new customers in the public sector. As a result, the TIT business has diminished throughout the years and gradually being phased out.
Taxation
Taoping and Taoping Holdings were incorporated in the BVI, and not subject to taxation in that jurisdiction. Under the “anti-inversion” rules of Section 7874 of the U.S. Internal Revenue Code, Taoping is treated for U.S. federal taxation purpose as a U.S. corporation and, accordingly, is subject to U.S. federal income tax on its worldwide income with a maximum income tax rate of 21%.
No provision for income tax in the United States has been made as Taoping has no taxable income in the United States.
IST HK, and our former subsidiary, HPC Electronics (China) Co., Limited (“HPC”) were incorporated in Hong Kong and subject to a Hong Kong Profits Tax of 16.5% according to the current Hong Kong tax laws.
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Under the Chinese EIT Law, IST is approved as High Technology Enterprises and respective income tax rates were reduced to 15%. Biznest is approved as software enterprises and enjoys EIT at the tax rate of 12.5%. TopCloud, ISIOT, iASPEC and Bocom are subject to regular EIT at 25%.
Business Segment Information
Segment information is consistent with how the Chief Operating Decision Maker, i.e., the Directors of the Company, review business health, make investment, allocates resources and assess operating performances. Transfers and sales between reportable segments, if any, are recorded at cost.
We report financial and operational information in the following three segments:
| (1) | Cloud-based Technology (CBT) segment — It includes the Company’s cloud-based products, high-end data storage servers and related services sold to private sectors including new media, healthcare, education and residential community management, and among other industries and applications. In this segment, the Company generates revenues from the sales of hardware and software total solutions with proprietary software and content as well as from designing and developing software products specifically customized for private sector customers’ needs for a fixed price. The Company includes the revenue and cost of revenue of high-end data storage servers in the CBT segment. Advertising services is included in the CBT segment, after the Company consummated the acquisition of TNM. Advertisements are delivered to the ads display terminals and vehicular ads display terminals through the Company’s cloud-based new media sharing platform. Incorporation of advertising services complements the Company’s out-of-home advertising business strategy. | |
| (2) | Blockchain Technology (BT) segment — The BT segment is the Company’s newly formed business sector. Cryptocurrency mining is the first initiative implemented in the BT segment. However, due to the decreased output and the highly volatile cryptocurrency market, the Company had ceased the operation of the BT segment by December 2022. |
| (3) | Traditional Information Technology (TIT) segment — The TIT segment includes the Company’s project-based technology products and services sold to the public sector. The solutions the Company has sold primarily include Geographic Information Systems (GIS), Digital Public Security Technology (DPST), and Digital Hospital Information Systems (DHIS). In this segment, the Company generates revenues from sales of hardware and system integration services. As a result of the business transformation, the TIT segment is being gradually phased out in 2021. |
For more information regarding our operating segments, see Note 20 (Consolidated Segment Data) to our audited consolidated financial statements included elsewhere in this report.
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Results of Operations
Comparison of Years Ended December 31, 2022 and 2021
The following table sets forth key components of our results of operations for fiscal years ended December 31, 2022 and 2021, both in dollars and as a percentage of our revenue.
| December 31, 2022 | December 31, 2021 | |||||||||||||||
| Amount | % of Revenue | Amount | % of Revenue | |||||||||||||
| Revenue | $ | 24,233,463 | 100.00 | % | $ | 19,390,579 | 100.00 | % | ||||||||
| Costs of revenue | 17,003,414 | 70.17 | % | 12,719,125 | 65.59 | % | ||||||||||
| Gross profit | 7,230,049 | 29.83 | % | 6,671,454 | 34.41 | % | ||||||||||
| Administrative expenses | (6,149,981 | ) | (25.38 | )% | (11,638,691 | ) | (60.02 | )% | ||||||||
| Research and development expenses | (3,606,653 | ) | (14.88 | )% | (4,479,045 | ) | (23.10 | )% | ||||||||
| Selling expenses | (639,052 | ) | (2.64 | )% | (694,474 | ) | (3.58 | )% | ||||||||
| (Loss) from operations | (3,165,637 | ) | (13.06 | )% | (10,140,756 | ) | (52.30 | )% | ||||||||
| Subsidy income | 148,577 | 0.61 | % | 181,620 | 0.94 | % | ||||||||||
| (Loss) from equity method investment | (261,397 | ) | (1.08 | )% | (814,440 | ) | (4.20 | )% | ||||||||
| Other income (loss), net | 3,314,433 | 13.68 | % | (59,867 | ) | (0.31 | )% | |||||||||
| Interest income | 7,956 | 0.03 | % | 4,631 | 0.02 | % | ||||||||||
| Interest expense | (556,434 | ) | (2.30 | )% | (928,352 | ) | (4.79 | )% | ||||||||
| (Loss) before income taxes | (512,502 | ) | (2.11 | )% | (11,757,164 | ) | (60.63 | )% | ||||||||
| Income tax (expense) benefit | (69,869 | ) | (0.29 | )% | (5,321 | ) | (0.03 | )% | ||||||||
| Net loss from continuing operations | (582,371 | ) | (2.40 | )% | (11,762,485 | ) | (60.66 | )% | ||||||||
| Net loss (income) from discontinued operations | (6,499,276 | ) | (26.82 | )% | 1,837,626 | 9.48 | % | |||||||||
| Net (loss) | (7,081,647 | ) | (29.22 | )% | (9,924,859 | ) | (51.18 | )% | ||||||||
| Less: Net loss attributable to non- controlling interest | - | - | - | - | ||||||||||||
| Net (loss) attributable to Company | $ | (7,081,647 | ) | (29.22 | )% | $ | (9,924,859 | ) | (51.18 | )% | ||||||
Revenue. We generate revenues from advertising, selling hardware, software, and other technology-related services to customers. For the year ended December 31, 2022, our total revenue of continuing operations was $24.2 million, of which approximately $0.2 million was from related parties, compared to total revenue of $19.4 million for the year ended December 31, 2021, an increase of $4.8 million, or 25.0%. The increase was primarily due to an increase of $1.5 million revenue from products, an increase of $2.8 million of advertising revenue, an increase of $0.8 million of other revenue, offset by a decrease of $0.3 million of software revenue. The Company expects that revenue for the year of 2023 would increase moderately as a result of the growth of advertising businesses, as well as the sales of its new cloud-based intelligent products and solutions.
The following table shows our revenue, percentage of revenue, cost of revenue and gross margin, by revenue categories:
| Year Ended December 31, 2022 | Year Ended December 31, 2021 | |||||||||||||||||||||||||||||||
| % of | Cost of | Gross | % of | Cost of | Gross | |||||||||||||||||||||||||||
| Revenue | Revenue | Revenue | Margin | Revenue | Revenue | Revenue | Margin | |||||||||||||||||||||||||
| Products | $ | 12,253,565 | 50.56 | % | 11,125,855 | 9.20 | % | $ | 10,724,707 | 55.31 | % | 9,890,346 | 7.78 | % | ||||||||||||||||||
| Software | 4,820,454 | 19.89 | % | 665,846 | 86.19 | % | 5,174,422 | 26.69 | % | 582,490 | 88.74 | % | ||||||||||||||||||||
| Advertising | 5,409,511 | 22.32 | % | 3,746,585 | 30.74 | % | 2,577,712 | 13.29 | % | 2,193,945 | 14.89 | % | ||||||||||||||||||||
| Others | 1,749,933 | 7.23 | % | 1,465,128 | 16.28 | % | 913,738 | 4.71 | % | 52,344 | 94.27 | % | ||||||||||||||||||||
| Total | $ | 24,233,463 | 100.00 | % | 17,003,414 | 29.83 | % | $ | 19,390,579 | 100.00 | % | 12,719,125 | 34.41 | % | ||||||||||||||||||
A breakdown of revenue, percentage of revenue, cost of revenue and gross margin by segments is as follows:
| Year Ended December 31, 2022 | Year Ended December 31, 2021 | |||||||||||||||||||||||||||||||
| % of | Cost of | Gross | % of | Cost of | Gross | |||||||||||||||||||||||||||
| Revenue | Revenue | Revenue | Margin | Revenue | Revenue | Revenue | Margin | |||||||||||||||||||||||||
| TIT Segment | $ | 235,128 | 0.97 | % | 715,907 | (204.48 | )% | $ | 636,743 | 3.28 | % | 633,713 | 0.48 | % | ||||||||||||||||||
| CBT Segment | 23,998,335 | 99.03 | % | 16,287,508 | 32.13 | % | 18,753,836 | 96.72 | % | 12,085,412 | 35.56 | % | ||||||||||||||||||||
| BT Segment | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||
| Total | $ | 24,233,463 | 100.00 | % | 17,003,415 | 29.83 | % | $ | 19,390,579 | 100.00 | % | 12,719,125 | 34.41 | % | ||||||||||||||||||
Cost of revenue and gross profit. As indicated in the tables above, our cost of revenue increased by $4.3 million, which were mainly attributed to increases in cost of products of $1.2 million, cost of advertising of $1.6 million, cost of software of $0.1 million, and cost of others of $1.4 million, or 33.7%, to $17.0 million, for the year ended December 31, 2022, from $12.7 million for the year ended December 31, 2021. As a percentage of revenue, our cost of revenue increased to 70.2% during the year ended December 31, 2022, from 65.6% during the year ended December 31, 2021. As a result, gross profit as a percentage of revenue decreased to 29.8% for the year ended December 31, 2022 from 34.4% for the year ended December 31, 2021. The decrease in the overall gross margin primarily resulted from lower margin of software and other revenue.
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Administrative expenses. Our administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, professional advisor consulting fees, audit fees, and other expenses incurred in connection with general operations. Our administrative expenses decreased by $5.5 million, or 47.2%, to $6.1 million for the year ended December 31, 2022, from $11.6 million for the year ended December 31, 2021. As a percentage of revenue, administrative expenses decreased to 25.4% for 2022, from 60.0% for 2021. Such decrease was primarily due to a decrease of $4.5 million in allowance for credit losses, and decrease in share-based compensation of $2.6 million to certain employees and consultants, offset by an increase of consulting fees of $0.6 million and an increase of foreign currency exchange loss of $0.7 million. We expect that the administrative expenses in 2023 will be consistent with that of fiscal year 2022. As a percentage of revenue, administrative expenses will decrease as result of the expected additions of new revenue streams.
Research and development expenses. Our research and development expenses consist primarily of personnel related expenses, as well as costs associated with new software and hardware development and enhancement. Our research and development expenses decreased by $0.9 million, or 19.5%, to $3.6 million for the year ended December 31, 2022, from $4.5 million for the year ended December 31, 2021. Such decrease was primarily due to the decrease of amortization of intangible assets, decrease of depreciation of R&D related hardware equipment and software, and the decrease in payroll and benefits to R&D staff. As a percentage of revenue, research and development expenses decreased to 14.9% for 2022, from 23.1% for 2021. We expect that the R&D expenses in 2023 will be consistent with that of fiscal 2022, while as a percentage of revenue, R&D expenses will slightly decrease.
Selling expenses. Our selling expenses consist primarily of the compensation and benefits to our sales and marketing staff, business entertainment expenses, and marketing expenses. Our selling expenses decreased by $0.06 million, or 8.0%, to $0.64 million for the year ended December 31, 2022, from $0.70 million for the year ended December 31, 2021. This decrease was due to the decrease of the other selling activities related costs. We expect that the selling expenses in 2023 will increase in line with revenue increase, while as a percentage of revenue, selling expenses will slightly decrease.
Subsidy income. Our subsidy income consists primarily of the compensation and benefits to governmental subsidies. Our subsidy income decreased by $0.03 million, or 18.2%, to $0.15 million for the year ended December 31, 2022, from $0.18 million for the year ended December 31, 2021.
Other income (loss). Other income for the year ended December 31, 2022 was approximately $3.3 million, compared to other loss of approximately $0.1 million in 2021. Other income in 2022 was mainly the income generated from the write-off of approximately $0.3 million of accounts payable and other payables, and an income of approximately $3.0 million for disposition of a subsidiary.
Interest expense. Interest expense for the year ended December 31, 2022 was approximately $0.6 million, compared to interest expense of approximately $0.9 million in 2021. The decrease of interest expense in 2022 was mainly due to the decrease of interest accrual and the amortization of debt discount from issuance of convertible notes in 2021.
Income tax expense. We recorded income tax expense of $69,869 for the year ended December 31, 2022, as compared to $5,321 of income tax expense in 2021.
Net loss (income) from discontinued operations. Net loss from discontinued operations for the year ended December 31, 2022 was approximately $6.5 million, compared to net income of approximately $1.8 million in 2021.
Net loss attributable to Company. As a result of the cumulative effect of the foregoing factors, we had a net loss attributable to the Company of $7.1 million for the year ended December 31, 2022, as compared to net loss of $9.9 million for the year ended December 31, 2021.
Comparison of Years Ended December 31, 2021 and 2020
Since the cessation of cryptocurrency mining business occurred in December 2022, the comparison of the results of operations for fiscal year ended 31, 2021 and 2020 remain unchanged as that disclosed in the annual report on Form 20-F filed for fiscal year 2021.
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The following table sets forth key components of our results of operations for fiscal years ended December 31, 2021 and 2020, both in dollars and as a percentage of our revenue.
| December 31, 2021 | December 31, 2020 | |||||||||||||||
| Amount | % of Revenue | Amount | % of Revenue | |||||||||||||
| Revenue | $ | 24,845,924 | 100.00 | % | $ | 11,062,775 | 100.00 | % | ||||||||
| Costs of revenue | 15,503,311 | 62.40 | % | 7,119,125 | 64.35 | % | ||||||||||
| Gross profit | 9,342,613 | 37.60 | % | 3,943,650 | 35.65 | % | ||||||||||
| Administrative expenses | (12,389,319 | ) | (49.86 | )% | (16,707,106 | ) | (151.02 | )% | ||||||||
| Impairment losses on cryptocurrencies | (493,617 | ) | (1.99 | )% | - | - | ||||||||||
| Research and development expenses | (4,479,045 | ) | (18.03 | )% | (3,889,126 | ) | (35.16 | )% | ||||||||
| Selling expenses | (694,474 | ) | (2.80 | )% | (714,147 | ) | (6.46 | )% | ||||||||
| (Loss) from operations | (8,713,842 | ) | (35.07 | )% | (17,366,729 | ) | (156.98 | )% | ||||||||
| Subsidy income | 181,620 | 0.73 | % | 556,186 | 5.03 | % | ||||||||||
| (Loss) from equity method investment | (814,440 | ) | (3.28 | )% | - | - | ||||||||||
| Other (loss) income, net | (60,143 | ) | (0.24 | )% | (578,766 | ) | (5.23 | )% | ||||||||
| Gain on sales of cryptocurrencies | 410,979 | 1.65 | % | - | - | |||||||||||
| Interest income | 4,640 | 0.02 | % | 4,798 | 0.04 | % | ||||||||||
| Interest expense | (928,352 | ) | (3.74 | )% | (1,018,013 | ) | (9.20 | )% | ||||||||
| (Loss) before income taxes | (9,919,538 | ) | (39.92 | )% | (18,402,524 | ) | (166.35 | )% | ||||||||
| Income tax (expense) benefit | (5,321 | ) | (0.02 | )% | 71,316 | 0.64 | % | |||||||||
| Net (loss) | (9,924,859 | ) | (39.95 | )% | (18,331,208 | ) | (165.70 | )% | ||||||||
| Less: Net loss attributable to non- controlling interest | - | - | 636,433 | 5.75 | % | |||||||||||
| Net (loss) attributable to Company | $ | (9,924,859 | ) | (39.95 | )% | $ | (17,694,775 | ) | (159.95 | )% | ||||||
Revenue. We generate revenues from cryptocurrency mining, advertising, selling hardware, software, and other technology-related services to customers. For the year ended December 31, 2021, our total revenue was $24.8 million, of which approximately $0.2 million was from related parties, compared to total revenue of $11.0 million for the year ended December 31, 2020, an increase of $13.8 million, or 124.6%. The revenue increase was mainly contributed by products and software sales totaling $5.8 million, advertising from TNM of $2.6 million, and cryptocurrency mining of $5.5 million.
Starting from January 2020, the coronavirus outbreak, also known as COVID-19, has caused the Chinese government to take quarantine measures, such as nationwide lockdowns, transportation restrictions, public gathering prohibitions and temporary closures of non-essential businesses, which had put economic activities in a suspension mode until late March 2020, in addition to the regular Chinese New Year Holiday. Although the COVID-19 pandemic was largely contained in China since the first quarter of 2020 and businesses have gradually resumed to normal operations in 2020, China’s out-of-home advertising market was adversely impacted. In addition, imported infection cases and regional outbreaks of infection persisted throughout 2021.
Upon completion of acquisition of TNM in June 2021, in the digital advertising sector, we became a fully integrated new media advertising enterprise with technical expertise in cloud based new media sharing platform, smart ads display terminal, and mobile applications extended to the end customers who pay for the advertising slots to promote their businesses or special events. In 2021, additional $2.6 million advertising revenue from TNM strengthened our revenue generation, cash flows, liquidity, and capital resources. In 2021 and 2022, we explored various opportunities in the blockchain and digital assets space, specifically by conducting cryptocurrency mining.
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The following table shows our revenue, percentage of revenue, cost of revenue and gross margin, by revenue categories:
| Year Ended December 31, 2021 | Year Ended December 31, 2020 | |||||||||||||||||||||||||||||||
| % of | Cost of | Gross | % of | Cost of | Gross | |||||||||||||||||||||||||||
| Revenue | Revenue | Revenue | Margin | Revenue | Revenue | Revenue | Margin | |||||||||||||||||||||||||
| Products | $ | 10,724,707 | 43.16 | % | 9,890,346 | 7.78 | % | $ | 6,966,868 | 62.98 | % | 6,211,647 | 10.84 | % | ||||||||||||||||||
| Software | 5,174,422 | 20.83 | % | 582,490 | 88.74 | % | 3,080,152 | 27.84 | % | 572,054 | 81.43 | % | ||||||||||||||||||||
| Advertising | 2,577,712 | 10.37 | % | 2,193,945 | 14.89 | % | - | - | - | - | ||||||||||||||||||||||
| Cryptocurrency | 5,455,345 | 21.96 | % | 2,767,186 | 49.28 | % | - | - | - | - | ||||||||||||||||||||||
| Others | 913,738 | 3.68 | % | 69,344 | 92.41 | % | 1,015,755 | 9.18 | % | 335,424 | 66.98 | % | ||||||||||||||||||||
| Total | $ | 24,845,924 | 100.00 | % | 15,503,311 | 37.60 | % | $ | 11,062,775 | 100.00 | % | 7,119,125 | 35.65 | % | ||||||||||||||||||
A breakdown of revenue, percentage of revenue, cost of revenue and gross margin by segments is as follows:
| Year Ended December 31, 2021 | Year Ended December 31, 2020 | |||||||||||||||||||||||||||||||
| % of | Cost of | Gross | % of | Cost of | Gross | |||||||||||||||||||||||||||
| Revenue | Revenue | Revenue | Margin | Revenue | Revenue | Revenue | Margin | |||||||||||||||||||||||||
| TIT Segment | $ | 636,743 | 2.56 | % | 633,713 | 0.48 | % | $ | 377,499 | 3.41 | % | 319,921 | 15.25 | % | ||||||||||||||||||
| CBT Segment | 18,753,836 | 75.48 | % | 13,166,742 | 29.79 | % | 10,685,276 | 96.59 | % | 6,799,204 | 36.19 | % | ||||||||||||||||||||
| BT Segment | 5,455,345 | 21.96 | % | 1,702,856 | 68.79 | % | - | - | - | - | ||||||||||||||||||||||
| Total | $ | 24,845,924 | 100.00 | % | 15,503,311 | 37.60 | % | $ | 11,062,775 | 100.00 | % | 7,119,125 | 35.47 | % | ||||||||||||||||||
Cost of revenue and gross profit. As indicated in the tables above, our cost of revenue increased by $8.4 million, which were mainly attributed to increases in cost of products of $3.7 million, cost of advertising of $2.2 million, and cost of cryptocurrency mining of $2.8 million, or 117.8%, to $15.5 million, for the year ended December 31, 2021, from $7.1 million for the year ended December 31, 2020. As a percentage of revenue, our cost of revenue decreased to 62.4% during the year ended December 31, 2021, from 64.4% during the year ended December 31, 2020. As a result, gross profit as a percentage of revenue increased to 37.6% for the year ended December 31, 2021 from 35.7% for the year ended December 31, 2020. The increase in the overall gross margin primarily resulted from higher margin of software revenue and cryptocurrency mining. We expect the gross margin of 2022 will increase slightly due to the new business developments in block chain related businesses.
Administrative expenses. Our administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, professional advisor consulting fees, audit fees, and other expenses incurred in connection with general operations. Our administrative expenses decreased by $4.3 million, or 25.8%, to $12.4 million for the year ended December 31, 2021, from $16.7 million for the year ended December 31, 2020. As a percentage of revenue, administrative expenses decreased to 49.9% for 2021, from 151.0% for 2020. Such decrease was primarily due to a decrease of $8.0 million in allowance for credit losses, offset by an increase in share-based compensation of $2.4 million to certain employees and consultants. We expect that the administrative expenses in 2022 will decrease as a result of the decrease of allowance of credit losses with the recovery of out-of-home advertising market and overall economy of China, and the decrease of share-based compensation to employees. As a percentage of revenue, administrative expenses will decrease as result of the decrease of its amount and the expected additions of new revenue streams.
Research and development expenses. Our research and development expenses consist primarily of personnel related expenses, as well as costs associated with new software and hardware development and enhancement. Our research and development expenses increased by $0.6 million, or 15.2%, to $4.5 million for the year ended December 31, 2021, from $3.9 million for the year ended December 31, 2020. Such increase was primarily due to the increase of depreciation of R&D related hardware equipment and software, and the increase in payroll and benefits to R&D staff. As a percentage of revenue, research and development expenses decreased to 18.0% for 2021, from 35.2% for 2020.
Selling expenses. Our selling expenses consist primarily of the compensation and benefits to our sales and marketing staff, traveling costs, and other selling activities related costs. Our selling expenses decreased by $0.02 million, or 2.8%, to $0.69 million for the year ended December 31, 2021, from $0.71 million for the year ended December 31, 2020. This decrease was due to the decrease of the amortization expenses, offset by the increased payroll expenses of sales department which was in line with the increase in revenues. We expect that the selling expenses in 2022 will slightly increase in line with revenue increase, while as a percentage of revenue, selling expenses will slightly decrease.
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Subsidy income. Because we have developed a number of new products that are promoted and designated by the Chinese government as highly innovative technology, we received governmental subsidies of $0.2 million and $0.6 million in years ended December 31, 2021 and 2020, respectively.
Other (loss) income. Other loss for the year ended December 31, 2021 was approximately $0.1 million, compared to other loss of approximately $0.6 million in 2020. Other loss in 2021 was mainly the income of the return of tax payable accrued in prior years of $0.4 million, offset by the loss of inventory write-off of $0.3 million and other miscellaneous losses of approximately $0.2 million.
Interest expense. Interest expense for the year ended December 31, 2021 was approximately $0.9 million, compared to interest expense of approximately $1.0 million in 2020. The decrease of interest expense in 2021 was mainly due to the decrease of interest accrual and the amortization of debt discount from issuance of convertible notes in 2020.
Income tax expense. We recorded income tax expense of $5,321 for the year ended December 31, 2021, as compared to $71,316 of income tax benefit in 2020, primarily as a result of the decrease of reclaims of excess accrual of income tax payable in the prior years.
Net loss attributable to Company. As a result of the cumulative effect of the foregoing factors, we had a net loss attributable to the Company of $9.9 million for the year ended December 31, 2021, as compared to net loss of $17.7 million for the year ended December 31, 2020.
Inflation
Inflation does not materially affect our business or the results of our operations.
Foreign Currency Fluctuations
See Item 11 “Quantitative and Qualitative Disclosures about Market Risk—Foreign Exchange Risk.”
B. Liquidity and Capital Resources
As of December 31, 2022, we had cash and cash equivalents of $1.0 million.
In January 2020, the Company adopted ASU 2016-13, Topics 326-Credit Losses, Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology, as its accounting standard for its trade accounts receivable.
The Company considers the following factors when determining whether to permit a longer payment period or provide other concessions to customers:
| ● | the customer’s past payment history; |
| ● | the customer’s general risk profile, including factors such as the customer’s size, age, and public or private status; |
| ● | macroeconomic conditions that may affect a customer’s ability to pay; and |
| ● | the relative importance of the customer relationship to the Company’s business. |
The normal credit term is ranging from 1 month to 3 months after the customers’ acceptance of high-end data storage servers or software, and completion of advertising and other services, and ranging from 1 month to 6 months after the customers’ acceptance of ads display terminals. However, because of various factors of business cycle, the actual collection of outstanding accounts receivable may be beyond the normal credit terms.
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The allowance for credit losses at December 31, 2022 and 2021, totaled approximately $25.5 million and $27.3 million, respectively, representing management’s best estimate. The following table describes the movement for allowance for credit losses during the year ended December 31, 2022.
| Balance at December 31, 2021 | $ | 27,262,848 | ||
| Decrease for balance due to transfer of a company | (771,189 | ) | ||
| Increase in allowance for credit losses | 674,664 | |||
| Foreign exchange difference | (1,682,028 | ) | ||
| Balance at December 31, 2022 | $ | 25,484,295 |
The following table summarizes the key cash flow components from our consolidated statements of cash flows for the periods indicated.
Cash Flows
| Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Net cash (used in) operating activities | (9,035,875 | ) | (16,149,498 | ) | (1,782,839 | ) | ||||||
| Net cash provided by (used in) investing activities | 4,310,557 | (14,000,268 | ) | (1,733,643 | ) | |||||||
| Net cash provided by financing activities | 22,716 | 33,028,157 | 3,072,948 | |||||||||
| Effects of exchange rate changes on cash and cash equivalents | 1,194,576 | 555,961 | 20,782 | |||||||||
| Net (decrease) increase in cash and cash equivalents | (3,508,026 | ) | 3,434,352 | (422,752 | ) | |||||||
| Cash, cash equivalents, and restricted cash at beginning of the year | 4,531,266 | 1,096,914 | 1,519,666 | |||||||||
| Cash, cash equivalents, and restricted cash at end of the year | 1,023,240 | 4,531,266 | 1,096,914 | |||||||||
Operating Activities
Net cash used in operating activities was $9.0 million for the year ended December 31, 2022 and net cash used in operating activities was $16.1 million for the year ended December 31, 2021 and $1.8 million for the year ended December 31, 2020. For the fiscal year 2022, net cash used in operating activities were primarily attributed to the increase in accounts receivable for approximately $4.0 million and approximately $6.0 million for decrease in accounts payable.
Investing Activities
Net cash provided by investing activities was $4.3 million and used in $14.0 million for the year ended December 31, 2022 and 2021, respectively. Net cash used in investing activities was $1.7 million for the year ended December 31, 2020. Net cash provided by investing activities in 2022 was mainly due to purchase of property and equipment of approximately $1.8 million, offset by the proceeds from sales of property and equipment of $1.1 million, and proceeds from sales of cryptocurrencies of $5.0 million.
Financing Activities
Net cash provided by financing activities was $22,700 for the year ended December 31, 2022, mainly attributable to proceeds from borrowings under short-term loans of $7.4 million, and repayment of short-term loan of $7.4 million. Net cash provided in financing activities was $33.0 million for the year ended December 31, 2021, mainly attributable to receipts of the borrowings from related party of $3.1 million, and net proceeds of $28.3 million from issuance of ordinary shares through private placement offerings. Net cash provided by financing activities was $3.1 million for the year ended December 31, 2020, mainly attributable to the receipts of $2.7 million of net proceeds from a convertible note financing, and $1.2 million of net proceeds from private placement.
Loan Facilities
As of December 31, 2022 and 2021, our loan facilities were as follows:
Short-term bank loans
| December 31, | ||||||||
| 2022 | 2021 | |||||||
| Secured short-term loans | $ | 7,203,762 | $ | 7,792,125 | ||||
| Total short-term bank loans | $ | 7,203,762 | $ | 7,792,125 | ||||
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Management’s Plans
In 2022, COVID-19 pandemic was largely contained in China. As a result of the gradual recovery of the market conditions and customer demands, the Company’s revenue of continuing operations achieved 25.0% for year 2022 year-over-year increase. The Company has also significantly improved profitability by $2.8 million by reducing net loss to $7.1 million. Cash and cash equivalents at December 31, 2022 was $1.0 million, compared to cash and cash equivalents of $4.5 million a year ago.
The Company incurred a net loss of approximately $7.1 million for year ended December 31, 2022, compared to a net loss of $9.9 million for 2021. The improved profitability was mainly due to the decrease of provision of allowance of credit losses and the expenses of stock-based compensation. As of December 31, 2022, the Company had a working capital deficit of approximately $0.2 million, improved from a working capital deficit of $3.9 million as of December 31, 2021.
