As filed with the Securities and Exchange Commission on June 14, 2006
Registration No. 333-120431
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form SB - 2
Post-Effective Amendment No. 3
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
CHINA DIGITAL WIRELESS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Nevada 90-0093373
(State or other jurisdiction (IRS Employer incorporation or
of organization) identification No.)
7374
(Primary Standard Industrial
Classification Code Number)
429 Guangdong Road
Shanghai 200001
People's Republic of China
Ph: (86-21) 6336-8686
------------------------------------------------------------------
(Address, including zip code, and telephone number, including area
code, of registrant's principal executive offices)
The Corporation Trust Company of Nevada
6100 Neil Road, Suite 500
Reno, Nevada 89511
Ph: (775) 688-3061
------------------------------------------------------------------
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
With copies to:
Preston Gates & Ellis LLP
Attention: Christopher Cunningham
Kristy Harlan
925 Fourth Avenue, Suite 2900
Seattle, Washington 98104
Ph: (206) 623-7580
Fax: (206) 623-7022
Approximate date of commencement of proposed sale to the public: From time to
time after the effective date of this registration statement.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act, check
the following box. [X]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act Registration Statement number of the earlier effective
Registration Statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
Registration Statement number of the earlier effective Registration Statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
Registration Statement number of the earlier effective Registration Statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. [_]
The Registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said section 8(a), may determine.
2,737,381 Shares
CHINA DIGITAL WIRELESS, INC.
Common Stock
---------------------------
This is an offering of 2,737,381 shares of common stock by the selling
stockholders. The shares are being registered to permit public secondary trading
of the shares that are being offered by the selling stockholders named in this
prospectus. We will not receive any of the proceeds from the sale of the shares.
The selling stockholders may, but are not obligated to, offer all or
part of their shares for resale from time to time through public or private
transactions, at either prevailing market prices or at privately negotiated
prices.
Our common stock is currently quoted on the OTC Bulletin Board under
the symbol "CHDW." On June 9, 2006, the last reported sales price on our common
stock was $0.53 per share.
Investing in our common stock involves risks. See "Risk Factors"
beginning on page 8 to read about factors you should consider before buying
shares of our common stock.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is , 2006.
---------------------------
TABLE OF CONTENTS
PROSPECTUS SUMMARY.............................................................3
CHINA DIGITAL WIRELESS, INC.................................................3
THE OFFERING................................................................7
RISK FACTORS...................................................................8
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................22
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND DIVIDEND
POLICY.....................................................................22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATION.....................23
BUSINESS......................................................................43
DIRECTORS AND EXECUTIVE OFFICERS..............................................55
PRINCIPAL STOCKHOLDERS........................................................58
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS..........................59
DESCRIPTION OF OUR CAPITAL STOCK..............................................60
SELLING STOCKHOLDERS..........................................................61
SHARES ELIGIBLE FOR FUTURE SALE...............................................62
PLAN OF DISTRIBUTION..........................................................62
INDEPENDENT PUBLIC ACCOUNTANTS................................................63
LEGAL MATTERS.................................................................63
EXPERTS.......................................................................64
WHERE YOU CAN FIND MORE INFORMATION...........................................64
INDEX TO FINANCIAL STATEMENTS................................................F-1
ABOUT THIS PROSPECTUS
You should rely only on the information contained in this document or
any other document to which we refer you. Neither we nor the selling
stockholders have authorized anyone to provide you with different information.
If anyone provides you with different or inconsistent information, you should
not rely on it. Neither we nor the selling stockholders are making an offer to
sell these securities in a jurisdiction where the offer or sale is not
permitted. The information contained in this document is current only as of its
date, regardless of the time of delivery of this prospectus or of any sales of
shares of common stock. Our business, financial condition, results of operations
and prospects may have changed since that date.
2
PROSPECTUS SUMMARY
This summary highlights selected information about us and the offering
that is contained elsewhere in this prospectus. You should read the entire
prospectus before making an investment decision, especially the information
presented under the heading "Risk Factors" and the financial statements and
related notes included elsewhere in this prospectus, as well as the other
documents to which we refer you. Except as otherwise indicated by the context,
references in this prospectus to "we," "us," "our," or the "company" are to the
combined business of China Digital Wireless, Inc. and its wholly-owned direct
subsidiary, Sifang Holdings Company Limited, or Sifang Holdings, and its
wholly-owned subsidiary, Shanghai TCH Data Technology Co., LTD, or TCH, and in
each case do not include the selling stockholders.
CHINA DIGITAL WIRELESS, INC.
Our Business
Value-added Information Services for Mobile Phone and Pager Users. We
render value-added information services in China by purchasing content from
third-party providers and reformatting that content. Our value-added information
services enable wireless receiver (mobile phone and pager) users in China to
access financial information and various entertainment-related services. We
contract with our affiliated wireless service providers to transmit the
reformatted content to customers of China's various network operators.
The primary focus of our value-added information services is on
providing wireless receiver users in China with access to financial information.
We derive the vast majority of our value-added information services revenue from
our financial information business. Our financial information software, Sifang
Gutong, allows our customers to access stock and currency exchange information
and execute stock trades. We are one of the largest stock information and
trading value-added information service providers in China.
We began providing our entertainment-related services, including icons,
screen savers, multiplayer games, Western horoscopes, jokes, and sports and
entertainment news during the latter part of 2003. These services are ancillary
to our financial information services and they represent only a small percentage
of our value-added information services revenue at the present time.
Leveraging our experience and understanding of the wireless value-added
services market in China, we purchase and reformat content, applications and
technologies that we believe are popular in the Chinese wireless market. To
further enhance and differentiate our services, we have entered into, and will
continue to actively pursue, collaborative relationships with third parties to
customize, market and provide access to their content through various wireless
technologies to Chinese consumers. In addition, all of our services are promoted
by our sales force and supported by our customer service team, each of which is
strategically based in Shanghai.
We primarily conduct our business in China solely through our
wholly-owned subsidiary, Sifang Holdings, and its wholly-owned subsidiary, TCH.
In order to meet ownership requirements under Chinese law that restrict us, as a
foreign company, from operating in certain industries such as value-added
telecommunication and Internet services, we have entered into information
service and cooperation agreements with two of our affiliates that are
incorporated in the People's Republic of China: Shanghai Sifang Information
Technology Co., Ltd., or Sifang Information, and Shanghai Tianci Industrial
Group Co., Ltd., or Tianci.
The original stockholder structure of Sifang Holdings was identical to
the current stockholder structure of Sifang Information, and each of Sifang
Information and Tianci are owned approximately 69% through direct and indirect
ownership by Tai Caihua, our president and the chairman of our board of
directors. We hold no ownership interest in Sifang Information or Tianci. Sifang
Information and Tianci contract with China Mobile Communications Corporation, or
China Mobile, and China United Telecommunications Corporation, or China Unicom,
3
respectively, to provide wireless value-added information services to wireless
receiver customers in China via China Mobile and China Unicom. Sifang
Information transmits those services to customers of China Mobile and China
Unicom on behalf of itself and Tianci pursuant to a signed agreement between
Sifang Information, Tianci and TCH, respectively.
Mobile Phone Distribution. We distribute various mobile phone brands in
the Shanghai, China region. We distribute mobile phones manufactured primarily
by SAMSUNG Electronics Co., Ltd., or Samsung, and to a lesser extent, by
Motorola, Inc., or Motorola. We began distributing Motorola mobile phones in
early 2002 and Samsung mobile phones in November 2002. We began discontinuing
our Motorola mobile phone distribution business on June 30, 2004. We are a
distributor, for the Shanghai region, of over ten different mobile phone models
manufactured by Samsung and plan to increase our sales of Samsung mobile phones.
Most of the Samsung models we distribute are compatible with the GSM
network and only a few Samsung models we distribute are compatible with the Code
Division Multiple Access, or CDMA, network.
We entered into an agreement to distribute select Nokia mobile phones
exclusively in the Shanghai region of China beginning in May 2005 and now have
obtained the right to distribute two popular models of Nokia's mobile phones.
Initially, we believed that this agreement would enhance both our market share
and profitability. However, as a result of the sudden change in the market
factors during the latter half of 2005, whereas the Chinese market started
becoming saturated and competition among mobile phone distributors intensified,
our sales mark-up of the Nokia mobile phones to our customers dropped
significantly from the initial 8% to approximately 1% during the 4th quarter of
2005. Our management is currently reviewing the market factors and considering
discontinuing the mobile phone distribution business in 2006 if the market
situation remains unchanged. There are three main first-tier wholesalers of
Samsung phones in China: Shanghai Taili Communication Equipment Co., Ltd.,
Shenzhen Tianyin Communication Development Co., Ltd., and Guangzhou Yingtai Data
Power Technology Co., Ltd. These wholesalers contract, through local branches,
with sub-wholesalers to distribute each model in a defined area. We have
contracts with Shanghai branch offices of the three main first-tier wholesalers
on whom we rely, making us a sub-wholesaler distributor of nine Samsung mobile
phone models in the Shanghai region. We received approximately 45% of the mobile
phones we sold in 2005 from the three retailers.
We have rebate programs with Shanghai Taili Communication Equipment
Co., Ltd. and Shenzhen Tianyin Communication Development Co., Ltd. whereby we
are credited a certain portion of the sales price we paid to the first-tier
wholesaler if we are able to fulfill certain sales volume prescribed by that
first-tier wholesaler. As a result, we are entitled to receive certain rebates
and credits for the inventory held and sold by us within a specified period of
time as set by the first-tier wholesaler offering the rebate program.
Digital Advertising. We launched a new digital media project to move
into the media market in China in 2005. In conjunction with charitable
organizations, we have installed donation boxes with digital TV incorporated on
top of them in the main lobbies of commercial banks, hotels, malls and other
public locations to call the public's attention to the charity and broadcast
commercial advertisements.
We have an agreement with China Charity Foundation ("CCF"), a national
non-profit charitable organization, which enables us to install donation boxes
for CCF in banks and other commercial locations throughout China that will also
have the Company's out-of-home digital television advertising media platform
attached. The completion of this agreement enables us to accelerate the
placement of out-of-home digital television platforms, particularly in banks
across China. We negotiate placement of the donation boxes and digital
television media platform with banks and other commercial entities that wish to
support the national charity. The China Banking Regulatory Commission ("CBRC")
has previously agreed, pending completion of the agreement with CCF, to support
and coordinate this effort with respect to approvals of donation box placements
in banks throughout China. This agreement facilitates the continued placement of
4
platforms with little or no direct costs. We believe that such costs may
constitute as much as 30% of the direct costs of competitors based upon an
analysis of publicly available information.
We have placed more than 850 multimedia donation boxes in the inbound
area of Shanghai and other arranged spots will be rolled out in the public
places with high traffic flow. Based on Shanghai, our strategy is to expand our
network to penetrate other large and mid-sized developed cities throughout
China. We believe the earnings potential from the advertising service will be a
new source of profit in view of the upcoming Special Olympic World Summer Games
in 2007 and World Exposition in 2010 to be held in Shanghai.
Other Advertising Services. During the year ended December 31, 2005,
TCH rendered advertisement designing and producing services to Shanghai Tianci
Real Estate Co. Ltd. ("Tianci Real Estate") for publicity and promoting its
apartments. Net advertising service revenue of $1,738,878 was derived from this
service. TCH performed such services via an agent, Shanghai Sifang Media Co.,
Ltd. ("Sifang Media"), which is a related company that granted the license to
provide advertising in China.
In January 2005, Sifang Media and TCH entered into the "Bank Digital
TV's Cooperation Agreement", where TCH will assist in the promotion of TV ads
for various customers, including Tianci Real Estate. TCH received a net fee of
$2,620,044 for providing the service from January 2005 to December 2005. There
was an "Advertisement Agency Contract" between Tianci Real Estate and Sifang
Media, which expired in November 2005. In June and September 2005, Sifang Media,
TCH and two unrelated customers, entered into certain agreements, where TCH will
assist in the promotion of TV ads for these customers. TCH received a net fee of
approximately $900,000 for providing the service via Sifang Media during the
fiscal year of 2005.
Energy Saving Products. In February 2006, we entered into an agreement
to acquire 95% of the equity interests of Shanghai Kena Energy Saving Electric
Co., Ltd. ("Kena") and related patent and patent rights to produce high-energy,
high-efficiency transformers. The Company's decision to enter into the Kena
acquisition is driven by an effort to re-focus the Company's strategy and
capitalize on the strategic opportunity this transaction presents.
Kena was established in China on April 26, 2005. Its chief scientist
Dr. Chang Kenan, an experienced Chinese-American scientist, is the inventor of
energy saving street lighting system ballasts which are noted for energy
savings, material savings, long-life, and being environmentally friendly. Since
its establishment, Kena has undertaken four street lighting projects and
generated revenue of over RMB 5,000,000. There are approximately nine street
lighting projects under negotiation.
We believe that the Kena acquisition represents a strategic opportunity
for the Company in the following ways:
1) The Chinese government has provided strong support of energy saving
products. In the first quarter of 2006, Kena's energy saving lighting products
will be included in the Chinese government purchasing lists. Official documents
will be issued by the Chinese government to help promote these products.
2) There is a large demand for energy saving streetlights. According to
the Chinese Construct Department, currently, there are 18,000,000 streetlights
in China with a 17%-18% yearly growth rate. The average replacement rate is 10%.
The worldwide demand is estimated at five times as much as the demand in China.
3) Kena's products present consumers with positive economic and social
effects. According to a Report from National Centre of Supervision & Inspection
on Electric Light Source Quality of Shanghai, Kena's energy saving lighting
system ballasts result in a 20% energy saving, allowing consumers to recover
their costs in two years. Compared to other similar products, Kena's system
ballasts use 15% less materials than other similar products and have a 20-year
service life, which is 10 years longer than other similar products.
5
Our Corporate Information
We originally began operations as a Colorado corporation known as
Boulder Brewing Company, or Boulder Brewing. Boulder Brewing was incorporated in
Colorado on May 8, 1980 and operated as a microbrewery of various beers. Boulder
Brewing was unable to become profitable within any segment of its core business,
became illiquid, and was forced to divest itself of all of its assets. Boulder
Brewing became dormant without any operations or assets in the second quarter of
1990.
In September 2001, Boulder Brewing changed its state of incorporation
from Colorado to Nevada through a merger and changed its name to Boulder
Acquisitions, Inc., or Boulder Acquisitions. From the date of reincorporation
until June 23, 2004 Boulder Acquisitions had no material operations or assets.
On June 23, 2004, we completed a stock exchange transaction with the
stockholders of Sifang Holdings. The exchange was consummated under Nevada and
Cayman Islands law pursuant to the terms of a Securities Exchange Agreement
dated effective as of June 23, 2004 by and among Boulder Acquisitions, Sifang
Holdings and the stockholders of Sifang Holdings. Pursuant to the Securities
Exchange Agreement, we issued 13,782,636 shares of our common stock, par value
$0.001 per share, to the stockholders of Sifang Holdings, representing
approximately 89.7% of our post-exchange issued and outstanding common stock, in
exchange for 100% of the outstanding capital stock of Sifang Holdings. We
presently carry on the business of Sifang Holdings' wholly-owned subsidiary,
TCH.
Effective August 6, 2004, we changed our name from Boulder
Acquisitions, Inc. to China Digital Wireless, Inc.
Our corporate headquarters is located at 429 Guangdong Road, Shanghai,
200001, Peoples Republic of China. Our telephone number is (86-21) 6336-8686.
6
THE OFFERING
Common stock outstanding prior to this offering..... 17,147,268 shares
Common stock offered by us.......................... 0 shares
Common stock offered by the selling stockholders.... 2,737,381 shares
Total shares of common stock offered................ 2,737,381 shares
Common stock to be outstanding after the offering... 17,147,268 shares
Risk factors........................................ See "Risk Factors" and other information
included in this prospectus for a
discussion of factors you should
consider before deciding to invest in
shares of our common stock.
7
RISK FACTORS
An investment in our securities involves a high degree of risk. You
should carefully consider the following risks and the other information set
forth elsewhere in this prospectus, including our financial statements and
related notes, before you decide to purchase shares of our common stock. If any
of these risks occur, our business, financial condition and results of
operations could be adversely affected. As a result, the trading price of our
common stock could decline, perhaps significantly, and you could lose part or
all of your investment.
Risks Related to Our Business
We depend upon contractual arrangements with our affiliated value-added mobile
phone service providers, Sifang Information and Tianci, for the success of our
business. These arrangements may not be as effective in providing operational
control as direct ownership of these businesses may be difficult to enforce.