In June 2021, the Company completed an acquisition of 100% of equity of TNM to offer more comprehensive services of the new media sharing platform and enhance revenue generation from new media and advertising sectors. As a result of the acquisition, revenue from advertising nearly doubled for year 2022, as compared with year 2021. In April 2021, the Company also formed a blockchain business segment and engages in cryptocurrency mining activities as the first initiative of this sector to supplement the diminished Traditional Information Technology (TIT) business segment as a part of new business transformation. However, due to the decreased output and the highly volatile cryptocurrency market, revenue generated from cryptocurrency mining decreased to $4.1 million in 2022, as compared to $5.5 million in 2021. In December 2022, the Company ceased its cryptocurrency mining business, and will continue to focus the efforts on its digital adverting, smart display and the newly added smart community and related businesses.
The Company’s two core competencies, the Taoping national sales network and the highly scalable and compatible cloud platform, and its strong software development capability, make it a valued partner by many other smart-community customers and solution providers. In addition to seeking strategic acquisition to expand its digital advertising business, the Company continues to explore business opportunity in the smart community and new energy sectors. From late 2022 to April 2023, the Company has entered into a series of long-term strategic cooperation agreements with various customers to provide Taoping’s cloud-based intelligent product solutions, including smart large screen, IoT smart rest station and off-grid wastewater treatment solution, which are expected to generate significant revenue growth and operating cashflow for the Company for year 2023 and beyond.
If the Company’s execution of business strategies is not successful in addressing its current financial concerns, additional capital raise from issuing equity security or debt instrument or additional loan facility may occur to support required cash flows. The Company’s existing $7.2 million revolving bank loan, which was collateralized with the Company’s office property, provides important capital support for its operation. In addition, it is in the process of renewing the bank facility line with a total value of approximately $11.9 million. From equity financing perspective, the Company’s effective F-3 registration statement facilitates potential future equity offerings. In conclusion, the Company believes that it has the ability to raise needed capital to fund its operations and business growth, and is able to operate as a going concern.
However, the Company can make no assurances that financing will be available for the amounts we need, or on terms commercially acceptable to us, if at all. If one or all of these events do not occur or subsequent capital raise was insufficient to bridge financial and liquidity shortfall, substantial doubt exists about the Company’s ability to continue as a going concern. The consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty.
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Intercompany Transfers
Our subsidiaries organized in the PRC may pay dividends only out of their accumulated profits. Our PRC subsidiaries are required to set aside at least 10% of their after-tax profit to their general reserves until such reserves cumulatively reach 50% of their respective registered capital. General reserves of our PRC subsidiaries are not distributable as cash dividends. Restrictions on our net assets also include the conversion of local currency into foreign currencies, tax withholding obligations on dividend distributions, the need to obtain approval from SAFE for loans to a non-PRC consolidated entity, and the covenants or financial restrictions related to outstanding debt obligations. We are not aware of other restrictions on our net assets or the transferability of assets via loans or advances to our non-PRC consolidated entities. As our operations are principally based in China, our non-PRC consolidated entities do not have material cash obligations.
The following table provides the amount of our statutory general reserve, the amount of restricted net assets, consolidated net assets, and the amount of restricted net assets as a percentage of consolidated net assets, as of December 31, 2022 and 2021:
| December 31, | ||||||||
| 2022 | 2021 | |||||||
| PRC general reserve - restricted net assets | $ | 10,209,086 | $ | 14,044,269 | ||||
| Consolidated net assets | $ | 9,616,692 | $ | 19,252,258 | ||||
| Restricted net assets as percentage of consolidated net assets | 106.16 | % | 72.95 | % | ||||
An offshore holding company, as a shareholder of a Foreign Investment Entity (FIE), can make loans to the FIE, provided the parties being in compliance with the PRC regulations governing such loans. Our parent company can make a shareholder loan to a PRC subsidiary provided that (i) the amount of the loan does not exceed the difference between the total investment and registered capital as approved by the local Administration for Industry and Commerce that issued the business license of the subsidiary; and (ii) before the loan can be converted into RMB, the subsidiary reports to SAFE the intended use of proceeds (which cannot be to purchase domestic assets). The subsidiary can finance the operations of iASPEC in accordance with the terms of the MSA with iASPEC.
As of December 31, 2022 and 2021, the breakdown of our cash and cash equivalents (including restricted cash) was as follows:
| December 31, | ||||||||
| 2022 | 2021 | |||||||
| Cash located outside of the PRC | $ | 17,348 | $ | 318,880 | ||||
| Cash held by VIE and its subsidiaries | - | - | ||||||
| Cash held by other entities located in the PRC (except VIEs noted above) | 997,243 | 4,206,472 | ||||||
| Cash and cash equivalents from continuing operations | 1,014,591 | 4,525,352 | ||||||
| Cash and cash equivalents from discontinued operations | 8,649 | 5,914 | ||||||
| $ | 1,023,240 | $ | 4,531,266 | |||||
We do not believe that there would be any material costs to transfer cash outside the PRC. In addition, as our operations are principally based in China, our non-PRC consolidated entities do not incur material cash obligations. If nature of the businesses for our non-PRC consolidated entities have changed in the future and require material amounts of cash being transferred to them, we will assess the feasibility and plan cash transfers in accordance with foreign exchange regulations, taking into account of tax consequences. A company registered in mainland China must apply for and receive an approval from the State Administration of Foreign Exchange to remit foreign currency to any foreign country, and must comply with PRC statutory reserve requirement as disclosed in Item 3 Key Information – D. Risk Factor of this annual report. As we conduct all of our operations in China, our inability to convert cash and short-term investments held in RMB to other currencies will materially affect our liquidity.
C. Research and Development, Patents and Licenses, Etc.
Our industry is characterized by extremely rapid technological change, evolving industry standards, and changing customer demands. These conditions require continuous expenditures on product research and development to enhance existing products, create new products, and avoid product obsolescence. See Item 3 “Key Information—D. Risk Factors—If we are unable to develop and offer competitive new products and services, our future operations could be adversely affected,” —”If we are unable to keep abreast with the rapid technological changes in our industry, demand for our products and services could decline and adversely affect our revenue and growth,” and —”Our technology may become obsolete, which could materially adversely affect our ability to sell our products and services.” For a detailed analysis of research and development costs, see Item 5.A. “Operating Results—Results of Operations—Research and development expenses”.
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D. Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trend, uncertainty, demand, commitment or event that is reasonably likely to have a material effect on our net revenues and income from continuing operations, profitability, liquidity, capital resources, or would cause reported financial information not necessarily to be indicative of future operation results or financial condition.
E. Critical Accounting Estimates.
The preparation of financial statements in conformity with U.S. GAAP requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:
Revenue Recognition
In accordance with the ASC 606, the Company recognizes revenues net of applicable taxes, when goods or services are transferred to customers in an amount that reflects the consideration to which the Company expects to receive in exchange for those goods or services.
The Company generates its revenues primarily from five sources: (1) product sales, (2) software sales, (3) advertising, (4) cryptocurrency mining, and (5) other sales. Revenue is recognized when obligations under the terms of a contract with our customers are satisfied, generally, upon delivery of the goods and services and receipts of cryptocurrencies from cryptocurrency mining pools.
Although our performance obligation in our contracts with the mining pool operator is the provision of computing power, we are not entitled to any compensation for computing power provided when the pool operator is unsuccessful in placing a block to the blockchain.
Revenue - Products
Product revenues are generated primarily from the sale of Cloud-Application-Terminal based digital ads display terminals with integrated software essential to the functionality of the hardware to our customers (inclusive of related parties) and high-end data storage servers. Although manufacturing of the products has been outsourced to the Company’s Original Equipment Manufacturer (OEM) suppliers, the Company has acted as the principal of the contract. The Company recognized the product sales at the point of delivery. The Company has indicated that it may from time to time provide future unspecified software upgrades to the hardware products’ essential software, which is expected to be infrequent and, free of charge. Non-software service is mainly the one-time training session provided to the customer to familiarize them with the software operation upon the customer’s initial introduction to the software platform. The costs of providing infrequent software upgrade and training are de minimis. As a result, the Company does not allocate transaction price to software upgrade and customer training. Product sales are classified as “Revenue-Products” on the Company’s consolidated statements of operations.
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Revenue – Software
The Company designs and develops software products. Software development projects usually include developing software, integrating various isolated software systems into one, and testing the system. The design and build services, together with the integration of the various elements, are generally determined to be essential to the functionality of the delivered software. The contracted price is usually paid at the delivery of the software. The Company usually provides non-software services including after-sale support, technical training. The technical training only occurs at the introduction of the software. The software is highly specialized and stable, after-sale support and subsequent upgrade or enhancement are infrequent. The Company has estimated the costs associated with the non-software performance obligations and concludes that these obligations are de minimis to the overall contract. Therefore, the Company does not further allocate transaction price.
The Company usually completes the software support service in one-off and recognizes the revenue at the point of delivery of service because the Company does not have an enforceable right to payment for performance completed to date. Revenues from software development contracts are classified as “Revenue-Software” on the Company’s consolidated statements of operations.
Revenue - Advertising
The Company generates revenues primarily from providing advertising slots to customers to promote their businesses by broadcasting advertisements on identifiable digital ads display terminals and vehicular ads display terminals in different geographic regions and locations through a cloud- based new media sharing platform. The Company is only obligated to broadcast the advertisements to the contracted digital ads display terminals, and therefore allocates 100% of the transaction price to advertisement broadcasting. The transaction price for advertisement broadcasting is fixed based on the numbers of advertisement delivery and duration of the contract, and has no variable consideration, or significant financing component, or subsequent price change, and is not refundable.
The Company recognizes the revenues, net of applicable taxes, from advertisement broadcasting contracts with customers over the contracted advertising duration.
Revenue - Cryptocurrency mining
The Company has entered into digital asset mining pools by executing contracts with the mining pool operators to provide computing power to the mining pool. The contracts are terminable under certain circumstances. Both the Company and the mining pool operator have the right to terminate the contract at any time, with or without cause, and without compensation. In exchange for providing computing power, the Company is entitled to a fractional share of the fixed cryptocurrency awards the mining pool operator receives (less digital asset transaction fees to the mining pool operator, if any.) for successfully adding a block to the blockchain. The Company’s fractional share is based on the proportion of computing power the Company contributed to the mining pool operator to the total computing power contributed by all mining pool participants in solving the current algorithm. The contract first exists upon the successful placement of a block on the blockchain by the pool operator because that is the point when the parties have performed their contract obligation and neither party can unilaterally terminate the contract without compensating the other party.
Providing computing power in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing such computing power is the only performance obligation in the Company’s contract with mining pool operator.
The transaction consideration the Company receives, if any, is noncash consideration, which the Company measures at fair value using the quoted price from principal market of the related cryptocurrency on the date received, which is not materially different than the fair value at the contract inception or at the time the Company has earned the award from the pools. The consideration is all variable. Because it is not probable that a significant reversal of cumulative revenue will not occur (ASC 606-10-32-11), the consideration is constrained until the mining pool operator successfully places a block (by being the first to solve an algorithm), and the Company receives confirmation of the consideration it will receive, at which time revenue is recognized. There is no financing component, nor allocation of transaction price in these transactions.
Revenue - Other
The Company also reports other revenue which comprises revenue generates from System upgrade and technical support services, platform service fee, and rental income.
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System upgrade and technical support revenue is recognized when performance obligations are satisfied upon completion of the services. Platform service fee is charged based on number of the display terminals used by the customers or a percentage of advertising revenue generated by the display terminals. Platform service revenue is recognized on a monthly basis over the contract period.
The Company follows ASC 842 – Leases that requires lessor to identify the underlying assets and allocate rental income among considerations in lease and non-lease components. The Company owns two units of office space renting out to a third party and TNM under non-cancelable operating lease agreements with lease terms of six years starting from May 1, 2016 and three years starting from July 1, 2019, respectively. The lease agreements have fixed monthly rental payments, and no non-lease component or option for lessees to purchase the underlying assets. The Company collects monthly rental payments from the lessees and recognizes rental income.
After completion of the business acquisition on June 9, 2021, TNM became a subsidiary of the Company, and is no longer a related party. The rental income from TNM has become an intercompany revenue and been eliminated since June 9, 2021.
Contract balances
The Company records advances from customers when cash payments are received or due in advance of our performance.
Practical expedients and exemptions
The Company generally expenses sales commissions if any incurred because the amortization period would have been one year or less. In many cases, the Company is approached by customers for customizing software products for their specific needs without incurring significant selling expenses.
The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
Accounts Receivable, Accounts Receivable –related parties
Accounts receivable are recognized and carried at carrying amount less an allowance for credit loss, if any. The Company maintains an allowance for credit losses resulting from the inability of its customers to make required payments based on contractual terms. The Company reviews the collectability of its receivables on a regular and ongoing basis according to historical trend, and estimates its provision for expected credit losses on receivables aging analysis.
The Company estimates allowance for credit losses for the anticipation of future economic condition and credit risk indicators of customers, including the potential impact of the COVID-19 pandemic on its customers’ businesses. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. In the event the Company recovers amounts previously reserved for, the Company will reduce the specific allowance for credit losses.
Inventories
Inventories are valued at the lower of cost (weighted average basis) and net realizable value. Net realizable value is the expected selling price in the ordinary course of business minus any costs of completion, disposal, and transportation to make the sale.
The Company performs an analysis of slow-moving or obsolete inventory periodically and any necessary valuation reserves, which could potentially be significant, are included in the period in which the evaluations are completed. Any inventory impairment results in a new cost basis for accounting purposes.
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Cryptocurrencies
Cryptocurrencies held, including Bitcoin and Ethereum, are accounted for as intangible assets with indefinite useful lives. An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the cryptocurrency at the time its fair value is being measured. If the carrying amount of the cryptocurrency exceeds its fair value, the Company recognizes an impairment loss in an amount equal to that excess. Subsequent reversal of impairment losses is not permitted.
There are no cash flows from cryptocurrencies included in net cash used in operating activities since the revenue recognized from mining is a noncash activity. The sales of cryptocurrencies are included within investing activities in the consolidated statements of cash flows and any realized gains or losses from such sales are included in other income (expense) in the consolidated statements of operations. The Company accounts for its gains or losses in accordance with the first in first out (FIFO) method of accounting.
Long-term investment
The Company’s long-term investment consists of investments accounted for under the equity method and equity investments without readily determinable fair value. Pursuant to ASC 321, equity investments, except for those accounted for under the equity method, those that result in consolidation of the investee and certain other investments, are measured at fair value, and any changes in fair value are recognized in earnings. For equity securities without readily determinable fair value and do not qualify for the existing practical expedient in ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) to estimate fair value using the net asset value per share (or its equivalent) of the investment, the Company elected to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any.
For equity investments that the Company elects to measure at cost, less any impairment, plus or minus changes resulting from observable price changes, the Company makes a qualitative assessment considering impairment indicators to evaluate whether investments are impaired at each reporting date. Impairment indicators considered include, but are not limited to, a significant deterioration in the earnings performance or business prospects of the investee, including factors that raise significant concerns about the investee’s ability to continue as a going concern, a significant adverse change in the regulatory, economic, or technologic environment of the investee and a significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates. If a qualitative assessment indicates that the investment is impaired, the entity has to estimate the investment’s fair value in accordance with the principles of ASC 820. For equity investments without readily determinable fair value, the Company uses Level 3 inputs of fair value accounting in accordance with ASC 820-10 and recognizes impairment loss other than temporary in the statement of operations equal to the difference between its initial investment and its proportional share of the net book value of the investee’s net assets which approximates its fair value.
For impairment on equity investments without readily determinable fair value, the Company uses Level 3 inputs of fair value accounting in accordance with ASC 820-10 and recognizes impairment loss in the statement of operations equal to the difference between its initial investment and its proportional share of the net book value of investee’s net assets which approximates its fair value if those are determined to be other than temporary.
Operating leases - Right-of-use assets and lease liabilities
The Company accounts for lease under ASC 842 “Leases”, and also elects practical expedient not to separate non-lease component from lease components in accordance with ASC 842-10-15-37 and instead to account for each separate lease component and the non-lease components associated with that lease component as a single lease component. The Company also elects the practical expedient not to recognize lease assets and lease liabilities for leases with a term of 12 months or less.
The Company recognized a lease liability and corresponding right-to-use asset based on the present value of minimum lease payments discounted at the Company’s incremental borrowing rate. The Company records amortization and interest expense on a straight-line basis based on lease terms and reduces lease liabilities upon making lease payments.
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Income Taxes
Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are recognized for all significant temporary differences at enacted rates and classified as non-current in the financial statements. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion, or all of, the deferred tax assets will not be realized. The Company classifies interest and/or penalties related to unrecognized tax benefits, if any, as a component of income tax expense.
Discontinued Operations
The Company follows “ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” for reporting discontinued operations. Under the revised standard, a discontinued operation must represent a strategic shift that has or will have a major effect on an entity’s operations and financial results. Examples could include a disposal of a major line of business, a major geographical area, a major equity method investment, or other major parts of an entity. The revised standard also allows an entity to have certain continuing cash flows or involvement with the component after the disposal. Additionally, the standard requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations.
Recent Accounting Pronouncements
Please refer to Note 2 to our audited consolidated financial statements for a discussion of relevant pronouncements.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management1
The following table sets forth certain information regarding our directors and senior management, as well as employees upon whose work we are dependent, as of the date of this annual report.
| NAME | AGE | POSITION | ||
| Jianghuai Lin | 54 | Chairman of the Board, Chief Executive Officer | ||
| Zhiqiang Zhao | 52 | President and Director | ||
| Liqiong (Iris) Yan | 46 | Chief Financial Officer | ||
| Zhixiong Huang | 54 | Chief Operating Officer | ||
| Guangzeng Chen | 44 | Chief Technology Officer | ||
| Qian Wang | 36 | Chief Investment Officer | ||
| Huan Li | 38 | Chief Marketing Officer | ||
| Yunsen Huang | 77 | Director | ||
| Yong Jiang | 49 | Director | ||
| Remington C.H. Hu | 57 | Director |
Mr. Jianghuai Lin. Mr. Lin has been the Chairman of Board of Directors and the Chief Executive Officer of the Company since 2006. Mr. Lin has also served as the Chairman and Chief Executive Officer of our subsidiary, IST, since its incorporation in January 2006. During the period from September 2000 to June 2004, Mr. Lin served as the President and Chief Executive Officer of Hong Kong United Development Group, a consolidated enterprise engaging in investment, high technology, and education. Before that, during the period from February 1995 through August 2000, Mr. Lin was a Director and the General Manager of Fujian Wild Wolf Electronics Limited, a company engaged in the business of manufacturing electrical consumer products. Mr. Lin holds a Master’s Degree in Software Engineering from Wuhan University and a Bachelor’s Degree in Industrial Accounting from Xiamen University.
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Mr. Zhiqiang Zhao. Mr. Zhao has been the President of the Company since August 2015 and a member of Board of Directors since June 19, 2012. Mr. Zhao has extensive experience in corporate operations and integrations, strategic planning, and human resource management. From March 2003 to March 2005, Mr. Zhao served as Supervisor of Human Resources for the Foxconn Technology Group. From April 2005 to July 2006, Mr. Zhao served as Administrative and Human Resource Director of iASPEC; and as Deputy General Manager of iASPEC from July 2006 to August 2010. From November 2010, Mr. Zhao began serving as the Chief Operating Officer and Vice President of the Company. From August 2010, he was vice chairman of iASPEC. From July 2011, Mr. Zhao served as General Manager of ISIOT (former HPC Electronics (Shenzhen) Ltd.). Mr. Zhao holds a Bachelor’s Degree in Mechanical & Electrical Engineering from Inner Mongolia University.
Ms. Liqiong (Iris) Yan. Ms. Yan has been the Chief Financial Officer of the Company since May 2021. Ms. Yan has over ten years’ experience in finance, investor relations and corporate governance. She served as the Company’s Assistant CFO between 2018 and 2021 and prior to that she was the Director of Investor Relations and Secretary of the Board of the Company since 2007. During her tenure, Ms. Yan assisted in Company’s NASDAQ listing, Company’s strategic acquisitions and overseas equity/debt financings, and was instrumental in strategy planning, financial management and capital strategy management. Ms. Yan is a Certified Management Accountant (CMA) licensed by the Institute of Management Accountants. Ms. Yan received a postgraduate diploma in Investment from Fudan University and a bachelor’s degree in International Economics from Beijing Normal University.
Mr. Zhixiong Huang. Mr. Huang has been Chief Operating Officer of the Company since August 2015. Between July 2001 and March 2002, Mr. Huang served as the General Manager of product development of Shenzhen Runsheng Information Systems Company Ltd., and was responsible for overseeing general operations. From September 2002 and October 2006, Mr. Huang served as the deputy general manager of iASPEC, where he supervised iASPEC’s research and development activities and consulted on various sophisticated technical issues. From January 2006 to September 2013, he served as the Company’s Vice President, and was Chief Technology Officer from December 2008 and September 2013. Mr. Huang holds a Bachelor’s Degree in computer science from Hehai University in China, and has over twenty years of’ experience in information systems. Mr. Huang is currently a Director of the Shenzhen Computer Association, and an expert with the Shenzhen Expert Association and the Shenzhen Science and Technology Innovation Association.
Mr. Guangzeng Chen. Mr. Chen has served as Chief Technology Officer of the Company since December 1, 2015. Mr. Chen joined the Company as Vice President of the Research & Development Division in March 2014. Prior to joining the Company, Mr. Chen was a project manager at CoolPad Group Limited, a Shenzhen-based telecommunications equipment company that was one of the top ten smartphone manufacturing companies in China, from May 2011 to February 2014. Previously, Mr. Chen was the head of research and development at VideoHome, a Taiwanese multimedia appliance manufacturer and exporter, from June 2004 to May 2011. Mr. Chen graduated from Zhengzhou University with a Bachelor’s Degree in Computer Science.
Mr. Qian Wang. Mr. Wang has served as Chief Investment Officer of the Company since March 2021. Mr. Wang has extensive industry experience in cloud computing services, blockchain applications and operations, and overseas capital market operations. Before joining the Company, he served as co-Chief Executive Officer of Grand Shores Technology (1647.HK), the major business of which focuses on design, construction, and operation of crypto cloud computing centers and development of blockchain innovation. Mr. Wang got CFA charter and received both a Postgraduate Diploma in Financial Markets and Portfolio Management and Bachelor’s degree in Accounting and Finance from the University of Hong Kong.
Mr. Huan Li. Mr. Li has served as Chief Marketing Officer of the Company since July 2021. He has over 15 years’ experience in the culture and media field. He has worked as a reporter for several media outlets including Asia Pacific Media Group. Mr. Li has been directly responsible for the planning and operation management of a number of large-scale commercial and cultural projects. Mr. Li holds a Bachelor’s Degree in Journalism from Jiangsu Ocean University in China.
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Mr. Yunsen Huang. Mr. Huang has been a member of Board of Directors of the Company since June 19, 2012, and was a member of the Board of CITN from August 10, 2007 until completion of the corporate reorganization on October 31, 2012. Mr. Huang has been a Professor in the School of Information Engineering at Shenzhen University since September 1984. He has involved in many computer application projects, and received many awards, including a First Grade Award of Technology Advancement from Sichuan Province, a Second Grade Award of Technology Advancement from Guangdong Province, and a Third Grade Award of Technology Advancement from the Chemical Ministry. Mr. Huang has published eight books in the field of Networks and Multimedia Applications. In addition, Mr. Huang was a founder and the Chairman of International Software Development (Shenzhen) Co., Ltd, a jointing venture incorporated by IBM, East Asia Bank, and Shenzhen SDC Company, between 2001 and 2006. Currently, Mr. Huang is a Director of the Shenzhen Computer Academy, a Vice Director of the Guangdong Province Computer Academy, as well as Executive Director of China University Computer Basic Education Committee. Mr. Huang holds a Bachelor’s Degree in Electronics Engineering from Tsinghua University.
Dr. Yong Jiang. Dr. Jiang has been a member of Board of Directors of the Company since August 13, 2013. As a professor and supervisor for Ph. D candidates, Dr. Jiang has been the Vice Director of Division of Information Science & Technology and the Director of Network Center in the Graduate School at Shenzhen, Tsinghua University (GSST) since 2002. Dr. Jiang is a member of Association of Computing Machinery (ACM), the world’s largest educational and scientific computing society, and a member of China Computer Federation (CCF). He also serves as the Vice Chairman of Shenzhen Association of Chief Information Officer, and a committee member of Shenzhen Association of Experts. Dr. Jiang was majored in the research of next generation internet and computer network architecture, and has led more than 10 national-level scientific research programs, including programs from National Natural Science Foundation of China (NSFC), the National 863 Program, the pilot program from China Next Generation Internet (CNGI), and National Major Projects. Dr. Jiang graduated from the Department of Computer Science and Technology of Tsinghua University.
Mr. Remington C.H. Hu. Mr. Hu has been a member of Board of Directors of the Company since June 19, 2012 and was a member of the Board of CITN from October 30, 2009 until completion of the corporate reorganization on October 31, 2012. He is a seasoned executive with more than 16 years of experience in corporate finance and investment management, and is the founder and CEO of Tomorrow Capital Limited, a financial advisory firm. Prior to founding Tomorrow Capital Limited, Mr. Hu served, from February 2008 to July 2009, as Chief Financial Officer of Yucheng Technologies Limited, a Nasdaq listed top IT solutions and BPO company servicing Chinese banking industry. From August 2004 to August 2007, Mr. Hu served as China Representative for CVM Capital Partners, LLC, the largest Taiwanese Venture Capital affiliated with the largest Taiwanese private equity investment group. Earlier in his career, Mr. Hu founded and served, from June 1999 to June 2002, as Chief Financial Officer of eSoon Communications International Corp., a software start-up focusing on the then fast-growing CRM/CTI market. He also served, from August 1996 to May 1999, as Vice President of Crimson Asia Capital Holdings, Ltd., former Asia’s largest venture capital firm backed by Taiwanese China Trust Financial Group. He began his career at Citibank, NA, as an Assistant Vice President in the Taipei and Hong Kong. Mr. Hu holds a Master’s Degree in Business Administration from the Wharton Business School and a Bachelor’s Degree in Computer Science and Information Engineering from the National Chiao Tung University.
There is no arrangement or understanding with any major shareholders, customers, suppliers or others, pursuant to which any person named above was selected as a director or member of senior management.
No family relationship exists between any of the persons named above.
B. Compensation
In 2022, we paid an aggregate of approximately $654,659 in cash compensation to our directors and senior management as a group. We do not set aside or accrue any amounts for pension, retirement or other benefits for our directors and senior management. However, we reimburse our directors for out-of-pocket expenses incurred in connection with their services in such capacity.
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2016 Equity Incentive Plan, as amended
On May 9, 2016, the Board of Directors of the Company adopted the 2016 Equity Incentive Plan, or the 2016 Plan, pursuant to which the Company may offer up to five million ordinary shares as equity incentives to its directors, employees and consultants. Such number of shares is subject to adjustment in the event of certain reorganizations, mergers, combinations, recapitalizations, stock splits, stock dividends, or other change in the corporate structure of the Company affecting the shares issuable under the 2016 Plan. On July 30, 2020, the Company effectuated a 6-to-1 reverse stock split, which effectively reduced the ordinary shares authorized to be issued under the 2016 Plan from 5,000,000 to 833,334. On May 9, 2021, the Board of Directors of the Company amended the 2016 Plan to, among other things, (1) increase the number of ordinary shares authorized to be issued pursuant to the 2016 Plan by 4,166,666 to 5,000,000, and (2) extend the term of the 2016 Plan to May 9, 2026.
The following paragraphs summarize the terms of our 2016 Plan:
Purpose. The purposes of the 2016 Plan are to promote the long-term growth and profitability of the Company and its Affiliates by stimulating the efforts of Employees, Directors and Consultants of the Company and its Affiliates who are selected to be participants, aligning the long-term interests of participants with those of shareholders, heightening the desire of participants to continue working toward and contributing to our success, attracting and retaining the best available personnel for positions of substantial responsibility, and generally providing additional incentive for them to promote the success of our business through the grant of Awards of or pertaining to the Company’s ordinary shares. The 2016 Plan permits the grant of ISOs, NSOs, Restricted Shares, Restricted Share Units, Share Appreciation Rights, Performance Units and Performance Shares as the Administrator may determine.
Administration. The 2016 Plan may be administered by our Board or a committee. The 2016 Plan is currently being administered by our Compensation Committee. The Administrator has the authority to determine the specific terms and conditions of all Awards granted under the 2016 Plan, including, without limitation, the number of ordinary shares subject to each Award, the price to be paid for the ordinary shares and the applicable vesting criteria. The Administrator has discretion to make all other determinations necessary or advisable for the administration of the 2016 Plan.