Because we conduct our business only in China, and because we are
restricted by the Chinese government from owning telecommunications or Internet
operations in China, we depend on our affiliated value-added mobile phone
service providers, Sifang Information and Tianci, in which we have no direct
ownership interest, but with which we have entered into information service and
cooperation agreements, to provide those services to mobile phone users in China
through contractual agreements with the mobile operators, China Mobile and China
Unicom. These arrangements may not be as effective in providing control over our
value-added information services to mobile phone users in China as would be
direct ownership of these businesses. For example, Sifang Information or Tianci
could fail to take actions required to operate our business, such as entering
into service contracts with China Mobile or China Unicom. Moreover, a portion of
the fees for our services are paid by the mobile operators directly to Sifang
Information and Tianci, which are then obligated to transfer all of those fees
to us, in return for a small fee. If Sifang Information or Tianci fails to
perform their obligations under these agreements, we may have to rely on legal
remedies under Chinese law, which we cannot assure you would be effective or
sufficient.
In the opinion of our Chinese counsel, Grandall Legal Group (Shanghai),
Sifang Information and Tianci each possesses such licenses, permits,
certificates, authorities and approvals, issued by appropriate governmental
agencies or bodies in the People's Republic of China, as are necessary to
conduct its business as presently conducted as well as to perform its
obligations under any contracts between it and China Mobile and China Unicom,
respectively. In addition, to the best knowledge of Grandall Legal Group
(Shanghai), TCH is not in breach of or in default under any laws of the People's
Republic of China or any approval, consent, waiver, authorization, exemption,
permission, endorsement or license granted by any People's Republic of China
governmental agencies. There are, however, substantial uncertainties regarding
the interpretation and application of current and future Chinese laws and
regulations, as discussed below.
We depend on one software developer for a significant portion of our software
development, as well as for important marketing relationships.
We rely on Shanghai Chengao Industrial Co., Ltd., or Chengao, to
develop a significant portion of our software, including our Sifang Gutong
software. We also rely on Chengao to provide us with an important marketing
relationship regarding the mobile phone version of our Sifang Gutong software.
If we lose our relationship with Chengao, we could have a difficult time finding
a suitable replacement in the short term.
Our corporate structure could be deemed to be in violation of current or future
Chinese laws and regulations which could adversely affect our ability to operate
our business effectively or at all.
In connection with China's entry into the World Trade Organization, or
WTO, foreign investment in telecommunications and Internet services in China was
liberalized to allow for 30.0% foreign ownership in value-added
telecommunication and Internet services in 2002, 49.0% in 2003, and 50.0%
8
thereafter. In order to meet these ownership requirements, we have entered into
information service and cooperation agreements with Sifang Information and
Tianci. We do not have any direct ownership interest in Sifang Information or
Tianci. The original stockholder structure of Sifang Holdings was identical to
the current stockholder structure of Sifang Information, and each of Sifang
Information and Tianci are beneficially owned 69% by Tai Caihua, our president
and the chairman of our board of directors. It is possible that the relevant
Chinese authorities could, at any time, assert that any portion or all of TCH's,
Sifang Information's, or Tianci's existing or future ownership structure and
businesses violate existing or future Chinese laws, regulations or policies. It
is also possible that the new laws or regulations governing the
telecommunication or Internet sectors in China that have been adopted or may be
adopted in the future will prohibit or restrict foreign investment in, or other
aspects of, TCH's, Sifang Information's or Tianci's current or proposed
businesses and operations. In addition, these new laws and regulations may be
retroactively applied. In any such case, we could be required to restructure our
operations, which could adversely affect our ability to operate our business
effectively or at all.
We depend on China Mobile and China Unicom for delivery of our value-added
information services to mobile phone users in China, and the termination or
alteration of Sifang Information's and Tianci's various contracts with either of
them or their provincial or local affiliates could materially and adversely
impact our business.
Our affiliated value-added mobile phone service providers, Sifang
Information and Tianci, contract with the two principal mobile phone operators
in China, China Mobile and China Unicom, to offer our wireless value-added
information services to mobile phone users through these mobile phone operators,
which service nearly all of China's approximately 282.2 million mobile phone
subscribers. Given their dominant market position, our affiliated value-added
mobile phone service providers' negotiating leverage with these operators is
limited. If our affiliated value-added mobile phone service providers' various
contracts with either operator are terminated or adversely altered, it may be
impossible for our affiliated value-added mobile phone service providers to find
appropriate replacement operators with the requisite licenses and permits,
infrastructure and customer base to offer our services, and our business would
be significantly impaired.
Our value-added information services are provided to mobile phone users
in China pursuant to contracts with Sifang Information and Tianci have with
China Mobile and China Unicom and their provincial or local affiliates. Each of
these contracts is non-exclusive, and has a limited term (generally one year).
Our affiliates usually renew these contracts or enter into new ones when the
prior contracts expire, but on occasion the renewal or new contract can be
delayed by periods of one month or more. The terms of these contracts vary, but
the operators are generally entitled to terminate them in advance for a variety
of reasons or, in some cases, for no reason in their discretion. For example,
several of our affiliates' contracts with the mobile operators can generally be
terminated if:
o our affiliate fails to achieve performance standards which are
established by the applicable operator from time to time;
o our affiliate breaches its obligations under the contracts,
which include, in many cases, the obligation not to deliver
content that violates the operator's policies and applicable
law;
o the operator receives high levels of customer complaints about
our affiliate's services; or
o the operator sends written notice to our affiliate that it
wishes to terminate the contract at the end of the applicable
notice period.
Our affiliates may also be compelled to alter their arrangements with
these mobile operators in ways which adversely affect our business. China Mobile
and China Unicom have unilaterally changed their policies as applied to
third-party service providers in the past, and may do so again in the future. We
may not be able to adequately respond to negative developments in the
contractual relationships between our affiliates and China Mobile or China
Unicom in the future because we do not have a contractual relationship with
China Mobile or China Unicom.
9
Our business could be adversely affected if China Mobile or China Unicom or both
begin providing their own wireless value-added services.
Our wireless value-added information services business may be adversely
affected if China Mobile or China Unicom or both decide to begin providing their
own wireless value-added services to mobile phone users. In that case, we would
face enhanced competition, and our services could be fully or partially denied
access to their networks.
We depend in part on China Mobile and China Unicom to maintain accurate records
and to continue to pay our affiliated value-added wireless service providers.
We depend in part on China Mobile and China Unicom to maintain accurate
records of the fees paid by mobile phone users and to pay our affiliated
value-added wireless service providers. Specifically, the mobile operators
provide our affiliates with monthly statements that do not provide itemized
information regarding which of our services are being paid for. Our business and
results of operation could be adversely affected if these mobile phone companies
miscalculate the revenue generated from our services and our affiliates' portion
of that revenue, or refuse to pay our affiliates altogether.
Our revenues and cost of services are affected by billing and transmission
failures which are often beyond our control.
Our affiliates do not collect fees for our services owed to them by
China Mobile and China Unicom in a number of circumstances, including if:
o the delivery of our service to a customer is prevented because
his or her phone is turned off for an extended period of time,
the customer's prepaid phone card has run out of value or the
customer has ceased to be a customer of the applicable
operator;
o China Mobile or China Unicom experiences technical problems
with their networks which prevent the delivery of our services
to the customer;
o we experience technical problems with our technology platform
that prevent delivery of our services;
o our affiliates experience technical problems with their
technology platforms that prevent delivery of our services; or
o the customer refuses to pay for our service due to quality or
other problems.
These situations are known in the industry as billing and transmission
failures, and we do not recognize any revenue for services which are
characterized as billing and transmission failures. The failure rate can vary
among the operators, and by province, and also has fluctuated significantly in
the past. If actual billing and transmission failures exceed our estimates, our
revenues could be materially adversely affected.
China Mobile and China Unicom may impose higher service or network fees on our
affiliated value-added service providers if we are unable to satisfy customer
usage and other performance criteria.
Fees for our wireless value-added information services are charged on a
monthly subscription or per use basis. Based on our contractual arrangement and
those of our wireless value-added service providers, we rely on China Mobile and
China Unicom to bill and collect fees for our services from mobile phone users.
China Mobile and China Unicom generally charge our affiliated
value-added service providers service fees of 15% and 30% of the revenues
generated by their services, respectively. To the extent that the number of
messages sent by Sifang Information over China Mobile's network exceeds the
number of messages their customers send to it, Sifang Information must pay per
message network fees, which decrease in several provinces as the volume of
customer usage of our services increases. The number of messages sent by Sifang
Information will exceed those sent by end-users, for example, if a user sends
Sifang Information a single message to order a game but Sifang Information in
turn must send that user several messages to confirm his or her order and
10
deliver the game itself. Tianci's service fees owed to China Unicom could also
rise if Tianci fails to meet certain customer usage, revenue and other
performance criteria. We cannot be certain that our affiliates will be able to
continue to satisfy these criteria in the future or that the mobile operators
will keep the criteria at their current levels. Any increase in China Mobile's
or China Unicom's network fees and service charges could reduce our gross
margins.
China Mobile and China Unicom may terminate their relationships with our
affiliates if our affiliates fail to achieve minimum customer usage, revenue and
other criteria.
Our business could be adversely affected if our affiliated value-added
mobile phone service providers fail to achieve minimum customer usage, revenue
and other criteria imposed or revised by China Mobile and China Unicom at their
discretion from time to time. China Mobile and China Unicom, through their
national and local offices, have historically preferred to work only with a
small group of the best performing wireless value-added service providers, based
upon the uniqueness of the service offered by each provider, total number of
users, usage and revenue generated in the applicable province or municipality,
the rate of customer complaints, and marketing expenditures in the applicable
province or municipality.
The services our affiliated value-added mobile phone service providers offer and
the prices they charge are subject to approval by China Mobile and China Unicom,
and if requested approvals are not granted in a timely manner, our business
could be adversely affected.
Our affiliated value-added mobile phone service providers must obtain
approval from China Mobile and China Unicom with respect to each service that
they propose to offer to their customers and the pricing for each such service.
In addition, any changes in the pricing of our affiliates' existing services
must be approved in advance by these operators. There can be no assurance that
such approvals will be granted in a timely manner or at all. Moreover, under
some of our affiliates' contracts with the operators, prices cannot be changed
more than once every six months and prices must be within fixed parameters,
depending on the service. Any failure of our affiliates to obtain, or any delay
in obtaining, such approvals could place us at a competitive disadvantage in the
market and adversely affect our business.
We operate in a rapidly evolving industry, which makes it difficult for
investors to evaluate our business.
We began commercially offering wireless value-added information
services to mobile phone and pager users in China in January 2002, and since
that time, the technologies and services used in the wireless value-added
information services industry in China have developed rapidly. As a result of
this rapid and continual change in the industry, the prospects of our
value-added information service business should be considered in light of the
risks and difficulties frequently encountered by businesses in an early stage of
development. These risks include our ability to:
o attract and retain users for our wireless value-added
information services;
o expand the content and services that we offer and, in
particular, develop and aggregate innovative new content and
service offerings;
o respond effectively to rapidly evolving competitive and market
dynamics and address the effects of mergers and acquisitions
among our competitors;
o build relationships with strategic partners; and
o increase awareness of our brand and user loyalty.
Due to these factors, there can be no certainty that we will maintain
or increase our current share of the highly competitive wireless value-added
information services market in which we operate.
11
The success of much of our wireless value-added information services is
significantly dependent on our ability to obtain and reformat desirable content
and technology from third parties.
We obtain much of our content, including financial information, games,
logos, music, news and other information, from third parties. Furthermore, we
expect that we will develop and purchase technology in connection with our
development of next generation services such as MMS, JAVA and BREW. As the
market for wireless value-added information services develops, content and
technology providers may attempt to increase their profits from distribution
arrangements by demanding greater fees or a share of revenues, which would
adversely affect our financial performance. Many of our arrangements with
content and technology providers are non-exclusive, have a term of one year, and
are subject to renewal. If our competitors are able to obtain such content in a
similar or superior manner or to develop, purchase or license the same
technologies, it could adversely affect the popularity of our services and our
negotiating leverage with third-party providers.
If we fail to establish and maintain economically attractive
relationships with content and technology providers and to thereafter
successfully reformat their products, we may not be able to attract and retain
customers or maintain or improve our financial performance.
We depend on our Sifang Gutong software continuing to be compatible with new
mobile phone models.
There can be no assurance that our Sifang Gutong software will be
compatible with new mobile phones developed by manufacturers such as Samsung. If
the software is no longer compatible, we will be forced to engage Chengao or an
alternative software developer to develop software that is compatible with the
new mobile phones or we will have to develop the software ourselves. If we are
unable to either engage a software developer or develop software in house that
is compatible with new mobile phones, we will lose a significant portion of our
value-added information services revenue, including all of the pre-charged
subscription fee revenues we receive pursuant to our information services and
cooperation agreement among us, Chengao, and Sifang Information.
We face intense competition from other wireless value-added service providers.
The Chinese market for wireless value-added services is intensely
competitive. We believe there are more than 800 service providers (including the
three groups discussed below) as of June 30, 2004. We compete directly or
indirectly with three groups of wireless value-added service providers in China:
o portal service providers, which have established expertise in
Internet content and have subsequently branched into mobile
space. The portals serve as content aggregators offering a
variety of wireless value-added services;
o dedicated service providers, whose businesses focus on
offering a variety of wireless content directly to mobile
phone users; and
o niche service providers, which focus primarily on a particular
market segment or application that often builds on a
pre-existing sector competency.
We have faced direct or indirect competition from all three groups
since our entry into this market. Moreover, there are low barriers to entry for
new competitors in the wireless value-added services market. As a result, our
existing or potential competitors may in the future achieve greater market
acceptance and gain additional market share, which in turn could reduce our
revenues. There is increasing number of competitors in the media industry and
the reduction of advertising fees, resulting in intense market competition. Our
advertising services have also facing direct or indirect competitions from other
more traditional advertising outlets such as television, radio and newspapers.
12
Most of our value-added information services revenues are derived from the
Shanghai municipal area and surrounding provinces, and the termination or
alteration of our affiliates' contracts with the mobile operators, or a general
economic downturn in those areas, could have a particularly adverse effect on
our business.
Per capita income levels and mobile phone penetration rates (i.e., the
number of mobile subscribers divided by the population of China) in China are
generally higher in the coastal and southern provinces, and most of our revenues
are derived from those areas, including the municipality of Shanghai and the
provinces of Beijing and Jiangsu. If our affiliates' contracts with the mobile
operators with respect to those areas are terminated or adversely modified, or
if there is a general economic downturn in those areas, it could have a
particularly adverse effect on our business.
Rapid growth and a rapidly changing operating environment strain our limited
resources.
As our value-added information services customer base increases, we
will need to increase our investment in our technology infrastructure,
facilities and other areas of operations, in particular our product development,
customer service and sales and marketing departments, which are important to our
future success. If we are unable to manage our growth and expansion effectively,
the quality of our services and our customer support could deteriorate and our
business may suffer. Our future success will depend on, among other things, our
ability to:
o develop and quickly introduce new services, adapt our existing
services and maintain and improve the quality of all of our
services, particularly as new mobile technologies such as 3G
are introduced;
o expand the percentage of our value-added information services
revenues which are recurring and are derived from monthly
subscription based services;
o continue to enter into and maintain relationships with
desirable content providers;
o continue training, motivating and retaining our existing
employees and attract and integrate new employees, including
our senior management, most of whom have been with our company
for less than one year;
o develop and improve our operational, financial, accounting and
other internal systems and controls; and
o maintain adequate controls and procedures to ensure that our
periodic public disclosure under applicable laws, including
U.S. securities laws, is complete and accurate.
Any failures of the mobile telecommunications network, the Internet or our
technology platform may reduce use of our services.
Both the continual accessibility of China Mobile's and China Unicom's
mobile networks and the performance and reliability of China's Internet
infrastructure are critical to our ability to attract and retain our value-added
information services customers . Moreover, our business depends on our ability
to maintain the satisfactory performance, reliability and availability of our
technology platform. The servers which constitute the principal system hardware
for our operations are located in one location in Shanghai. Any server
interruptions, break-downs or system failures, including failures caused by
sustained power shutdowns, floods or fire causing loss or corruption of data or
malfunctions of software or hardware equipment, or other events outside our
control that could result in a sustained shutdown of all or a material portion
of the mobile networks, the Internet or our technology platform, could adversely
impact our ability to provide our services to our value-added information
services customers and decrease our revenues.
Computer viruses and hacking may cause delays or interruptions on our systems
and may reduce use of our services and harm our reputation.
Computer viruses and hacking may cause delays or other service
interruptions on our systems. "Hacking" involves efforts to gain unauthorized
access to information or systems or to cause intentional malfunctions or loss or
corruption of data, software, hardware or other computer equipment. In addition,
13
the inadvertent transmission of computer viruses could expose us to a material
risk of loss or litigation and possible liability. We may be required to expend
significant capital and other resources to protect our systems against the
threat of such computer viruses and hacking and to rectify any damage to our
systems. Moreover, if a computer virus or hacking which affects our systems is
highly publicized, our reputation could be materially damaged and usage of our
services may decrease.