Eligibility. NSOs, Restricted Shares, Restricted Share Units, Share Appreciation Rights, Performance Units and Performance Shares may be granted to Employees, Directors or Consultants either alone or in combination with any other Awards. ISOs may be granted only to employees of the Company, and of any Parent or Subsidiary.
Shares Available for Issuance Under the 2016 Plan. Subject to adjustment as described below, (a) the maximum aggregate number of Shares that may be issued under the 2016 Plan is 5,000,000 ordinary shares, (b) to the extent consistent with Section 422 of the Code, not more than an aggregate of 5,000,000 Ordinary Shares may be issued under ISOs, and (c) not more than 500,000 ordinary shares (or for Awards denominated in cash, the Fair Market Value of 500,000 ordinary shares on the Grant Date), may be awarded to any individual Participant in the aggregate in any one fiscal year of the Company, such limitation to be applied in a manner consistent with the requirements of, and only to the extent required for compliance with, the exclusion from the limitation on deductibility of compensation under Code Section 162(m). The number and class of shares available under the 2016 Plan are subject to adjustment in the event of certain reorganizations, mergers, combinations, recapitalizations, share splits, share dividends, or other similar events which change the number or kind of shares outstanding.
Transferability. Unless otherwise provided in the 2016 Plan or otherwise determined by the Administrator, an Award may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Participant, only by the Participant. However, the Administrator may, at or after the grant of an Award other than an ISO, provide that such Award may be transferred by the recipient to a “family member” (as defined in the 2016 Plan); provided, however, that any such transfer is without payment of any consideration whatsoever and that no transfer shall be valid unless first approved by the Administrator, acting in its sole discretion, and as required by the Company’s memorandum and articles of association. If the Administrator makes an Award transferable, such Award will contain such additional terms and conditions as the Administrator deems appropriate.
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Termination of, or Amendments to, the 2016 Plan. The Board may at any time amend, alter, suspend or terminate the 2016 Plan, provided that the Company will obtain shareholder approval of any 2016 Plan amendment to the extent necessary and desirable to comply with Applicable Laws. No amendment, alteration, suspension or termination of the 2016 Plan will impair the rights of any Participant, unless mutually agreed otherwise between the Participant and the Administrator, which agreement must be in writing and signed by the Participant and the Company. Termination of the 2016 Plan will not affect the Administrator’s ability to exercise the powers granted to it hereunder with respect to Awards granted prior to the date of such termination.
The 2016 Plan will expire on May 9, 2026, unless sooner terminated by the Board.
On May 27, 2016, the following directors and officers were granted options to purchase ordinary shares of the Company under the 2016 Plan:
| ● | Jianghuai Lin, options to purchase 50,000 ordinary shares | |
| ● | Zhiqiang Zhao, options to purchase 33,334 ordinary shares | |
| ● | Zhixiong Huang, options to purchase 33,334 ordinary shares | |
| ● | Guangzeng Chen, options to purchase 25,000 ordinary shares |
The options are exercisable at the fair market value of the Company’s ordinary shares on the grant date ($7.26 per share) with 40% of the options vesting 18 months after the date of grant, 30% vesting 30 months after the date of grant and the remaining 30% vesting 42 months after the date of grant. On January 22, 2018, Messrs. Lin, Zhao, Huang and Chen partially exercised their options granted on May 27, 2016 on a cashless basis, and received 11,934, 7,956, 7,956 and 5,967 ordinary shares of the Company, respectively. On July 31, 2020, Messrs. Lin, Zhao, Huang and Chen partially exercised their options on a cashless basis, and received 5,250, 3,500, 3,500, 2,625 ordinary shares of the Company, respectively.
On May 17, 2017, Mr. Chen was granted options to purchase additional 40,000 ordinary shares of the Company under the 2016 Plan. The options are exercisable at the fair market value of the Company’s ordinary shares on the date of the grant ($5.94 per share) with 40% of the options vesting 12 months after the date of grant, 30% vesting 24 months after the date of grant and the remaining 30% vesting 36 months after the date of grant. On July 31, 2020, Mr. Chen exercised his options on a cashless basis, and received 13,000 ordinary shares of the Company.
On July 10, 2020, a total of 57,366 share options were granted to certain consultants of the Company.
On July 24, 2020, the following directors and officers were granted options to purchase ordinary shares of the Company under the 2016 Plan:
| ● | Jianghuai Lin, options to purchase 42,500 ordinary shares | |
| ● | Zhiqiang Zhao, options to purchase 33,334 ordinary shares | |
| ● | Zhixiong Huang, options to purchase 33,334 ordinary shares | |
| ● | Guangzeng Chen, options to purchase 30,834 ordinary shares |
From December 2021 to July 2022, a total of 30,000 restricted shares were granted to certain consultant of the Company.
As of the date of this report, we have issued 384,524 restricted shares and granted options to purchase an aggregate of approximately 390,714 ordinary shares under the 2016 Plan.
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C. Board Practices
Terms of Directors and Executive Officers
Our Board of Directors currently consists of five directors, who were elected to serve until they resign, are removed or otherwise leave offices. Eligible directors may be elected by shareholders at any general meeting by a majority of votes cast assuming properly proposed or nominated in accordance with our memorandum and articles of association.
Any member or the Board may propose any person for election as a director. Where any person, other than a director retiring at the meeting or a person proposed for re-election or election as a director by the Board, is to be proposed for election as a director, notice must be given to the Company of the intention to propose him and of his willingness to serve as a director. Such notice must be given not later than 10 days following the earlier of the date on which notice of the general meeting was posted to the shareholders or the date on which public disclosure of the date of the next general meeting was made. Where the number of persons validly proposed for re-election or election as a director is greater than the number of directors to be elected, the persons receiving the most votes (up to the number of directors to be elected) shall be elected as directors, and an absolute majority of the votes cast shall not be a prerequisite to the election of such directors.
Each director so elected holds office for the term, if any, as may be specified in the resolution appointing him or until his earlier death, disqualification, resignation or removal. The directors may appoint one or more directors to fill a vacancy on the Board of Directors. We do not have any contracts with our directors providing for benefits upon termination of employment.
Our executive officers are appointed by our Board of Directors. The executive officers shall hold office until their successors are duly elected and qualified, but any officer elected or appointed by the directors may be removed at any time, with or without cause, by a majority vote of the directors.
The chairman of the board of directors shall have a second or casting vote in the case of an equality of votes at any meeting of the board of directors.
Board Composition and Committees
The Board has established three standing committees: Audit Committee, Compensation Committee and Governance and Nominating Committee. Each of the Audit Committee, Compensation Committee and Governance and Nominating Committee is comprised entirely of independent directors. From time to time, the Board may establish other committees. The Board has adopted a written charter for each of the Committees which are available on the corporate governance page of our website at www.taop.com. Printed copies of these charters may be obtained, without charge, by contacting the Corporate Secretary, Taoping Inc., 21st Floor, Everbright Bank Building, Zhuzilin, Futian District, Shenzhen, Guangdong 518040, China.
Audit Committee and Audit Committee Financial Expert
Our Audit Committee is currently composed of three members: Messrs. Yunsen Huang, Yong Jiang, and Remington C.H. Hu. Our Board of Directors determined that each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for audit committee membership and is an “independent” director within the meaning of the NASDAQ Marketplace Rules. Each Audit Committee member also meets NASDAQ’s financial literacy requirements. Mr. Hu serves as Chair of the Audit Committee.
Our Audit Committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our Audit Committee is responsible for, among other things:
| ● | selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors; | |
| ● | reviewing with our independent auditors any audit problems or difficulties and management’s response; | |
| ● | reviewing and approving all proposed related-party transactions; | |
| ● | discussing the annual audited financial statements with management and our independent auditors; |
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| ● | reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies; | |
| ● | annually reviewing and reassessing the adequacy of our Audit Committee charter; | |
| ● | meeting separately and periodically with management and our internal and independent auditors; | |
| ● | reporting regularly to the full Board of Directors; and | |
| ● | such other matters that are specifically delegated to our Audit Committee by our Board of Directors from time to time. |
Our Board of Directors has determined that Mr. Hu is the “audit committee financial expert” as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC and also meets NASDAQ’s financial sophistication requirements.
Compensation Committee
Our Compensation Committee is currently composed of three members: Messrs. Yunsen Huang, Yong Jiang, and Remington C.H. Hu, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Huang serves as Chair of the Compensation Committee.
The purpose of our Compensation Committee discharges the responsibilities of the Company’s Board of Directors relating to compensation of the Company’s executives, to produce an annual report on executive compensation for inclusion in the Company’s proxy statement, if required, and to oversee and advise the Board on the adoption of policies that govern the Company’s compensation programs, including stock and benefit plans. Our chief executive officer may not be present at any Compensation Committee meeting during which his compensation is deliberated. The Compensation Committee is responsible for, among other things:
| ● | Reviewing and approving the compensation structure for corporate officers at the level of corporate vice president and above; | |
| ● | Overseeing an evaluation of the performance of the Company’s executive officers and approving the annual compensation, including salary, bonus, incentive and equity compensation, for the executive officers; | |
| ● | Reviewing and approving chief executive officer goals and objectives, evaluating chief executive officer performance in light of these corporate objectives, and setting chief executive officer compensation consistent with Company philosophy; | |
| ● | Making recommendations to the Board regarding the compensation of board members; | |
| ● | Reviewing and making recommendations concerning long-term incentive compensation plans, including the use of equity-based plans. Except as otherwise delegated by the Board of Directors, the Compensation Committee will act on behalf of the Board of Directors as the “Committee” established to administer equity-based and employee benefit plans, and as such will discharge any responsibilities imposed on the Compensation Committee under those plans, including making and authorizing grants, in accordance with the terms of those plans. |
Governance and Nominating Committee
Our Governance and Nominating Committee is currently composed of three members: Messrs. Yunsen Huang, Yong Jiang, and Remington C.H. Hu, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Jiang serves as Chair of the Governance and Nominating Committee.
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The Governance and Nominating Committee assists the Board in identifying individuals qualified to become our directors and in determining the composition of the Board and its committees.
The Governance and Nominating Committee is responsible for, among other things:
| ● | identifying and recommending to the Board nominees for election or re-election of the Board, or for appointment to fill any vacancy; | |
| ● | reviewing annually with the Board the current composition of the Board in light of the characteristics of independence, age, skills, experience and availability of service to us; | |
| ● | identifying and recommending to the Board the directors to serve as members of the Board’s committees; and | |
| ● | monitoring compliance with our code of ethics. |
The procedures by which stockholders may recommend nominees have not changed materially since last year’s proxy statement.
| Board Diversity Matrix (As of April 21, 2023) | ||
| Country of Principal Executive Offices: | China | |
| Foreign Private Issuer | Yes | |
| Disclosure Prohibited under Home Country Law | No | |
| Total Number of Directors | 5 | |
| Female | Male | Non- Binary | Did Not Disclose Gender | |||||||||||||
| Part I: Gender Identity | ||||||||||||||||
| Directors | 0 | 5 | 0 | 0 | ||||||||||||
| Part II: Demographic Background | ||||||||||||||||
| Underrepresented Individual in Home Country Jurisdiction | 0 | |||||||||||||||
| LGBTQ+ | 0 | |||||||||||||||
| Did Not Disclose Demographic Background | 0 | |||||||||||||||
D. Employees
As of December 31, 2022, we had approximately 63 full-time employees. The following table illustrates the allocation of these employees among the various job functions conducted at our company.
| Department | Number of Employees | |
| Software Development | 16 | |
| Sales & Marketing | 7 | |
| Administration & Human Resources | 11 | |
| Operation | 11 | |
| Finance and Accounting | 12 | |
| Management | 6 | |
| TOTAL | 63 |
We believe that our relationship with our employees is good. Our Chinese subsidiaries have trade unions which protect employees’ rights, aim to assist in the fulfillment of our economic objectives, encourage employee participation in management decisions and assist in mediating disputes between us and union members. We have not experienced any significant problems or disruption to our operations due to labor disputes, nor have we experienced any difficulties in recruitment and retention of experienced staff. The remuneration payable to employees includes basic salaries and allowances. We also provide training for our staff from time to time to enhance their technical knowledge.
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As required by applicable Chinese law, we have entered into employment contracts with all of our officers, managers and employees.
Our employees in China participate in a state pension scheme organized by Chinese municipal and provincial governments. We are required to contribute to the scheme at rates ranging from 13% to 18% of the average monthly salary. As of the date of this report, we have complied with the regulation and have paid the state pension plan as required by law. In addition, we are required by Chinese law to cover employees in China with various types of social insurance. We have purchased social insurance for all of our full-time employees.
E. Share Ownership
The following table sets forth information regarding beneficial ownership of each class of our voting securities as of April 21, 2023 (i) by each person who is known by us to beneficially own 5% or more of each class of our voting securities; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of the Company, 21st Floor, Everbright Bank Building, Zhuzilin, Shenzhen 518040, China.
| Name and Address of Beneficial Owner | Office, If Any | Title of Class | Amount and Nature of Beneficial Ownership(1) | Percent of Class(2) | ||||||||
| Officers and Directors | ||||||||||||
| Jianghuai Lin | Chairman and CEO | Ordinary Shares | 4,232,055 | 27.1 | % | |||||||
| Zhiqiang Zhao | President and Director | Ordinary Shares | 99,909 | * | ||||||||
| Liqiong (Iris) Yan | Chief Financial Officer | Ordinary Shares | 38,453 | * | ||||||||
| Zhixiong Huang | Chief Operating Officer | Ordinary Shares | 82,789 | * | ||||||||
| Guangzeng Chen | Chief Technology Officer | Ordinary Shares | 40,834 | * | ||||||||
| Qian Wang | Chief Investment Officer | Ordinary Shares | - | * | ||||||||
| Huan Li | Chief Marketing Officer | Ordinary Shares | - | * | ||||||||
| Yunsen Huang | Director | Ordinary Shares | - | * | ||||||||
| Yong Jiang | Director | Ordinary Shares | - | * | ||||||||
| Remington C.H. Hu | Director | Ordinary Shares | - | * | ||||||||
| All officers and directors as a group (10 persons named above) | Ordinary Shares | 4,494,040 | 28.5 | % | ||||||||
| 5% Security Holders | ||||||||||||
| Jianghuai Lin | Ordinary Shares | 4,232,055 | 27.1 | % | ||||||||
* Less than 1%
| (1) | Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to our ordinary shares. | |
| (2) | As of April 21, 2023, a total of 15,600,789 ordinary shares are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1). For each Beneficial Owner above, any securities that are exercisable or convertible within 60 days have been included in the denominator. |
None of our major shareholders have different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our Company.
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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
Please refer to Item 6 “Directors, Senior Management and Employees—E. Share Ownership.”
B. Related Party Transactions
The following includes a summary of transactions since January 1, 2020 between us and certain related persons. We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.
| ● | Since May 2017, the Company has entered into a series of contracts with Taoping New Media Co., Ltd. (TNM) and its affiliates for the sale of the Company’s Cloud-Application-Terminal based digital ads display terminals, software and technical services. Taoping New Media was a related party company controlled by Mr. Lin, the Company’s Chairman and Chief Executive Officer, until the Company’s completion of the acquisition on June 9, 2021, after which date the related party transactions were eliminated in the Company’s consolidated financial statements. For the years ended December 31, 2022, 2021 and 2020, revenues from related parties for sales of products and advertising were approximately $0.1 million, $0.1 million and $0.4 million, respectively. Accounts receivable from related parties, net of allowance for credit losses, as of December 31, 2022, 2021 and 2020 were approximately $0.1 million, $0.4 million and $4.2 million, respectively. Advances received from related parties were approximately $0.1 million, $0.1 million and $0.2 million as of December 31, 2022, 2021 and 2020, respectively. | |
| ● | For the years ended December 31, 2021 and 2020, the Company had a rental income of approximately $27,000 and $61,000, respectively, from TNM which was for the office lease between TNM and the Company. Upon completion of the Company’s acquisition of TNM on June 9, 2021, the related party rental income was eliminated in the Company’s consolidated financial statements thereafter. Other revenue generated from related parties also includes system maintenance service provided to Taoping affiliate customers, which was approximately $20,000, $49,000 and $85,000, for the years ended December 31, 2022, 2021 and 2020, respectively. | |
| ● | As of December 31, 2022 and 2021, the amount due to related parties was $3.3 million and $3.1 million, respectively, which included a loan of RMB20 million from a related company 100% owned by Mr. Lin for 12-month at the interest of 5.85% per annum, which matures on May 18, 2023. | |
| ● | On June 9, 2021, the Company and Biznest, a subsidiary of the Company, consummated an acquisition of 100% of the equity interests of TNM. Mr. Jianghuai Lin, the Chairman and CEO of the Company, who owns approximately 27.1% of total shares outstanding of the Company, owned approximately 51% of TNM. TNM is a new media operator focusing on digital life scenes and mainly engaged in selling out-of-home advertising time slots on its networked smart digital advertising display terminals with artificial intelligence and big data technologies. Acquiring TNM and synergizing its new media network will enhance the Company’s presence in the new media and advertising sectors. After completion of the acquisition, TNM becomes a wholly owned subsidiary of Biznest. | |
| ● | On September 18, 2021, the Company and the Company’s wholly owned subsidiary, Information Security Technology (China) Co., Ltd. entered into an equity transfer agreement with Mr. Jianghuai Lin, the sole shareholder of iASPEC. Upon closing of the equity transfer, the Company’s existing variable interest entity structure was dissolved and iASPEC became a wholly owned subsidiary of the Company. |
See also Item 6 “Directors, Senior Management and Employees—B. Compensation.”
C. Interests of Experts and Counsel
Not applicable.
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ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
Financial Statements
We have appended consolidated financial statements filed as part of this annual report. See Item 18 “Financial Statements.”
Legal Proceedings
We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time.
Dividend Policy
To date, we have not paid any cash dividends on the Company ordinary shares. As a BVI company, we may only declare and pay dividends if our directors are satisfied, on reasonable grounds, that immediately after the distribution (i) the value of our assets will exceed our liabilities and (ii) we will be able to pay our debts as they fall due. We currently anticipate that we will retain any available funds to finance the growth and operation of our business and we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our cash held in foreign countries may be subject to certain control limitations or repatriation requirements, limiting our ability to use this cash to pay dividends.
B. Significant Changes
No significant change has occurred since the date of our consolidated financial statements filed as part of this annual report.
ITEM 9. THE OFFER AND LISTING
A. Offer and Listing Details
Taoping’s ordinary shares have been listed on the NASDAQ Capital Market under the trading symbol “TAOP” since June 1, 2018. Prior to that, the ordinary shares were listed on the NASDAQ Capital Market under the symbol “CNIT.”
B. Plan of Distribution
Not applicable.
C. Markets
See our disclosures above under “A. Offer and Listing Details.”
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
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F. Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
The following represents a summary of certain key provisions of the Company’s memorandum and articles of association. The summary does not purport to be a summary of all of the provisions of the Company’s memorandum and articles of association and of all relevant provisions of BVI law governing the management and regulation of BVI companies.
Register
Taoping was incorporated in the BVI on June 18, 2012 under the BVI Act. Its memorandum of association authorizes the issuance of up to 100,000,000 ordinary shares without par value, which may be issued from time to time at the discretion of the Board of Directors without shareholder approval. Subject to the memorandum of association being amended by resolution of shareholders, the Board of Directors is authorized to issue shares in different classes and series and, with respect to each class or series, to determine the designations, powers, preferences, privileges and other rights, including dividend rights, conversion rights, terms of redemption and liquidation preferences, any or all of which may be greater than the powers and rights associated with the ordinary shares, at such times and on such other terms as they think proper.
On July 30, 2020, we completed a share combination of Taoping’s ordinary shares at a ratio of one-for-six, which decreased the Company’s outstanding ordinary shares to approximately 7,332,434 shares. This share combination did not change the maximum number of shares Taoping is authorised to issue or the par value of Taoping ordinary shares. Accordingly, except as otherwise indicated, all share and per share information contained in this annual report has been restated to retroactively show the effect of the share combination.
Objects and Purposes
Taoping’s memorandum of association grants the Company full power and authority to carry out any object not prohibited by the BVI Act or any other BVI legislation.
Directors
Directors may exercise all such powers necessary for managing, and for directing and supervising the business and affairs of the Company as are not by the BVI Act or by the memorandum and articles of association of the Company required to be exercised by the shareholders, including general powers to borrow on behalf of the Company.
Taoping’s memorandum and articles of association provide that a director who is interested in a transaction entered into or to be entered into by the Company may: (i) vote on a matter relating to the transaction; (ii) attend a meeting of directors at which a matter relating to the transaction arises and be included among the directors present at the meeting for the purposes of a quorum; and (iii) sign a document on our behalf, or do any other thing in his capacity as a director, that relates to the transaction. Additionally, Taoping’s articles of association provide that no director shall be disqualified by his office from contracting with the Company either as a buyer, seller or otherwise, nor shall any such contract or arrangement entered into by or on the Company’s behalf in which any director shall be in any way interested be voided, nor shall any director so contracting or being so interested be liable to account to us for any profit realized by any such contract or arrangement, by reason of such director holding that office or by reason of the fiduciary relationship thereby established, provided such director shall, immediately after becoming aware of the fact that he is interested in a transaction entered into or to be entered into by us, disclose such interest to the Company’s Board of Directors. A director is not required to make such a disclosure if: (i) the transaction or proposed transaction is between us and the director, and (ii) the transaction or proposed transaction is or is to be entered into in the ordinary course of the Company’s business and on usual terms and conditions. A disclosure to the Company’s Board to the effect that a director is a member, director, officer or trustee of another named company or other person and is to be regarded as interested in any transaction which may, after the date of the entry or disclosure, be entered into with that company or person, is a sufficient disclosure of interest in relation to that transaction. Such a disclosure is not made to our Board of directors unless it is made or brought to the attention of every director on the Board. Subject to Section 125(1) of the BVI Act, the failure by a director to comply with this provision does not affect the validity of a transaction entered into by the director or the Company.
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Pursuant to the Company’s articles of association, a director shall not require a share qualification, but nevertheless shall be entitled to attend and speak at any meeting of the directors and meeting of the shareholders and (if applicable) at any separate meeting of the holders of any class of the Company’s shares. In addition, the remuneration of directors (whether by way of salary, commission, participation in profits or otherwise) in respect of services rendered or to be rendered in any capacity to us (including to any company in which we may be interested) shall be fixed by resolution of directors or shareholders. The directors may also be paid such travelling, hotel and other expenses properly incurred by them in attending and returning from meetings of the directors, or any committee of the directors or meetings of the shareholders, or in connection with our business as shall be approved by resolution of directors or of shareholders.
Notwithstanding any other requirement of the memorandum of association or articles of association, immediately following each annual meeting of the shareholders, there shall be held at the same place as the annual meeting of the shareholders as aforesaid, a meeting of the directors (and there shall be no requirement for any further notice of that meeting of the directors to be provided to the directors). This requirement may only be disapplied where the directors (being the directors in office immediately after the annual meeting of the shareholders as aforesaid) unanimously resolve to change such time or place of such meeting of the directors.
Rights and Obligations of Shareholders
Dividends. Subject to the BVI Act, the directors may, by resolution of directors, authorize a distribution (including a dividend) by us to shareholders at such time and of such an amount as they think fit if they are satisfied, on reasonable grounds, that immediately after the distribution, the value of our assets exceeds our liabilities and we are able to pay our debts as they fall due. Any distribution payable in respect of a share which has remained unclaimed for three years from the date when it became due for payment shall, if the board of the directors so resolves, be forfeited for the benefit of the Company. The directors may, before recommending any distribution, set aside out of the profits of the Company such sums as they think proper as a reserve or reserves which shall, at their discretion, either be employed in the business of the Company or be invested in such investments as the directors may from time to time think fit. The holder of each ordinary share has the right to an equal share in any distribution paid by us.
Voting Rights. Each ordinary share confers on the shareholder the right to one vote at a meeting of the shareholders or on any resolution of shareholders on all matters before the Company’s shareholders.
Winding Up. The holder of each ordinary share is entitled to an equal share in the distribution of the surplus assets of us on a winding up.
Redemption. The directors may, on behalf of the Company, purchase, redeem or otherwise acquire any of the Company’s own shares for such consideration as the directors consider fit, and either cancel or hold such shares as treasury shares. Shares may be purchased or otherwise acquired in exchange for newly issued shares. The directors shall not, unless permitted pursuant to the BVI Act, purchase, redeem or otherwise acquire any of the Company’s own shares unless immediately after such purchase, redemption or other acquisition, the value of the Company’s assets exceeds the Company’s liabilities and we are able to pay the Company’s debts as they fall due.
Changes in Rights of Shareholders
Under the Company’s memorandum and articles of association, if at any time the shares which we are authorized to issue are divided into more than one class or series of shares, the rights attaching to any class may only be changed by a consent in writing of the holders of a majority of the issued shares of that class or with the sanction of a resolution passed by the holders of at least a majority of the shares of the class present in person or by proxy at a separate general meeting of the holders of the shares of the class. At such a separate general meeting, the quorum shall be at least one person holding or representing by proxy a majority of the issued shares of the class.
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Meetings
Under the BVI Act, there is no requirement for an annual meeting of shareholders. Under the Company’s memorandum and articles of association, we are not required to hold an annual meeting of shareholders. The Company’s shareholders’ meetings may be held at such times and in such place within or outside the BVI as our Board of Directors considers appropriate.
Our Board of Directors shall call a shareholders’ meeting if requested in writing to do so by shareholders entitled to exercise at least 10% of the voting rights in respect of the matter for which the meeting is being requested. Our Board of Directors shall give not less than 10 days and not more than 60 days prior written notice of a shareholders’ meeting to those persons whose names on, either (a) the date the notice is given or (b) on a date fixed by the directors as the record date (which must be a date that is not less than 10 days nor more than 60 days prior to the meeting), appear as shareholders in our register and are entitled to vote at the meeting. The inadvertent failure of the directors to give notice of a meeting to a shareholder, or the fact that a shareholder has not received notice, does not invalidate the meeting.
The Company’s memorandum and articles of association provide that a meeting of shareholders is duly constituted if, at the commencement of the meeting, there are shareholders present in person or by proxy representing not less than a majority of the votes of the shares or class or series of shares entitled to vote on resolutions of shareholders to be considered at the meeting. A shareholder may be represented at a meeting of shareholders by a proxy (who need not be a shareholder) who may speak and vote on behalf of the shareholder. A written instrument giving the proxy such authority must be produced at the place appointed for the meeting before the time for holding the meeting at which the person named in such instrument proposes to vote. A shareholder or his proxy shall be deemed to be present at the meeting if he participates by telephone or other electronic means and all shareholders and proxies participating in the meeting are able to hear each other.
Holders of the Company’s ordinary shares are entitled to one vote for each share held of record on all matters at all meetings of shareholders. The Company’s shareholders have no cumulative voting rights. The Company’s shareholders take action by a majority of votes cast by shareholders entitled to vote and voting, unless otherwise provided by the BVI Act or the Company’s memorandum and articles of association. A resolution of shareholders may be also be passed in writing by the holders of a majority of in excess of fifty (50) percent of the votes of those shareholders entitled to vote on the resolution.
Notices
Any notice, information or written statement required to be given to shareholders shall be served by mail (air-mail service if available) addressed to each shareholder at the address shown in the Company’s register of members.
All notices directed to be given to the shareholders shall, with respect to any registered shares to which persons are jointly entitled, be given to whichever of such persons is named first in the Company’s register of members, and notice so given shall be sufficient notice to all the holders of such shares.
Any notice, if served by post, shall be deemed to have been served within ten days of posting, and in proving such service it shall be sufficient to prove that the letter containing the notice was properly addressed and mailed with the postage prepaid.
Limitations on Ownership of Securities
There are no limitations on the right of non-residents or foreign persons to own the Company’s securities imposed by BVI law or by the Company’s memorandum and articles of association.
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Change in Control of Company
Our Board of Directors is authorized to issue the Company’s ordinary shares at such times and on such other terms as they think proper. Subject to the memorandum of association being amended by resolution of shareholders, the Board of Directors is authorized to issue these shares in different classes and series and, with respect to each class or series, to determine the designations, powers, preferences, privileges and other rights, including dividend rights, conversion rights, terms of redemption and liquidation preferences, any or all of which may be greater than the powers and rights associated with the ordinary shares, at such times and on such other terms as they think proper. Such power could be used in a manner that would delay, defer or prevent a change of control of the Company.
Ownership Threshold
There are no provisions governing the ownership threshold above which shareholder ownership must be disclosed imposed by BVI law or by the Company’s memorandum and articles of association.