We may be held liable for information we purchase and reformat.
We may face liability for defamation, negligence, copyright, patent or
trademark infringement and other claims based on the reformatted content to
which we provide access through our wireless value-added information services.
For example, SMS news updates provided by us could possibly be deemed to contain
state secrets in violation of applicable Chinese law. In addition, third parties
could assert claims against us for losses incurred in reliance on information
distributed by us. We may incur significant costs in investigating and defending
these claims, even if they do not result in liability.
We may not be able to adequately protect our intellectual property, and we may
be exposed to infringement claims by third parties.
We rely on contractual restrictions on disclosure to protect our
intellectual property rights. Monitoring unauthorized use of our information
services is difficult and costly, and we cannot be certain that the steps we
take will effectively prevent misappropriation of our technology and content.
Our management may determine in the future to make application for copyright,
trademark or trade secret protection if management determines that such
protection would be beneficial and cost-effective.
From time to time, we may have to resort to litigation to enforce our
intellectual property rights, which could result in substantial costs and
diversion of our resources. In addition, third parties may initiate litigation
against us for alleged infringement of their proprietary rights. In the event of
a successful claim of infringement and our failure or inability to develop
non-infringing technology or content or license the infringed or similar
technology or content on a timely basis, our business could suffer. Moreover,
even if we are able to license the infringed or similar technology or content,
license fees that we pay to licensors could be substantial or uneconomical.
Our ability to generate revenues could suffer if the Chinese market for wireless
value-added services does not develop as anticipated.
The wireless value-added services market in China has evolved rapidly
over the last four years, with the introduction of new services, development of
consumer preferences, market entry by new competitors and adaptation of
strategies by existing competitors. We expect each of these trends to continue,
and we must continue to adapt our strategy to successfully compete in our
market.
In particular, we currently offer a wide range of wireless value-added
information services for mobile phones using 2.5G technologies. There can be no
assurance, however, that these 2.5G technologies and any services compatible
with them will be accepted by consumers or promoted by the mobile operators.
Moreover, there are numerous other technologies in varying stages of
development, such as third generation mobile technologies, which could radically
alter or eliminate the market for SMS or 2.5G services.
Accordingly, it is extremely difficult to accurately predict consumer
acceptance and demand for various existing and potential new offerings and
services, and the future size, composition and growth of this market.
Furthermore, given the limited history and rapidly evolving nature of our
market, we cannot predict the price that wireless subscribers will be willing to
pay for our services or the services of our affiliated value-added service
providers or whether subscribers will have concerns about security, reliability,
14
cost and quality of service associated with wireless services. If acceptance of
our wireless value-added information services is different than anticipated, our
ability to maintain or increase our revenue and profits could be materially and
adversely affected.
The popularity of our services which operate with next generation technology
standards are necessarily dependent on the market penetration of mobile phones
that are compatible with those standards, which is beyond our control.
Mobile phone users can access our MMS, WAP, JAVA, BREW and other
services which operate with next generation technology standards only if they
purchase mobile phones that are compatible with those standards. In particular,
mobile phones that are 2.5G-compatible have historically been significantly more
expensive in China than mobile phones using older technology such as GSM.
Although the prices of 2.5G-compatible mobile phones have been dropping rapidly
in recent quarters, we cannot be certain whether this trend will continue or the
extent to which existing users will be willing to upgrade their mobile phones to
obtain the latest technology. The pricing, marketing and other factors which
affect the sales of more sophisticated mobile phones are all outside of our
control, and weak sales of mobile phones for which we have developed services
could adversely affect our business.
The telecommunication laws and regulations in China are evolving and subject to
interpretation and will likely change in the near future. If we are found to be
in violation of current or future Chinese laws or regulations, we could be
subject to severe penalties.
Although wireless value-added services are subject to general
regulations regarding telecommunication services, we believe that currently
there are no Chinese laws at the national level explicitly governing wireless
value-added services, such as our services related to MMS, WAP, JAVA, and BREW,
and no Chinese government authority has been specifically designated to regulate
these services. Many providers of wireless value-added services have obtained
various value-added telecommunication services licenses, such as the licenses
possessed by our Chinese affiliates, Sifang Information and Tianci. These
value-added telecommunication licenses were issued by the local Shanghai
Municipal Telecommunications Administration Bureau, and may not be sufficient to
offer wireless value-added services on a national basis. Sifang Information and
Tianci are in the process of applying with the Ministry of Information
Industries for an inter-provincial value-added telecommunication license in
accordance with the Ministry's general regulations regarding telecommunication
services. However, we cannot predict whether either will be granted that
license. Moreover, we cannot be certain that any local or national value-added
telecommunication license requirements will not conflict with one another or
that any given license will be deemed sufficient by the relevant governmental
authorities for the provision of this category of service. It is also possible
that new national legislation might be adopted to regulate such services.
If we or our affiliates are found to be in violation of any existing or
future Chinese laws or regulations regarding wireless value-added services or
Internet access, the relevant Chinese authorities have the power to, among other
things:
o levy fines;
o confiscate our income or the income of our affiliated
value-added service providers;
o revoke our business license or the business licenses of our
affiliated value-added service providers;
o shut down our servers or the servers of our affiliated
value-added service providers or block any Web sites that we
or our affiliated value-added service providers may operate;
o require us to discontinue any portion or all of our wireless
value-added information services business; or
o require our affiliated value-added service providers to
discontinue any portion or all of their wireless value-added
services business.
15
The Chinese government, China Mobile or China Unicom may prevent us from
distributing, and we may be subject to liability for, content that any of them
believe is inappropriate.
China has enacted regulations governing telecommunication service
providers, Internet access and the distribution of news and other information.
In the past, the Chinese government has stopped the distribution of information
over the Internet that it believes violates Chinese law, including content that
is obscene, incites violence, endangers national security, is contrary to the
national interest, or is defamatory. In addition, our affiliated value-added
service providers may not publish certain news items, such as news relating to
national security, without permission from the Chinese government. Furthermore,
the Ministry of Public Security has the authority to cause any local Internet
service provider to block any Web site maintained outside China at its sole
discretion.
China Mobile and China Unicom also have their own policies regarding
the distribution of inappropriate content by wireless value-added service
providers and have recently punished certain providers for distributing content
deemed by them to be obscene. Such punishments have included censoring of
content, delaying payments of fees by the mobile operators to the offending
service provider, forfeiture of fees owed by the mobile operators to the
offending service provider and suspension of the service on the mobile
operators' networks. Accordingly, even if our affiliated wireless value-added
service providers comply with Chinese governmental regulations relating to
licensing and foreign investment prohibitions, if the Chinese government, China
Mobile or China Unicom were to take any action to limit or prohibit the
distribution of information or to limit or regulate any current or future
content or services available to users, our revenues could be reduced and our
reputation harmed.
The Chinese government is expected to grant licenses to offer wireless
services in China to China Telecom, China Netcom and possibly other parties with
which our affiliated wireless value-added service providers have not yet
developed close relationships. If those parties receive licenses and are
successful in the market but our affiliates are unable to develop cooperative
relationships with them, our business could be adversely affected.
It is also possible that China Telecom, China Netcom and any other
parties receiving wireless licenses may decide to offer wireless value-added
services created by them, rather than by third-party service providers such as
our affiliated wireless value-added service providers. In that case, our
business could be adversely affected.
Government regulation of the telecommunications and Internet industries may
become more complex.
Government regulation of the telecommunications and Internet industries
is highly complex. New regulations could increase our costs of doing business
and prevent us from efficiently delivering our services. These regulations may
stop or slow down the expansion of our wireless value-added information services
customer base and limit access to our services. We are dependent on three main
first-tier wholesalers to supply all of our mobile phones.
Our performance depends on whether we can continue to secure contracts
with the three first-tier wholesalers of Samsung mobile phones on whom we rely.
We have no long-term purchase contracts or other contracts that provide
continued supply, pricing or access to new mobile phone models and any of the
first-tier wholesalers on whom we rely could discontinue selling to us at any
time. We may not be able to acquire new Samsung models in the future and we may
not be able to acquire the models that we need in sufficient quantities or on
terms that are acceptable to us in the future. As a result, our revenues may
decrease.
Our performance is dependent on the popularity of Samsung's mobile phone models.
We primarily distribute mobile phones manufactured by Samsung and thus
are dependant on Samsung's ability to create and deliver high quality mobile
phone models in a cost effective and timely manner. Samsung is a leading
16
manufacturer of mobile phones based on both the CDMA network and the GSM network
in China. There can be no assurance that Samsung will continue to create high
quality mobile phone models that are popular with consumers. As a result, our
revenues may decrease. In addition, our success depends on our ability to
anticipate and respond to changing mobile phone model trends and consumer
demands in a timely manner. The models we distribute must appeal to a broad
range of consumers whose preferences cannot always be predicted with certainty
and may change between sales seasons. If we misjudge which mobile phone models
will be popular or the market for the models we distribute, our sales may
decline or we may be required to sell our models at lower prices.
We rely on cash flow to purchase mobile phones from wholesalers, and any
significant decrease in cash flow could have a negative impact on our ability to
meet customer demand.
It is important that we have sufficient cash flow to purchase enough
mobile phones from the first-tier wholesalers on whom we rely. If our cash flow
decreases significantly, we will not be able to purchase a sufficient quantity
of inventory to meet our customers' demands, which would have a negative impact
on our sales, and may cause the first-tier wholesalers on whom we rely to look
to other sub-wholesalers to distribute their mobile phones. This development
would have a negative impact on our revenues.
Our customers are under no obligation to do business with us, and if they
terminate or materially reduce their relationship with us it would adversely
impact our business.
One of the factors the first-tier wholesalers on whom we rely consider
when determining who they will use as a sub-wholesaler is the sub-wholesaler's
relationship with retailers. Currently approximately 72% of our mobile phone
sales are made to five retailers. We have no long-term sales contracts or other
contracts that provide continued selling or pricing and any of the retailers we
supply could discontinue buying from us at any time. If we lose our
relationships with our five largest retailers, we will have a difficult time
finding new large retailers to purchase our Samsung mobile phones and may lose
our relationships with the first-tier wholesalers on whom we rely. This would
have a negative impact on our business.
We face certain risks relating to customer service, and any resulting problems
could adversely affect our sales.
Any material disruption or slowdown in our order processing systems
resulting from labor disputes, mechanical problems, human error or accidents,
fire, natural disasters, or comparable events could cause delays in our ability
to receive and distribute orders and may cause orders to be lost or to be
shipped or delivered late. As a result, customers may cancel orders or refuse to
receive goods on account of late shipments, which would result in a reduction in
our net sales and could result in increased administrative and shipping costs.
We face risks associated with the concentration of our distribution operations
in one location.
We conduct all of our distribution operations from one facility in
Shanghai, China. Any disruption in the operations at our distribution center
could have a negative impact on our business.
We face competition from distributors selling other mobile phone models.
Despite the fact that we distribute nine Samsung mobile phone models in
the Shanghai, China region, we face competition from distributors of different
models of mobile phones manufactured by Samsung in the Shanghai region and from
distributors of phones manufactured by companies other than Samsung that
distribute in the Shanghai region.
Competition is based on a variety of factors including maintenance of
product quality, competitive pricing, delivery efficiency, customer service and
17
satisfaction levels and the ability to anticipate technological changes and
changes in customer preferences. The first-tier wholesalers on whom we rely or
Samsung may acquire, startup, or expand their own distribution systems to sell
directly to our customers.
We are dependent on advertising contracts, some of which are short term. If
these contracts are terminated or completed without replacement, our results of
operations would be materially adversely affected.
We are dependent upon "Bank Digital TV's Cooperation Agreement", where
TCH will assist in the promotion of TV ads for various customers, including
Tianci Real Estate, a related party. Service revenue from Tianci Real Estate was
approximately $1.9 million, or 9%, of total consolidated revenue for the year
ended December 31, 2005 and represented approximately 47% of the service
revenues for the year. There was an "Advertisement Agency Contract" between
Tianci Real Estate and Sifang Media, which expired in November 2005. We may not
be able to renew these contracts and agreements in future. Because of the
significance of the revenues from these contracts to our consolidated results of
operations, the termination of either contract could have a material adverse
effect on our financial condition and results of operations.
We may not be able to complete or successfully realize the benefits of the Kena
acquisition.
The Kena acquisition is subject to certain conditions, including
regulatory approval in The People's Republic of China. We cannot assure you that
we will obtain regulatory approval or otherwise be able to complete the
acquisition. In addition, to be successful after the acquisition, we will need
to integrate the operations of Kena into ours. We could encounter difficulties
in this integration process, such as distraction of our management team. If we
cannot integrate Kena's business successfully, we may fail to realize the
benefits we expect to result from the acquisition.
We depend on key personnel for the success of our business. Our business may be
severely disrupted if we lose the services of our key executives and employees
or fail to add new senior and middle managers to our management.
Our future success is heavily dependent upon the continued service of
our key executives, particularly Tai Caihua, our president and chairman of our
board of directors, Fu Sixing, our chief executive officer, and Qian Fang, our
chief financial officer. Each of our executive officers has entered into a
non-competition agreement with TCH. Management will spend approximately 30% of
its time managing Sifang Information. We also rely on a number of key technology
staff for the operation of our company. Our future success is also dependent
upon our ability to attract and retain qualified senior and middle managers to
our management team. If one or more of our current or future key executives or
employees are unable or unwilling to continue in their present positions, we may
not be able to easily replace them, and our business may be severely disrupted.
In addition, if any of these key executives or employees joins a competitor or
forms a competing company, we could lose customers and suppliers and incur
additional expenses to recruit and train personnel. Each of our executive
officers has entered into non-competition agreements with TCH. We do not
maintain key-man life insurance for any of our key executives.
We also rely on a number of key technology staff for the operation of
our company. Given the competitive nature of our industry, the risk of key
technology staff leaving our company is high and could disrupt our operations.
Our management does not devote full-time efforts to the Company and may have
potential conflicts of interest.
Our executive officers spend approximately 30% of their time managing
Sifang Information. Thus, they do not devote full-time effort to the Company. In
addition, as discussed in Item 12, "Certain Relationships and Related
18
Transactions", the Company has had numerous significant transactions with
businesses controlled by, and with people who are related to, the officers and
directors of the Company. Our management may thus have potential conflicts of
interest.
We have limited business insurance coverage.
The insurance industry in China is still at an early stage of
development. Insurance companies in China offer limited business insurance
products, and do not, to our knowledge, offer business liability insurance. As a
result, we do not have any business liability insurance coverage for our
operations. Moreover, while business disruption insurance is available, we have
determined that the risks of disruption and cost of the insurance are such that
we do not require it at this time. Any business disruption, litigation or
natural disaster might result in substantial costs and diversion of resources.
A downturn in the Chinese economy may slow down our growth and profitability.
The growth of the Chinese economy has been uneven across geographic
regions and economic sectors. There can be no assurance that growth of the
Chinese economy will be steady or that any downturn will not have a negative
effect on our business. Our profitability, will decrease if expenditures for
wireless value-added services decrease due to a downturn in the Chinese economy.
More specifically, increased penetration of wireless value-added services in the
less economically developed central and western provinces of China will depend
on those provinces achieving certain income levels so that mobile phones and
related services become affordable to a significant portion of the population.
The uncertain legal environment in China could limit the legal protections
available to you.
The Chinese legal system is a civil law system based on written
statutes. Unlike common law systems, it is a system in which decided legal cases
have little precedential value. In the late 1970s, the Chinese government began
to promulgate a comprehensive system of laws and regulations governing economic
matters. The overall effect of legislation enacted over the past 20 years has
significantly enhanced the protections afforded to foreign invested enterprises
in China. However, these laws, regulations and legal requirements are relatively
recent and are evolving rapidly, and their interpretation and enforcement
involve uncertainties. These uncertainties could limit the legal protections
available to foreign investors, such as the right of foreign invested
enterprises to hold licenses and permits such as requisite business licenses.
Any recurrence of Avian influenza, or another widespread public health problem,
could adversely affect our business and results of operations.
A renewed outbreak of Avian influenza or another widespread public
health problem in China, where all of our revenue is derived, and in Shanghai,
where our operations are headquartered, could have a negative effect on our
operations. Our operations may be impacted by a number of health-related
factors, including the following:
o quarantines or closures of some of our offices which would severely
disrupt our operations,
o the sickness or death of our key officers and employees, and
o a general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
Changes in China's political and economic policies could harm our business.