Changes in Capital
Subject to the provisions of the Company’s memorandum and articles of association, the BVI Act and the rules of NASDAQ, the Company’s unissued shares shall be at the disposal of the directors who may, without prejudice to any rights previously conferred on the holders of any existing shares, offer, allot, grant options over or otherwise dispose of the shares to such persons, at such times and upon such terms and conditions as we may by resolution of directors determine.
We may, by a resolution of shareholders, amend the Company’s memorandum of association to increase or decrease the maximum number of ordinary shares authorized to be issued.
Amendments to Memorandum and Articles of Association
The Company’s memorandum of association may be amended by resolution of shareholders and the Company’s articles of association may be amended by resolution of shareholders or resolution of directors. For the avoidance of doubt, the memorandum of association cannot be amended the directors.
Further, the directors shall not have the power to amend the articles of association of the Company (a) to restrict the rights or powers of shareholders to amend the memorandum of association or articles of association, (b) to change the percentage of shareholders required to pass a resolution to amend the memorandum of association or articles of association, (c) to change the manner prescribed in the articles of association for the election of directors to hold office, (d) where to do so would involve amending the provisions of Regulations 17.3 or 23.9 of the articles of association, and (e) in circumstances where the memorandum of association or articles of association may only be amended by the shareholders.
The rights conferred upon the holders of the shares of any class issued with preferred or other rights (for the purpose of this paragraph, any such shares of any class being referred to herein as “Preferred Shares”) shall not, unless otherwise expressly provided by the terms of issue of the Preferred Shares, be deemed to be varied by the creation or issue of further shares (a) ranking pari passu with the Preferred Shares, or (b) which in all respects do not rank ahead of the Preferred Shares and which would not confer on the holders of such further shares any rights which are superior to the rights conferred upon the holders of the Preferred Shares.
The directors shall give notice of such resolutions passed to amend the memorandum and / or articles of association to the registered agent of the Company, for the registered agent to file with the Registrar of Corporate Affairs of the British Virgin Islnads a notice of the amendment to the memorandum of association or articles of association, or a restated memorandum and articles of association incorporating the amendment(s) made, and any such amendment(s) to the memorandum of association or articles of association will take effect from the date of the registration by the Registrar of Corporate Affairs of the notice of amendment or restated memorandum and articles of association incorporating the amendment(s) made.
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Differences in Corporate Law
BVI law differs from laws applicable to U.S. corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of BVI law applicable to us and the laws applicable to companies incorporated in the United States and their shareholders.
Protection for Minority Shareholders
Under the laws of most U.S. jurisdictions, majority and controlling shareholders of a company generally have certain “fiduciary” responsibilities to the minority shareholders. Corporate actions taken by majority and controlling shareholders which are unreasonable and materially detrimental to the interests of minority shareholders may be declared null and void. Minority shareholders may have less protection for their rights under BVI law than they would have under U.S. law.
Powers of Directors
Unlike most U.S. jurisdictions, the directors of a BVI company, subject in certain cases to court approval but without shareholders’ approval, may implement the sale, transfer, exchange or disposition of any Company asset, property, part of the business, or securities, with the exception that shareholder approval is required for the disposition of over 50% in the value of the Company’s total assets.
Conflict of Interests
Similar to the laws of most U.S. jurisdictions, when a director becomes aware of the fact that he has an interest in a transaction which we are to enter into, he must disclose it to our Board. However, with sufficient disclosure of interest in relation to that transaction, the director who is interested in a transaction entered into or to be entered into by us may (i) vote on a matter relating to the transaction; (ii) attend a meeting of directors at which a matter relating to the transaction arises and be included in the quorum; and (iii) sign a document on behalf of us, or do any other thing in his capacity as a director, that relates to the transaction.
Written Consent and Cumulative Voting
Similar to the laws of most U.S. jurisdictions, under BVI law, shareholders are permitted to approve matters by way of written resolution in place of a formal meeting. There are no prohibitions in relation to cumulative voting under the laws of the British Virgin Islands but the Company’s memorandum and articles of association do not provide for cumulative voting. As a result, our shareholders are not afforded any less protections or rights on this issue than shareholders of a Delaware corporation.
Takeover Provisions
Some provisions of the Company’s memorandum and articles of association may discourage, delay or prevent a change in control of the Company or management that shareholders may consider favorable. For instance, subject to the memorandum of association being amended by resolution of shareholders, the Board of Directors is authorized to issue shares in different classes and series and, with respect to each class or series, to determine the designations, powers, preferences, privileges and other rights, including dividend rights, conversion rights, terms of redemption and liquidation preferences, any or all of which may be greater than the powers and rights associated with the ordinary shares, at such times and on such other terms as they think proper.
However, under British Virgin Islands law, our directors may only exercise the rights and powers granted to them under the Company’s memorandum and articles of association for a proper purpose and for what they believe in good faith to be in the best interests of the Company.
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Shareholder’s Access to Corporate Records
A shareholder of the Company is entitled, on giving written notice to the Company, to inspect (a) the memorandum and articles of association of the Company; (b) the register of members; (c) the register of directors; and (d) the minutes of meetings and resolutions of shareholders and of those classes of shares of which he is a shareholder; and to make copies of or take extracts from the documents and records. Subject to the Company’s memorandum and articles of association, the directors may, if they are satisfied that it would be contrary to the Company’s interests to allow a shareholder to inspect any document, or part of a document, specified in (b), (c) and (d) above, refuse to permit the shareholder to inspect the document or limit the inspection of the document, including limiting the making of copies or the taking of extracts from the records.
Where a company fails or refuses to permit a shareholder to inspect a document or permits a shareholder to inspect a document subject to limitations, that shareholder may apply to the BVI High Court for an order that he should be permitted to inspect the document or to inspect the document without limitation.
A company is required to keep at the office of its registered agent: its memorandum and articles of association of the company; the register of members or a copy of the register of members; the register of directors or a copy of the register of directors; and copies of all notices and other documents filed by the company in the previous ten years.
In addition, the Company’s memorandum and articles of association allow any shareholder of record who owns at least 15% of the Company’s outstanding shares, upon at least five days’ written demand, to inspect, during usual business hours, the books of account and all financial records, to make copies of records, and to conduct an audit of such records at their own cost.
Indemnification
BVI 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 BVI High Court to be contrary to public policy (e.g. for purporting to provide indemnification against the consequences of committing a crime). An indemnity will be void and of no effect and will not apply to a person unless the person acted honestly and in good faith and in what he believed to be in the best interests of the company and, in the case of criminal proceedings, the person had no reasonable cause to believe that his conduct was unlawful. The Company’s memorandum and articles of association permit indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such unless such losses or damages arise from dishonesty or fraud of such directors or officers.
Under the Company’s memorandum and articles of association, subject to the BVI Act, we shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that such person is or was a director or officer (excluding the auditors), or who is or was serving at our request as a director or officer of another company, partnership, joint venture, trust or other enterprise. Each such indemnified person shall be indemnified out of our assets against any liability, action, proceeding, claim, demand, judgments, fines, costs, damages or expenses, including legal expenses, whatsoever which they or any of them may reasonably incur as a result of any act or failure to act in carrying out their functions other than such liability that they may incur by reason of their own actual fraud or willful default. In addition, to be entitled to indemnification, an indemnified person must not have acted in such a manner as to have incurred the liability by virtue of having committed actual fraud or willful default but no person shall be found to have committed actual fraud or willful default unless or until a court of competent jurisdiction shall have made a finding to that effect.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling us under the foregoing provisions, we have been advised that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Mergers and Similar Arrangements
Under the BVI Act two or more BVI companies or a BVI company and non-BVI company, each a “constituent company”, may merge or consolidate. The BVI Act provides for slightly different procedures depending on the nature of the parties to the merger.
A merger involves the merging of two or more companies into one of the constituent companies (to the merger) with one constituent company continuing in existence to become the surviving company post-merger. A consolidation involves two or more companies consolidating into a new company.
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A merger is effective on the date that the articles of merger (as described below) are registered by the Registrar of Corporate Affairs in the BVI, or on such later date, not exceeding 30 days from the date of registration as is stated in the articles of merger.
As soon as a merger becomes effective:
| a) | the surviving company (so far as is consistent with its memorandum and articles, as amended by the articles of merger) has all rights, privileges, immunities, powers, objects and purposes of each of the constituent companies; | |||
| b) | the memorandum and articles of the surviving company are automatically amended to the extent, if any, that changes to its memorandum and articles are contained in the articles of merger; | |||
| c) | assets of every description, including choses in action and the business of each of the constituent companies, immediately vest in the surviving company; | |||
| d) | the surviving company is liable for all claims, debts, liabilities and obligations of each of the constituent companies; | |||
| e) | no conviction, judgment, ruling, order, claim, debt, liability or obligation due or to become due, and no cause existing, against a constituent company or against any shareholder, director, officer or agent thereof, is released or impaired by the merger; and | |||
| f) | no proceedings, whether civil or criminal, pending at the time of a merger by or against a constituent company, or against any shareholder, director or officer, or agent thereof, are abated or discontinued by the merger; but | |||
| i. | the proceedings may be enforced, prosecuted, settled or compromised by or against the surviving company or against the shareholder, director, officer or agent thereof, as the case may be; or | |||
| ii. | the surviving company may be substituted in the proceedings for a constituent company. | |||
| iii. | ||||
The registrar shall strike off the Register of Companies a constituent company that is not the surviving company in the merger.
Dissenter Rights
The BVI Act provides that any shareholder of the Company is entitled to payment of the fair value of his shares upon dissenting from a merger, unless the Company is the surviving company of the merger and the shareholder continues to hold the same or similar shares. The following is a summary of the position in respect of dissenters rights in the event of a merger under the BVI Act.
A dissenter is in most circumstances required to give to the Company written objection to the merger, which must include a statement that the dissenter proposes to demand payment for his shares if the merger takes place. This written objection must be given before the meeting of shareholders at which the merger is submitted to a vote, or at the meeting but before the vote. However, no objection is required from a shareholder to whom the Company did not give notice of the meeting of shareholders or where the proposed merger is authorized by written consent of the shareholders without a meeting.
Within 20 days immediately following the written consent, or the meeting at which the merger was approved, the Company shall give written notice of the consent or resolution to each shareholder who gave written objection or from whom written objection was not required, except those shareholders who voted for, or consented in writing to, the proposed merger.
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A shareholder to whom the Company was required to give notice who elects to dissent shall, within 20 days immediately following the date on which the copy of the plan of merger or an outline of the merger is given to him, give to the Company a written notice of his decision to elect to dissent, stating:
| a) | his name and address; | |
| b) | the number and classes of shares in respect of which he dissents (which must be all shares that he holds in the Company); and | |
| c) | a demand for payment of the fair value of his shares. |
Upon the giving of a notice of election to dissent, the dissenter ceases to have any of the rights of a shareholder except the right to be paid the fair value of his shares, and the right to institute proceedings to obtain relief on the ground that the action is illegal.
The Company shall make a written offer to each dissenter to purchase his shares at a specified price that the Company determines to be their fair value. Such offer must be given within 7 days immediately following the date of the expiration of the period within which shareholders may give their notices of election to dissent, or within 7 days immediately following the date on which the merger is put into effect, whichever is later.
If the Company and the dissenter fail, within 30 days immediately following the date on which the offer is made, to agree on the price to be paid for the shares owned by the dissenter, then within 20 days:
| a) | the Company and the dissenter shall each designate an appraiser; | |
| b) | the two designated appraisers together shall designate an appraiser; | |
| c) | the three appraisers shall fix the fair value of the shares owned by the dissenter as of the close of business on the day prior to the date of the meeting or the date on which the resolution was passed, excluding any appreciation or depreciation directly or indirectly induced by the action or its proposal, and that value is binding on the Company and the dissenter for all purposes; and | |
| d) | the Company shall pay to the dissenter the amount in money upon the surrender by him of the certificates representing his shares, and such shares shall be cancelled. |
Shareholders’ Suits
Under the provisions of the BVI Act, the memorandum and articles of association of a company are binding as between the company and its shareholders and between the shareholders.
If the majority shareholders have infringed a minority shareholder’s rights, the minority may seek to enforce its rights either by derivative action or by personal action. A derivative action concerns the infringement of the company’s rights where the wrongdoers are in control of the company and are preventing it from taking action, whereas a personal action concerns the infringement of a right that is personal to the particular shareholder concerned.
The BVI Act provides for a series of remedies available to shareholders. Where a company incorporated under the BVI Act conducts some activity which breaches the BVI Act or the company’s memorandum and articles of association, the BVI High Court can issue a restraining or compliance order. Shareholders can now also bring derivative, personal and Representative Actions under certain circumstances.
Generally any other claims against a company by its shareholders must be based on the general laws of contract or tort applicable in the BVI or their individual rights as shareholders as established by the company’s memorandum and articles of association.
In certain circumstances, a shareholder has the right to seek various remedies against the company in the event the directors are in breach of their duties under the BVI Act. Pursuant to Section 184B of the BVI Act, if a company or director of a company engages in, proposes to engage in or has engaged in, conduct that contravenes the provisions of the BVI Act or the memorandum or articles of association of the company, the courts of the British Virgin Islands may, on application of a shareholder or director of the company, make an order directing the company or director to comply with, or restraining the company or director from engaging in conduct that contravenes the BVI Act or the memorandum or articles. Furthermore, pursuant to Section 184I(1) of the BVI Act, a shareholder of a company who considers that the affairs of the company have been, are being or likely to be, conducted in a manner that is, or any acts of the company have been, or are likely to be oppressive, unfairly discriminatory, or unfairly prejudicial to him in that capacity, may apply to the courts of the British Virgin Islands for an order which, inter alia, can require the company or any other person to pay compensation to the shareholders.
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C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described in Item 4 “Information on the Company,” Item 5 “Operating and Financial Review and Prospects—F. Tabular Disclosure of Contractual Obligations,” Item 7 “Major Shareholders and Related Party Transactions,” or filed (or incorporated by reference) as exhibits to this annual report or otherwise described or referenced in this annual report.
D. Exchange Controls
BVI Exchange Controls
There are no material exchange controls restrictions on payment of dividends, interest or other payments to the holders of Taoping’s ordinary shares or on the conduct of our operations in the BVI, where Taoping was incorporated. There are no material BVI laws that impose any material exchange controls on us or that affect the payment of dividends, interest or other payments to nonresident holders of Taoping’s ordinary shares. BVI law and the Company’s memorandum and articles of association do not impose any material limitations on the right of non-residents or foreign owners to hold or vote the Company’s ordinary shares.
PRC Exchange Controls
Regulations on Foreign Currency Exchange
Under the PRC Foreign Currency Administration Rules promulgated on January 29, 1996 and last amended on August 5, 2008 and various regulations issued by SAFE and other relevant PRC government authorities, payment of current account items in foreign currencies, such as trade and service payments, payment of interest and dividends can be made without prior approval from SAFE by following the appropriate procedural requirements. By contrast, the conversion of RMB into foreign currencies and remittance of the converted foreign currency outside the PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investment, requires prior approval from SAFE or its local office.
On February 13, 2015, SAFE promulgated the Circular on Simplifying and Improving the Foreign Currency Management Policy on Direct Investment, effective from June 1, 2015, which cancels the requirement for obtaining approvals of foreign exchange registration of foreign direct investment and overseas direct investment from SAFE. The application for the registration of foreign exchange for the purpose of foreign direct investment and overseas direct investment may be filed with qualified banks, which, under the supervision of SAFE, may review the application and process the registration.
The Circular of the SAFE on Reforming the Management Approach regarding the Settlement of Foreign Capital of Foreign-invested Enterprise, or SAFE Circular 19, was promulgated on March 30, 2015 and became effective on June 1, 2015. According to SAFE Circular 19, a foreign-invested enterprise may, according to its actual business needs, settle with a bank the portion of the foreign exchange capital in its capital account for which the relevant foreign exchange bureau has confirmed monetary contribution rights and interests (or for which the bank has registered the account-crediting of monetary contribution). For the time being, foreign-invested enterprises are allowed to settle 100% of their foreign exchange capitals on a discretionary basis; a foreign-invested enterprise shall truthfully use its capital for its own operational purposes within the scope of business; where an ordinary foreign-invested enterprise makes domestic equity investment with the amount of foreign exchanges settled, the invested enterprise shall first go through domestic re-investment registration and open a corresponding Account for Foreign Exchange Settlement Pending Payment with the foreign exchange bureau (bank) at the place of registration. The Circular of the SAFE on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular 16, was promulgated and became effective on June 9, 2016. According to SAFE Circular 16, enterprises registered in PRC may also convert their foreign debts from foreign currency into Renminbi at the enterprise’s discretion. SAFE Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) on self—discretionary basis, which applies to all enterprises registered in the PRC. SAFE Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope and may not be used for investments in securities or other investment with the exception of bank financial products that can guarantee the principal in the PRC unless otherwise specifically provided. Besides, the converted Renminbi shall not be used to make loans for related enterprises unless it is within the business scope or to build or to purchase any real estate that is not for the enterprise own use with the exception for the real estate enterprise.
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On January 26, 2017, SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, or SAFE Circular 3, which stipulates several capital control measures with respect to the outbound remittance of profits from domestic entities to offshore entities, including (i) banks must check whether the transaction is genuine by reviewing board resolutions regarding profit distribution, original copies of tax filing records and audited financial statements, and (ii) domestic entities must retain income to account for previous years’ losses before remitting any profits. Moreover, pursuant to SAFE Circular 3, domestic entities must explain in detail the sources of capital and how the capital will be used, and provide board resolutions, contracts and other proof as a part of the registration procedure for outbound investment.
On October 25, 2019, SAFE promulgated the Notice on Further Facilitating Cross-Board Trade and Investment, which became effective on the same date (except for Article 8.2 thereof). The notice removed restrictions on the capital equity investment in China by non-investment foreign-invested enterprises. In addition, restrictions on the use of funds for foreign exchange settlement of domestic accounts for the realization of assets have been removed and restrictions on the use and foreign exchange settlement of foreign investors’ security deposits have been relaxed. Eligible enterprises in the pilot areas are also allowed to use revenues under capital accounts, such as capital funds, foreign debts and overseas listing revenues for domestic payments without providing materials to the bank in advance for authenticity verification on an item by item basis, while the use of funds should be true, in compliance with applicable rules and conforming to the current capital revenue management regulations.
Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents
SAFE issued the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, which became effective in July 2014, to replace the Circular of the State Administration of Foreign Exchange on Issues Concerning the Regulation of Foreign Exchange in Equity Finance and Roundtrip Investments by Domestic Residents through Offshore Special Purpose Vehicles, to regulate foreign exchange matters in relation to the use of special purpose vehicles, or SPVs, by PRC residents or entities to seek offshore investment and financing or conduct round trip investment in China. SAFE Circular 37 defines a SPV as an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate onshore or offshore assets or interests, while “round trip investment” is defined as direct investment in China by PRC residents or entities through SPVs, namely, establishing foreign-invested enterprises to obtain the ownership, control rights and management rights. SAFE Circular 37 stipulates that, prior to making contributions into an SPV, PRC residents or entities be required to complete foreign exchange registration with SAFE or its local branch. In addition, SAFE promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment in February 2015, which amended SAFE Circular 37 and became effective on June 1, 2015, requiring PRC residents or entities to register with qualified banks rather than SAFE in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.
PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to SPVs but had not obtained registration as required before the implementation of the SAFE Circular 37 must register their ownership interests or control in the SPVs with qualified banks. An amendment to the registration is required if there is a material change with respect to the SPV registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in SAFE Circular 37 and the subsequent notice, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations. See “Risk Factors—Risks Relating to Doing Business in China—PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiary to liability or penalties, limit our ability to inject capital into our PRC subsidiary or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.”
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Regulations on Stock Incentive Plans
SAFE promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, or the Stock Incentive Plan Notice, in February 2012, replacing the previous rules issued by SAFE in March 2007. Pursuant to the Stock Incentive Plan Notice and other relevant rules and regulations, PRC residents participating in stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and follow certain other procedures. Participants of a stock incentive plan who are PRC residents must conduct the SAFE registration and other procedures with respect to the stock incentive plan through a qualified PRC agent, which could be a PRC subsidiary of the overseas publicly listed company or another qualified institution appointed by the PRC subsidiary. In addition, the PRC agent is required to update the relevant SAFE registration should there be any material change to the stock incentive plan, the PRC agent or other material changes. The PRC agent must, on behalf of the PRC residents who have the right to exercise the employee stock options, apply to SAFE or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC residents from the sale of shares under the stock incentive plans granted and dividends distributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents prior to distribution to such PRC residents.
We adopted an equity incentive plan, under which we have the discretion to award incentives and rewards to eligible participants. We have advised the recipients of awards under our equity incentive plan to handle relevant foreign exchange matters in accordance with the Stock Incentive Plan Notice. However, we cannot guarantee that all employee awarded equity-based incentives can successfully register with SAFE in full compliance with the Stock Incentive Plan Notice. See “Risk Factors—Risks Relating to Doing Business in China—Any failure to comply with PRC regulations regarding employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.”
E. Taxation
The following is a general summary of certain material BVI, PRC and U.S. federal income tax considerations. The discussion is not intended to be, nor should it be construed as, legal or tax advice to any particular shareholder or prospective shareholder. The discussion is based on laws and relevant interpretations thereof in effect as of the date hereof, all of which are subject to change or different interpretations, possibly with retroactive effect.
BVI Taxation
The Company and all dividends, interest, rents, royalties, compensation and other amounts paid by the Company to persons who are not resident in the BVI and any capital gains realized with respect to any shares, debt obligations, or other securities of the Company by persons who are not resident in the BVI are exempt from all provisions of the Income Tax Ordinance in the BVI.
No estate, inheritance, succession or gift tax, rate, duty, levy or other charge is payable by persons who are not resident in the BVI with respect to any shares, debt obligation or other securities of the Company.
All instruments relating to transfers of property to or by the Company and all instruments relating to transactions in respect of the shares, debt obligations or other securities of the Company and all instruments relating to other transactions relating to the business of the Company are exempt from payment of stamp duty in the BVI. This assumes that the Company does not hold an interest in real estate in the BVI.
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There are currently no withholding taxes or exchange control regulations in the BVI applicable to the Company or its shareholders
PRC Taxation
Taoping is a holding company incorporated in the BVI, which indirectly holds equity interests in its PRC operating subsidiaries. The EIT Law and its implementation rules, both of which became effective as of January 1, 2008, as amended on February 24, 2017, provide that a PRC enterprise is subject to a standard income tax rate of 25% and China-sourced income of foreign enterprises, such as dividends paid by a PRC subsidiary to its overseas parent, will normally be subject to PRC withholding tax at a rate of 10%, unless there are applicable treaties between the overseas parent’s jurisdiction of incorporation and China to reduce such rate.
The EIT Law also provides that enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered PRC resident enterprises and therefore subject to PRC enterprise income tax at the rate of 25% on their worldwide income. Its implementation rules further define the term “de facto management body” as the management body that exercises substantial and overall management and control over the business, personnel, accounts, and properties of an enterprise. While we do not currently consider Taoping or any of Taoping’s overseas subsidiaries to be a PRC resident enterprise, there is a risk that the PRC tax authorities may deem Taoping or any of its overseas subsidiaries as a PRC resident enterprise since a substantial majority of the members of Taoping’s management team as well as the management team of our overseas subsidiaries are located in China, in which case Taoping or the overseas subsidiaries, as the case may be, would be subject to the PRC enterprise income tax at the rate of 25% on worldwide income. If the PRC tax authorities determine that Taoping is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. Under the EIT Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends paid to investors that are non-resident enterprises, which do not have an establishment or place of business in the PRC or which have such establishment or place of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived from sources within the PRC. In addition, any gain realized on the transfer of shares by such investors is also subject to PRC tax at a rate of 10%, if such gain is regarded as income derived from sources within the PRC. If we are deemed a PRC resident enterprise, dividends paid on the Company’s ordinary shares, and any gain realized from the transfer of the Company’s ordinary shares, may be treated as income derived from sources within the PRC and may as a result be subject to PRC taxation. Furthermore, if we are deemed a PRC resident enterprise, dividends paid to individual investors who are non-PRC residents and any gain realized on the transfer of ordinary shares by such investors may be subject to PRC tax at a current rate of 20% (which in the case of dividends may be withheld at source). Any PRC tax liability may be reduced under applicable tax treaties or tax arrangements between China and other jurisdictions. If Taoping or any of its subsidiaries established outside of China are considered a PRC resident enterprise, it is unclear whether holders of Taoping ordinary shares would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas.
U.S. Federal Income Taxation
The following is a discussion of certain material U.S. federal income tax consequences of the acquisition, ownership and disposition of the Company’s ordinary shares. It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s situation. The discussion applies only to holders that hold their ordinary shares as capital assets (generally property held for investment) within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended, or the Code. This discussion is based on the Code, income tax regulations promulgated thereunder, judicial positions, published positions of the Internal Revenue Service, or the IRS, and other applicable authorities, all as in effect as of the date hereof and all of which are subject to change, possibly with retroactive effect. This discussion is general in nature and is not exhaustive of all possible tax considerations, nor does the discussion address any state, local or foreign tax considerations or any U.S. tax considerations (e.g., estate or gift tax) other than U.S. federal income tax considerations, that may be applicable to particular holders.
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This discussion does not address all aspects of U.S. federal income taxation that may be relevant in light of particular circumstances, nor does it address the U.S. federal income tax consequences to persons who are subject to special rules under U.S. federal income tax law, including:
| (a) | banks, insurance companies or other financial institutions; | |
| (b) | persons subject to the alternative minimum tax; | |
| (c) | tax-exempt organizations; | |
| (d) | controlled foreign corporations, passive foreign investment companies and corporations that accumulate earnings to avoid United States federal income tax; | |
| (e) | certain former citizens or long-term residents of the United States; | |
| (f) | dealers in securities or currencies; | |
| (g) | traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; | |
| (h) | persons that own, or are deemed to own, more than five percent of the Company shares; | |
| (i) | holders who acquired the Company shares as compensation or pursuant to the exercise of a share option; or | |
| (j) | persons who hold the Company shares as a position in a hedging transaction, “straddle,” or other risk reduction transaction. |
For purposes of this discussion, a U.S. holder is (i) an individual who is a citizen or resident of the United States for U.S. federal income tax purposes; (ii) a corporation, or other entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States (or treated as such under applicable U.S. tax laws), any state thereof, or the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income tax regardless of its source; or (iv) a trust if (a) a U.S. court is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) it has a valid election in effect under applicable law and regulations to be treated as a U.S. person for U.S. federal income tax purposes. A non-U.S. holder is a holder that is neither a U.S. holder nor a partnership or other entity classified as a partnership for U.S. federal income tax purposes.
In the case of a partnership or entity classified as a partnership for U.S. federal income tax purposes, the U.S. federal income tax treatment of a partner generally will depend on the status of the partner and the activities of the partnership. Partners of partnerships should consult their tax advisors regarding the U.S. federal income tax consequences to them of the merger or of the ownership and disposition of the Company’s ordinary shares.
Because of the redomestication transaction in 2012 by which the Company, which is a British Virgin Islands company, became the parent of the U.S. domestic company of which it was formerly a subsidiary, the Company is treated, under Section 7874 of the Code, as a U.S. domestic corporation for U.S. federal tax purposes and, among other consequences, is subject to U.S. federal income tax on its worldwide income. This discussion assumes that Section 7874 of the Code continues to apply to treat the Company as a U.S. corporation for all purposes under the Code. If, for some reason (e.g., future repeal of Section 7874 of the Code), the Company were no longer treated as a U.S. corporation under the Code, the U.S. federal income tax consequences described herein could be materially and adversely affected.
U.S. Federal Income Tax Consequences for U.S. Holders
Distributions
We do not currently anticipate paying distributions on the Company’s ordinary shares. In the event that distributions are paid, however, the gross amount of such distributions will be included in the gross income of the U.S. holder as dividend income on the date of receipt to the extent that the distribution is paid out of current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Such dividends will be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations. Dividends received by non-corporate U.S. holders, including individuals, may be subject to reduced rates of taxation under current law. A U.S. holder may be eligible to claim a foreign tax credit with respect to any PRC withholding tax imposed on dividends paid by us. However, the foreign tax credit rules are complex, and their application in connection with Section 7874 of the Code and the Agreement Between the Government of the United States of America and the Government of the People’s Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with Respect to Taxes on Income, or the U.S.-PRC Tax Treaty, is not entirely clear at this time. U.S. holders should consult their own tax advisors with respect to any benefits they may be entitled to under the foreign tax credit rules and the U.S.-PRC Tax Treaty.
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To the extent that dividends paid on the Company’s ordinary shares exceed current and accumulated earnings and profits, the distributions will be treated first as a tax-free return of tax basis on the Company’s ordinary shares, and to the extent that the amount of the distribution exceeds tax basis, the excess will be treated as gain from the disposition of those ordinary shares. Because Section 7874 of the Code has applied to treat the Company as a U.S. corporation only since our redomestication in 2012, we may not be able to demonstrate to the IRS the extent to which a distribution on the Company’s ordinary shares exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles), in which case all of such distribution will be treated as a dividend for U.S. federal income tax purposes.