19
The economy of China has historically been a planned economy subject to
governmental plans and quotas and has, in certain aspects, been transitioning to
a more market-oriented economy. Although we believe that the economic reform and
the macroeconomic measures adopted by the Chinese government have had a positive
effect on the economic development of China, we cannot predict the future
direction of these economic reforms or the effects these measures may have on
our business, financial position or results of operations. In addition, the
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD. These
differences include:
o economic structure;
o level of government involvement in the economy;
o level of development,
o level of capital reinvestment;
o control of foreign exchange;
o methods of allocating resources; and
o balance of payments position.
As a result of these differences, our business may not develop in the
same way or at the same rate as might be expected if the Chinese economy were
similar to those of the OECD member countries.
Restrictions on currency exchange may limit our ability to receive and use our
revenues effectively.
Because almost all of our future revenues may be in the form of
Renminbi, any future restrictions on currency exchanges may limit our ability to
use revenue generated in Renminbi to fund any future business activities outside
China or to make dividend or other payments in U.S. dollars. Although the
Chinese government introduced regulations in 1996 to allow greater
convertibility of the Renminbi for current account transactions, significant
restrictions still remain, including primarily the restriction that
foreign-invested enterprises may only buy, sell or remit foreign currencies,
after providing valid commercial documents, at those banks authorized to conduct
foreign exchange business. In addition, conversion of Renminbi for capital
account items, including direct investment and loans, is subject to governmental
approval in China, and companies are required 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 Renminbi, especially with respect to foreign
exchange transactions.
The value of our securities will be affected by the foreign exchange rate
between U.S. dollars and Renminbi.
The value of our common stock will be affected by the foreign exchange
rate between U.S. dollars and Renminbi. For example, to the extent that we need
to convert U.S. dollars into Renminbi for our operational needs and should the
Renminbi appreciate against the U.S. dollar at that time, our financial position
and the price of our common stock may be adversely affected. Conversely, if we
decide to convert our Renminbi into U.S. dollars for the purpose of declaring
dividends on our common stock or for other business purposes and the U.S. dollar
appreciates against the Renminbi, the U.S. dollar equivalent of our earnings
from our subsidiaries in China would be reduced.
Risks Related to our Common Stock
20
The market price for our common stock may be volatile.
The market price for our common stock is likely to be highly volatile
and subject to wide fluctuations in response to factors including the following:
o actual or anticipated fluctuations in our quarterly operating
results;
o announcements of new services by us or our competitors;
o changes in financial estimates by securities analysts;
o conditions in the wireless value-added services market;
o changes in the economic performance or market valuations of
other companies involved in wireless value-added services or
distribution of mobile phones;
o announcements by our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
o additions or departures of key personnel;
o potential litigation; or
o conditions in the mobile phone market.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are not related to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
Stockholders could experience substantial dilution.
We may issue additional shares of our capital stock to raise additional
cash for working capital. If we issue additional shares of our capital stock,
our stockholders will experience dilution in their respective percentage
ownership in the company.
We have no present intention to pay dividends.
Neither during the preceding two fiscal years nor during the year ended December
31, 2005 did we pay dividends or make other cash distributions on our common
stock, and we do not expect to declare or pay any dividends in the foreseeable
future. We intend to retain any future earnings for working capital and to
finance current operations and expansion of our business.
A large portion of our common stock is controlled by a small number of
stockholders.
A large portion of our common stock is held by a small number of
stockholders. As a result, these stockholders are able to influence the outcome
of stockholder votes on various matters, including the election of directors and
extraordinary corporate transactions including business combinations. In
addition, the occurrence of sales of a large number of shares of our common
stock, or the perception that these sales could occur, may affect our stock
price and could impair our ability to obtain capital through an offering of
equity securities. Furthermore, the current ratios of ownership of our common
stock reduce the public float and liquidity of our common stock which can in
turn affect the market price of our common stock.
We may be subject to "penny stock" regulations.
The Securities and Exchange Commission, or SEC, has adopted rules that
regulate broker-dealer practices in connection with transactions in "penny
stocks." Penny stocks generally are equity securities with a price of less than
$5.00 (other than securities registered on certain national securities exchanges
or quoted on the NASDAQ system, provided that current price and volume
information with respect to transactions in such securities is provided by the
exchange or system). Penny stock rules require a broker-dealer, prior to a
transaction in a penny stock not otherwise exempt from those rules, to deliver a
standardized risk disclosure document prepared by the SEC, which specifies
information about penny stocks and the nature and significance of risks of the
penny stock market. A broker-dealer must also provide the customer with bid and
21
offer quotations for the penny stock, the compensation of the broker-dealer, and
our sales person in the transaction, and monthly account statements indicating
the market value of each penny stock held in the customer's account. In
addition, the penny stock rules require that, prior to a transaction in a penny
stock not otherwise exempt from those rules, the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser's written agreement to the transaction.
These disclosure requirements may have the effect of reducing the trading
activity in the secondary market for stock that becomes subject to those penny
stock rules. Whenever any of our securities become subject to the penny stock
rules, holders of those securities may have difficulty in selling those
securities.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve risks
and uncertainties. These statements relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "could," "expect," "plan,"
"intend," "anticipate," "believe," "estimate," "predict," "potential," or
"continue," or the negative of such terms or other comparable terminology. These
statements are only predictions and are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
projected due to a number of factors beyond our control. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined in the "Risk
Factors" section above. These factors may cause our actual results to differ
materially from any forward-looking statement.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. You are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof. We are under no duty to update any of the forward-looking
statements after the date of this prospectus to conform such statements to
actual results or to changes in our expectations.
Factors that might cause actual results, performance or achievements to
differ materially from those projected or implied in such forward-looking
statements include, among other things: (i) the impact of competitive products;
(ii) changes in law and regulations; (iii) adequacy and availability of
insurance coverage; (iv) limitations on future financing; (v) increases in the
cost of borrowings and unavailability of debt or equity capital; (vi) the effect
of adverse publicity regarding our products; (vii) our inability to gain and/or
hold market share; (viii) exposure to and expense of resolving and defending
product liability claims and other litigation; (ix) consumer acceptance of our
products; (x) managing and maintaining growth; (xi) customer demands; (xii)
market and industry conditions including pricing and demand for products, (xiii)
the success of product development and new product introductions into the
marketplace; (xiv) the departure of key members of management; and (xv) our
ability to efficiently market its products; as well as other risks and
uncertainties that are described from time to time in our filings with the SEC.
MARKET FOR COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND DIVIDEND POLICY
Our common stock is traded on the OTC Bulletin Board under the symbol
"CHDW." On August 6, 2004, we changed our name from Boulder Acquisitions, Inc.
to China Digital Wireless, Inc. and changed our symbol from "BAQI" to "CHDW." On
June 9, 2006, the last reported sales price for our common stock was $0.53 per
share.
22
The following table sets forth, for the quarters indicated, the range
of closing high and low bid prices of our common stock as reported by the
Over-the-Counter Bulletin Board, as adjusted for all previously effected stock
splits.
Common Stock
------------------
By Quarter Ended High Low
---------------- ---- ----
Fiscal 2004
March 31, 2004.................................... $5.00 $0.42
June 30, 2004..................................... $4.05 $2.30
September 30, 2004................................ $3.90 $1.98
December 31, 2004................................. $4.85 $2.80
Fiscal 2005
----------------------------------------------------
March 31, 2005.................................... $5.50 $3.42
June 30, 2005..................................... $5.20 $1.40
September 30, 2005................................ $3.01 $1.41
December 31, 2005................................. $2.49 $1.60
Fiscal 2006
----------------------------------------------------
March 31, 2006.................................... $1.75 $0.60
June 30, 2006 (through June 9, 2006).............. $0.55 $0.53
------------------------
As of June 9, 2006 there were 17,147,268 shares of our common stock
outstanding held by approximately 2,553 stockholders of record.
We did not pay any cash dividends on our common stock in fiscal 2003,
2004 or 2005. We do not anticipate paying any cash dividends on our common stock
in the foreseeable future. We currently intend to retain future earnings, if
any, to finance operations and the expansion of our business.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATION
The following discussion should be read in conjunction with our
financial statements and the notes thereto and the other financial information
appearing elsewhere in this document.
Overview of Business Background
Sifang Holdings was formed under the laws of the Cayman Islands on
February 9, 2004 for the purpose of holding a 100% equity interest in TCH. TCH
was established as a foreign investment enterprise in Shanghai under the laws of
the PRC on May 25, 2004, with a registered capital of $7.2 million.
Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business by
presenting a set of carve-out financial statements for the years ended December
31, 2002 and 2003 and three months ended March 31, 2004 as if the spun-off
business had been a stand-alone company for two years and one quarter. On March
31, 2004, Sifang Information transferred the spun-off business into TCH. Being a
receiving entity under common control, TCH initially recognized all the assets
23
and liabilities transferred at their carrying amounts in the accounts of Sifang
Information at the date of transfer under the guidance of SFAS No. 141, Appendix
D. On May 26, 2004 Sifang Information exchanged 100% of equity interest in TCH
for a 100% equity interest in Sifang Holdings. Since the ultimate owners of the
three entities were the same owners and the three entities remained under common
control, the ownership exchange transaction was accounted for at historical
costs under the guidance of SFAS No. 141, Appendix D. Prior to May 26, 2004,
there were no activities in Sifang Holdings. As a result of exchanging the
ownership between TCH and Sifang Holdings, TCH's historical financial statements
become the historical financial statements of Sifang Holdings.
Sifang Information operates in a business segment that is subject to
certain restrictions imposed by the government of the PRC. For example, paging
facilities, radio transmitting stations and transmitting equipment owned by
Sifang Information are not allowed to be owned by foreign investment enterprises
in accordance with PRC government regulations. Therefore, Sifang Information
still maintains a small part of its business and paging facilities in order to
stay in compliance with relevant regulations and laws in PRC.
As a result of the spin-off, TCH engages in the business of mobile
phone distribution and the provision of pager and mobile phone (collectively
"wireless receiver") users with access to certain information reformatted by
TCH. TCH purchases mobile phones from first tier distributors and sells them to
retailers with a mark-up. In the process of providing value-added information
services through entering into monthly subscription agreements with various
users, TCH purchases trading activity information from stock exchanges, comments
and analysis on PRC stock markets provided by certain reputable security and
investment companies, lottery information, weather forecast, and other
value-added products and reformats the aforementioned information through
decoding and recoding and then has the reformatted information transmitted by
Sifang Information, via service contracts, to pager users. The information is
constantly saved in TCH's server in order for mobile phone users to dial in via
China Mobile or China Unicom. By signing a monthly subscription agreement,
wireless users agree to make advance payments for either three or six-month
subscription periods.
We launched a new digital media project to move into the media market
in China in 2005. In conjunction with charitable organizations, we have
installed donation boxes with digital TV incorporated on top of them in the main
lobbies of commercial banks, hotels, malls and other public locations to call
the public's attention to the charity and broadcast commercial advertisements.
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The preparation of these financial statements requires the use of
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amount of revenues and expenses
during the reporting period. Management periodically evaluates the estimates and
judgments made. Management bases its estimates and judgments on historical
experience and on various factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates as a result of
different assumptions or conditions.
The following critical accounting policies affect the more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
Revenue Recognition
We derive revenues from the sale of mobile phones, advertisement
designing services and the provision of wireless information services that are
used on mobile phones, pagers and prepaid phone cards. We additionally earn
commission income, or Agency Income, from the sale of CDMA mobile phones on the
behalf of a related party. We recognize revenues net of related business taxes
and value added taxes.
24
Mobile Phone Sales
Revenues generated from the sale of mobile phones are recognized when
the products are shipped to the distributor or retailer and when persuasive
evidence of an arrangement exists, delivery of the products has occurred, and
customer acceptance has been obtained, which means the significant risks and
rewards of ownership have been transferred to the customer, the price is fixed
or determinable and collectibility is reasonably assured.
Advertising Servicing Revenue, Net
Advertising revenues are derived from advertisement designing, masterminding and
producing services. We recognize service revenue over the term of the noted
agreement at the time of completion of the services. We record the revenue from
Shanghai Sifang Media Co., Ltd. ("Sifang Media") on a net basis in accordance
with EITF 99-19, "Reporting Revenue Gross as a Principle versus Net as an Agent"
because the Company is not the primary obligor in the arrangements, receives a
fixed fee from Sifang Media, and has no latitude in determining prices.
Information Services
We recognize service revenues over the term of the noted agreement and/
or when the services have been provided to the end user.
i) Information Services - TCH. By signing a subscription agreement,
wireless receiver users agree to make payments for three- to six-month
subscriptions in advance. We record the proceeds as deferred revenue and
amortize the deferred revenue over the subscription period. When customers buy a
pre-charged service card, we record the proceeds as deferred revenue. When a
customer starts to use this card to access to our server and starts to use a
pager to access the aforementioned information, we identify the subscription
period and amortize the deferred revenue over the subscription period.
ii) Information Services - Installing Agent. In response to a
retailer's request, we have an installing agent install our software on mobile
phones, which are owned by the retailer. The retailer sells these phones for a
premium covering a fee to be paid to the installing agent and pre-charged
six-month subscription fees to be paid to us. After a customer using such a
phone dials into the server to access the desired information, the server
records a unique identification number installed on the mobile phone, which
indicates that a specific phone user starts his or her subscription period.
After we receive a detailed list from the installing agent regarding the number
of phones that have been installed with our software, we match this information
with a detailed list from the retailer setting forth how many such phones have
been sold. Based on the number of such phones sold, we record accounts
receivable and deferred revenue. At the date on which a customer starts to dial
into the server, the six-month subscription period begins and we amortize
deferred revenue accordingly.
iii) Information Services - China Mobile and / or China Unicom. Our
affiliates, Sifang Information and Tianci, contract with the Mobile Operators
(China Mobile and China Unicom) for the transmission of our value-added
information services. The Mobile Operators bill and collect from customers and
then pass those fees (net of billing and collection service fees charged by the
Mobile Operators) to Sifang Information and Tianci who in turn pass those fees
to us. We recognize net revenues based on the total amount paid by our
customers, for which the Mobile Operators bill and collect on our behalf. There
is a time lag ranging from 10 days to 45 days between the end of the service
period and the date the Mobile Operators send out their billing statements due
to the segregated billing systems of each of the provincial subsidiaries of the
Mobile Operators. We received the December invoice before the issuance of our
financial statements to reconcile the monthly revenues to the Mobile Operators
billing statement. We have not recognized service revenue based on the records
provided by its own server but have performed a reconciliation on a monthly
basis of the revenues recognized by our server to the Mobile Operator's billing
statement. In addition, the Mobile Operators charge a network usage fee based on
a fixed per message fee multiplied by the excess of messages sent over messages
received.
25
This type of service is not covered by a monthly service subscription and we
have no control whether or not it will occur Network usage fees charged by the
Mobile Operators are reduced for messages received by us because the Mobile
Operators separately charge the sender a fee for these transmissions.
We record the revenue from China Mobile / China Unicom on a net basis
in compliance with EITF 99-19, "Reporting Revenues Gross as a Principal versus
Net as an Agent" because we:
o are not the primary obligor in the arrangement, as we rely on
Sifang Information to transmit the information services to the
end user;
o have limited ability to adjust the cost of services by
adjusting the design or marketing of the service;
o have limited ability to determine prices, as we must follow
the price policy within ranges prescribed by Mobile Operators;
and
o have limited ability to assume risk of non-payment by
customers.
Our dependence on the substance and timing of the billing systems of
the mobile telecommunications operators may require us to estimate portions of
our reported revenue for wireless Internet services from time to time. As a
result, subsequent adjustments may have to be made to our wireless Internet
service revenue in our financial statements. As we do not bill our wireless
Internet services users directly, we depend on the billing systems and records
of the mobile telecommunications operators to record the volume of our wireless
Internet services provided, charge our users through mobile telephone bills and
collect payments from our users and pay us.
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, we extend unsecured credit to our
retailers and distributors who are mainly located in the Shanghai metropolitan
area. Typically, for mobile phone distributors, the credit terms require payment
to be made within 30 days of the sale. We do not require collateral from our
customers. Our policy is to provide for delinquent receivable balances as an
allowance for doubtful accounts that is based on 5% of total trade accounts
receivable less amounts due from related parties and from the installing agent.
We regularly evaluate and monitor the creditworthiness of each customer
on a case-by-case basis. We include any account balances that are determined to
be uncollectable in the overall allowance for doubtful accounts. After all
attempts to collect a receivable have failed, the receivable is written off
against the allowance. Based on the information available to management, we
believe that our allowance for doubtful accounts was adequate as of March 31,
2005 and 2004. However, actual write-offs might exceed the recorded allowance.
Cash and Cash Equivalents
We consider all highly liquid investments with maturities of three
months or less to be cash equivalents. We maintain our cash accounts at credit
worthy financial institutions.
Inventories
Inventories consist principally of mobile phones manufactured by name
brand manufacturers with various features and are stated at the lower of cost
(weighted-average) or market.
Rebates and Credits Receivable
In 2004 our major vendor began providing sales rebates and credits if
we fulfill certain sales volumes prescribed by the vendor in order to induce our
distributors to sell more of our products. As a result, we are entitled to
receive certain rebates and credits for the inventory held and sold by us within
the specified period of time as defined by our vendor through submitting the
26
necessary application forms. In general, once the vendor approves these
applications the amounts of these rebates and credits will be deducted from our
accounts payable to our vendor and decrease the cost of goods sold or inventory
held correspondingly.
Capitalization of Software Costs
Our software is developed by an independent third party to enable pager
users to accept certain recoded information which is transmitted by us, through
affiliates, and enables mobile phone users to dial into our server. The software
is for internal use and gives us the ability to provide value added information
services. In accordance with SOP 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," we capitalize the external
cost incurred to develop this internal-use software by an engineering company at
the application development stage and amortize that cost over the estimated
economic life of the software (two or three years) which is consistent with the
expected life of a particular type of mobile phone.
Property and equipment
Property and equipment are recorded at cost and are stated net of
accumulated depreciation. Depreciation expense is determined using the
straight-line method over the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
Maintenance and repairs are charged directly to expense as incurred,
whereas betterment and renewals are generally capitalized in their respective
property accounts. When an item is retired or otherwise disposed of, the cost
and applicable accumulated depreciation are removed and the resulting gain or
loss is recognized and reflected as an item before operating income.
Impairment of Long-Lived Assets
We apply the provisions of Statement of Financial Accounting Standard
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," or
SFAS No. 144, issued by the Financial Accounting Standards Board, or FASB. SFAS
No. 144 requires that long-lived assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable through the estimated undiscounted cash flows expected to
result from the use and eventual disposition of the assets. Whenever any such
impairment exists, an impairment loss will be recognized for the amount by which
the carrying value exceeds the fair value. There was no impairment of long-lived
assets in the years ended December 31, 2004 and 2005.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, advances
and deposits to suppliers, accounts payable and other current liabilities are
reasonable estimates of their fair value because of the short maturity of these
items.
Advertising Expenses
Advertising expenses are expensed in the period incurred. Advertising expenses
for the years ended December 31, 2004 and 2005 were $60,092 and $17,468,
respectively.
Stock Based Compensation
The Company utilizes SFAS No. 123 "Accounting for Stock-Based Compensation",
when accounting for stock based compensation and recognizes the fair value
27
impact of the compensation granted to employees and consultants as a charge to
net income in the period that the services associated with the compensation are
provided. The Company does not currently have a stock option plan.
Value Added Tax
TCH is subject to value added tax ("VAT") imposed by the PRC on TCH's domestic
product sales. The output VAT is charged to customers who purchase mobile phones
from TCH and the input VAT is paid when TCH purchases mobile phones from its
vendors. The VAT rate applied for TCH is 17%. The input VAT can be offset
against the output VAT.
Income Taxes
We account for income taxes in accordance with Statement of Financial
Accounting Standards No 109, "Accounting for Income Taxes," or SFAS No. 109.
SFAS No. 109 requires an entity to recognize deferred tax liabilities and
assets. Deferred tax assets and liabilities are recognized for the future tax
consequence attributable to the difference between the tax bases of assets and
liabilities and their reported amounts in the financial statements. Deferred tax
assets and liabilities are measured using the enacted tax rate expected to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that included the
enactment date. We establish a valuation when it is more likely than not that
the assets will not be recovered.
TCH is registered at Pudong District in Shanghai and subject to a
favorable income tax rate of 15% compared to a normal income tax rate of 33%
(30% for the central government and 3% for the local government) under current
PRC tax laws. However, Sifang Information is registered in the Shanghai downtown
area and has been treated by the Shanghai Municipal Administration of Labor as
an enterprise that provides unemployed and handicapped people with jobs.
Accordingly, Sifang Information is entitled to be subject to a favorable income
tax rate of 15% and qualified for income tax exemption for three years from
January 1, 2000 to December 31, 2002, and 50% of income tax reduction for three
years from January 1, 2003 to December 31, 2005. The income tax provisions
presented in our financial statements are based on the historical actual income
tax rates of Sifang Information at 7.5% for the year ended December 31, 2003.
The income tax provision presented for the year ended December 31, 2004 is based
on 7.5% for the months of January to June and 15% for the months of July to
December. The income tax provisions for the nine months ended September 30, 2004
are based on the historical actual income tax rates of Sifang Information at
7.5%. The income tax provision presented for the nine months ended September 30,
2005 is based on 15%. The deferred tax assets are determined based on the
historical income tax rates applicable at the TCH level.
There is no income tax for companies domiciled in the Cayman Islands.
Accordingly, Sifang Holdings financial statements do not present any income tax
provisions related to Cayman Islands tax jurisdiction.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 revenues and
expenses during the reporting period. Actual results could differ materially
from those estimates.
28
Discussion and Analysis of Operating Results
Three months ended March 31, 2006 Compared to Three months Ended March 31, 2005
Revenues
Total Revenues
Total sales revenues consist of product sales, product sales to related
parties, and net information and advertising service revenue. Total sales
revenues for the three months ended March 31, 2006 decreased by $4,118,366,
representing a 71.0% decrease, to $1,679,685 as compared to $5,798,051 for the
same period of the prior year. The decrease was mainly due to the significant
decline of the advertising service revenue and mobile phone sales to related
parties. The demand for mobile phones in the Chinese telecommunication Market is
decreasing as the Market gradually becomes saturated.
In the three months ended March 31, 2006, Samsung and Nokia's mobile
phones accounted for about 79.4% and 20.6% of our total product sales,
respectively, compared to the same period of the prior year, in which Samsung's
mobile phones accounted for 97% of our total product sales and other brands
accounted for the balance. During 2006, market competition for mobile phone
sales continued to intensify, causing us to reposition ourselves in the
marketplace and move away from the low-margin sales. The increase of our overall
mark-up ratio to 10.4%, in comparison with a mark-up ratio of 3.4% for the same
period of the prior year, primarily resulted from the exceptionally high mark-up
for the sales of Samsung mobile phone to a related party during the period.
Product Sales
Revenue for product sales in the three months ended March 31, 2006
decreased by $319,194, representing a 47.7% decrease, to $349,997 as compared to
$669,191 for the same period of the prior year. The decrease was mainly due to
the market factors described above. We reduced the effort and cost of generating
sales from such business throughout the period.
We entered an agreement to distribute selected Nokia mobile phones
exclusively in the Shanghai region of China in May 2005 and now have obtained
the right to distribute two popular models of Nokia's mobile phones. Initially,
we believed that this agreement would enhance both our market share and
profitability. The initial margin of Nokia was as high as 8% in mid 2005,
however, as a result of the sudden change in the market factors during the
latter half of 2005, the sales mark-up of the Nokia mobile phones to our
customers dropped significantly to 1% during the 4th quarter of 2005. The
mark-up for Nokia phone was 1.5% during the 1st quarter of 2006. The Company's
management is currently reviewing the market factors and considering
discontinuing the mobile phone distribution business in latter 2006 if the
market situation remains soft.
Product sales to a related party
We distributed Samsung mobile phones to our related party, Shantian, in
which Sifang Information holds a 51% equity interest, for its retail market
channel and facility. During the three months ended March 31, 2006, we sold
$890,744 worth of mobile phones to Shantian, with an average mark-up of
approximately 12.7%, (compared to $4,060,514 at gross profit margin of 2.4% in
2005), which represents a $3,169,770 or 78.1% decrease compared to the same
period of the prior year. The decrease in sales was also attributable to the
market factors mentioned above. However, due to the urgent demand of a specific
model of Samsung mobile phones from Shantian, we were able to charge a
exceptionally high mark-up during the period.
Information service revenue, net
Total information service revenue net of related business tax and
service fee for the three months ended March 31, 2006 decreased by $347,430,
representing a decrease of approximately 57.0%, to $261,785 compared to $609,215
for the same period of the prior year.
Value-added service revenue from mobile phone users for the three
months ended March 31, 2006 decreased by $269,053 to $132,557 compared to
$401,610 for the same period of the prior year, representing a 67.0% decrease.
During the three months ended March 31, 2006, there is no service revenue from
mobile phone users was attributable to prepaid service fees generated by an
installing agent, Chengao Industry Co. Ltd, who installed the software on a
29
retailer's (Beijing Jianghe Communication Co., Ltd.) inventories and collected
proceeds from the retailer and transferred the proceeds to the Company,
representing a $388,637 decrease compared to the same period of the prior year.
The remaining $12,973 of the service revenue was generated by our SMS service
via China Mobile's network, representing a material decrease compared to the
same period of the prior year. The decrease was mainly due to the decline of our
financial value-added service. The sluggish Chinese stock market along with
inactive stock exchanges hindered our growth in this segment of business.
In addition, service revenue from pager users for the three months
ended March 31, 2006 decreased by $78,377 to $129,228 compared to $ 207,605 for
the same period of the prior year, representing a decrease of approximately
37.8%. We believe that service revenue from pager users will continue to
decrease given the increased popularity of mobile phones over beepers and
pagers. We project that the decrease in service revenue from pager users will
likely plateau at a certain level as most lower income pager users still like to
use pagers to access our information services.
Advertising service revenue, net
We launched a digital media project to enter into the media market in
China in 2005. In conjunction with charitable organizations, we have installed
donation boxes with digital TV incorporated on top of them in the main lobbies
of commercial banks, hotels, malls and other public locations to call the
public's attention to the charity and broadcast commercial advertisements.
We entered into an agreement with China Charity Foundation ("CCF"), a
national non-profit charitable organization, which enables the Company to
install donation boxes for CCF in banks and other commercial locations
throughout China that will also have the Company's out-of-home digital
television advertising media platform attached. The completion of this agreement
enables us to accelerate the placement of out-of-home digital television
platforms, particularly in banks across China. The Company negotiates placement
of the donation boxes and digital television media platform with banks and other
commercial entities that wish to support the national charity. The China Banking
Regulatory Commission ("CBRC") has previously agreed, pending completion of the
agreement with CCF, to support and coordinate this effort with respect to
approvals of donation box placements in banks throughout China.
This agreement facilitates the continued placement of platforms with
little or no direct costs. We believe that such costs may constitute as much as
30% of the direct costs of our competitors based upon an analysis of publicly
available information.
We have placed more than 850 multimedia donation boxes in the inbound
area of Shanghai and other arranged spots will be rolled out in the public
places with high traffic flow. Based on our experience in Shanghai, our strategy
is to expand our network to penetrate other large and mid-sized developed cities
throughout China. We believe the earnings potential from the advertising service
will be a new source of profit in view of the upcoming Special Olympic World
Summer Games in 2007 and World Exposition in 2010 to be held in Shanghai.
In addition, during the three months ended March 31, 2006, TCH
generated $177,159 in service income from advertisement designing and producing
services, which represents a decrease of $281,972 or 61.4%, compared to the
service revenue of $459,131 rendered from the advertisement designing and
producing services to Tianci Real Estate, a related party, for publicity and
promoting its apartment during the three months ended March 31, 2005.
Cost of goods sold
The cost of goods sold for the three months ended March 31, 2006
decreased by $3,458,175 to $1,111,618 compared to $4,569,793 for the same period
of the prior year, representing a 75.7% decrease. The decrease was consistent
with the decrease in revenue from product sales.
30
Cost of service
The cost of service for the three months ended March 31, 2006 increased
by $35,878 to $229,375 compared to $193,497 for the same period of the prior
year, representing a 18.5% increase. The increase was mainly due to the increase
of personnel costs for the value-added mobile phone and pager services. The
breakdown of our service business has changed and the proportion of pager
services that are related to financial information has increased, resulting in
an increase in associated costs pertaining to the securities information fee
paid. During the three months ended March 31, 2006, we continued to maintain
current fee structures and establish collaborative relationships or partnerships
with Chinese mobile operators and certain information content providers. Most of
the cost of service was fixed costs and thus it cannot be reduced in response to
the decrease in information service revenue.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for the three months ended March 31, 2006 decreased by $696,069
to $338,692, representing a 67.3% decrease, compared to gross profit of
$1,034,761 for the same period of the prior year. The decrease in gross profit
was primarily attributable to the drop of proceeds generated from the
advertising service and phone sales during the three months ended March 31,
2006.
The following table summarizes certain information related to the
various components of revenue.
Information
Advertising Service - Information
Service Mobile Service -
Revenue Phone Sales Phone Pager Total
----------- ----------- ----------- ----------- -----------
For three months ended March 31, 2005
Revenue $ 459,131 $ 4,729,705 $ 401,610 $ 207,605 $ 5,798,051
----------- ----------- ----------- ----------- -----------
Cost 22,819 4,569,793 103,197 67,481 4,763,290
----------- ----------- ----------- ----------- -----------
Gross profit 436,312 159,912 298,413 140,124 1,034,761
----------- ----------- ----------- ----------- -----------
Gross profit ratio 95.0% 3.4% 74.3% 67.5% 17.8%
----------- ----------- ----------- ----------- -----------
For three months ended March 31, 2006
Revenue $ 177,159 1,240,741 $ 132,557 $ 129,228 $ 1,679,685
----------- ----------- ----------- ----------- -----------
Cost 40,056 1,111,618 122,715 66,604 1,340,993
----------- ----------- ----------- ----------- -----------
Gross profit 137,103 129,123 9,842 62,624 338,692
----------- ----------- ----------- ----------- -----------
Gross profit ratio 77.4% 10.4% 7.4% 48.4% 20.2%
----------- ----------- ----------- ----------- -----------
Sales and marketing expenses
Sales and marketing expenses for the three months ended March 31, 2006
decreased by $16,322 to $26,967 compared to $43,289 for the same period of the
prior year. The decrease was primarily due to the drop of the management fee
paid for Sifang Information as a result of the declining revenue generated from
information services.
General and administrative expenses
General and administrative expenses for the three months ended March
31, 2006 increased by $15,575 to $207,614 compared to $192,039 for the same
period of the prior year, representing a 8.1% decrease. The increase was mainly
due to the increase of audit fee and partially offset by the tightened control
of expense incurred in TCH.
31
General and administrative expenses incurred at the TCH level for the
three months ended March 31, 2006 decreased from $102,002 to $69,949,
representing a 31.4% decrease. The decrease was primarily attributable to the
collection of accounts receivable from our clients, resulting in the recovery of
provisions for bad debts, and cost control, which lead to the decline of office
expenses and professional fees. At the parent level, we incurred an aggregate of
$137,665 of audit fee and other general expenses in the three months ended March
31, 2006, compared to audit fees and service fees for Investor Relations and
Public Relations of $90,037 incurred in the prior year.
Interest income, net
During the three months ended March 31, 2006, the interest income
derived from bank deposits increased by $866 to $1,331, compared to $465 for the
same period of the prior year.
During the three months ended March 31, 2006, finance expense incurred
in discounting bank drafts net of interest income from bank deposits increased
by $1,216 to $1,216, compared to nil for the same period of the prior year.
Income taxes
The Company's Chinese subsidiary, TCH is registered at Pudong District
in Shanghai and is subject to a favorable income tax rate of 15% compared to a
normal income tax rate of 33% (30% for the central government and 3% for the
local government) under current PRC tax laws. The income tax provisions
presented in the Company's consolidated financial statements are based on the
historical actual income tax rates of TCH at 15% for the year ended December 31,
2005. In the three months ended March 31, 2005 and 2006, income tax expense was
$133,490 and $36,296, respectively, based on pretax income of $799,898 and
$104,430, respectively.
Comprehensive income
We recorded comprehensive income of $106,129 for the three months ended
March 31, 2006, a $560,277 decrease in comprehensive income compared to
comprehensive income of $666,406 for the same period of the prior year,
representing a decrease of approximately 84.1%. The decrease in comprehensive
income was attributable to (i) the decrease of revenue contribution from our
advertising business that was newly initiated in the 2005 fiscal year, and (ii)
the significant declines in revenue from sales of mobile phones and information
services. These factors offset the appreciation of Chinese RMB to US dollars of
$37,995 in the quarter ended March 31, 2006.
Earnings per share
The earnings per share for the three months ended March 31, 2006 was
$0.00 compared to $0.04 for the same period of the prior year. The decrease was
due mainly to the decrease in the net income.
Fiscal Year Ended December 31, 2005 Compared to the Fiscal Year Ended December
31, 2004
32
Revenue
Total Revenues
Total revenue consists of product sales, product sales to related
parties, and net information and advertising service revenue. Total revenue for
the 2005 fiscal year decreased by $4,101,928, representing a decrease of
approximately 16.7%, to $20,419,022 as compared to $24,520,950 for the same
period of the prior year. The decrease was mainly due to the decline of mobile
phone sales to non-related third parties. The market for mobile phones in China
is gradually becoming saturated.