Sale or Other Disposition
U.S. holders of the Company’s ordinary shares will recognize taxable gain or loss on any sale, exchange, or other taxable disposition of ordinary shares equal to the difference between the amounts realized for the ordinary shares and the U.S. holder’s tax basis in the ordinary shares. This gain or loss generally will be capital gain or loss. Under current law, non-corporate U.S. holders, including individuals, are eligible for reduced tax rates if the ordinary shares have been held for more than one year. The deductibility of capital losses is subject to limitations. A U.S. holder may be eligible to claim a foreign tax credit with respect to any PRC withholding tax imposed on gain from the sale or other disposition of ordinary shares. However, the foreign tax credit rules are complex, and their application in connection with Section 7874 of the Code and the U.S.-PRC Tax Treaty is not entirely clear at this time. U.S. holders should consult their own tax advisors with respect to any benefits they may be entitled to under the foreign tax credit rules and the U.S.-PRC Tax Treaty.
Net Investment Income Tax
Certain U.S. holders who are individuals, trusts or estates are required to pay an additional 3.8% net investment income tax on, among other things, dividends on and capital gains from the sale or other disposition of shares of stock. U.S. holders should consult their own advisors regarding the effect, if any, of this rule on their ownership and disposition of the Company’s ordinary shares.
U.S. Federal Income Tax Consequences for Non-U.S. Holders
Distributions
The rules applicable to non-U.S. holders for determining the extent to which distributions on the Company’s ordinary shares, if any, constitute dividends for U.S. federal income tax purposes are the same as for U.S. holders. See “–U.S. Federal Income Tax Consequences for U.S. Holders– Distributions.”
Any dividends paid to a non-U.S. holder by us are treated as income derived from sources within the United States and generally will be subject to U.S. federal income tax withholding at a rate of 30% of the gross amount of the dividends, or at a lower rate provided by an applicable income tax treaty if non-U.S. holders provide proper certification of eligibility for the lower rate (usually on IRS Form W-8BEN or Form W-8BEN-E). Dividends received by a non-U.S. holder that are effectively connected with such holder’s conduct of a U.S. trade or business (and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the non-U.S. holder in the U.S.) are exempt from such withholding tax, provided that applicable certification requirements are satisfied. In such case, however, non-U.S. holders will be subject to U.S. federal income tax on such dividends, net of certain deductions, at the rates applicable to U.S. persons. In addition, corporate non-U.S. holders may be subject to an additional branch profits tax equal to 30% or such lower rate as may be specified by an applicable tax treaty on dividends received that are effectively connected with the conduct of a trade or business in the United States.
If non-U.S. holders are eligible for a reduced rate of U.S. withholding tax pursuant to an applicable income tax treaty, such non-U.S. holders may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS.
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Sale or Other Disposition
Except as described below for a reduced rate of U.S. withholding tax pursuant to an applicable income tax treaty, any gain realized by a non-U.S. holder upon the sale or other disposition of the Company’s ordinary shares generally will not be subject to U.S. federal income tax unless:
| ● | the gain is effectively connected with the conduct of a trade or business in the United States by such non- U.S. holder, and, if an income tax treaty applies, is attributable to a permanent establishment maintained by such non- U.S. holder in the United States; | |
| ● | the non-U.S. holder is an individual who is present in the United States for 183 days or more in the taxable year of the disposition, and certain other conditions are met; or | |
| ● | the Company is or has been a “U.S. real property holding corporation,” or USRPHC, for U.S. federal income tax purposes at any time during the shorter of the five-year period ending on the date of disposition or the period during which the holder has held the Company’s ordinary shares. |
Non-U.S. holders whose gain is described in the first bullet point above will be subject to U.S. federal income tax on the gain derived from the sale, net of certain deductions, at the rates applicable to U.S. persons. Corporate non-U.S. holders whose gain is described in the first bullet point above may also be subject to the branch profits tax described above at a 30% rate or lower rate provided by an applicable income tax treaty. Individual non-U.S. holders described in the second bullet point above will be subject to a flat 30% U.S. federal income tax rate on the gain derived from the sale, which may be offset by U.S.-source capital losses, even though such non-U.S. holders are not considered to be residents of the United States.
A corporation will be a United States real property holding company, or USRPHC, if the fair market value of its U.S. real property interests equals or exceeds 50 percent of the aggregate of its real property interests (U.S. and non-U.S.) and its assets used or held for use in a trade or business. Because we do not currently own significant U.S. real property, we believe that we are not currently and will not become a USRPHC. However, because the determination of whether we are a USRPHC depends on the fair market value of our U.S. real property relative to the fair market value of our other business assets, there can be no assurance that we will not become a USRPHC in the future. Even if we become a USRPHC, however, so long as the Company’s ordinary shares are regularly traded on an established securities market, such ordinary shares will be treated as U.S. real property interests only if a non-U.S. holder actually or constructively holds more than 5% of such regularly traded ordinary shares at any time during the applicable period that is specified in the Code.
Foreign Account Tax Compliance
The Foreign Account Tax Compliance provisions of the Hiring Incentives to Restore Employment Act (generally referred to as “FATCA”), when applicable, impose a U.S. federal withholding tax of 30% on payments of dividends on, and gross proceeds from dispositions of, the Company’s ordinary shares that are held through “foreign financial institutions” (which is broadly defined for this purpose and in general includes investment vehicles) and certain other non-U.S. entities unless various U.S. information reporting and due diligence requirements (generally relating to ownership by U.S. persons of certain interests in or accounts with those entities) have been satisfied or an exemption applies. An intergovernmental agreement between the United States and an applicable foreign country may modify these requirements. U.S. Holders should consult their tax advisers regarding the effect, if any, of the FATCA provisions on their particular circumstances.
Information Reporting and Backup Withholding
Payments of dividends or of proceeds on the disposition of stock made to a holder of the Company’s ordinary shares may be subject to information reporting and backup withholding at a current rate of 24% unless such holder provides a correct taxpayer identification number on IRS Form W-9 (or other appropriate withholding form) or establishes an exemption from backup withholding, for example by properly certifying the holder’s non-U.S. status on a Form W-8BEN, Form W-8BEN-E or another appropriate version of IRS Form W-8. Payments of dividends to holders must generally be reported annually to the IRS, along with the name and address of the holder and the amount of tax withheld, if any. A similar report is sent to the holder. Pursuant to applicable income tax treaties or other agreements, the IRS may make these reports available to tax authorities in the holder’s country of residence.
Backup withholding is not an additional tax; rather, the U.S. income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may generally be obtained from the IRS, provided that the required information is furnished to the IRS in a timely manner.
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F. Dividends and Paying Agents
Not applicable.
G. Statement by Experts
Not applicable.
H. Documents on Display
We have filed this annual report on Form 20-F with the SEC under the Exchange Act. Statements made in this report as to the contents of any document referred to are not necessarily complete. With respect to each such document filed as an exhibit to this report, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference.
We are subject to the informational requirements of the Exchange Act as a foreign private issuer and file reports and other information with the SEC. Reports and other information filed by us with the SEC, including this report, may be inspected and copied at the public reference room of the SEC at 100 F Street, N.E., Washington D.C. 20549. You can also obtain copies of this report by mail from the Public Reference Section of the SEC, 100 F. Street, N.E., Washington D.C. 20549, at prescribed rates. Additionally, copies of this material may be obtained from the SEC’s Internet site at http://www.sec.gov. The SEC’s telephone number is 1-800-SEC-0330. In accordance with NASDAQ Stock Market Rule 5250(d), we will also post this annual report on Form 20-F on our website at www.taop.com. In addition, we will provide hardcopies of our annual report free of charge to shareholders upon request.
As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
I. Subsidiary Information
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We deposit surplus funds with Chinese banks earning daily interest. We do not invest in any instruments for trading purposes. Most of our outstanding debt instruments carry fixed rates of interest. Our operations generally are not directly sensitive to fluctuations in interest rates. There was no long-term debt outstanding as of December 31, 2022 and 2021. A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities under which we had outstanding borrowings at December 31, 2022 would increase net loss before income taxes by approximately $105,000 or less than 1% for the year ended December 31, 2022. Management monitors the banks’ prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.
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Foreign Exchange Risk
While our reporting currency is the U.S. dollar, substantially all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. Substantially all of our assets are denominated in RMB except for cash. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities are translated at exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in determining other comprehensive income, a component of equity. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $1.2 million based on our outstanding revenues, costs and expenses, assets and liabilities denominated in RMB as of December 31, 2022. As of December 31, 2022, our accumulated other comprehensive income was approximately $23.6 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.
The value of RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, RMB has not been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in RMB exchange rate and lessen intervention in the foreign exchange market.
Inflation
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
A. Debt Securities
Not applicable.
B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
D. American Depositary Shares
We do not have any American Depositary Shares.
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PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS AND USE OF PROCEEDS
None.
ITEM 15. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15(e), our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Jianghuai Lin and our Chief Financial Officer, Ms. Liqiong (Iris) Yan, of the effectiveness of the design and operation of our disclosure controls and procedures, as of December 31, 2022. Based upon, and as of the date of this evaluation, Mr. Lin and Ms. Yan, determined that, as of December 31, 2022, our disclosure controls and procedures were not effective due to the material weaknesses in our internal control over financial reporting, which are described below.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
(1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. 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.
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Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2022. In making this assessment, management used the framework set forth in the report entitled Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on our assessment, as a result of the material weaknesses described below, we determined that, as of December 31, 2022, our internal control over financial reporting was not effective based on those criteria.
As a result of our assessment, management identified the following control deficiencies that represent material weaknesses as of December 31, 2022: (1) We lack of formal process in respect of management going concern assessment and (2) We do not have sufficient formal procedures to be applied for the impairment assessment of the property, plant and equipment and long-lived assets and to consider appropriately all the internal and external impairment indicators as well.
We have taken steps to remediate these deficiencies as soon as practicable by implementing a plan to improve our internal control over financial reporting including, but not limited to, hiring additional internal staff and/or outside consultants experienced in US GAAP financial reporting as well as in SEC reporting requirements. In 2021 we have promoted Ms. Liqiong (Iris) Yan to be our Chief Financial Officer to oversee our internal control over financial reporting, and recruited seasoned accounting staff to improve our technical capability for financial reporting process. Our management team will continue to monitor and evaluate the effectiveness of our internal controls and procedures and our internal controls over financial reporting on an ongoing basis and is committed to taking further action and implementing additional enhancements or improvements.
Our management does not believe that these deficiencies had a material effect on our financial condition or results of operations or caused our financial statements as of and for the year ended December 31, 2022 to contain a material misstatement.
Attestation Report of the Registered Public Accounting Firm
Because the Company is a non-accelerated filer, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
Except as described above, there have been no changes in our internal control over financial reporting during the fiscal year ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Remington C.H. Hu is an “audit committee financial expert” and that he is an “independent director” as defined by the rules and regulations of NASDAQ.
ITEM 16B. CODE OF ETHICS
Our code of conduct and business ethics conforms to the rules and regulations of NASDAQ. The code of conduct and business ethics applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer, and addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of conduct and business ethics has been filed as Exhibit 11.1 to the annual report on Form 20-F dated March 30, 2018. Our code of ethics is also posted on the corporate governance page of our website at www.taop.com. During the fiscal year ended December 31, 2022, there were no waivers of our code of ethics.
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ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees by categories specified below in connection with services rendered by our principal external auditors for the periods indicated.
| Fiscal Year Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Audit Fees | $ | 212,353 | $ | 242,009 | ||||
| Tax Fees | 40,000 | 25,000 | ||||||
| TOTAL | $ | 252,353 | $ | 267,009 | ||||
“Audit Fees” consisted of the aggregate fees billed for professional services rendered for the audit of our annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.
“Tax Fees” consisted of the aggregate fees billed for professional services rendered for tax compliance, tax advice and tax planning. Included in such Tax Fees were fees for preparation of our tax returns and consultancy and advice on other tax planning matters.
Our Audit Committee pre-approves all auditing services and permitted non-audit services to be performed for us by our independent auditor, including the fees and terms thereof (subject to the de minimums exceptions for non-audit services described in Section 10A(i)(l)(B) of the Exchange Act that are approved by our Audit Committee prior to the completion of the audit). The percentage of services provided for which we paid audit-related fees, tax fees, or other fees that were approved by our Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X promulgated by the SEC was 100%.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
We have not asked for, nor have we been granted, an exemption from the applicable listing standards for our Audit Committee.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
There were no purchases of equity securities made by or on behalf of us or any “affiliated purchaser” as defined in Rule 10b-18 of the Exchange Act during the period covered by this Annual Report.
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
On December 3, 2021, the Company received notice from its independent registered public accounting firm, UHY LLP (“UHY”), that UHY has resigned as the Company’s auditor, effective immediately. As a result, the client-auditor relationship between the Company and UHY ceased. The resignation of UHY was not recommended by the Company’s audit committee nor was the audit committee’s approval required. On December 3, 2021, upon the audit committee’s approval, the Company engaged PKF Littlejohn LLP as its new independent registered public accounting firm to audit the Company’s financial statements for the fiscal year ending December 31, 2021. The disclosures required pursuant to this Item 16F was included in the Company’s Report on Form 6-K furnished with the SEC on December 3, 2021, including Exhibit 15.1, which are hereby incorporated by reference into this Form 20-F.
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ITEM 16G. CORPORATE GOVERNANCE
We are incorporated in the BVI and our corporate governance practices are governed by applicable BVI law, our memorandum and articles of association. In addition, because our ordinary shares are listed on NASDAQ, we are subject to NASDAQ’s corporate governance requirements.
NASDAQ Listing Rule 5615(a)(3) permits a foreign private issuer like us to follow home country practices in lieu of certain requirements of Listing Rule 5600, provided that such foreign private issuer discloses in its annual report filed with the SEC each requirement of Rule 5600 that it does not follow and describes the home country practice followed in lieu of such requirement.
We currently follow our home country practice that (i) does not require us to seek shareholders’ approval of any issuance of securities in connection with a transaction other than a public offering where such transaction involves the issuance of securities representing more than 20% of or more of the voting power outstanding before the issuance at a price lower than the “Minimum Price”, in lieu of the corporate governance requirements of Nasdaq Listing Rule 5635(d) with respect to shareholder approval; (ii) does not require us to seek shareholders’ approval for the establishment of or any material amendments to our equity compensation plans in lieu of the corporate governance requirements of Nasdaq Listing Rule 5635(c) with respect to shareholder approval; and (iii) does not require us to seek shareholders’ approval for the issuance of securities to external consultants, in lieu of the corporate governance requirements of Nasdaq Listing Rule 5635(c) with respect to shareholder approval. Our BVI counsel, Maples and Calder, has provided relevant letters to NASDAQ certifying that under BVI law, we are not required to seek shareholders’ approval in the above circumstances.
In addition, Maples and Calder has provided a letter to NASDAQ certifying that under BVI law, we are not required to hold annual shareholders’ meetings. In the fiscal year 2022, we followed the home country practice and did not hold an annual meeting of shareholders.
ITEM 16H. MINE SAFETY DISCLOSURE
Not applicable.
ITEM 16I. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not Applicable.
ITEM 16J. INSIDER TRADING POLICIES
Not Applicable.
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PART III
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide our financial statements pursuant to Item 18.
ITEM 18. FINANCIAL STATEMENTS
The full text of our audited consolidated financial statements begins on page F-1 of this annual report.
ITEM 19. EXHIBITS
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SIGNATURE
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
| Date: April 25, 2023 | TAOPING INC. |
| /s/ Jianghuai Lin | |
| Jianghuai Lin | |
| Chief Executive Officer |
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TAOPING INC.
CONSOLIDATED FINANCIAL STATEMENTS
| F-1 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF Taoping INC
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Taoping Inc. (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity (deficit) and cash flows for each of the years ended December 31, 2022 and 2021 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, 2022 and 2021, and the results of its operations and its cash flows for each of the years ended December 31, 2022 and 2021, in conformity with accounting principles generally accepted in the United States of America.
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 audit. 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 audit 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 audit, 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 audit 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 consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Substantial Doubt about the Company’s Ability to Continue as a Going Concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Critical Audit Matters – Going Concern in our auditors’ report and Note 1 to the consolidated financial statements, the Company’s significant losses from operations, working capital deficit, bank loans of $7.2m which are repayable within one year and the uncertainty about the availability of future financing raise substantial doubt about its ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of the uncertainty.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Going concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in the “Substantial Doubt about the Company’s Ability to Continue as a Going Concern” section in our auditors’ report and Note 1 to the consolidated financial statements, the Company’s significant losses from operations, working capital deficit, bank loans of $7.2m which are repayable within one year and the uncertainty about the future financing raise substantial doubt about its ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 1 to the consolidated financial statements.
The principal consideration for our determination that the evaluation of management’s going concern assessment was a critical audit matter are the significant judgment and subjectivity inherent risk in the Company’s assumptions made in the going concern assessment and the uncertainty of the Company’s ability to secure funding subsequent to December 31, 2022.
| F-2 |
Our audit procedures related to the evaluation of management’s going concern assessment included the following, among others:
| a. | assessing the overall reasonableness of the Company’s going concern assessment, including significant assumptions utilized by the Company. | |
| b. | assessing the projected revenue and operating costs, liquidity of existing assets, the terms of the bank loans and related party loans and the finance facilities available. | |
| c. | considering the impact on the Company’s working capital of the acquisition in 2022. | |
| d. | evaluating the adequacy of the Company’s financial statement disclosures. |
Revenue recognition
The Company has the following revenue streams:
| a. | revenue from sale of products | |
| b. | revenue from software | |
| c. | revenue from advertising service | |
| d. | revenue from the mining and subsequent sale of cryptocurrencies |
As disclosed in Note 2 to the consolidated financial statements, the Company recognizes revenue from product, software, advertising and mining and subsequent sale of cryptocurrencies upon transfer of control of promised products or services. Significant judgment is exercised by the Company in determining criteria in recognizing revenue. The principal considerations for our determination that revenue recognition is a critical audit matter are:
| a. | revenue is material to the consolidated financial statements; and | |
| b. | significant judgement by management in assessing the criteria to recognize revenue was extensive and it required a high degree of auditor judgment. |
Our audit procedures in respect related to revenues recognition included:
| a. | obtaining understanding of the internal control environment for revenue; | |
| b. | understanding the management’s assessment process for revenue recognition criteria; | |
| c. | Performing substantive transaction and cut-off testing for revenue; | |
| d. | Reviewing collection of recognized revenue; and | |
| e. | obtaining management’s view on the macroeconomic conditions that may have impact on revenue. |
Business Combination – Acquisition of Zhenjiang Taoping IoT Tech. Co., Ltd.
As described in Note 3 to the consolidated financial statements, the Company acquired 95.56% equity interest of Zhenjiang Taoping IoT Tech. Co., Ltd. on January 13, 2022 for purchase consideration of 201,552 restricted ordinary shares of the Company equivalent to the fair value of approximately $0.27m. The purchase price allocations resulted in the Company recording various assets and liabilities at the estimated fair values at the acquisition date.
The Company accounted for the acquisition under the acquisition method of accounting for business combinations. Assets acquired and liabilities assumed have been recorded at their estimated fair values as of the acquisition date. The fair value of the assets and liabilities was determined based on valuations using the asset-based approach (including replacement costs model where applicable), which requires significant estimates and assumptions. Management, with the assistance of an independent valuation expert, concluded that there are no material intangible assets. Goodwill generated in the acquisition, being the difference between fair value of consideration and fair value of assets acquired and liabilities assumed, was tested for impairment based on the income approach. Management, with the assistance of an independent valuation expert, concluded that there was no impairment of goodwill.
| F-3 |
Given the fair value determination of the assets and liabilities and the goodwill impairment assessment process requires management to make significant estimates and assumption, performing procedures to evaluate the reasonableness of the estimates and assumptions required a high degree of auditor judgement and an increased extent of effort.
Our audit procedures related to the business combination included:
| a. | reviewing the sales and purchase agreement and evaluating the transactions to determine whether the acquisition met the definition of a business combination and our analysis of the initial allocation of the purchase price accounting; | |
| b. | obtaining independent third party valuation report to gain an understanding of the creditability of the valuation expert, the process and key assumptions for estimating the fair value of assets and liabilities, and the methodologies and assumptions used in developing the recoverable amount of goodwill; and | |
| c. | agreeing the underlying data used as part of the valuations to source documents, including the sales and purchase agreement. |
Furthermore, we assessed the appropriateness of the disclosure in the consolidated financial statements.
| /s/
|
|
| PKF Littlejohn LLP | |
| April 25, 2023 | |
| PCAOB ID: 2814 |
We have served as the Company’s auditor since December 3, 2021.
| F-4 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Shareholders of Taoping Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Taoping Inc. and its subsidiaries (the “Company”) as of December 31, 2020, and the related consolidated statements of operations and comprehensive income (loss), changes in equity, and cash flows for the year ended December 31, 2020, 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, 2020, and the results of its operations and its cash flows for the year ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Substantial Doubt about the Company’s Ability to Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company had limited income from operations and had significant accumulated deficit that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
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 consolidated 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 consolidated 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 consolidated 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 consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
| F-5 |
Assessment of Accounts Receivable Allowance for Credit Losses
Critical Audit Matter Description
As disclosed in Note 2 to the consolidated financial statements, the Company recognizes accounts receivable at carrying amount less an allowance of credit losses. Significant judgment and estimation are exercised by the Company in determining the collectability of the accounts receivable, especially under the global pandemic environment during 2020.
The principal considerations for our determination that performing procedures relating to the accounts receivables allowance for credit losses is a critical audit matter are (i) accounts receivable is significant to the Company’s consolidated financial statements, which amounted to approximately $10.3 million and represented 33.6% of the Company’s total assets; (ii) the evaluation of Management’s judgments and estimates in developing the accounts receivable allowance for credit losses at December 31, 2020 requires a high degree of auditor’s judgement.
How the Critical Audit Matter Was Addressed in the Audit
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included obtaining understanding of the controls over the Company’s determination of the accounts receivable allowance for credit losses. These procedures also included, among others, testing Management’s process for estimating the accounts receivable allowance for credit losses by, evaluating the appropriateness of the methodology used to estimate the allowance, evaluating the reasonableness of the probability of default and loss assumptions, testing the data used in the models, and evaluating the reasonableness of management’s judgment regarding qualitative factors related to economic uncertainty, observable changes in customers’ financial performance, and other relevant factors.
Evaluation of Revenue Recognition
Critical Audit Matter Description
As disclosed in Note 2 to the consolidated financial statements, the Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. Significant judgment is exercised by the Company in determining collectability in recognizing revenue, especially under the global pandemic environment during 2020.
The principal considerations for our determination that performing procedures relating to the collectability in recognizing revenue is a critical audit matter are (i) revenue is material to the consolidated financial statements, which amounted to approximately $11 million for the year ended December 31, 2020; (ii) significant judgement by Management in assessing the collectability to recognize revenue was extensive and required a high degree of auditor judgment.
How the Critical Audit Matter Was Addressed in the Audit
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included obtaining an understanding of the controls over the Company’s revenue recognition including the estimation of customer collections. These procedures also included, among others, testing management’s process for estimating the collectability in recognizing revenue by, evaluating the appropriateness of the methodology used to estimate the collection, testing the customers’ historical payment behavior, evaluating reasonableness of the Management’s assessment on new customers’ creditworthiness, macroeconomic conditions that may affect customers’ ability to pay, testing the data used in the models, and evaluating the reasonableness of the estimated collection periods and financing component if any, associated with the expected longer collection period.
/s/
We have served as the Company’s auditor since 2016.