Product Sales
In the year ended December 31, 2005, Samsung and Nokia's mobile phones
accounted for 89% and 8% of our total product sales and other brands accounted
for the balance, compared to the 2004 fiscal year, in which Samsung's mobile
phones accounted for about 97% of our total product sales and other name brand
mobile phones accounted for the remaining 3%. During 2005 market competition for
mobile phone sales intensified, causing us to decrease our overall mark-up ratio
to 2.1% in order to maintain our market position, in comparison with a mark-up
ratio of 6.4% for the same period the prior year.
Revenue from product sales for our 2005 fiscal year decreased by
$5,282,329, representing a decrease of approximately 47.8%, to $5,775,069 as
compared to $11,057,398 for the same period of the prior year. The decrease was
mainly due to market factors. The market for mobile phones in China is becoming
saturated along with intensified competition developing among mobile phone
distributors.
We entered an agreement to distribute select Nokia mobile phones
exclusively in the Shanghai region of China in May 2005 and now have obtained
the right to distribute two popular models of Nokia's mobile phones. Initially,
we believed that this agreement would enhance both our market share and
profitability. However, as a result of the sudden change in the market factors
during the latter half of 2005, the sales mark-up of the Nokia mobile phones to
our customers dropped significantly from the initial 8% to approximately 1%
during the 4th quarter of 2005. The management of the Company is currently
reviewing the market factors and considering discontinuing the mobile phone
distribution business in 2006 if the market situation remains unchanged.
Product sales to a related party
We distributed Samsung mobile phones to our related party, Shanghai
Shantian Telecommunication Co. Ltd. ("Shantian"), in which Sifang Information
holds a 51% equity interest, for its retail market channel and facility. During
the 2005 fiscal year, we sold $10,608,287 worth of mobile phones to Shantian,
with an average markup ratio of approximately 3.6% (compared to $9,178,674 at
gross profit margin of 4% in 2004). This represents an aggregate increase of
$1,429,613 compared to the prior year. During the year ended December 31, 2004,
TCH also sold mobile phones to other related parties, which included Tianci
Industry and Tianci Group for $136,310 and $576,707 at gross profit margins of
14% and 14%, respectively. There were no mobile phone sales to Tianci Industry
and Tianci Group during the year ended December 31, 2005. The decrease in the
markup ratio was also attributable to the market factors mentioned above.
33
Information Service revenue, net
Total information service revenue net of related business tax and
service fee for the 2005 fiscal year decreased by $2,297,793, representing a
decrease of approximately 64.3%, to $1,274,068 compared to $3,571,861 for the
prior year.
Value-added service revenue from mobile phone users for the 2005 fiscal
year decreased by $1,957,664 to $634,728 compared to $2,592,392 for the prior
year, representing a 75.5% decrease. $588,385 of the service revenue from mobile
phone users was attributable to prepaid service fees generated by an installing
agent, Chengao Industry Co. Ltd, who installed the software on a retailer's
(Beijing Jianghe Communication Co., Ltd.) inventories and collected proceeds
from the retailer and transferred the proceeds to the Company, representing a
$1,385,457 decrease compared to the prior year. The remaining $46,343 portion of
the service revenue was generated by our SMS service via China Mobile's network,
representing a material decrease compared to the prior year. The decrease was
mainly due to the decline of our financial value-added service. The sluggish
Chinese stock market along with inactive stock exchanges hindered our growth in
this segment of business. In addition, service revenue from pager users for the
2005 fiscal year decreased by $340,129 to $639,340 compared to $979,469 for the
prior year, representing a decrease of approximately 34.7%. We believe that
service revenue from pager users will continue to decrease given the increased
popularity of mobile phones over beepers and pagers. We project that the
decrease in service revenue from pager users will likely plateau at a certain
level as most lower income pager users still like to use pagers to access our
information services.
Advertising service revenue, net
We launched a new digital media project to move into the media market
in China in 2005. In conjunction with charitable organizations, we have
installed donation boxes with digital TV incorporated on top of them in the main
lobbies of commercial banks, hotels, malls and other public locations to call
the public's attention to the charity and broadcast commercial advertisements.
We reached an agreement with CCF, a national non-profit charitable
organization, which enables the Company to install donation boxes for CCF in
banks and other commercial locations throughout China that will also have the
Company's out-of-home digital television advertising media platform attached.
The completion of this agreement enables us to accelerate the placement of
out-of-home digital television platforms, particularly in banks across China.
The Company negotiates placement of the donation boxes and digital television
media platform with banks and other commercial entities that wish to support the
national charity. The CBRC has previously agreed, pending completion of the
agreement with CCF, to support and coordinate this effort with respect to
approvals of donation box placements in banks throughout China.
This agreement facilitates the continued placement of platforms with
little or no direct costs. We believe that such costs may constitute as much as
30% of the direct costs of our competitors based upon an analysis of publicly
available information.
We have placed more than 850 multimedia donation boxes in the inbound
area of Shanghai and other arranged spots will be rolled out in public places
with high traffic flow. Based on our experience in Shanghai, our strategy is to
expand our network to penetrate other large and mid-sized developed cities
throughout China. We believe the earnings potential from the advertising service
will be a new source of profit in view of the upcoming Special Olympic World
Summer Games in 2007 and World Exposition in 2010 to be held in Shanghai.
In addition, during the 2005 fiscal year, TCH rendered advertisement
designing and producing services to Tianci Real Estate, a related party, for
34
publicity and promoting its apartments. Service revenue of $1,879,965 was
derived from this service. TCH has also generated advertising service income
from other customers amounting to $881,633 during the 2005 fiscal year.
Cost of goods sold
The cost of goods sold for the 2005 fiscal year decreased by $3,583,873
to $16,024,959 compared to $19,608,832 for the prior year, representing a
decrease of approximately 18.3%. The percentage of decrease, which was lower
than the decrease in revenue from product sales, resulted from the declining
product markup as the Chinese market is gradually becoming saturated.
Cost of service
The cost of service for the 2005 fiscal year decreased by $222,815 to
$823,178 compared to $1,045,993 for the prior year, representing a decrease of
approximately 21.3%. The decline was mainly due to the decrease of information
fees paid to content providers for the value-added service. The breakdown of our
service business has changed and the proportion of beep services that are
related to financial services has decreased, resulting in a decrease in
associated costs pertaining to the securities information fee paid. During the
2005 fiscal year, we continued to maintain current fee structures and to
establish collaborative relationships or partnerships with mobile operators and
certain information content providers in China. The percentage of decrease of
cost of service was less than the decrease in information service revenue
because the fixed costs remained unchanged.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for the 2005 fiscal year decreased by $295,240 to $3,570,885,
representing a decrease of approximately 7.6%, compared to gross profit of
$3,866,125 for the prior year. The decrease in gross profit was primarily
attributable to the continuing decline in mobile phone sales to non-related
parties and gross profit margin thereon being offset by the proceeds generated
from the new advertising service with related parties during the 2005 fiscal
year.
The following table summarizes certain information related to the
various components of revenue.
Advertising Phone Sales/ Information Information
Service Mobile Phone Service - Service -
Revenue Distribution Mobile Phone Pager Total
------------ ------------ ------------ ------------ ------------
For the year ended December
31, 2004
Revenue $ -- $ 20,949,089 $ 2,592,392 $ 979,469 $ 24,520,950
---------------------------- ------------ ------------ ------------
Cost -- 19,608,832 498,194 547,799 20,654,825
---------------------------- ------------ ------------ ------------
Gross profit -- 1,340,257 2,094,198 431,670 3,866,125
---------------------------- ------------ ------------ ------------
Gross profit ratio -- 6.4% 80.8% 44.1% 15.8%
---------------------------- ------------ ------------ ------------
For the year ended December 31,
2005
Revenue $ 2,761,598 $ 16,383,356 $ 634,728 $ 639,340 $ 20,419,022
---------------------------- ------------ ------------ ------------
Cost 141,554 16,024,959 410,898 270,726 16,848,137
---------------------------- ------------ ------------ ------------
Gross profit 2,620,044 358,397 223,830 368,614 3,570,885
---------------------------- ------------ ------------ ------------
Gross profit ratio 94.9% 2.2% 35.3% 58.1% 17.5%
---------------------------- ------------ ------------ ------------
Sales and marketing expenses
Sales and marketing expenses for the 2005 fiscal year decreased by
$112,000 to $134,639 compared to $246,639 for the prior year, representing a
decrease of approximately 45.4%. The decrease was primarily due to the decrease
in commission fees paid to the salesmen for mobile phones and advertising
expenses.
General and administrative expenses
General and administrative expenses for the 2005 fiscal year decreased
by $405,675 to $1,251,166 compared to $1,656,841 for the same period of the
prior year, representing a 24.5% decrease. The higher expenses in 2004 were
mainly due to one time non-cash compensation of $1,014,423 related to the
reverse merger that was generated at the parent level, consisting of 167,895
shares issued to a consultant in lieu of a cash payment at a fair market value
of $604,000 and the issuance of 166,667 redeemable shares pursuant to a stock
purchase agreement resulting in a charge of $410,000 representing the premium
between the trading price ($3.60 per share) and the pre-negotiated stock
purchase price ($1.14 per share) of the shares.
General and administrative expenses incurred at the TCH level in the
2005 fiscal year increased slightly from $456,445 to $512,844, representing a
12.4% increase, which is mainly due to the increase of staff welfare expenses.
35
In June 2005, we signed a Consulting Agreement with HNZ Bearings Point
Inc., a firm that helps companies with fund raising and arranging investor
conferences. Under this agreement, we paid $45,000 for consulting fees for the
first three months of service. The remaining $45,000 has not been paid as the
consulting service is deferred. Also in June 2005, we entered an agreement with
Insight Communication Inc., and paid $130,000 for its management consulting and
advisory services for 2005.
The other cash-based expenses incurred at the parent level in the 2005
fiscal year of $557,760 represented payments for audit fees, retainer fees and
other consultancy fees.
Governmental subsidy
During our 2005 fiscal year, we received a general government subsidy
from the local bureau, which is equivalent to 7% of the taxable income of TCH
throughout the period from September 2004 to December 2004. The subsidy is
non-recurring and subject to government approval. It represented a 100% increase
from nil to $108,476.
Interest income (expense)
During our 2005 fiscal year, the interest income derived from bank
deposits increased by $535 to $2,490, compared to $1,955 for the prior year.
During our 2005 fiscal year, finance expense incurred in discounting
bank drafts net of interest income from bank deposit increased by $1,739 to
$11,583, compared to $9,844 for the prior year.
Income tax
The Company's Chinese subsidiary TCH is registered at Pudong District
in Shanghai and is subject to a favorable income tax rate of 15% compared to a
normal income tax rate of 33% (30% for the central government and 3% for the
local government) under current PRC tax laws. The income tax provisions
presented in the Company's financial statements are based on the historical
actual income tax rates of TCH at 15% for the year ended December 31, 2005. The
income tax provision presented for the year ended December 31, 2004 was based on
7.5% for the months of January to June and 15% for the months of July to
December. In the 2004 and 2005 fiscal years, income tax expense was $369,971 and
$481,743, respectively, based on pretax income of $1,964,600 (which included the
stock compensation of $1,014,423 incurred in the U.S.) and $2,292,850,
respectively. Because the loss of approximately $1,014,423 incurred in the U.S.
did not offset the taxable income in China, the income tax expense of $369,971
incurred in China was based on the taxable income of $2,979,023 during our 2004
fiscal year.
Comprehensive income
We recorded comprehensive income of $2,096,503 for the 2005 fiscal
year, a $501,611 increase in comprehensive income compared to comprehensive
income of $1,594,892 for the prior year, representing an increase of
approximately 31.4%. The increase in comprehensive income was attributable to
(i) the non-cash expenses that offset the net profit generated in the 2004
fiscal year, (ii) the contribution of our new advertising business that was
initiated in the 2005 fiscal year, and (iii) the appreciation of Chinese RMB to
US dollars. These factors offset the declines in gross profit from sales of
mobile phones and information services.
Earnings per share
The earnings per share for the 2005 fiscal year increased by $0.01 to
$0.11 compared to $0.10 for the prior year. The increase was due mainly to the
increase in our net income which was partially offset by the increase in the
weighted average number of shares of common stock outstanding for the 2005
fiscal year, compared with the weighted average number of shares of common stock
outstanding for the prior year.
Fiscal Year Ended December 31, 2004 Compared to the Fiscal Year Ended December
31, 2003
Total revenues
Total revenues for our 2004 fiscal year increased by approximately
$7,488,572, representing an approximately 44.0% increase, to $24,520,950 as
compared to $17,032,378 for the same period of the prior year. The increase was
due mainly to our marketing effort and further facilitated by Samsung's
marketing promotion. Total revenues consist of product sales, product sales to
related parties and service revenue, net. In the Chinese telecommunication
market, mobile phones have rapidly replaced beepers and pagers as the mobile
communication device preferred by consumers, resulting in an increase in mobile
phone distribution. For our 2004 fiscal year, Samsung's mobile phones accounted
for about 97% of our total product sales and other name brands mobile phones
accounted for the remaining 3%, compared to our 2003 fiscal year, in which
36
Samsung's mobile phones accounted for 99.6% of our total product sales and other
brands accounted for the balance. During 2004 market competition for mobile
phone sales intensified, causing us to decrease our overall mark-up ratio to
6.4% in order to maintain our market position, in comparison to a mark-up ratio
of 8.2% for the same period the prior year.
Product sales
Revenue from product sales for our 2004 fiscal year decreased by
approximately $2,471,881, representing an approximately 18.3% decrease, to
$11,057,398 as compared to $13,529,279 for the same period of the prior year.
The decrease was due mainly to the spun-off business of THC.
Product sales to related parties
Before January 1, 2004 we only distributed CDMA mobile phones in the
Shanghai area. Beginning in January 2004 we entered into the GSM mobile phone
distribution business. Since the retail market channel related to our GSM mobile
phone distribution was developed and maintained by Shanghai Shantian, in which
Sifang Information holds a 51% equity interest, all of our Samsung GSM mobile
phones were sold to Shanghai Shantian, which made Shanghai Shantian our second
tier distributor in the first half of 2004. During our 2004 fiscal year, we sold
a total of $9,891,691 worth of mobile phones to related parties, including
$9,178,674 worth of mobile phones to Shanghai Shantian, and $713,017 to Tianci
and Shanghai Tianci Industry Co.Ltd with a total competitive mark-up on average
of approximately 4.8 % as compared to an average mark-up ratio of 7.8% for the
products sold to all of our other customers.
Service revenue, net
Total service revenue net of related business tax for our 2004 fiscal
year increased by $68,762, representing approximately a 2.0% increase, to
$3,571,861 compared to $3,503,099 for the same period of the prior year. It was
due mainly to the increase of mobile phone value-added services and the revenue
derived from agent service income.
Value-added service revenue from mobile phone users for our 2004 fiscal
year increased by $1,090,855 to $2,388,178 compared to $1,297,323 for the same
period of the prior year, representing a material increase, which resulted in
the overall increase in our service revenue. Approximately $1,973,842 of the
service revenue from mobile phone users was attributable to prepaid service fees
generated by an installing agent, Chengao Industry Co. Ltd, who installed the
software on a retailer's (Beijing Jianghe Communication Co., Ltd) inventories
and collected proceeds from the retailer and transferred the proceeds to the
Company, representing a $745,057 increase compared to the same period of the
prior year. The remaining $404,336 portion of the service revenue was generated
by our SMS service, representing a material increase compared to the same period
of the prior year. The increase was mainly due to the aggressive expansion of
our subscriber base as the result of the Company's marketing campaigns. In
addition, service revenue from pager users for our 2004 fiscal year decreased by
$1,226,307 to $ 979,469 compared to $2,205,776 for the same period of the prior
year, representing approximately a 55.6% decrease. We believe that service
revenue from pager users will continue to decrease given the increased
popularity of mobile phones over beepers and pagers. We project that the
decrease in service revenue from pager users will likely plateau at a certain
level as most lower income pager users still like to use pagers to access our
information services.
Moreover, On July 16, 2004, Tianci, a related party to TCH, entered
into an agreement with China Unicom to promote CDMA mobile phones and agent
service for China Unicom. Under the agreement, Tianci is entitled to receive a
sales commission from China Unicom of $15.70 per unit, $3.62 per SIM card based
on sales to customers who agree to subscribe for monthly service for a minimum
period of two years at a minimum monthly service fee of $3.38. Tianci then
entered into an agent agreement with TCH pursuant to which TCH agreed to sell
the CDMA mobile phones, SIM cards and monthly service subscriptions on behalf of
Tianci and, consequently, is entitled to receive sales commissions from Tianci
based on the terms agreed upon between Tainci Group and China Unicom. The agent
relationship began in August 2004 at the same time as a sales promotion
initiated by China Unicom. We recognized agent service income of $204,214 during
the second half year of our 2004 fiscal year at the TCH level.
37
Total cost of goods sold
The total cost of goods sold for our 2004 fiscal year increased by
$8,230,371 to $19,608,832 compared to $12,424,454 for the same period of the
prior year, representing an approximately 57.8% increase. The increase was
consistent with the increases in revenue from product sales.
Cost of service
The cost of service for our 2004 fiscal year increased by $29,675 to
$1,045,993 compared to $1,016,318 for the same period of the prior year,
representing an approximately 2.9% increase. In addition, software amortization
for mobile phone value-added service generated in the 2004 fiscal year
represented a $42,338 increase compared to the prior year. During 2004, we
continued to strive to expand the content offered by our value-added services
while maintaining current fee structures and to establish collaborative
relationships or partnerships with Chinese mobile operators and certain
information content providers.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for our 2004 fiscal year increased by approximately $274,519 to
approximately $3,866,125, representing approximately a 7.6% increase, compared
to gross profit of $3,591,606 for the same period of the prior year. The
increase in gross profit was primarily attributable to the following factors:
(i) the gross profit derived from mobile phone distribution and mobile phone
information services increased significantly, which offset the decrease in pager
information service income; and (ii) the agent service income generated in the
second half of 2004.
The following table presents in summary certain information related to
the various components of revenue.
Information
Mobile Service - Information
Agency Phone Mobile Service -
Income Distribution Phone Pager Total
------------ ------------ ------------ ------------ ------------
For the year ended December 31, 2004
Revenue ............................ $ 204,214 $ 20,949,089 $ 2,388,178 $ 979,469 $ 24,520,950
Cost ............................... -- 19,608,832 498,194 547,799 20,654,825
Gross profit ....................... 204,214 1,340,257 1,889,984 431,670 3,866,125
Gross profit ratio ................. 100.0% 6.4% 79.1% 44.1% 15.8%
For the year ended December 31, 2003
Revenue ............................ $ -- $ 13,529,279 $ 1,297,323 $ 2,205,776 $ 17,032,378
Cost ............................... -- 12,424,454 287,464 728,854 13,440,772
Gross profit ....................... -- 1,104,825 1,009,859 1,476,922 3,591,606
Gross profit ratio ................. -- 8.2% 77.8% 67.0% 21.1%
Other income, net
On July 16, 2004, Tianci, a related party to TCH, entered into an
agreement with China Unicom to promote CDMA mobile phones and agent service for
China Unicom. Under the agreement, Tianci is entitled to receive a sales
commission from China Unicom of $15.70 per unit, $3.62 per SIM card based on
sales to customers who agree to subscribe for monthly service for a minimum
period of two years at a minimum monthly service fee of $3.38. Tianci then
entered into an agent agreement with TCH pursuant to which TCH agreed to sell
the CDMA mobile phones, SIM cards and monthly service subscriptions on behalf of
Tianci and, consequently, is entitled to receive sales commissions from Tianci
based on the terms agreed upon between Tainci Group and China Unicom. The agent
relationship began in August 2004 at the same time as a sales promotion
initiated by China Unicom. As the sales commission revenue from this business is
more uncertain in nature, we reported this revenue as other income instead of
regular revenue. We recognized agency income of $204,214 in the 2004 fiscal year
at the TCH level.
Selling expenses
Selling expenses for our 2004 fiscal year increased by $93,202 to
$246,639 compared to $153,437 for the same period of the prior year,
representing approximately a 61% increase. This increase was due to promotion
expenses for value-added information services related to mobile phone users.
Advertising fees and expenses for a series of marketing campaigns increased by
$41,183 in our 2004 fiscal year, from $18,909 to $60,092, representing a
material increase in comparison to the prior year. We have moved our marketing
focus from beeper and pager users to mobile phone users in line with changing
consumer demands. Salaries paid to the Company's marketing team in the 2004
fiscal year rose from $33,836 to $84,946, representing a 151% increase in
comparison to the prior year.
38
General and administrative expenses
General and administrative expenses for our 2004 fiscal year increased
by $1,365,428 to $1,656,841 compared to $291,413 for the same period of the
prior year, representing a material increase. The increase was due mainly to the
reorganization and recapitalization transaction and related audit and legal
fees.
General and administrative expenses incurred at the TCH level in the
2004 fiscal year increased from $286,058 to $456,445, representing a 52.5%
increase. These general and administrative expenses were comprised of salaries
paid to the management, which increased from $94,437 to $117,800, representing a
$23,363 increase, and office expenses, which rose from $11,888 to $20,015,
representing a $8,127 increase.
During our 2004 fiscal year there was stock-based compensation of
$1,014,000 related to the reverse merger generated at parent level, consisting
of 167,895 shares issued to a consultant in lieu of cash payment at a fair
market value of $604,000 and the issuance of 166,667 redeemable shares pursuant
to a stock purchase agreement resulting in a charge of $410,000 representing the
premium between the trading price ($3.60 per share) and the pre-negotiated stock
purchase price ($1.14 per share) of the purchased shares. The other cash-based
expenses incurred in the 2004 fiscal year of $205,376, represented payments for
the audit fees, a retainer fee and other consultant fees.
Interest income (expense)
During our 2003 fiscal year, we borrowed funds from Sifang Information
for temporary working capital and mobile phone distribution. As a result, we
paid interest totaling $12,082 to Sifang Information during the 2003 fiscal
year.
During our 2004 fiscal year, the interest income derived from deposits
in banks was $1,955.
Income tax
TCH is subject to taxation under the laws of the PRC, and the statutory
income tax rate for 2003 and 2004 fiscal years was 33%. The income tax
provisions presented on our financial statements are based on the historical
actual income tax rates of Sifang Information at 7.5% for the 2003 fiscal year
and the six months ended June 30, 2004. The income tax provision presented for
the six months ended December 31, 2004 are based on a 15% effective rate. In our
2003 and 2004 fiscal years, income tax expense was $246,694 and $369,971,
respectively, based on pretax income of $3,134,674 and $1,964,600 (which
included the stock compensation of $1,014,000 incurred in the U.S.). Since the
loss of approximately $1,014,000 incurred in the U.S. did not offset the taxable
income in China, a portion of income tax expense totaling $169,643, which was
incurred in China, was based on taxable income of approximately $2,979,023.
Net income
We recorded net income of $1,594,629 for our 2004 fiscal year, a
$1,293,351 decrease in net income compared to net income of $2,887,980 for the
prior year, representing approximately a 45% decrease. The decrease in net
income was attributable to (i) the increase in general and administrative
expenses for the period compared to general and administrative expenses for the
prior year (we incurred a $1,014,423 charge for services performed by
consultants related to the reverse merger and related activities, and the
issuance of common stock in 2004), and (ii) the decrease of the gross profit
generated from mobile phone distribution and our pager service business.
Earnings per share
Earnings per share for our 2004 fiscal year decreased by $0.11 to $0.10
compared to $0.21 for the prior year. The decrease was due mainly to the
decrease in our net income and the increase in the total outstanding shares of
our common stock, as the weighted average number of shares of common stock
outstanding for the 2004 fiscal year increased by approximately 12.1%, compared
the weighted average number of common stock outstanding for the same period of
the prior year.
Liquidity and Capital Resources
Our net cash used during the three months ended March 31, 2006 was
$2,483,547 while we generated cash of $328,731 during the same period in 2005,
which represents a net change of $2,812,278.
Our cash balance increased from $75,511 as of December 31, 2004 to
$3,578,367 as of December 31, 2005. This increase in cash and cash equivalents
was primarily due to the increase in accounts payable and the collection of
accounts receivable. At December 31, 2005 and 2004, our net working capital was
$5,808,706 and $9,877,040, respectively, reflecting current ratios of 4.2:1 and
7.2:1, respectively, at such dates.
39
Net cash flows used in operating activities was $19,665 during the
three months ended March 31, 2006 compared to net cash flows provided by
operating activities of $311,208 during the same period of the prior year. The
net decrease in cash provided was primarily due to the decrease in collection of
accounts receivable, accounts payable and net income which was offset by the
decrease in advances and deposits to suppliers and inventories.
Net cash provided by operating activities was $5,290,767 during our
2005 fiscal year, compared to net cash provided by operating activities of
$2,953,773 during the prior year. The increase of cash provided by operating
activities was due mainly to the increase of $3,778,282 in cash from the
collection of accounts receivable and the increase of $825,379 in accounts
payable, partially offset by the change in deferred revenue of $586,096, and
increase in amounts due from related parties of $929,345.
Net cash flows used in investing activities for the three months ended
March 31, 2006 increased to $2,494,699 compared to $1,482,475 for the same
period of the prior year. The change in cash used in investing activities was
mainly due to the increase in loan to related parties. As of March 31, 2006, the
amounts due from Sifang Media and Sifang Information represent $860,671 and
$4,779,528 respectively.
Net cash used in investing activities for the 2005 fiscal year
decreased to $3,551,569 compared to $4,874,843 for the prior year, representing
a $1,323,274 decrease. The change in cash used in investing activities was due
mainly to the increase of $3,435,258 in the change in the amounts due from
related parties. As of December 31, 2005, the amounts due from Tianci Real
Estate and Sifang Information represented $929,345 and $8,423,214 (including the
deposit paid to Sifang Information for business acquisition amount of
$6,257,590), respectively.
Net cash provided by financing activities for the three months ended
March 31, 2006 was nil compared to $1,500,000 for the same period of the prior
year. The cash inflow of $1,500,000 during the three months ended March 31, 2005
related to proceeds for shares that were issued in fiscal 2004 but were held in
escrow until we filed a Registration Statement on Form SB-2 with the SEC in
2005. We treated the proceeds held in escrow as a current asset as the entire
amount was released from escrow in March 2005 and paid to us.
Net cash provided by financing activities for the 2005 fiscal year was
$1,500,000 compared to $282,570 for the same period of the prior year. The
$1,500,000 relates to proceeds for shares that were issued in fiscal 2004 but
were held in escrow until we filed a Registration Statement on Form SB-2 with
the SEC in March 2005. We treated the proceeds held in escrow as a current asset
as the entire amount was released from escrow in March 2005 and paid to us.
40
We believe that current cash balance and cash flows from operations, if
any, will be sufficient to meet present growth strategies and related working
capital. In regards to the capital expenditures, we have sufficient funds to
expand our operations. We plan to utilize a combination of internally generated
funds from operations with potential debt and/or equity financings to fund our
longer-term growth over a period of two to five years. The availability of
future financings will depend on market conditions. There is no assurance that
the future funding will be available.
The forecast of the period of time through which our financial
resources will be adequate to support operations is a forward-looking statement
that involves risks and uncertainties.
Recent Accounting Pronouncements
In November 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 151, Inventory Costs, which clarifies the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted
material. SFAS No. 151 will be effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. We do not believe the adoption of
SFAS No. 151 will have a material impact on our consolidated financial
statements.
In December 2004, the FASB issued SFAS No. 123-R, Share Based Payments,
which requires that the compensation cost relating to share-based payment
transactions (including the cost of all employee stock options) be recognized in
the financial statements. The cost will be measured based on the estimated fair
value of the equity or liability instruments issued. SFAS 123-R covers a wide
range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans. Management believes the adoption of this
pronouncement will not have a material effect on our consolidated financial
statements.
Also, in December 2004, the FASB issued SFAS 153, "Exchanges of
Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for
Nonmonetary Transactions." The amendments made by SFAS No. 153 are based on the
principle that the exchange of nonmonetary assets should be measured using the
estimated fair market value of the assets exchanged. SFAS No. 153 eliminates the
narrow exception for nonmonetary exchanges of similar productive assets, and
replaces it with a broader exception for exchanges of nonmonetary assets that do
not have commercial substance. A nonmonetary exchange has "commercial substance"
if the future cash flows of the entity are expected to change significantly as a
41
result of the transaction. This pronouncement is effective for monetary
exchanges in fiscal periods beginning after June 15, 2005. Management believes
the adoption of this pronouncement will not have a material effect on our
consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." This statement requires entities that voluntarily make a
change in accounting principle to apply that change retrospectively to prior
periods' financial statements, unless this would be impracticable. SFAS No. 154
supersedes APB Opinion No. 20, "Accounting Changes", which previously required
that most voluntary changes in accounting principle be recognized by including
in the current period's net income the cumulative effect of changing to the new
accounting principle. SFAS No. 154 also makes a distinction between
"retrospective application" of an accounting principle and the "restatement" of
financial statements to reflect the correction of an error. SFAS No. 154 applies
to accounting changes and error corrections that are made in fiscal years
beginning after December 15, 2005. Management believes the adoption of this
statement will not have an immediate material impact on the consolidated
financial statements of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"),
"Accounting for Conditional Asset Retirement Obligations". FIN 47 clarifies that
the term "conditional asset retirement obligation," which as used in SFAS No.
143, "Accounting for Asset Retirement Obligations", refers to a legal obligation
to perform an asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the
control of the entity. The entity must record a liability for a "conditional"
asset retirement obligation if the fair value of the obligation can be
reasonably estimated. FIN 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. Management believes the adoption of this statement will
not have an immediate material impact on the consolidated financial statements
of the Company.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140,"
to permit fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation in
accordance with the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 155 is effective for all financial
instruments acquired, issued, or subject to a remeasurement event occurring
after the beginning of an entity's fiscal year that begins after September 15,
2006. We will adopt SFAS No. 155 in fiscal year beginning January 1, 2007. The
adoption of this statement is not expected to have a material effect on our
consolidated financial statements.
In March 2006, FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets-an amendment of FASB Statement No. 140," that provides guidance
on accounting for separately recognized servicing assets and servicing
liabilities. In accordance with the provisions of SFAS No. 156, separately
recognized servicing assets and servicing liabilities must be initially measured
at fair value, if applicable. Subsequent to initial recognition, the company may
use either the amortization method or the fair value measurement method to
account for servicing assets and servicing liabilities within the scope of this
statement. SFAS No. 156 is effective as of the beginning of an entity"s fiscal
year that begins after September 15, 2006. The Company will adopt SFAS No. 156
in fiscal year beginning January 1, 2007. The adoption of this statement is not
expected to have a material effect on our consolidated financial statements.
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)", that will become effective beginning July 2006. FSP FIN No. 46(R)-6
clarifies that the variability to be considered in applying Interpretation 46(R)
shall be based on an analysis of the design of the variable interest entity. The
adoption of this FSP is not expected to have a material effect on our
consolidated financial statement.
Other recent accounting pronouncements issued by the FASB (including
its Emerging Issues Task Force), the AICPA, and the SEC did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
Quantitative and Qualitative Disclosures About Market Risk
Substantially all our revenues and expenses are denominated in
Renminbi, but a portion of our cash is kept in U.S. dollars. Although we believe
that, in general, our exposure to foreign exchange risks should be limited, our
cash flows and revenues will be affected by the foreign exchange rate between
U.S. dollars and Renminbi. For example, to the extent that we need to convert
U.S. dollars into Renminbi for our operational needs and should the Renminbi
appreciate against the U.S. dollar at that time, our cash flows would be reduced
which could materially adversely affect our business. Conversely, if we decide
to convert our Renminbi into U.S. dollars for the purpose of declaring dividends
on our ordinary shares or for other business purposes and the U.S. dollar
appreciates against the Renminbi, the U.S. dollar equivalent of our earnings
from our subsidiaries in China would be reduced.
We have experienced minute foreign exchange gains or losses to date.
However, we do not engage in any hedging activities, and we may in the future
experience economic loss as a result of any foreign currency exchange rate
fluctuations.
42
BUSINESS
General
Overview
Value-Added Information Services for Mobile Phone and Pager Users. We
render value-added information services in China by purchasing content from
third-party providers and reformatting that content. Our value-added information
services enable wireless receiver (mobile phone and pager) users in China to
access financial information and various entertainment-related services. We
contract with our affiliated wireless service providers to transmit the
reformatted content to customers of China's various network operators.
The primary focus of our value-added information services is on
providing wireless receiver users in China with access to financial information.
We derive the vast majority of our value-added information services revenue from
our financial information business. Our financial information software, Sifang
Gutong, allows our customers to access stock and currency exchange information
and execute stock trades. We are one of the largest stock information and
trading value-added information service providers in China.
We began providing our entertainment-related services, including icons,
screen savers, multiplayer games, Western horoscopes, jokes, and sports and
entertainment news during the latter part of 2003. These services are ancillary
to our financial information services and they represent only a small portion of
our value-added information services revenue at the present time.