April 30, 2021
| F-6 |
TAOPING INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2022 AND 2021
| NOTES | December 31, 2022 | December 31, 2021 | ||||||||
| ASSETS | ||||||||||
| CURRENT ASSETS | ||||||||||
| Cash and cash equivalents | $ | $ | ||||||||
| Accounts receivable, net | 2(e) | |||||||||
| Accounts receivable-related parties, net | 2(e) | |||||||||
| Advances to suppliers | 2(f) | |||||||||
| Prepaid expenses | ||||||||||
| Inventories, net | 8 | |||||||||
| Other current assets | 13(a) | |||||||||
| Current assets from discontinued operations | 10 | |||||||||
| TOTAL CURRENT ASSETS | ||||||||||
| Property, equipment and software, net | 9 | |||||||||
| Right-of-use assets | 2(q) | |||||||||
| Long-term investments | 15 | |||||||||
| Goodwill | ||||||||||
| Other assets, non-current, net | 13(b) | |||||||||
| TOTAL ASSETS | $ | $ | ||||||||
| LIABILITIES AND EQUITY | ||||||||||
| CURRENT LIABILITIES | ||||||||||
| Short-term bank loans | 11 | $ | $ | |||||||
| Accounts payable | ||||||||||
| Advances from customers | ||||||||||
| Advances from customers-related parties | 7(a) | |||||||||
| Amounts due to related parties | 7(c) | |||||||||
| Accrued payroll and benefits | ||||||||||
| Other payables and accrued expenses | 17 | |||||||||
| Income tax payable | ||||||||||
| Lease liability-current | 14 | |||||||||
| Other current liability | ||||||||||
| Current liabilities from discontinued operations | 10 | |||||||||
| TOTAL CURRENT LIABILITIES | ||||||||||
| Lease liability | 14 | |||||||||
| TOTAL LIABILITIES | ||||||||||
| EQUITY | ||||||||||
| Ordinary shares, 2022 and 2021: par $ | 19 | |||||||||
| Additional paid-in capital | 19 | |||||||||
| Reserve | 18 | |||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||||
| Accumulated other comprehensive income | ||||||||||
| Total equity of the Company | ||||||||||
| Non-controlling interest | ( | ) | ||||||||
| TOTAL EQUITY | ||||||||||
| TOTAL LIABILITIES AND EQUITY | $ | $ | ||||||||
The accompanying notes are an integral part of these consolidated financial statements
| F-7 |
TAOPING INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2022, 2021 AND 2020
| NOTES | 2022 | 2021 | 2020 | |||||||||||
| Revenue – Products | $ | $ | $ | |||||||||||
| Revenue – Products-related parties | 7(a) | |||||||||||||
| Revenue – Advertising | ||||||||||||||
| Revenue - Advertising-related parties | ||||||||||||||
| Revenue – Software | ||||||||||||||
| Revenue – Others | ||||||||||||||
| Revenue – Others-related parties | 7(b) | |||||||||||||
| TOTAL REVENUE | ||||||||||||||
| Cost – Products | ||||||||||||||
| Cost – Advertising | 2(s) | |||||||||||||
| Cost – Software | ||||||||||||||
| Cost – System integration | ||||||||||||||
| Cost – Others | ||||||||||||||
| TOTAL COST | ||||||||||||||
| GROSS PROFIT | ||||||||||||||
| Administrative expenses | ||||||||||||||
| Research and development expenses | ||||||||||||||
| Selling expenses | ||||||||||||||
| LOSS FROM OPERATIONS | ( | ) | ( | ) | ( | ) | ||||||||
| Subsidy income | ||||||||||||||
| Loss from equity method investment | ( | ) | ( | ) | ||||||||||
| Other income (loss), net | ( | ) | ( | ) | ||||||||||
| Interest income | ||||||||||||||
| Interest expense and debt discounts expense | ( | ) | ( | ) | ( | ) | ||||||||
| Loss before income taxes | ( | ) | ( | ) | ( | ) | ||||||||
| Income tax (expense) benefit | 12 | ( | ) | ( | ) | |||||||||
| Net loss from continuing operations | ( | ) | ( | ) | ( | ) | ||||||||
| Net loss (income) from discontinued operations | 10 | ( | ) | |||||||||||
| NET LOSS | ( | ) | ( | ) | ( | ) | ||||||||
| Less: net loss attributable to the non-controlling interest | 4 | |||||||||||||
| NET LOSS ATTRIBUTABLE TO THE COMPANY | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||||
| (Loss) income per share - Basic and Diluted* | ||||||||||||||
| CONTINUING OPERATIONS | ||||||||||||||
| Basic | 6 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| Diluted | 6 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| DISCONTINUED OPERATIONS | ||||||||||||||
| Basic | 6 | $ | ( | ) | $ | $ | ||||||||
| Diluted | 6 | $ | ( | ) | $ | $ | ||||||||
| LOSS PER SHARE ATTRIBUTABLE TO THE COMPANY | ||||||||||||||
| Basic | 6 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| Diluted | 6 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| * |
The accompanying notes are an integral part of these consolidated financial statements
| F-8 |
TAOPING INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2022, 2021 AND 2020
| 2022 | 2021 | 2020 | ||||||||||
| Net loss | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Other comprehensive (loss) income: | - | - | - | |||||||||
| Foreign currency translation (loss) gain | ( | ) | ||||||||||
| Comprehensive loss | ( | ) | ( | ) | ( | ) | ||||||
| Comprehensive loss attributable to the non- controlling interest | ||||||||||||
| Comprehensive loss attributable to the Company | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
The accompanying notes are an integral part of these consolidated financial statements
| F-9 |
TAOPING INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
YEARS ENDED DECEMBER 31, 2022, 2021 AND 2020
| Accumulated | ||||||||||||||||||||||||||||||||
| Additional | other | Non | ||||||||||||||||||||||||||||||
| Ordinary shares* | Paid-in | Accumulated | comprehensive | controlling | ||||||||||||||||||||||||||||
| Shares | Amount | Capital | Reserve | deficit | income | interest | Total | |||||||||||||||||||||||||
| BALANCE AS AT JANUARY 1, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||
| Stock-based payment for consulting fee (Note 19) | ||||||||||||||||||||||||||||||||
| Exercise of non-employee warrants | ( | ) | ||||||||||||||||||||||||||||||
| Exercise of Employee Stock Options (Note 19) | ( | ) | ||||||||||||||||||||||||||||||
| Conversion of convertible notes (Note 19) | ( | ) | ||||||||||||||||||||||||||||||
| Insurance of ordinary shares for financing (Note 19) | ||||||||||||||||||||||||||||||||
| Detachable warrant and beneficial conversion feature in connection with Convertible note (Note 16) | - | |||||||||||||||||||||||||||||||
| Net loss for the year | - | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||||
| Round-up of fractional shares in connection with 6-for-1 reverse stock split | ||||||||||||||||||||||||||||||||
| Foreign currency translation gain | - | ( | ) | |||||||||||||||||||||||||||||
| Employee Stock Incentive | ||||||||||||||||||||||||||||||||
| BALANCE AS AT DECEMBER 31, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||
| Stock-based payment for consulting fee (Note 19) | ||||||||||||||||||||||||||||||||
| Stock-based Compensation (Note 19) | - | |||||||||||||||||||||||||||||||
| Conversion of convertible notes (Note 16) | ( | ) | ||||||||||||||||||||||||||||||
| Insurance of ordinary shares for financing (Note 19) | ||||||||||||||||||||||||||||||||
| Employee stock incentive (Note 19) | ||||||||||||||||||||||||||||||||
| Net loss for the year | - | ( | ) | ( | ) | |||||||||||||||||||||||||||
| Foreign currency translation gain | - | ( | ) | |||||||||||||||||||||||||||||
| Dissolve of variable interest entity and ordinary shares issued for acquisition of a wholly owned subsidiary | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Ordinary shares issued for business acquisition | ||||||||||||||||||||||||||||||||
| Minority shareholders’ contribution | - | ( | ) | ( | ) | |||||||||||||||||||||||||||
| BALANCE AS AT DECEMBER 31, 2021 | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Stock-based payment for consulting fee (Note 19) | ||||||||||||||||||||||||||||||||
| Net loss for the year | - | ( | ) | ( | ) | |||||||||||||||||||||||||||
| Foreign currency translation (loss) | - | ( | ) | ( | ) | |||||||||||||||||||||||||||
| Disposal of a wholly owned subsidiary | - | ( | ) | ( | ) | |||||||||||||||||||||||||||
| Ordinary shares issued for business acquisition | ||||||||||||||||||||||||||||||||
| Reversal of minority shareholders’ interest upon disposal of a subsidiary | - | |||||||||||||||||||||||||||||||
| BALANCE AS AT DECEMBER 31, 2022 | ( | ) | ||||||||||||||||||||||||||||||
| * |
The accompanying notes are an integral part of these consolidated financial statements
| F-10 |
TAOPING INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2022, 2021 AND 2020
| 2022 | 2021 | 2020 | ||||||||||
| OPERATING ACTIVITIES | ||||||||||||
| Net loss | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Adjustments to reconcile net (loss) to net cash (used in) provided by operating activities: | ||||||||||||
| Provision for losses on accounts receivable and other current assets | ||||||||||||
| Provision for obsolete inventories | ( | ) | ||||||||||
| Depreciation | ||||||||||||
| Amortization of intangible assets and other asset | ||||||||||||
| Amortization of convertible note discount | ||||||||||||
| Loss (gain) on sale of property and equipment | ( | ) | ||||||||||
| Impairment of property and equipment | ||||||||||||
| Loss from disposal of inventories | ||||||||||||
| Stock-based payments for consulting services | ||||||||||||
| Stock-based compensation to employees | ||||||||||||
| Impairment on cryptocurrencies | ||||||||||||
| (Gain) on sales of cryptocurrencies | ( | ) | ( | ) | ||||||||
| (Gain) on disposal of subsidiaries | ( | ) | ||||||||||
| Loss on long-term investment | ||||||||||||
| Changes in operating assets and liabilities: | ||||||||||||
| Increase in accounts receivable | ( | ) | ( | ) | ( | ) | ||||||
| Decrease (increase) in accounts receivable from related parties | ( | ) | ||||||||||
| Decrease in accounts payable from related party | ( | ) | ||||||||||
| Decrease in inventories | ||||||||||||
| Cryptocurrencies - mining and purchases | ( | ) | ( | ) | ||||||||
| Decrease in other non-current assets | ||||||||||||
| (Increase) decrease in other receivables and prepaid expenses | ( | ) | ||||||||||
| Decrease (increase) in advances to suppliers | ( | ) | ( | ) | ||||||||
| Increase in amounts due to/from related parties | ( | ) | ||||||||||
| Increase (decrease) in other payables and accrued expenses | ( | ) | ||||||||||
| Increase (decrease) in advances from customers | ( | ) | ||||||||||
| (Decrease) increase in advances from related parties | ( | ) | ( | ) | ||||||||
| Increase in payroll payable and benefits | ||||||||||||
| (Decrease) increase in lease liability | ( | ) | ||||||||||
| (Decrease) increase in accounts payable | ( | ) | ( | ) | ||||||||
| (Decrease) increase in income tax payable | ( | ) | ( | ) | ||||||||
| Net cash (used in) operating activities | ( | ) | ( | ) | ( | ) | ||||||
| INVESTING ACTIVITIES | ||||||||||||
| Proceeds from sales of cryptocurrencies | ||||||||||||
| Proceeds from sales of property and equipment | ||||||||||||
| Purchases of property, equipment and software | ( | ) | ( | ) | ( | ) | ||||||
| Acquisition of cash in connection with a business acquisition | ||||||||||||
| Consideration paid for acquisition | ( | ) | ||||||||||
| Disbursement of loan receivable - related party | ( | ) | ||||||||||
| Net cash provided by (used in) investing activities | ( | ) | ( | ) | ||||||||
| FINANCING ACTIVITIES | ||||||||||||
| Proceeds from borrowings under short-term loans | ||||||||||||
| Borrowings from related parties | ||||||||||||
| Repayment of short-term loans | ( | ) | ( | ) | ( | ) | ||||||
| Proceeds from issuance of convertible note, net of debt issuance costs | ||||||||||||
| Proceeds from issuance of ordinary shares in connection with Private placement net of offering costs | ||||||||||||
| Net cash provided by financing activities | ||||||||||||
| Effect of exchange rate changes on cash and cash equivalents | ||||||||||||
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | ( | ) | ( | ) | ||||||||
| CASH AND CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING | ||||||||||||
| CASH AND CASH EQUIVALENTS, AND RESTRICTED CASH, ENDING | $ | $ | $ | |||||||||
| Supplemental disclosure of cash flow information: | ||||||||||||
| Cash paid during the year | ||||||||||||
| Income taxes | $ | $ | $ | |||||||||
| Interest | $ | $ | $ | |||||||||
| F-11 |
December 31, 2022 | December 31, 2021 | |||||||
| Reconciliation to amounts on consolidated balance sheets | ||||||||
| Cash and cash equivalents from continuing operations | $ | $ | ||||||
| Cash and cash equivalents from discontinued operations | ||||||||
| Total cash, cash equivalents, and restricted cash | $ | $ | ||||||
Supplemental disclosure of significant non-cash transactions*:
During
2020, the Company issued an aggregate of restrict ordinary shares, non-restricted ordinary shares, and
In
March 2020, the Company issued two individual investors warrants with fair value of $
In July 2020, under the 2016 Equity Incentive Plan the Company granted options to purchase ordinary shares of the Company to the directors and employees rewarding them for their past services and promoting future performance.
In July 2020, under the 2016 Equity Incentive Plan the Company granted options to purchase ordinary shares of the Company to certain consultants rewarding them for their past services.
In July and September 2020, under the 2016 Equity Incentive Plan the Company granted ordinary shares of the Company to an employee for the individual’s job performance.
In
September 2020, the Company issued an investor warrants with fair value of $
In
September and October 2020, the holder of the Company’s convertible promissory note issued in September 2019 converted in full
an amount of $
In
September 2020, each of the two holders of the Company’s convertible promissory notes issued in March 2020 converted an amount
of $
| F-12 |
In
December 2020, each of the two holders of the Company’s convertible promissory notes issued in March 2020 converted the remaining
principal and accrued interest in an amount of $
In
January 2021, the Company issued non-restricted shares with a fair value of $
In
March 2021, the Company issued restricted ordinary shares under its 2016 Equity Incentive Plan to certain employees with the
fair value of approximately $
In
April 2021, the Company issued warrants to an investor relationship consultant to purchase
In
April 2021, the Company obtained right-of-use assets of approximately $
In
June 2021, the Company issued restricted ordinary shares for the acquisition of Taoping New Media Co., Ltd. The fair value
of the restricted ordinary shares was approximately $
In
September 2021, the Company issued ordinary shares for the acquisition of iASPEC Technology Group Co., Ltd. The fair value of
the ordinary shares was approximately $
In
November 2021, the Company issued restricted ordinary shares with a fair value of $
In
December 2021, the Company issued ordinary shares with a fair value of $
In
2021, purchase of software and equipment in an amount of approximately $
In
2021, the Company held cryptocurrencies in an amount of approximately of $
In February 2022, the Company issued the first phase of restricted ordinary shares with a fair value of approximately $, for the acquisition of Zhenjiang Taoping IoT Tech. Co., Ltd. The Company agreed to issue to the shareholders of Zhenjiang Taoping a total of restricted ordinary shares in three phases, conditioned upon the satisfaction of certain performance targets.
In
March 2022 and July 2022, the Company issued ordinary shares with a fair value of $
The accompanying notes are an integral part of these consolidated financial statements
| F-13 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION, PRINCIPAL ACTIVITIES AND MANAGEMENT’S PLANS
Taoping Inc. (f/k/a China Information Technology, Inc.), together with its subsidiaries (the “Company” or “TAOP”), is a blockchain technology and smart cloud services provider. The Company provides cloud-based display terminal and service of digital advertising distribution network and new media resource sharing platform in the Out-of-Home advertising market in China. It’s integrated end-to-end digital advertising solutions enables customers to distribute and manage ads on the ads display terminals. With multiple cloud data centers deployed, the Company also provides computing power and creates value for the encrypted digital currency industry.
In May 2018, we changed our corporate name from “China Information Technology Inc.” to “Taoping Inc.”, to reflect our current business operations in the new media and IoT industries. In 2021, Information Security Tech International Co. Ltd. (“IST HK”), one of the Company’s Hong Kong subsidiaries then, changed its corporate name to Taoping Group (China) Ltd. to reflect the Company’s current corporate structure to be in line with the new business strategies. As listed in the table below, these services are provided through the Company’s operating subsidiaries, primarily in Hong Kong, mainland China and Kazakhstan.
On
June 9, 2021, the Company consummated an acquisition of
In 2021, the Company launched blockchain related new business in cryptocurrency mining operations and newly established subsidiaries in Hong Kong to supplement its diminished Traditional Information Technology (TIT) business segment as a part of new business transformation. However, due to the decreased output and the highly volatile cryptocurrency market, the Company ceased the operation of cryptocurrency mining business by December 2022, and will continue to focus the efforts on its digital adverting, smart display and the newly added smart community and related businesses.
As the cessation of the operation of cryptocurrency mining business represent a strategic shift in the Company’s strategy that will have a major effect on the Company’s operations and financial results, the operations of cryptocurrency mining business have been presented as “discontinued operations” in the Company’s consolidated financial statements. See Note 10.
In September 2021, the Company and the Company’s wholly owned subsidiary, Information Security Technology (China) Co., Ltd. (“IST”) entered into an equity transfer agreement with Mr. Jianghuai Lin, the sole shareholder of iASPEC Technology Group Co., Ltd. (“iASPEC”). Upon closing of the equity transfer, the Company’s variable interest entity structure was dissolved and iASPEC became a wholly owned indirect subsidiary of the Company.
In September 2021, the Company also strategically relocated its global corporate headquarters to Hong Kong to better implement cryptocurrency mining operations and blockchain related new businesses and streamline its international business development, client communication, and service delivery. The office located in Shenzhen, China becomes the TAOP’s regional headquarters in Mainland China.
As
a result of the Company’s business transformation and its exit from the TIT business, the Company disposed of
| F-14 |
| December 31, | December 31, | December 31, | ||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||
| Entities | Subsidiaries | % owned | % owned | % owned | Location | |||||||||||
| % | % | % | ||||||||||||||
| % | % | % | ||||||||||||||
| % | % | - | ||||||||||||||
| % | % | - | ||||||||||||||
| % | % | - | ||||||||||||||
| % | - | |||||||||||||||
| % | % | - | ||||||||||||||
| % | % | - | ||||||||||||||
| % | % | % | ||||||||||||||
| % | % | % | ||||||||||||||
| % | % | % | ||||||||||||||
| % | VIE | |||||||||||||||
| % | % | VIE | ||||||||||||||
| % | % | VIE | ||||||||||||||
| % | % | - | ||||||||||||||
| % | - | |||||||||||||||
| % | - | |||||||||||||||
| % | - | |||||||||||||||
| % | % | - | ||||||||||||||
| % | % | - | ||||||||||||||
| % | % | - | ||||||||||||||
| F-15 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Dissolution of the Variable Interest Entity Structure
iASPEC was a VIE of the Company. To comply with PRC laws and regulations that restrict foreign ownership of companies that provide public security information technology and Geographic Information Systems software operating services to certain government and other customers, the Company used to operate the restricted aspect of its business through iASPEC.
In
September 2021, we dissolved the variable interest entity structure by exercising the purchase option under certain Option Agreement
among IST, iASPEC and its shareholders, to purchase all of the equity interests in iASPEC at an aggregate exercise price of $
Upon the closing of the equity transfer, the Company’s variable interest entity structure was dissolved and iASPEC became a wholly owned indirect subsidiary of the Company. The amended and restated MSA was automatically terminated.
Going Concern and Management’s Plans
In
2022, COVID-19 pandemic was largely contained in China. As a result of the gradual recovery of the market conditions and customer demands,
the Company’s revenue of continuing operations achieved 25.0% for year 2022 year-over-year increase. The Company has also
significantly improved profitability by $
The
Company incurred a net loss of approximately $
| F-16 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In
June 2021, the Company completed an acquisition of
The Company’s two core competencies, the Taoping national sales network and the highly scalable and compatible cloud platform, and its strong software development capability, make it a valued partner by many other smart-community customers and solution providers. In addition to seeking strategic acquisition to expand its digital advertising business, the Company continues to explore business opportunity in the smart community and new energy sectors. From late 2022 to April 2023, the Company has entered into a series of long-term strategic cooperation agreements with various customers to provide Taoping’s cloud-based intelligent product solutions, including smart large screen, IoT smart rest station and off-grid wastewater treatment solution, which are expected to generate significant revenue growth and operating cashflow for the Company for year 2023 and beyond.
If the Company’s execution of business strategies
is not successful in addressing its current financial concerns, additional capital raise from issuing equity security or debt instrument
or additional loan facility may occur to support required cash flows. The Company’s existing $
However, the Company can make no assurances that financing will be available for the amounts we need, or on terms commercially acceptable to us, if at all. If one or all of these events do not occur or subsequent capital raise was insufficient to bridge financial and liquidity shortfall, substantial doubt exists about the Company’s ability to continue as a going concern. The consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation and Principles of Consolidation
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, all adjustments (consisting of normal recurring adjustments) have been made that are necessary to present fairly the financial position, the results of its operations and cash flows. The consolidated financial statements include the accounts of the Company, and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
(b) Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. The Company’s significant estimates include its accounts receivable, assessment of credit losses, fair value of stock options and warrants, valuation allowance of deferred tax assets, useful lives of property and equipment, the recoverability of long-lived assets, revenue recognition, valuation of prepayments, goodwill, and other intangible assets, inventories, cryptocurrencies, purchase price allocation of business combination, right-of-use assets, and lease liabilities. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ from those estimates.
| F-17 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(c) Economic, Pandemic, Political, and Currency Exchange Risks
All the Company’s revenue-generating operations are conducted in Hong Kong and mainland China. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic, public health, and legal environments in the PRC, and by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks that are not typically pertaining to the companies in North America and Western Europe. These include risks associated with, among others, the political, economic, public health concerns with persistent outbreaks of COVID-19 infections in various regional localities, and legal environments, geopolitical influences, and foreign currency exchange, notably in recent events, where the government’s sudden interventions or modifications of the laws and regulations currently in effective could negatively impact the Company’s operations and financial results.
The functional currency of the Company is primarily Chinese Renminbi Yuan (“RMB”), which is not freely convertible into foreign currencies. The Company cannot guarantee that the current exchange rate will remain steady. Therefore, there is a possibility that the Company could post the same amount of profit for two comparable periods and yet, because of fluctuating exchange rates, record higher or lower profit depending on exchange rate of RMB. RMB converted to U.S. dollars on the relevant dates. The exchange rate could fluctuate depending on changes in the political and economic environment without notice.
(d) Cash and Cash Equivalents
The
Company considers all highly liquid investments purchased and cash deposits with financial institutions with original maturities of three
months or less to be cash equivalents. The Company had
The
Company maintains its cash accounts at credit worthy financial institutions and closely monitors the movements of its cash positions.
As of December 31, 2022 and 2021, approximately $
(e) Accounts Receivable, Accounts Receivable–related parties, and Concentration of Risk
Accounts receivable are recognized and carried at carrying amount less an allowance for credit loss, if any. The Company maintains an allowance for credit losses resulting from the inability of its customers to make required payments based on contractual terms. The Company reviews the collectability of its receivables on a regular and ongoing basis according to historical trend, and estimates its provision for expected credit losses on receivables aging analysis.
The
Company estimates allowance for credit losses for the anticipation of future economic condition and credit risk indicators of customers,
including the potential impact of the COVID-19 pandemic on its customers’ businesses. After all attempts to collect a receivable
have failed, the receivable is written off against the allowance. In the event the Company recovers amounts previously reserved for,
the Company will reduce the specific allowance for credit losses. The balance of allowance for credit losses for the year ended December
31, 2022 has decreased approximately $
| F-18 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Accounts receivable as at December 31, 2022 and 2021 are as follows:
| December 31, 2022 | December 31, 2021 | |||||||
| Accounts Receivable | $ | $ | ||||||
| Allowance for credit losses | ( | ) | ( | ) | ||||
| Accounts Receivable, net | $ | $ | ||||||
| Accounts Receivable - related parties | $ | $ | ||||||
| Allowance for credit losses | ( | ) | ( | ) | ||||
| Accounts Receivable - related parties, net | $ | $ | ||||||
The normal credit term is ranging from 1 month to 3 months after the customers’ acceptance of high-end data storage servers or software, and completion of advertising and other services, and ranging from 1 month to 6 months after the customers’ acceptance of ads display terminals. However, because of various factors of business cycle, the actual collection of outstanding accounts receivable may be beyond the normal credit terms.
The
allowance for credit losses at December 31, 2022 and 2021, totaled approximately $
| Balance at January 1, 2021 | $ | |||
| Addition from acquisition of subsidiaries under common control | ||||
| Increase in allowance for credit losses | ||||
| Foreign exchange difference | ||||
| Balance at December 31, 2021 | $ | |||
| Decrease for balance due to transfer of a company | ( | ) | ||
| Increase in allowance for credit losses | ||||
| Foreign exchange difference | ( | ) | ||
| Balance at December 31, 2022 | $ |
(f) Advances to Suppliers
Advances to suppliers include but are not limited to cash deposits for the purchase of inventory items and super-computing server machines from suppliers.
(g) Advances from Customers and Related Parties
Advances from customers and related parties represent cash received from customers and related parties as advance payments for the purchases of the Company’s products and services.
| F-19 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(h) Fair Value and Fair Value Measurement of Financial Instruments
Management has estimated that carrying amounts reported in the consolidated balance sheets for cash, accounts receivable, accounts receivable – related parties, advances to suppliers, other current assets, other non-current assets, short-term bank loans, accounts payable, advances from customers, advances from customers - related parties, other payables and accrued expenses, income taxes payable, and due to related parties approximate their fair market value based on the short-term maturity of these instruments.
(i) Fair Value Accounting
Financial Accounting Standards Board (FASB) Accounting Standards Codifications (ASC) 820-10 “Fair Value Measurements and Disclosures”, establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). As required by FASB ASC 820-10, assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The three levels of the fair value hierarchy under FASB ASC 820-10 are described below:
| Level 1 | Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; |
| Level 2 | Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and |
| Level 3 | Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity). |
| F-20 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(j) Inventories, net
Inventories are valued at the lower of cost (weighted average basis) and net realizable value. Net realizable value is the expected selling price in the ordinary course of business minus any costs of completion, disposal, and transportation to make the sale.
The Company performs an analysis of slow-moving or obsolete inventory periodically and any necessary valuation reserves, which could potentially be significant, are included in the period in which the evaluations are completed. Any inventory impairment results in a new cost basis for accounting purposes.
(k) Property, equipment and software
Property, equipment and software are stated at cost less accumulated amortization and depreciation. Amortization and depreciation is provided over the assets’ estimated useful lives, using the straight-line method. Estimated useful lives of property, equipment and software are as follows:
| Office buildings | ||
| Lease improvement | ||
| Electronics equipment, furniture and fixtures | ||
| Motor vehicles | ||
| Purchased software | ||
| Media display equipment | ||
| Cryptocurrency mining machine |
Expenditures for maintenance and repairs, which do not materially extend the useful lives of the assets, are charged to expense as incurred. Expenditures for major renewals and betterments which substantially extend the useful life of assets are capitalized. The cost and related accumulated depreciation of assets retired or sold are removed from the respective accounts, and any gain or loss are included in the Company’s results of operations.
(l) Cryptocurrencies
Cryptocurrencies held, including Bitcoin and Ethereum, are accounted for as intangible assets with indefinite useful lives. An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the cryptocurrency at the time its fair value is being measured. If the carrying amount of the cryptocurrency exceeds its fair value, the Company recognizes an impairment loss in an amount equal to that excess. Subsequent reversal of impairment losses is not permitted.
There are no cash flows from cryptocurrencies included in net cash used in operating activities since the revenue recognized from mining is a noncash activity. The sales of cryptocurrencies are included within investing activities in the consolidated statements of cash flows and any realized gains or losses from such sales are included in other income (expense) in the consolidated statements of operations. The Company accounts for its gains or losses in accordance with the first in first out (FIFO) method of accounting.
Upon disposal of cryptocurrencies, the Company will evaluate whether the control of the cryptocurrencies is transferred in accordance with ASC 610-20. The control over the cryptocurrencies disposed will transfer at the same time of the disposal, hence the cryptocurrencies transferred will be derecognized at the same time of the disposal. The gain or loss on disposal is calculated as the difference between the consideration allocated to each distinct cryptocurrency and its carrying amount.
(m) Business combination
In accordance with ASC 805, the Company applies acquisition method to account for business combination. The acquisition method requires that the fair value of the underlying exchange transaction is used to establish a new accounting basis of the acquired entity upon the acquirer taking control over the acquiree. Furthermore, because of obtaining control the acquirer is responsible and accountable for all of the acquiree’s assets, liabilities and operations, the acquirer recognizes and measures the assets acquired and liabilities assumed at their full fair values as of the date control is obtained, which may result in goodwill, when purchase consideration exceeds the net of fair value of the assets acquired and liabilities assumed, or a bargain purchase gain, when the net of fair value of the assets acquired and liabilities assumed exceeds the purchase consideration, regardless of the percentage ownership in the acquiree or how the acquisition was achieved.
| F-21 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(n) Disposal of subsidiary
The Company deconsolidates a subsidiary upon the loss of control, the related subsidiary’s assets (including goodwill), liabilities, non-controlling interest and other components of equity are de-recognized. This may mean that amounts previously recognized in other comprehensive income are reclassified to profit or loss.
Any consideration received is recognized at fair value. Any resultant gain or loss is recognized in the Statement of Operations.
(o) Long-term investment
The Company’s long-term investment consists of investments accounted for under the equity method and equity investments without readily determinable fair value. Pursuant to ASC 321, equity investments, except for those accounted for under the equity method, those that result in consolidation of the investee and certain other investments, are measured at fair value, and any changes in fair value are recognized in earnings. For equity securities without readily determinable fair value and do not qualify for the existing practical expedient in ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) to estimate fair value using the net asset value per share (or its equivalent) of the investment, the Company elected to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any.
For equity investments that the Company elects to measure at cost, less any impairment, plus or minus changes resulting from observable price changes, the Company makes a qualitative assessment considering impairment indicators to evaluate whether investments are impaired at each reporting date. Impairment indicators considered include, but are not limited to, a significant deterioration in the earnings performance or business prospects of the investee, including factors that raise significant concerns about the investee’s ability to continue as a going concern, a significant adverse change in the regulatory, economic, or technologic environment of the investee and a significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates. If a qualitative assessment indicates that the investment is impaired, the entity has to estimate the investment’s fair value in accordance with the principles of ASC 820. For equity investments without readily determinable fair value, the Company uses Level 3 inputs of fair value accounting in accordance with ASC 820-10 and recognizes impairment loss other than temporary in the statement of operations equal to the difference between its initial investment and its proportional share of the net book value of the investee’s net assets which approximates its fair value.
For impairment on equity investments without readily determinable fair value, the Company uses Level 3 inputs of fair value accounting in accordance with ASC 820-10 and recognizes impairment loss in the statement of operations equal to the difference between its initial investment and its proportional share of the net book value of investee’s net assets which approximates its fair value if those are determined to be other than temporary.
(p) Impairment of Long-Lived Assets
Long-lived
assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying
amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology
or other industry changes. Recoverability of assets to be held and used is determined by comparing their carrying amount with their expected
future net undiscounted future cash flows from the assets. If such assets are considered to be impaired, the impairment to be recognized
is measured by how much the carrying amount exceeds the fair value of the assets. There were impairment charges of approximately $
(q) Operating leases - Right-of-use assets and lease liabilities
The Company accounts for lease under ASC 842 “Leases”, and also elects practical expedient not to separate non-lease component from lease components in accordance with ASC 842-10-15-37 and instead to account for each separate lease component and the non-lease components associated with that lease component as a single lease component. The Company also elects the practical expedient not to recognize lease assets and lease liabilities for leases with a term of 12 months or less.
The Company recognized a lease liability and corresponding right-to-use asset based on the present value of minimum lease payments discounted at the Company’s incremental borrowing rate. The Company records amortization and interest expense on a straight-line basis based on lease terms and reduces lease liabilities upon making lease payments.
(r) Revenue Recognition
In accordance with the ASC 606, the Company recognizes revenues net of applicable taxes, when goods or services are transferred to customers in an amount that reflects the consideration to which the Company expects to receive in exchange for those goods or services.
The Company generates its revenues primarily from five sources: (1) product sales, (2) software sales, (3) advertising, (4) crypto-currency mining, and (5) other sales. Revenue is recognized when obligations under the terms of a contract with our customers are satisfied, generally, upon delivery of the goods and services and receipts of cryptocurrencies from cryptocurrency mining pools.
Although our performance obligation in our contracts with the mining pool operator is the provision of computing power, we are not entitled to any compensation for computing power provided when the pool operator is unsuccessful in placing a block to the blockchain.
| F-22 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Revenue - Products
Product revenues are generated primarily from the sale of Cloud-Application-Terminal based digital ads display terminals with integrated software essential to the functionality of the hardware to our customers (inclusive of related parties) and high-end data storage servers. Although manufacturing of the products has been outsourced to the Company’s Original Equipment Manufacturer (OEM) suppliers, the Company has acted as the principal of the contract. The Company recognized the product sales at the point of delivery. The Company may from time to time provide future unspecified software upgrades to the hardware products’ essential software, which is expected to be infrequent and, free of charge. Non-software service is mainly the one-time training session provided to the customer to familiarize them with the software operation upon the customer’s initial introduction to the software platform. The costs of providing infrequent software upgrade and training are de minimis. As a result, the Company does not allocate transaction price to software upgrade and customer training. Product sales are classified as “Revenue-Products” on the Company’s consolidated statements of operations.
Revenue - Software
The Company designs and develops software products. Software development projects usually include developing software, integrating various isolated software systems into one, and testing the system. The design and build services, together with the integration of the various elements, are generally determined to be essential to the functionality of the delivered software. The contracted price is usually paid at the delivery of the software. The Company usually provides non-software services including after-sale support, technical training. The technical training only occurs at the introduction of the software. The software is highly specialized and stable, after-sale support and subsequent upgrade or enhancement are infrequent. The Company has estimated the costs associated with the non-software performance obligations and concludes that these obligations are de minimis to the overall contract. Therefore, the Company does not further allocate transaction price.
The Company usually completes the software support service in one-off and recognizes the revenue at the point of delivery of service because the Company does not have an enforceable right to payment for performance completed to date. Revenues from software development contracts are classified as “Revenue-Software” on the Company’s consolidated statements of operations.
Revenue - Advertising
The Company generates revenues primarily from providing advertising slots to customers to promote their businesses by broadcasting advertisements on identifiable digital ads display terminals and vehicular ads display terminals in different geographic regions and locations through a cloud-based new media sharing platform. The Company also contracts individuals to promote special events or for various occasions. The Company is only obligated to broadcast the advertisements to the contracted digital ads display terminals, and therefore allocates 100% of the transaction price to advertisement broadcasting. The transaction price for advertisement broadcasting is fixed based on the numbers of advertisement delivery and duration of the contract, and has no variable consideration, or significant financing component, or subsequent price change, and is not refundable.
The Company recognizes the revenues, net of applicable taxes, from advertisement broadcasting contracts with customers over the contracted advertising duration.
| F-23 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Revenue - Cryptocurrency mining
The Company has entered into digital asset mining pools by executing contracts with the mining pool operators to provide computing power to the mining pool. The contracts are terminable under certain circumstances. Both the Company and the mining pool operator have the right to terminate the contract at any time, with or without clause, and without compensation. In exchange for providing computing power, the Company is entitled to a fractional share of the fixed cryptocurrency awards the mining pool operator receives (less digital asset transaction fees to the mining pool operator, if any.) for successfully adding a block to the blockchain. The Company’s fractional share is based on the proportion of computing power the Company contributed to the mining pool operator to the total computing power contributed by all mining pool participants in solving the current algorithm. The contract first exists upon the successful placement of a block on the blockchain by the pool operator because that is the point when the parties have performed their contract obligation and neither party can unilaterally terminate the contract without compensating the other party.
Providing computing power in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing such computing power is the only performance obligation in the Company’s contract with mining pool operator.
The transaction consideration the Company receives, if any, is noncash consideration, which the Company measures at fair value using the quoted price from principal market of the related cryptocurrency on the date received, which is not materially different than the fair value at the contract inception or at the time the Company has earned the award from the pools. The consideration is variable. Because it is not probable that a significant reversal of cumulative revenue will not occur (ASC 606-10-32-11), the consideration is constrained until the mining pool operator successfully places a block (by being the first to solve an algorithm), and the Company receives confirmation of the consideration it will receive, at which time revenue is recognized. There is no financing component, nor allocation of transaction price in these transactions.
Revenue - Other
The Company also reports other revenue which comprises revenue generates from System upgrade and technical support services, platform service fee, and rental income.
System upgrade and technical support revenue is recognized when performance obligations are satisfied upon completion of the services. Platform service fee is charged based on number of the display terminals used by the customers or a percentage of advertising revenue generated by the display terminals. Platform service revenue is recognized on a monthly basis over the contract period.
The
Company follows ASC 842 – Leases that requires lessor to identify the underlying assets and allocate rental income among considerations
in lease and non-lease components. The Company owns two units of office space renting out to a third party and TNM under non-cancelable
operating lease agreements with lease terms of two years starting from May 1, 2022 and four years starting from July 1, 2022, respectively.
The lease agreements have fixed monthly rental payments, and no non-lease component or option for lessees to purchase the underlying
assets. The Company collects monthly rental payments from the lessees, and has generated approximately $
After completion of the business acquisition on June 9, 2021, TNM became a subsidiary of the Company. The rental income from TNM has become an intercompany revenue and been eliminated since June 9, 2021.
| F-24 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| Annual minimum rental income to be received in the next 5 years: | ||||
| 2023 | ||||
| 2024 | ||||
| Total |
Contract balances
The
Company records advances from customers when cash payments are received or due in advance of our performance. For the year ended December
31, 2022, 2021 and 2020, the Company recognized revenue of $
Practical expedients and exemptions
The Company generally expenses sales commissions if any incurred because the amortization period would have been one year or less. In many cases, the Company is approached by customers for customizing software products for their specific needs without incurring significant selling expenses.
The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
(s) Cost of Sales - advertising and cost of cryptocurrencies
The cost of sales for advertising revenue mainly comprises of direct costs of generating advertising revenue including lease expense for the wall space, to where the ads display terminal to be installed, installation costs of ads display terminals, depreciation of display termination, labor, and other related expenses.
The cost of sales for cryptocurrencies revenue consists primarily of direct costs of earning Bitcoin and Ethereum related to mining operations, including mining platform fees, mining pool fees, mining facility rental fees, electric power costs, other utilities, depreciation of mining machines, labor, insurance, and among other ancillary costs.
The Company applies ASC No. 718, “Compensation-Stock Compensation”, which requires that share-based payment transactions with employees, such as share options, be measured based on the grant date fair value of the equity instrument and recognized as compensation expense over the requisite service period, with a corresponding addition to equity. Under this method, compensation cost related to employee share options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the period during which an employee is required to provide service in exchange for the award, which generally is the vesting period.
The Company adopted ASU 2018-07, Compensation-Stock Compensation (Topic: 718): Improvements to Nonemployee Share-Based Payment Accounting on January 1, 2019, to account for stock-based compensation to goods and services provided by the third parties. The fair value of the equity awards to nonemployee are measured on the grant day. Under this guidance, compensation cost related to nonemployee share options or similar equity instruments is recognized in the same period and in the same manner (i.e. capitalize or expense) the entity would if it paid cash for the goods or services. The Company’s adoption of ASU 2018-07 has no material impact to the Company’s consolidated financial statements, nor requirement for cumulative adjustment in retained earnings or other components of equity or net assets.
During the year ended December 31, 2022, 2021, and 2020, the Company recognized approximately $, $, and $, respectively, of stock-based compensation expense.
| F-25 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(u) Foreign Currency Translation
The functional currency of the US and BVI companies is the United States dollar. The functional currency of the Company’s Hong Kong subsidiaries is the Hong Kong dollar.
The functional currency of the Company’s wholly-owned PRC subsidiaries is the Chinese Renminbi Yuan, (“RMB”). RMB is not freely convertible into foreign currencies. The Company’s PRC subsidiaries’ financial statements are maintained in the functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Exchange gains or losses arising from foreign currency transactions are included in the determination of net loss for the respective periods.
For financial reporting purposes, the financial statements of the Company have been translated into United States dollars. Assets and liabilities are translated at exchange rates at the balance sheet dates, revenue and expenses are translated at average exchange rates, and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in other comprehensive loss, a component of equity.
The exchange rates adopted are as follows:
December 31, 2022 | December 31, 2021 | |||||||
| Year-end RMB to US$ exchange rate | ||||||||
| Average yearly RMB to US$ exchange rate | ||||||||
| Year-end HKD to US$ exchange rate | ||||||||
| Average yearly HKD to US$ exchange rate | ||||||||
The
average yearly RMB to US$ exchange rate adopted for the year ended December 31, 2020 was
No representation is made that the RMB amounts and HKD amounts could have been, or could be, converted into United States dollars at the rates used in translation.
(v) Research & Development Expenses
The Company follows the guidance in FASB ASC 985-20, Cost of Software to Be Sold, Leased or Marketed, regarding software development costs to be sold, leased, or otherwise marketed.
FASB ASC 985-20-25 requires research and development costs for software development to be expensed as incurred until the software model is technologically feasible. Technological feasibility is established when the enterprise has completed all planning, designing, coding, testing, and identification of risks activities necessary to establish that the product can be produced to meet its design specifications, features, functions, technical performance requirements. A certain amount of judgment and estimation is required to assess when technological feasibility is established, as well as the ongoing assessment of the recoverability of capitalized costs. The Company’s products reach technological feasibility shortly before the products are released and sold to the public. Therefore research and development costs are generally expensed as incurred.
(w) Subsidy Income
Subsidy income mainly represents income received from various local governmental agencies in China for developing high technology products in the fields designated by the government as new and highly innovative. The Company has no continuing obligation under the subsidy provision. The Company recognizes subsidy income upon receipt of official grant notice from local government authorities.
(x) Sales, use, other value-added taxes, and income taxes
Revenue is recorded net of applicable sales, use, and value-added taxes.
Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are recognized for all significant temporary differences at enacted rates and classified as non-current in the financial statements. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion, or all of, the deferred tax assets will not be realized. The Company classifies interest and/or penalties related to unrecognized tax benefits, if any, as a component of income tax expense.
| F-26 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company applies the provisions of ASC No. 740 “Income Taxes” (“ASC 740”), which clarifies the accounting for uncertainty in income taxes recognized by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides accounting guidance on de-recognition, classification, interest and penalties, and disclosure.
(y) Discontinued Operations
The Company follows “ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” for reporting discontinued operations. Under the revised standard, a discontinued operation must represent a strategic shift that has or will have a major effect on an entity’s operations and financial results. Examples could include a disposal of a major line of business, a major geographical area, a major equity method investment, or other major parts of an entity. The revised standard also allows an entity to have certain continuing cash flows or involvement with the component after the disposal. Additionally, the standard requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations.
(z) Segment reporting
Segment information is consistent with how the Chief Operating Decision Maker, i.e., the Directors of the Company, review the businesses, make investing and resource allocation decisions and assess operating performance. Transfers and sales between reportable segments, if any, are recorded at cost.
The Company reports financial and operating information in the following three segments:
| (1) | Cloud-based Technology (CBT) segment — It includes the Company’s cloud-based products, high-end data storage servers and related services sold to private sectors including new media, healthcare, education and residential community management, and among other industries and applications. In this segment, the Company generates revenues from the sales of hardware and software total solutions with proprietary software and content as well as from designing and developing software products specifically customized for private sector customers’ needs for a fixed price. The Company includes the revenue and cost of revenue of high-end data storage servers in the CBT segment. Advertising services is included in the CBT segment, after the Company consummated the acquisition of TNM. Advertisements are delivered to the ads display terminals and vehicular ads display terminals through the Company’s cloud-based new media sharing platform. Incorporation of advertising services complements the Company’s out-of-home advertising business strategy. |
| (2) | Blockchain Technology (BT) segment — The BT segment is the Company’s newly formed business sector. Cryptocurrency mining is the first initiative implemented in the BT segment. However, due to the decreased output and the highly volatile cryptocurrency market, the Company had ceased the operation of the BT segment by December 2022. |
| (3) | Traditional Information Technology (TIT) segment — The TIT segment includes the Company’s project-based technology products and services sold to the public sector. The solutions the Company has sold primarily include Geographic Information Systems (GIS), Digital Public Security Technology (DPST), and Digital Hospital Information Systems (DHIS). In this segment, the Company generates revenues from sales of hardware and system integration services. As a result of the business transformation, the TIT segment is gradually being phased out in 2021. |
For more information regarding our operating segments, see Note 20 (Consolidated Segment Data).
| F-27 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(aa) Recent Accounting Pronouncements
In August 2020, the FASB issued ASU No. 2020-06 (“ASU 2020-06”) “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” ASU 2020-06 will simplify the accounting for convertible instruments by reducing the number of accounting models for convertible debt instruments and convertible preferred stock. Limiting the accounting models results in fewer embedded conversion features being separately recognized from the host contract as compared with current GAAP. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative, and that do not qualify for a scope exception from derivative accounting and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in capital. ASU 2020-06 is effective for public business entities fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. The adoption of ASU 2020-06 did not have material impact on the group’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The guidance provides clarification of the interaction of rules for equity securities, the equity method of accounting and forward contracts and purchase options on certain types of securities. ASU 2020-01 is effective for the Company in the first quarter of 2021. The adoption did not have any significant impact on the Company’s consolidated financial statements.
In October 2021, the FASB issued ASU 2021-08, Business Combination (Topic 805) “Accounting for Contract Assets and Contract Liabilities from Contracts with Customers”. The ASU 2021-08 requires that an entity (acquirer) recognizes and measures contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. The ASU 2021-08 also provides certain practical expedients for acquirers when recognizing and measuring acquired contract assets and contract liabilities from revenue contracts in a business combination. The ASU 2021-08 also applies to contract assets and contract liabilities from other contracts to which the provisions of Topic 606 apply, such as contract liabilities from the sale of nonfinancial assets within the scope of Subtopic 610-20, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets. For public business entities, the ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. The ASU 2021-08 should be applied prospectively to business combinations occurring on or after the effective date of the amendments. Early adoption of the amendments is permitted, including adoption in an interim period. An entity that early adopts in an interim period should apply the amendments (1) retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early application and (2) prospectively to all business combinations that occur on or after the date of initial application. Adoption of ASU 2021-08 is not expected to have material impact on the consolidated financial statements.
In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832), “Disclosures by Business Entities about Government Assistance”. The ASU 2021-10 requires the following annual disclosures about transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy: 1. Information about the nature of the transactions and the related accounting policy used to account for the transactions 2. The line items on the balance sheet and income statement that are affected by the transactions, and the amounts applicable to each financial statement line item 3. Significant terms and conditions of the transactions, including commitments and contingencies. The amendments in this Update are effective for all entities within their scope for financial statements issued for annual periods beginning after December 15, 2021. Early application of the amendments is permitted. An entity should apply the amendments in this Update either (1) prospectively to all transactions within the scope of the amendments that are reflected in financial statements at the date of initial application and new transactions that are entered into after the date of initial application or (2) retrospectively to those transactions. Adoption of ASU 2021-10 is not expected to have material impact on the consolidated financial statements.
The Company has considered all other recently issued accounting pronouncements and does not believe that the adoption of such pronouncements will have a material impact on the consolidated financial statements.
| F-28 |
3. BUSINESS ACQUISITION
On
June 9, 2021, the Company and Biznest, a subsidiary of the Company, consummated an acquisition of
Pursuant
to the share purchase agreement, as a consideration of the purchase, the Company issued to the shareholders of TNM a total of
ordinary shares equivalent to the value of approximately $
The Company uses Level 3 inputs of fair value accounting for the identifiable assets and liabilities of TNM. The allocation of the purchase consideration is final, which was determined after the completion of a detailed analysis of the fair value for all assets acquired.
The following table summarizes the purchase price allocation for TNM, and the amounts of the assets acquired, and liabilities assumed which were based on their estimated fair values at the acquisition date:
| Cash | $ | |||
| Accounts receivable, net | ||||
| Advances to suppliers | ||||
| Other receivables and other current assets, net | ||||
| Long-term investments | ||||
| Property and equipment | ||||
| Right of use assets | ||||
| Accounts payable | ( | ) | ||
| Advances from customers | ( | ) | ||
| Accrued payroll and benefits | ( | ) | ||
| Amount due to related parties | ( | ) | ||
| Other payables and accrued expenses | ( | ) | ||
| Lease liabilities | ( | ) | ||
| Total net assets acquired | ||||
| Bargain purchase gain | ( | ) | ||
| Total purchase price | $ |
Due
to the negative impact from COVID-19 pandemic and slowdown of the out-of-home advertising industry in China, the total consideration
paid by the Company was less than the net amount of identifiable assets acquired and liabilities assumed of TNM, which resulted in a
bargain purchase gain of approximately $
The
Company’s consolidated statement of operations for the year ended December 31, 2021 included revenue of $
The
Company’s consolidated statement of operations for the year ended December 31, 2022 included revenue of $
On
January 13, 2022, the Company entered into a share purchase agreement to acquire %
equity interest in Zhenjiang Taoping IoT Tech. Co., Ltd. (“ZJIOT”), aiming to accelerate the Company’s smart charging
pile and digital new media businesses in East China. Pursuant to the share purchase agreement, as consideration TAOP agreed to issue
to the shareholders of ZJIOT a total of restricted ordinary shares of TAOP. The shares are expected to be issued in three phases.
The first phase will issue shares within 20 days after closing of the transaction; the second phase will issue shares before
May 31, 2023; the third phase will issue shares before May 31, 2024. Issuance of shares during the second and third phases will
be conditioned upon the satisfaction of certain performance targets of ZJIOT as set forth in the share purchase agreement. Specifically,
the second phase issuance requires from the closing date to December 31, 2022, ZJIOT have at least
The total fair value of the contingent consideration presented as other current liability is in accordance with ASC 820-10 “Fair Value Measurements and Disclosures”. ordinary shares issued under the share purchase agreement were deemed as the consideration transferred for the acquisition. The fair value of the shares issued was measured based on the average share price of the Company during year 2022, which therefore is categorized as Level 3 measurement of fair value.
The following table summarizes the purchase price allocation for ZJIOT, and the amounts of the assets acquired, and liabilities assumed which were based on their estimated fair values at the acquisition date:
| Cash | $ | |||
| Accounts receivable, net | ||||
| Advances to suppliers | ||||
| Other receivables, net | ||||
| Property, plant and equipment, net | ||||
| Accounts payable | ( | ) | ||
| Advances from customers | ( | ) | ||
| Accrued payroll and benefits | ( | ) | ||
| Other payables and accrued expenses | ( | ) | ||
| Total net assets acquired | ||||
| Goodwill | ||||
| Total purchase price | $ |
The
Company’s consolidated statement of operations for the year ended December 31, 2022 included revenue of $
| F-29 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4. VARIABLE INTEREST ENTITY
Prior to the dissolution of the Company’s VIE structure in September 2021, iASPEC was a variable interest entity of the Company and the Company was the primary beneficiary of iASPEC. iASPEC’s assets, liabilities and financial results were consolidated into the Company’s financial statements. From September 2021 to June 7, 2022, iASPEC was a wholly-owned subsidiary of the Company. Accordingly, the assets and liabilities and revenues and expenses of iASPEC have been included in the accompanying consolidated financial statements up to June 7, 2022.
In June 2021, iASPEC, through its subsidiary Biznest, acquired TNM. In addition, Biznest formed Shenzhen Taoping Education Technology Co., Ltd. and Wuhu Taoping Education Technology Co., Ltd. in 2021 where iASPEC indirectly owned 51% equity interests of each entity. As indirect wholly owned or majority owned subsidiaries of iASPEC, the financial results of TNM, Shenzhen Taoping Education Technology Co., Ltd. and Wuhu Taoping Education Technology Co., Ltd. have been consolidated into the Company’s financial statements.
Prior to the dissolution of the VIE structure, government licenses, permits and certificates represented substantially all of the unrecognized revenue-producing assets held by iASPEC, the VIE, and its subsidiaries; recognized revenue-producing assets held by iASPEC and its subsidiaries consisted of property, equipment and software.
On September 18, 2021, the Company and the Company’s wholly owned subsidiary, IST entered into an equity transfer agreement with Mr. Jianghuai Lin, the sole shareholder of iASPEC. Upon closing of the equity transfer, the Company’s then existing variable interest entity structure was dissolved and iASPEC became a wholly owned indirect subsidiary of the Company. As a result, all assets and liabilities of iASPEC were incorporated into the Company’s balance sheet since December 31, 2021.
On
June 7, 2022, the Company transferred
| F-30 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. DISPOSALS OF CONSOLIDATED ENTITIES
ADG, SZTET, WHTET, and TDTDG were dissolved on January 28, June 14, May 31, and May 17, 2022, respectively. The dissolution of these companies result in minimal gain or loss for the year ended December 31, 2022.
None of the above-referenced dispositions in 2022 qualified as discontinued operations as they do not individually or in the aggregate represent a strategic shift that has had a major impact on the Company’s operations or financial results.
Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of ordinary shares outstanding during the period. Diluted loss per share reflects the potential dilution that could occur, if securities or other contracts to issue ordinary shares were exercised or converted into ordinary shares, or resulted in the issuance of ordinary shares that shared in the earnings of the entity.
| 2022 | 2021 | 2020* | ||||||||||
| Net loss attributable to the Company | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Weighted average outstanding ordinary shares-Basic | ||||||||||||
| -dilutive effect of stock options- employees | ||||||||||||
| -dilutive effect of stock options- nonemployees | ||||||||||||
| Weighted average outstanding ordinary shares- Diluted | ||||||||||||
| Loss per share: | ||||||||||||
| Basic | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Diluted | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| CONTINUING OPERATIONS | ||||||||||||
| Net loss attributable to the Company | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Weighted average outstanding ordinary shares-Basic | ||||||||||||
| -dilutive effect of stock options- employees | ||||||||||||
| -dilutive effect of stock options- nonemployees | ||||||||||||
| Weighted average outstanding ordinary shares- Diluted | ||||||||||||
| Loss per share: | ||||||||||||
| Basic | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Diluted | $ | ( | ) | $ | ( | ) | $ | ( | ) |
| DISCONTINUED OPERATIONS | ||||||||||||
| Net (loss) income attributable to the Company | $ | ( | ) | $ | $ | |||||||
| Weighted average outstanding ordinary shares-Basic | ||||||||||||
| -dilutive effect of stock options- employees | ||||||||||||
| -dilutive effect of stock options- nonemployees | ||||||||||||
| Weighted average outstanding ordinary shares-Diluted | ||||||||||||
| (Loss) income per share: | ||||||||||||
| Basic | $ | ( | ) | $ | $ | |||||||
| Diluted | $ | ( | ) | $ | $ | |||||||
For the years ended December 31, 2022, 2021, and 2020, there was shares included in the diluted earnings per share calculation, these incremental shares were not added to denominator for the period that stock options were outstanding due to the average market price of the Company’s stock in the period is lower than the exercise prices of the stock options granted to the Company’s employees and various consultants. The incremental shares were computed under the treasury stock method. The EPS calculation excluded the if-converted shares from the convertible promissory note or exercised shares from detachable warrant associated with the convertible promissory note based on the Company’s recent stock prices, which were significantly below the stated convertible price and among other conversion prices of alternative conversions or exercise price of the warrant. Because the effect would be anti-dilutive, there were stock options for employees, stock options and warrants for nonemployees outstanding that were not included in the computation of dilutive weighted average shares outstanding for the year ended December 31, 2022. There were stock options for employees, stock options and warrants for nonemployees outstanding that were not included in the computation of dilutive weighted average shares outstanding for the year ended December 31, 2021. Also, warrants associated with the convertible promissory notes for purchase of shares were not included in the computation of dilutive weighted average shares outstanding for the year ended December 31, 2020, as their effect would have been anti-dilutive.
| * |
| F-31 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
7. RELATED PARTY TRANSACTIONS
(a) Revenue – related party
Since
May 2017, the Company has entered into a series of contracts with Taoping New Media Co., Ltd. (TNM) and its affiliates for the sale of
the Company’s Cloud-Application-Terminal based digital ads display terminals, software and technical services. Taoping New Media
was a related party company controlled by Mr. Lin, the Company’s Chairman and Chief Executive Officer, until the Company’s
completion of the acquisition on June 9, 2021, after which date the related party transactions were eliminated in the Company’s
consolidated financial statements. For the years ended December 31, 2022, 2021 and 2020, revenues from related parties for sales of products
and advertising were approximately $
(b) Other revenue – related parties
For
the years ended December 31, 2021 and 2020, the Company had a rental income of approximately $
(c) Amount due to related parties
As
of December 31, 2022 and 2021, the amount due to related parties was $
8. INVENTORIES
As of December 31, 2022 and 2021, inventories consist of:
| December 31, 2022 | December 31, 2021 | |||||||
| Raw materials | $ | $ | ||||||
| Finished goods | ||||||||
| Cost of projects | ||||||||
| Inventories, gross | $ | $ | ||||||
| Allowance for slow-moving or obsolete inventories | ( | ) | ( | ) | ||||
| Inventories, net | $ | $ | ||||||
For
the year ended December 31, 2022, impairments for obsolete inventories were approximately $
| F-32 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9. PROPERTY, EQUIPMENT AND SOFTWARE
As of December 31, 2022 and 2021, property, equipment and software consist of:
| December 31, | ||||||||
| 2022 | 2021 | |||||||
| Office buildings | $ | $ | ||||||
| Electronic equipment, furniture and fixtures | ||||||||
| Motor vehicles | ||||||||
| Media display equipment | ||||||||
| Leasehold improvement | ||||||||
| Purchased software | ||||||||
| Less: accumulated depreciation | ( | ) | ( | ) | ||||
| Property, equipment and software, net | $ | $ | ||||||
Depreciation
expense for the year ended December 31, 2022, 2021, and 2020 were approximately $
Management regularly evaluates property, equipment and software for impairment, if an event occurs or circumstances change that would potentially indicate that the carrying amount of the property, equipment and software exceeded its fair value. Management utilizes the discounted cash flow method to estimate the fair value of the property, equipment and software.
Company’s
office buildings, with net carry value of approximately $
10. DISCONTINUED OPERATIONS
In December 2022, the Company ceased its cryptocurrency mining business by entering into a series of contracts with certain third parties to sell its cryptocurrency mining and related equipment, terminating the leases for both the office facility and the storage rooms for most mining machines, and laying off relevant employees. As a result, the operations of Cryptocurrency mining business are reflected within “discontinued operations” periods presented.
The significant items included within discontinued operations are as follows:
| Year Ended December 31 | ||||||||
| 2022 | 2021 | |||||||
| Revenue - Cryptocurrency mining | $ | $ | ||||||
| Cost - Cryptocurrency mining | ||||||||
| Cost - Others | ||||||||
| Administrative expenses | ||||||||
| Impairment losses on cryptocurrencies | ||||||||
| (Gain) on sales of cryptocurrencies | ( | ) | ( | ) | ||||
| Impairment on property, equipment and software | ||||||||
| Operating (loss) income from discontinued operations | ( | ) | ||||||
| Subsidy income | ||||||||
| Other (loss) | ( | ) | ( | ) | ||||
| Interest income | ||||||||
| Interest expense | ( | ) | ||||||
| (Loss) income from discontinued operations before income taxes | ( | ) | ||||||
| Income tax expense | ||||||||
| Net (loss) income from discontinued operations | $ | ( | ) | $ | ||||
| F-33 |
Assets and liabilities of discontinued operations included within the Consolidated Balance Sheets are comprised of the following:
| December 31, 2022 | December 31, 2021 | |||||||
| Cash and cash equivalents | $ | $ | ||||||
| Advances to suppliers | ||||||||
| Prepaid expenses | ||||||||
| Inventories, net | ||||||||
| Other current assets | ||||||||
| Cryptocurrencies, net | ||||||||
| Property, equipment and software, net | ||||||||
| Right-of-use assets | ||||||||
| Long-term investments | ||||||||
| Current assets from discontinued operations | $ | $ | ||||||
| Accounts payable | ||||||||
| Accrued payroll and benefits | ||||||||
| Other payables and accrued expenses | ||||||||
| Lease liability | ||||||||
| Current liabilities from discontinued operations | $ | $ |
| Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Net cash (used in) provided by operating activities | ( | ) | ||||||||||
| Net cash provided by (used in) investing activities | ( | ) | ||||||||||
CRYPTOCURRENCIES
As of December 31, 2022 and 2021, cryptocurrencies mainly included Bitcoin and Ethereum the Company held which were primarily received from mining activities.
The following table presents the movements of cryptocurrencies for the year ended December 31, 2022:
Amounts 2022 | Amounts 2021 | |||||||
| Balance at January 1, 2022 and 2021 | $ | $ | ||||||
| Receipt of cryptocurrencies from mining activities | ||||||||
| Purchases of cryptocurrencies | ||||||||
| Sales of cryptocurrencies | ( | ) | ( | ) | ||||
| Payment of cryptocurrencies for other expenses | ( | ) | ||||||
| Realized gain on sale of cryptocurrencies | ||||||||
| Impairment loss on cryptocurrencies | ( | ) | ( | ) | ||||
| Others | ||||||||
| Balance at December 31, 2022 and 2021 | $ | $ | ||||||
The following table presents additional information about each type of cryptocurrency for the year ended December 31, 2022 and 2021:
| BTC | ETH | USDT | Total | |||||||||||||
| Balance at January 1, 2021 | $ | $ | $ | $ | ||||||||||||
| Receipt of cryptocurrencies from mining activities | ||||||||||||||||
| Exchange of cash into USDT | ||||||||||||||||
| Sales of cryptocurrencies | ( | ) | ( | ) | ( | ) | ||||||||||
| Payment of cryptocurrencies for other expenses | ( | ) | ( | ) | ( | ) | ||||||||||
| Realized gain on sale of cryptocurrencies | ||||||||||||||||
| Impairment loss on cryptocurrencies | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Balance at December 31, 2021 | $ | $ | $ | $ | ||||||||||||
| BTC | ETH | USDT | ETHW | Total | ||||||||||||||||
| Balance at January 1, 2022 | $ | $ | $ | $ | $ | |||||||||||||||
| Receipt of cryptocurrencies from mining activities | ||||||||||||||||||||
| Purchases of cryptocurrencies | ||||||||||||||||||||
| Proceeds from sales of cryptocurrencies | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Payment of cryptocurrencies for other expenses | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Realized gain on sale of cryptocurrencies | ||||||||||||||||||||
| Impairment loss on cryptocurrencies | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
| Others | ( | ) | ||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | $ | $ | $ | |||||||||||||||
11. BANK LOANS
| December 31, 2022 | December 31, 2021 | |||||||
| Secured short-term loans | $ | $ | ||||||
| Total short-term bank loans | $ | $ | ||||||
| F-34 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Detailed information of secured short-term loan balances as of December 31, 2022 and 2021 were as follows:
| December 31, 2022 | December 31, 2021 | |||||||
| Guaranteed by IST and Mr. Lin and Collateralized by the real property of ISIOT and equity investment of ISTIL | $ | $ | ||||||
| Total | $ | $ | ||||||
As
of December 31, 2022, the Company had short-term bank loans of approximately $
12. INCOME TAXES
Pre-tax income (loss) from continuing operations and discontinued operations for the year ended December 31, 2022, 2021, and 2020in the following jurisdictions:
| 2022 | 2021 | 2020 | ||||||||||
| PRC | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Hong Kong | ( | ) | ( | ) | ( | ) | ||||||
| BVI | ( | ) | ( | ) | ( | ) | ||||||
| Total (loss) before income taxes | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
United States
Because of the domestication transaction in 2012 by which CNIT BVI became the parent of our group, under Section 7874 of the Internal Revenue Code of 1986, as amended, the Company is treated for U.S. federal tax purposes as a U.S. corporation and, among other consequences, is subject to U.S. federal income tax on its worldwide income. It is management’s intention to reinvest all the income attributable to the Company earned by its operations outside the United States.
On
December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Act”).
The Act makes broad and complex changes to the U.S. tax code, including, but not limited to, (1) reducing the U.S. federal corporate
tax rate from
The SEC staff issued Staff Accounting Bulletin 118, which provides guidance on accounting for the tax effects of the Act for which the accounting under ASC 740, Income Taxes (“ASC 740”) is incomplete. To the extent that a company’s accounting for certain income tax effects of the Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before enactment of the Act.
| F-35 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company from time to time evaluates the tax effect of GILTI, and determined that there was no impact of GILTI tax to the Company’s consolidated financial statements as of December 31, 2022.
BVI
Under the current laws of the BVI, dividends and capital gains arising from the Company’s investments in the BVI and ordinary income, if any, are not subject to income taxes.
Hong Kong
Under the current laws of Hong Kong, IST HK is subject to a profit tax rate of 16.5%.
PRC
Income tax expense (benefit) from continuing operations consists of the following:
| 2022 | 2021 | 2020 | ||||||||||
| Current taxes | $ | $ | $ | ( | ) | |||||||
| Deferred taxes | ||||||||||||
| Income tax expense (benefit) | $ | $ | $ | ( | ) | |||||||
Current income tax expense (benefit) was recorded in 2022, 2021 and 2020 and was related to differences between the book and corporate income tax returns.
| 2022 | 2021 | 2020 | ||||||||||
| PRC statutory tax rate | % | % | % | |||||||||
| Computed expected income tax (benefit) expense | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Tax rate differential benefit from tax holiday | ||||||||||||
| Permanent differences arising from consolidation | ( | ) | ( | ) | ||||||||
| Tax effect of deductible temporary differences not recognized | ||||||||||||
| Tax effect of tax losses unrecognised | ||||||||||||
| Income tax expense (benefit) | $ | $ | $ | ( | ) | |||||||
| F-36 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The
Company has net operating loss carry forwards totaling RMB
IST
is approved as being high-technology enterprises and subject to PRC enterprise income tax rate (“EIT”) at
The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes by the State. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current State officials.
Based on all known facts, circumstances, and current tax law, the Company has not recorded tax benefits from year 2020 to 2022. The Company believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax laws and policies, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months, individually or in the aggregate, and have a material effect on the Company’s results of operations, financial condition or cash flows.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. Any accrued interest or penalties associated with any unrecognized tax benefits were not significant for the year ended December 31, 2022, 2021, and 2020.
Since the Company intends to reinvest its earnings to further expand its businesses in the PRC, the PRC subsidiaries do not intend to declare dividends to their parent companies in the foreseeable future. The Company’s foreign subsidiaries are in a cumulative deficit position. Accordingly, the Company has not recorded any deferred taxes on the cumulative amount of any undistributed deficit. It is impractical to calculate the tax effect of the deficit at this time.
13. OTHER CURRENT AND NON-CURRENT ASSETS
(a) As of December 31, 2022 and 2021, other current assets consist of:
| December 31, 2022 | December 31, 2021 | |||||||
| Advances to unrelated-parties (i) | $ | $ | ||||||
| Advances to a related party | ||||||||
| Advances to employees | ||||||||
| Other current assets | ||||||||
| $ | $ | |||||||
| (i) | |
As
of December 31, 2022, the balance included the amount due from a third-party vendor of approximately $
Based
on the amendment of the contract, the Company agrees to make advances to the vendor specifically for its market development purposes,
and the total commitment of funding was RMB
If the Company’s revenue facilitated by the vendor does not reach certain threshold during specified periods, the contract could be terminated by the Company, and all funding with applicable interest, less any commissions and subcontractor fees payable to the vendor, shall be repaid to the Company within one month after the termination of the contract. If the two parties terminate the cooperation on the condition that the vendor meet the target, all funding without interest, shall be repaid.
The
first period as specified is from January 1, 2021 to December 31, 2021 with a threshold revenue of RMB |
| F-37 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(b) As of December 31, 2022 and 2021, Other assets, non-current consist of:
| December 31, 2022 | December 31, 2021 | |||||||
| Other assets, non-current, net | $ | $ | ||||||
| $ | $ | |||||||
During
2019 and 2020, the Company advanced RMB
Based
on the amendment of the contract, if the Company’s new media advertising revenue generated from IOV software does not reach certain
threshold during specified period, the contract could be terminated by the Company, and all funding with applicable interest, and less
the revenue generated from the IOV software shall be repaid to the Company within one half year after the termination of the contract.
Before the full repayment of the funding, the Company owns
Starting
in October 2020, IOV software revenue will be divided into eight periods. The first period as specified was from October 1, 2020 to April
30, 2021 with a threshold advertising revenue from IOV software of RMB
The
development of IOV software was completed by September 30, 2020. Since the Company has the right to use the IOV software under
the contract term, software was capitalized as “other assets, non-current, net” and started to amortize from October
1, 2020 over the -year contract
term. As of December 31, 2022 and December 31, 2021, the balance of “other assets, non-current, net” was $
If full repayment is achieved within the contract term, the Company might be charged to continue using the software and related equipment, depending on both parties’ future agreement.
| F-38 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14. OPERATING LEASES
In
addition to the lease with a related party for computing server room in Dongguan City, commenced in April 2021, and terminated in March
2022, the Company leased an office space, three server rooms, and a dormitory in Hong Kong for executing the Blockchain business strategy,
and the Company also leased an office space in Zhenjiang commenced in October 1, 2021. The office space and two of the server rooms in
Hong Kong were terminated in September 2022 and November 2022, respectively. The fixed monthly lease payment for the Zhenjiang
office space is $
The
Company has also leased specific and identifiable wall spaces with a certain dimension in commercial and residential building lobbies,
inside elevators, elevator waiting areas, and various places to install the new media advertising display terminals without substitution
for purpose of broadcasting advertisements paid by the customers to promote their businesses or special events. The lease terms with
negotiated payment terms range from
The
Company incurred rent expenses of approximately $
The Company has elected to apply the short-term lease exception to all leases with a term of one year or less. The future short-term lease costs are $nil for the year subsequent to December 31, 2022.
Weighted-average remaining lease term as of December 31, 2022, and discount rate for its operating leases are as follows:
| Weighted-average remaining lease term | ||||
| Weighted-average discount rate | % | |||
The weighted-average discount rate was based on the three-year interest rate of People’s Bank of China.
The following table outlines maturities of operating lease liabilities as of December 31, 2022:
| Year ending December 31 | Leases for office/ server rooms/ Dormitory | |||
| 2023 | $ | |||
| 2024 | ||||
| Total lease payments | ||||
| Less: Imputed interest | ( | ) | ||
| Present value of lease liabilities | $ | |||
| F-39 |
15. LONG-TERM INVESTMENTS
As of December 31, 2022, the carrying value of the Company’s equity investments were $95,966, which consisted of the followings:
(1) Equity method investments:
As
of December 31, 2022, the Company’s equity method investments had a carrying value of $
| Investees | Abbreviation | % of Ownership | Carrying value | |||||||
| Qingdao Taoping IoT Co., Ltd. | QD Taoping, or QD | % | $ | |||||||
| Yunnan Taoping IoT Co., Ltd. | YN Taoping, or YN | % | ||||||||
| Jiangsu Taoping IoT Technology Co., Ltd. | JS Taoping, or JS | % | ||||||||
| Jiangsu Taoping New Media Co., Ltd | JS New Media, or JN | % | ||||||||
| $ | ||||||||||
The
Company’s initial investments in the above equity method investments were approximately $
(2) Equity investments without readily determinable fair value that is not accounted for under equity method accounting:
In accordance with ASC 321, the Company elected to use the measurement alternative to measure such investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any.
As
of December 31, 2022, the carrying value for the equity investments without readily determinable fair value was $
| F-40 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16. CONVERTIBLE NOTE PAYABLE
In
October 2019, March 2020, and September 2020, the Company issued Convertible Promissory Notes with principal amount of $
In
conjunction with issuance of the Notes, the Company also issued the holders of the Notes warrants to purchase
In
June 2021, the investor of Note-3 converted $
The
Company recognized interest expense of approximately $
17. OTHER PAYABLES AND ACCRUED EXPENSES
As of December 31, 2022 and 2021, other payables and accrued expenses consist of:
| December 31, 2022 | December 31, 2021 | |||||||
| Advances from unrelated third-parties (i) | $ | $ | ||||||
| Other taxes payable (ii) | ||||||||
| Accrued professional fees | ||||||||
| Amount due to employees(iii) | ||||||||
| Others | ||||||||
| $ | $ | |||||||
| (i) | |
| (ii) | |
| (iii) |
| F-41 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
18. RESERVE AND DISTRIBUTION OF PROFIT
In
accordance with relevant PRC regulations and the Articles of Association of our PRC subsidiaries, our PRC subsidiaries are required to
allocate at least
Under the applicable PRC regulations, the Company may pay dividends only out of the accumulated profits, if any, determined in accordance with the PRC accounting standards and regulations. The statutory reserve funds can only be used for specific purposes under the PRC laws and regulations. The general reserves are not distributable as cash dividends.
Our after-tax profits or losses with respect to the payment of dividends out of accumulated profits and the annual appropriation of after-tax profits as calculated pursuant to the PRC accounting standards and regulations do not result in significant differences as compared to after-tax earnings as presented in our consolidated financial statements. However, there are certain differences between the PRC accounting standards and regulations and the U.S. generally accepted accounting principles, arising from different treatment of items such as amortization of intangible assets and change in fair value of contingent consideration arising from business combinations.
19. EQUITY
(a) Ordinary shares
The Company is authorized to issue ordinary shares at no par value.
In
March 2020, the Company issued a total of ordinary shares to certain individual investors at $ per share, which generated
approximately $
In
the first half of 2020, the Company issued a total of ordinary shares as compensation for investor
relations service, fair value of which was approximately $
In
April 2020, the Company issued restricted shares to a consultant as its service
compensation. The fair value of the restricted shares was approximately $
| F-42 |
In
July 2020, the Company issued ordinary shares to a consultant as service compensation. The fair value of issued shares was approximately
$
In
July and September 2020, the Company issued an aggregate of ordinary shares to an employee for the individual’s job performance.
The fair value of issued shares was approximately $
In
September 2020, the Company issued restricted shares to a consultant as a part of finder fees for the financing services, the
fair value of which was approximately $
In
September, October, and December 2020, the holders of the convertible notes issued in September 2019, and March 2020 converted all principal
balance of the notes and accrued interests to the Company’s ordinary shares in an aggregate of ordinary shares of which
shares converted on December 30, 2020 were not issued until February 2021 (see Note 16). The total amount of principal and accrued
interest converted was approximately $
In
January 2021, the Company issued a total of ordinary shares to certain individual investors at $ per share, which generated
approximately $
In
January 2021, the Company issued ordinary shares with fair value of approximately $
In
February 2021, the Company issued a total of million ordinary shares to certain institutional and individual investors at $ per
share, resulting in approximately $
In
March 2021, the Company issued ordinary shares with fair value of approximately $
In
March 2021, the Company issued ordinary shares in the registered direct offering at the offering price of $ per share resulting
in approximately $
In
June 2021, the Company issued ordinary shares with 6 months restricted period upon the closing of acquisition of Taoping New
Media Co., Ltd (“TNM”), at unit price of $ per share with discounts for lack of marketability as the consideration equivalent
to approximately $
In
June 2021, the holder of the convertible note issued in September 2020 converted
In
July 2021, the Company issued a total of ordinary shares in a registered direct offering at $ per share, which generated
approximately $
In
September 2021, the Company issued ordinary shares at a price of $ per share with discounts for lack of marketability, as
the consideration of approximately $
In
November 2021, the Company issued restricted shares with a fair value of $
In
December 2021, the Company issued ordinary shares with a fair value of $
In
February 2022, the Company issued the first phase of restricted ordinary shares with a fair value of approximately $
In
March 2022 and July 2022, the Company issued ordinary shares with a fair value of $
| F-43 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(b) Stock-based compensation
| For the Year Ended | ||||||||||||
| December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Employees and directors share-based payments | $ | $ | (a)(c) | $ | (a)(c) | |||||||
| Stock options issued for services | $ | $ | $ | (d) | ||||||||
| Shares issued for services | $ | (a) | $ | (a) | $ | (a) | ||||||
| $ | $ | $ | ||||||||||
(c) Stock options to employees and directors
On May 9, 2016, the Board of Directors of the Company adopted the 2016 Equity Incentive Plan, or the 2016 Plan. Pursuant to the 2016 Plan, the Company may offer up to ordinary shares as equity incentives to its directors, employees and consultants. Such number of shares is subject to adjustment in the event of certain reorganizations, mergers, business combinations, recapitalizations, stock splits, stock dividends, or other change in the corporate structure of the Company affecting the issuable shares under the 2016 Plan. The Company accounts for its stock option awards to employees and directors pursuant to the provisions of ASC 718, Compensation – Stock Compensation. The fair value of each option award is estimated on the date of grant using the Black-Scholes Merton valuation model. The Company recognizes the fair value of each option as compensation expense ratably using the straight-line attribution method over the service period, which is generally the vesting period.
On
May 27, 2016, the Company granted options to purchase an aggregate of ordinary shares under the 2016 Plan. The fair value of
these options was approximately $
On
May 17, 2017, the Company granted options to employees and directors to purchase an aggregate of ordinary shares under the 2016
Plan. The fair value of these options was approximately $
On
July 24, 2020, the Company granted options to employees and directors to purchase an aggregate of ordinary shares under the 2016
Plan. The fair value of these options was approximately $
On
July 31, 2020, the stock options granted to employees and directors in 2016 and 2017 were fully exercised on a cashless method, and
| Weighted Average | ||||||||||||||||
| Remaining | ||||||||||||||||
| Weighted | Contractual | Aggregated | ||||||||||||||
| Options | Average | Life | Intrinsic | |||||||||||||
| Outstanding * | Exercise Price* | (Year) | Value | |||||||||||||
| Outstanding at January 1, 2019 | $ | $ | ||||||||||||||
| Exercised | - | - | ||||||||||||||
| Canceled | ( | ) | $ | - | $ | - | ||||||||||
| Outstanding at December 31, 2019 | $ | $ | ||||||||||||||
| Granted | - | - | ||||||||||||||
| Exercised | ( | ) | - | - | ||||||||||||
| Canceled | ( | ) | $ | - | $ | - | ||||||||||
| Outstanding at December 31, 2020 | ||||||||||||||||
| Granted | - | - | - | |||||||||||||
| Exercised | - | - | - | |||||||||||||
| Canceled | ( | ) | $ | - | $ | - | ||||||||||
| Outstanding at December 31, 2021 | ||||||||||||||||
| Granted | - | - | - | |||||||||||||
| Exercised | - | - | - | |||||||||||||
| Canceled | ( | ) | $ | - | $ | - | ||||||||||
| Outstanding at December 31, 2022 | ||||||||||||||||
| Vested and expected to be vested as of December 31, 2022 | ||||||||||||||||
| Options exercisable as of December 31, 2022 (vested) | ||||||||||||||||
| F-44 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
There were stock options granted to employees during the year ended December 31, 2022 and 2021. There were stock options granted to employees during the year ended December 31, 2020. There was option exercised during the years ended December 31, 2022 and 2021. The total intrinsic value of stock options exercised during the years ended December 31, 2020 was approximately and $. The Company did not receive any proceeds related to the cashless exercise of stock options from employees for the years ended December 31, 2022, 2021 and 2020.
| Weighted | ||||||||
| Average | ||||||||
| Grant Date | ||||||||
| Options* | Fair Value* | |||||||
| Non-vested at January 1, 2022 | $ | |||||||
| Granted | $ | |||||||
| Vested | ( | ) | $ | |||||
| Canceled | ( | ) | $ | |||||
| Non-vested at December 31, 2022 | $ | |||||||
As of December 31, 2022 and 2021, approximately $ and $ million of total unrecognized compensation expense related to non-vested share options expected to be recognized over a weighted average remaining vesting period of approximately year and year respectively. The total fair value of options vested during the year ended December 31, 2021, 2020 and 2019 was approximately $ million, $ million and $ million, respectively. To the extent the actual forfeiture rate is different from what the Company has anticipated; stock-based compensation related to these awards will be different from its expectations.
| * |
(d) Stock options and warrants to non-employees
Pursuant
to the Company’s 2016 Equity Incentive Plan, for the year ended December 31, 2018, the Company issued stock options to consultants
with options vested in 2018 and options vested in 2019. The stock options issued to non-employees would be forfeited either
three months after the expiration of the service agreement or upon the expiry of contractual life of the options. On February 20, 2019,
the Company issued warrants to the Consultant to purchase
The
issuance of warrants to purchase up to
As of December 31, 2022, the exercise price for the stock options issued to non-employee for service was $ and remaining life was years. The stock options granted to non-employees were expired in three years after the grant date. The following table outlines the options outstanding and exercisable as of December 31, 2022:
| 2021 | ||||||||||||
| Number of | ||||||||||||
| Options | ||||||||||||
| Outstanding | Exercise | Expiration | ||||||||||
| and Exercisable | Price | Date | ||||||||||
| July 2020 stock options to consultants | $ | |||||||||||
| Total | ||||||||||||
| F-45 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
20. CONSOLIDATED SEGMENT DATA
Segment information is consistent with how the Chief Operating Decision Maker, i.e., the Directors of the Company, review the businesses, make investing and resource allocation decisions and assess operating performance. Transfers and sales between reportable segments, if any, are recorded at cost.
The Company ceased the operation of cryptocurrency mining business by December 2022, and the operations of cryptocurrency mining business have been presented as “discontinued operations” in the Company’s consolidated financial statements. Please refer to Note 10.
The Company reports financial and operating information in the following three segments:
| (1) | Cloud-based Technology (CBT) segment — It includes the Company’s cloud-based products, high-end data storage servers and related services sold to private sectors including new media, healthcare, education and residential community management, and among other industries and applications. In this segment, the Company generates revenues from the sales of hardware and software total solutions with proprietary software and content as well as from designing and developing software products specifically customized for private sector customers’ needs for a fixed price. The Company includes the revenue and cost of revenue of high-end data storage servers in the CBT segment. Advertising services is included in the CBT segment, after the Company consummated the acquisition of TNM. Advertisements are delivered to the ads display terminals and vehicular ads display terminals through the Company’s cloud-based new media sharing platform. Incorporation of advertising services complements the Company’s out-of-home advertising business strategy. |
| (2) | Blockchain Technology (BT) segment — The BT segment is the Company’s newly formed business sector. Cryptocurrency mining is the first initiative implemented in the BT segment. However, due to the decreased output and the highly volatile cryptocurrency market, the Company had ceased the operation of the BT segment by December 2022. |
| (3) | Traditional Information Technology (TIT) segment — The TIT segment includes the Company’s project-based technology products and services sold to the public sector. The solutions the Company has sold primarily include Geographic Information Systems (GIS), Digital Public Security Technology (DPST), and Digital Hospital Information Systems (DHIS). In this segment, the Company generates revenues from sales of hardware and system integration services. As a result of the business transformation, the TIT segment is gradually being phased out in 2021. |
Selected information by segment is presented in the following tables for the year ended December 31, 2022, 2021, and 2020.
| 2022 | 2021 | 2020 | ||||||||||
| Revenues(1) | ||||||||||||
| TIT Segment | $ | $ | $ | |||||||||
| CBT Segment | ||||||||||||
| $ | $ | $ | ||||||||||
| (1) |
| 2022 | 2021 | 2020 | ||||||||||
| (Loss) income from operations | ||||||||||||
| TIT Segment | $ | ( | ) | $ | $ | ( | ) | |||||
| CBT Segment | ( | ) | ( | ) | ( | ) | ||||||
| Corporate and others(2) | ( | ) | ( | ) | ( | ) | ||||||
| (Loss) from operations | ( | ) | ( | ) | ( | ) | ||||||
| Corporate other income (loss), net | ( | ) | ( | ) | ||||||||
| Corporate interest income | ||||||||||||
| Corporate interest expense | ( | ) | ( | ) | ( | ) | ||||||
| (Loss) before income taxes | ( | ) | ( | ) | ( | ) | ||||||
| Income tax (expense) benefit | ( | ) | ( | ) | ||||||||
| Net (loss) from continuing operations | ( | ) | ( | ) | ( | ) | ||||||
| Net (loss) income from discontinued operations | ( | ) | ||||||||||
| Net (loss) | ( | ) | ( | ) | ( | ) | ||||||
| Less: Loss (income) attributable to the non-controlling interest | ||||||||||||
| Net (loss) attributable to the Company | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| (2) |
Non-cash employee compensation by segment for the year ended December 31, 2022, 2021, and 2020 are as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Non-cash employee compensation: | ||||||||||||
| Corporate and others | ||||||||||||
| $ | $ | $ | ||||||||||
Depreciation and amortization by segment for the year ended December 31, 2022, 2021, and 2020 are as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Depreciation and amortization: | ||||||||||||
| TIT Segment | $ | $ | $ | |||||||||
| CBT Segment | ||||||||||||
| $ | $ | $ | ||||||||||
| F-46 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| 2022 | 2021 | 2020 | ||||||||||
| Provisions for allowance for credit losses on accounts receivable, other receivable and advances to suppliers: | ||||||||||||
| TIT Segment | $ | ( | ) | $ | ( | ) | $ | |||||
| CBT Segment | ||||||||||||
| Corporate and others | ||||||||||||
| $ | $ | $ | ||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Inventory obsolescence provision: | ||||||||||||
| TIT Segment | $ | $ | $ | |||||||||
| CBT Segment | ( | ) | ( | ) | ||||||||
| $ | $ | ( | ) | $ | ||||||||
Total assets by segment as at December 31, 2022 and 2021 are as follows:
| 2022 | 2021 | |||||||
| Total assets | ||||||||
| TIT Segment | $ | $ | ||||||
| CBT Segment | ||||||||
| Assets from discontinued operations | ||||||||
| Corporate and others | ||||||||
| $ | $ | |||||||
| F-47 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
21. COMMITMENTS AND CONTINGENCIES
The Company may from time to time be subject to legal proceedings, investigations, and claims incidental to conduct of our business. The Company is currently not subject to any legal proceeding, investigations, and claims.
In addition to various promulgations in the past few years, ten Chinese regulatory authorities recently collectively promulgated a guidance to further control and monitor cryptocurrency related trading, exchanges, transaction, banking and financial service, initial coin offering, and other intermediary and derivatives transactions, which are considered illegal in accordance with effectuated laws and regulations and may be subject to penalty criminally. The new guidance also bars foreign cryptocurrency trading platforms and related businesses to provide services to China domestic individuals and business entities, and expands the application of laws and regulations to Chinese employees or contractors of foreign operatives, that provide related services to individuals or business entities domiciled in China. Although, the legality of cryptocurrency mining activity was not specifically mentioned in the guidance, notably in recent events, where the government’s sudden interventions or modifications of the laws and regulations currently in effective could negatively impact the Company’s operations and financial results. The legality of cryptocurrency mining activity may be subject to challenge by Chinese authorities. However, since the Company has ceased the cryptocurrency mining business starting from 2023, the risk of potential legal proceedings may not be applicable going forward.
22. CONCENTRATIONS
For
the year ended December 31, 2022, 2021 and 2020, the revenue from cryptocurrency mining consisted 14%, 22%, and -0-% of the total revenues,
and no single customer accounted for greater than 10% of total revenues. For the year ended December 31, 2022, 2021, and 2020, the Company’s
top five customers accounted for
The
Company’s top five accounts receivable accounted for
For the year ended December 31, 2022, 2021 and 2020, approximately %, % and %, respectively, of total inventory purchases were from five unrelated suppliers. One supplier accounted for greater than 10% of total inventory purchases in 2022, and three suppliers each accounted for greater than 10% of total inventory purchases in 2021 and 2020.
| F-48 |
TAOPING INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
23. SUBSEQUENT EVENTS
On
February 28, 2023, the Company entered into a preliminary intention agreement (“Intention agreement”) with Shenzhen Juxin
Hengying Information Technology Co., Ltd. to sell certain cryptocurrency mining equipment for a total price of approximately $
On
March 10, 2023, the Company entered into a sales and purchase agreement with Dongguan Yuanyouhui Technology Co., Ltd., pursuant to which
the Company sold certain cryptocurrency mining equipment for a total price of approximately $
On
March 10, 2023, the Company entered into a termination agreement (“Agreement”) to cancel the original contract signed with
Hong Kong TAS Trading Co, Limited on April 15, 2022, pursuant to which the Company purchased certain cryptocurrency mining equipment
at the price of $
Upon the full execution of the above agreements, the Company disposed/ will dispose all the remaining cryptocurrency mining machine.
On September 16, 2022, the Company received a letter from The Nasdaq Stock Market LLC (“Nasdaq”), notifying the Company that it is currently not in compliance with the minimum bid price requirement set forth under Nasdaq Listing Rule 5550(a)(2), which requires listed securities to maintain a minimum bid price of US$1.00 per share. Nasdaq Listing Rule 5810(c)(3)(A) provides that a failure to meet the minimum bid price requirement exists if the deficiency continues for a period of 30 consecutive business days. Based on the closing bid price of the Company’s ordinary shares for the 30 consecutive business days from August 4, 2022 through September 15, 2022, the Company no longer meets the minimum bid price requirement. Pursuant to Nasdaq Listing Rule 5810(c)(3)(A), the Company has a compliance period of 180 calendar days, or until March 15, 2023 (the “Compliance Period”), to regain compliance with Nasdaq’s minimum bid price requirement. If at any time during the Compliance Period, the closing bid price per share of the Company’s ordinary shares is at least $1.00 for a minimum of 10 consecutive business days, Nasdaq will provide the Company a written confirmation of compliance and the matter will be closed.
On March 16, 2023, the Company received a letter from The Nasdaq Stock Market LLC (“Nasdaq”) confirming the Company has been granted an additional 180 calendar day period for compliance under its minimum bid price requirement through September 11, 2023 (the “Additional Compliance Period”). The Additional Compliance Period was granted because the Company meets the continued listing requirement for market value of publicly held shares and all other applicable requirements for initial listing on the Nasdaq Capital Market with the exception of the bid price requirement, and the Company’s written notice to Nasdaq of its intention to cure the deficiency during the Additional Compliance Period by effecting a reverse stock split, if necessary. The notification has no immediate effect on the listing of the Company’s ordinary shares, which will continue to trade uninterrupted on Nasdaq under the ticker “TAOP”. To regain compliance with Nasdaq’s minimum bid price requirement, the closing bid price of the Company’s ordinary shares needs to be at least $1.00 per share or greater for at least ten consecutive business days by September 11, 2023, at which time Nasdaq will provide the Company a written confirmation of compliance and the matter will be closed.
| F-49 |