Leveraging our experience and understanding of the wireless value-added
services market in China, we have consistently purchased and reformatted
content, applications and technologies that are popular in the Chinese wireless
market. To further enhance and differentiate our services, we have entered into,
and will continue to actively pursue, collaborative relationships with third
parties to customize, market and provide access to their content through various
wireless technologies to Chinese consumers. In addition, all of our services are
promoted by our sales force and supported by our customer service team, each of
which is strategically based in Shanghai.
In order to meet ownership requirements under Chinese law that restrict
us, as a foreign company, from operating in certain industries such as
value-added telecommunication and Internet services, we have entered into
information service and cooperation agreements with two of our affiliates that
are incorporated in the People's Republic of China: Sifang Information and
Tianci. We hold no ownership interest in Sifang Information or Tianci. Sifang
Information and Tianci contract with China Mobile Communications Corporation, or
China Mobile, and China United Telecommunications Corporation, or China Unicom,
respectively, to provide wireless value-added information services to wireless
receiver customers in China via China Mobile and China Unicom. Sifang
Information transmits those services to customers of China Mobile and China
Unicom on behalf of itself and Tianci pursuant to a signed agreement between
Sifang Information and Tianci.
Mobile Phone Distribution. We distribute various mobile phone brands in
the Shanghai, China region. We distribute mobile phones manufactured primarily
by SAMSUNG Electronics Co., Ltd. ("Samsung") and NOKIA Corporation ("Nokia"),
and to a lesser extent, by Motorola, Inc. ("Motorola"). We began distributing
Motorola mobile phones in early 2002, Samsung mobile phones in November 2002 and
Nokia mobile phones in March 2005. We began discontinuing our Motorola mobile
phone distribution business on June 30, 2004. We are a distributor, for the
Shanghai region, of over ten different mobile phone models manufactured by
Samsung and plan to increase our sales of Samsung mobile phones.
Most of the Samsung models we distribute are compatible with the GSM
network and only a few Samsung models we distribute are compatible with the Code
Division Multiple Access, or CDMA, network.
We entered into an agreement to distribute select Nokia mobile phones
exclusively in the Shanghai region of China beginning in May 2005 and now have
obtained the right to distribute two popular models of Nokia's mobile phones.
Initially, we believed that this agreement would enhance both our market share
and profitability. However, as a result of the sudden change in the market
factors during the latter half of 2005, whereas the demand for mobile phones in
the Chinese market started becoming saturated along with the intensified
competition among mobile phone distributors, our sales mark-up of the Nokia
43
mobile phones to our customers dropped significantly from the initial 8% to
approximately 1% during the 4th quarter of 2005. Our management is currently
reviewing the market factors and considering discontinuing the mobile phone
distribution business in 2006 if the market situation remains unchanged.
There are three main first-tier wholesalers of Samsung phones in China:
Shanghai Taili Communication Equipment Co., Ltd., Shenzhen Tianyin Communication
Development Co., Ltd., and Guangzhou Yingtai Data Power Technology Co., Ltd.
These wholesalers contract, through local branches, with sub-wholesalers to
distribute each model in a defined area. We have contracts with Shanghai branch
offices of the three main first-tier wholesalers on whom we rely, making us a
sub-wholesaler distributor of nine Samsung mobile phone models in the Shanghai
region. We received approximately 45% of the mobile phones we sold in 2005 from
the three retailers.
We have rebate programs with Shanghai Taili Communication Equipment
Co., Ltd. and Shenzhen Tianyin Communication Development Co., Ltd. whereby we
are credited a certain portion of the sales price we paid to the first-tier
wholesaler if we are able to fulfill a certain sales volume prescribed by that
first-tier wholesaler. As a result, we are entitled to receive certain rebates
and credits for the inventory held and sold by us within a specified period of
time as set by the first-tier wholesaler offering the rebate program.
Digital Advertising. We launched a new digital media project to move
into the media market in China in 2005. In conjunction with charitable
organizations, we have installed donation boxes with digital TV incorporated on
top of them in the main lobbies of commercial banks, hotels, malls and other
public locations to call the public's attention to the charity and broadcast
commercial advertisements.
We have an agreement with China Charity Foundation ("CCF"), a national
non-profit charitable organization, which enables us to install donation boxes
for CCF in banks and other commercial locations throughout China that will also
have the Company's out-of-home digital television advertising media platform
attached. The completion of this agreement enables us to accelerate the
placement of out-of-home digital television platforms, particularly in banks
across China. We negotiate placement of the donation boxes and digital
television media platform with banks and other commercial entities that wish to
support the national charity. The China Banking Regulatory Commission ("CBRC")
has previously agreed, pending completion of the agreement with CCF, to support
and coordinate this effort with respect to approvals of donation box placements
in banks throughout China. This agreement facilitates the continued placement of
platforms with little or no direct costs. We believe that such costs may
constitute as much as 30% of the direct costs of competitors based upon an
analysis of publicly available information.
We have placed more than 850 multimedia donation boxes in the inbound
area of Shanghai and other arranged spots will be rolled out in public places
with high traffic flow. Based on Shanghai, our strategy is to expand our network
to penetrate other large and mid-sized developed cities throughout China. We
believe the earnings potential from the advertising service will be a new source
of profit in view of the upcoming Special Olympic World Summer Games in 2007 and
World Exposition in 2010 to be held in Shanghai.
Other Advertising Services. During the year ended December 31, 2005,
TCH rendered advertisement designing and producing services to Shanghai Tianci
Real Estate Co. Ltd. ("Tianci Real Estate") for publicity and promoting its
apartments. Net advertising service revenue of $1,738,878 was derived from this
service. TCH performed such services via an agent, Shanghai Sifang Media Co.,
Ltd. ("Sifang Media"), which is a related company that granted the license to
provide advertising in China.
In January 2005, Sifang Media and TCH entered into the "Bank Digital
TV's Cooperation Agreement", where TCH will assist in the promotion of TV ads
for various customers, including Tianci Real Estate. TCH received a net fee of
$2,620,044 for providing the service from January 2005 to December 2005. There
was an "Advertisement Agency Contract" between Tianci Real Estate and Sifang
Media, which expired in November 2005. In June and September 2005, Sifang Media,
TCH and two unrelated customers, entered into certain agreements, where TCH will
44
assist in the promotion of TV ads for these customers. TCH received a net fee of
approximately $900,000 for providing the service via Sifang Media during the
fiscal year of 2005.
Energy Saving Products.
In February 2006, we entered into an agreement to acquire 95% of the
equity interests of Shanghai Kena Energy Saving Electric Co., Ltd. ("Kena") and
related patent and patent rights to produce high-energy, high-efficiency
transformers. The Company's decision to enter into the Kena acquisition is
driven by an effort to re-focus the Company's strategy and capitalize on the
strategic opportunity this transaction presents.
Kena was established in China on April 26, 2005. Its chief scientist
Dr. Chang Kenan, an experienced Chinese-American scientist, is the inventor of
energy saving street lighting system ballasts which are noted for energy
savings, material savings, long-life, and being environmentally friendly. Since
its establishment, Kena has undertaken four street lighting projects and
generated revenue of over RMB 5,000,000. There are approximately nine street
lighting projects under negotiation.
We believe that the Kena acquisition represents a strategic opportunity
for the Company in the following ways:
1) The Chinese government has provided strong support of energy saving
products. In the first quarter of 2006, Kena's energy saving lighting products
will be included in the Chinese government purchasing lists. Official documents
will be issued by the Chinese government to help promote these products.
2) There is a large demand for energy saving streetlights. According to
the Chinese Construct Department, currently, there are 18,000,000 streetlights
in China with a 17%-18% yearly growth rate. The average replacement rate is 10%.
The worldwide demand is estimated at five times as much as the demand in China.
3) Kena's products present consumers with positive economic and social
effects. According to a Report from National Centre of Supervision & Inspection
on Electric Light Source Quality of Shanghai, Kena's energy saving lighting
system ballasts result in a 20% energy saving, allowing consumers to recover
their costs in two years. Compared to other similar products, Kena's system
ballasts use 15% less materials than other similar products and have a 20-year
service life, which is 10 years longer than other similar products.
Our Business Strategy
Our main objective is to maintain and strengthen our position both as a
provider of wireless value-added information services and as a distributor of
mobile phones in the Shanghai region. In order to achieve our objective, we plan
to, among other things, increase the number of subscribers to our value-added
information services by increasing the number of mobile phones we distribute and
pre-installing those phones with the end-user portion of our Sifang Gutong
software.
We launched an "out-of-home" digital television advertising business in
January 2005. However, we have decided to shift our focus away from the digital
advertising business in light of the lack of demand for out-of-home digital
advertising in China. We believe that the lack of demand is caused by several
factors, including the availability of other more traditional advertising
outlets such as television, radio and newspapers, and the reduction of
advertising fees due to the merger of media companies. In addition, there are an
increasing number of competitors in the media industry, resulting in intense
market competition. Key strategies for achieving our goal are to:
o Continue to expand and diversify our portfolio of wireless
value-added information services, including new SMS, 2.5G and
other next generation services such as those compatible with
3G;
45
o Increase investment in sales, marketing and branding, both in
conjunction with network operators and through independent
activities, in order to promote customer awareness of our
wireless value-added information services in China;
o Continue to strengthen our relationships with China Mobile and
China Unicom by increasing our sales presence at the national
and local levels and through joint marketing and promotion
activities;
o Expand our marketing channels by continuing to develop
integrated marketing campaigns with traditional media outlets
and other media companies; and
o Continue to pursue strategic opportunities, such as the Kena
acquisition.
Our Value-Added Information Services
Financial Services
Our primary focus with regard to value-added information services is
the provision of financial information services utilizing our Sifang Gutong
software. This software, developed by Chengao, utilizes the JAVA and BREW
platforms. JAVA and BREW utilize the more advanced 2.5G technology standard,
which enables high-capacity wireless data transmissions. As a result, services
offered over these platforms are more sophisticated and offer users higher
quality graphics and richer content and interactivity, commanding a premium
price over our other services. Our Sifang Gutong software enables our mobile
phone and pager customers to access quotes and retrieve customized
investment-related information, as well as access our currency exchange
information.
Sifang Gutong provides our mobile phone and pager customers with the
ability to receive streaming real-time quotes, including stocks, most active
issues, largest gainers and losers, and mutual funds for securities trading on
the Shenzhen and Shanghai stock exchanges. Our Sifang Gutong software available
to mobile phone users includes a stock trading function that enables our mobile
phone customers to directly place orders to buy and sell securities listed on
the two aforementioned stock exchanges. Our trading window corresponds with the
hours that securities markets are open from 9:30 a.m. to 11:30 a.m., and from
1:00 p.m. to 3:00 p.m., Beijing Time.
We receive a continuous direct feed of detailed quote data, market
information and news. Our customers can create customized lists of stocks for
quick access to current trading information. Through our relationships with
financial information companies such as Shanghai Stock Information Company, we
also provide access to breaking news, charts, market commentary and analysis.
The value-added financial information we offer can only be accessed by
a customer on whose mobile phone or pager the end-user portion of our Sifang
Gutong software has been installed. We plan to pre-install the end-user portion
of our Sifang Gutong software in all of the Samsung mobile phones that we
distribute. With regard to mobile phones and pagers not distributed by us, we
will provide installation of our Sifang Gutong software free of charge upon
request.
Pursuant to the request of a Beijing retailer, we entered into an
agreement with Chengao and Sifang Information whereby Chengao installs the
end-user portion of our Sifang Gutong software into mobile phones owned by the
retailer. The retailer sells these phones at a premium price to consumers. In
return for the premium price, the consumers receive our value-added information
services for six months free of charge. The retailer passes the premium back to
Chengao, who retains a small installation fee and then passes the remainder on
to us. This relationship helps us market our value-added information services
and enables us to establish relationships with new customers.
Other Services
We also provide icons and screen savers, multiplayer action games,
Western horoscopes, jokes and event-driven or entertainment news updates. These
services represent only a small portion of our value-added information services
46
revenues at the present time. However, we believe that providing wireless
receiver users in China access to entertainment-related services increases our
ability to retain our financial information subscribers and expand our
subscriber base, and we expect the entertainment-related services portion of our
value-added information services business will grow over time.
o Horoscopes. With this service, users can obtain daily Western
horoscopes via their mobile phones or pagers.
o Jokes. We send users of this service a variety of jokes on
demand or via automatic daily messages.
o News. We automatically send periodic SMS messages on recent
event-driven news, sports (especially soccer), or
entertainment events to subscribers of this service. Mobile
phone users can also download desired information on demand.
We obtain our news content from government affiliated media
companies, such as XinhuaNet and other local media.
Content Relationships
Our content collaborators authorize the inclusion of their content in
one or more of our value-added information services for a fixed fee which we pay
directly to the provider. Our agreements with our content collaborators usually
have a one-year term, and are non-exclusive. Currently, our key content
collaborators are:
o Shanghai Stock Information Company.
o Shanghai Wanguo Stock Information Company.
o Shanghai Yibang Stock Information Company.
o Shanghai Shiji Stock Information Company.
Marketing Relationships
Sifang Information and Tianci, our affiliated value-added mobile phone
service providers, have marketing relationships with China Mobile and China
Unicom. We sell and market our services principally through China Mobile and
China Unicom. We also sell and market through Sifang Information's website,
www.sifang.net, and promotional events, direct marketing, media advertising and
other activities.
We sell all of our paging value-added information services through our
affiliated value-added paging service provider, Sifang Information. We contract
directly with end users to settle all payments from pager users. We market our
paging value-added information services through traditional media outlets,
including newspapers and magazines, and directly to end-users.
Operator Channels
General. All of our paging value-added information services are
provided through the paging network owned by Sifang Information. We contract
directly with the pager users to collect all fees generated from our value-added
information services. We have an information service and cooperation agreement
with Sifang Information that provides us exclusive access to their paging
network for ten years. This agreement is automatically renewable for additional
one year terms unless we decide to terminate. All of our mobile phone
value-added information services are provided to mobile phone users by Sifang
Information through the networks of China Mobile and China Unicom. Previously,
mobile phone users paid for our services by purchasing pre-paid services cards.
Now, our services are billed to mobile phone customers in one of two ways: (1)
certain of our customers pay for our services in advance when they purchase our
services and a mobile phone together in a premium package (through our
relationship with Chengao and Sifang Information), and (2) our other customers
(who do not purchase our services as part of any such premium package) are
billed by the mobile operators, who collect the fees for our services, including
47
both our data access and short message services, from their mobile phone
subscribers. The mobile operators then pass those fees (net of fees charged by
the mobile operator) to our affiliated value-added service providers, Sifang
Information and Tianci, who in turn pass those fees to us in return for a small
fee pursuant to the terms of information service and cooperation agreements
between us and each of them.
Our management team utilizes our experience in China to develop close
ties with the key personnel of the mobile operators at the central and
provincial levels. As of March 31, 2005, we had two sales professionals
strategically located in provinces and municipalities concentrated in the
eastern and southern regions of China to work closely with the mobile operators
at the local level, where pricing and important marketing and operational
decisions are made. Our sales network enables us to work closely with operators
to facilitate the approval required for new service offerings and for related
pricing and to enjoy enhanced marketing and promotional support. We are also
able to gain insight into developments in the local markets and the competitive
landscape, as well as new market opportunities. Our sales professionals are
well-incentivized; most of their compensation is tied to usage of our services
in the applicable region.
Coordinated Marketing Campaigns. Our affiliated wireless service
providers cooperate in marketing campaigns with China Mobile and China Unicom.
These network operators distribute literature marketing us and our affiliates.
Non-Operator Channels
We also focus on non-mobile operator sales and marketing activities,
such as:
o promoting Sifang Information's website, www.sifang.net, to
potential users as a fun, easy-to-access place to request our
wireless content and applications;
o engaging in direct marketing to mobile phone users by, for
example, including advertising inserts in users' bills from
Shanghai Mobile and Shanghai Unicom;
o engaging in direct marketing to stock market investors by, for
example, including advertising inserts in investors' bills
from brokerage companies such as GF Securities Co., Ltd.,
Guotai Junan Securities Co., Ltd., Everbright Securities Co.,
Ltd. and Guoxin Securities Co., Ltd.;
o utilizing our database of users to create targeted marketing
campaigns;
o advertising in traditional media outlets such as newspapers
and magazines; and
o we plan to pre-install the Samsung mobile phones we distribute
with the end-user portion of our Sifang Gutong software, and
place brochures touting our stock information, stock trading
and currency exchange services in the packaging of those
phones, before distributing them to retailers.
Customer Research
We spent $60,092 and $17,468 on marketing and advertising fees for our
mobile phone distribution and value-added service business in fiscal 2004 and
2005, respectively. Our sales, marketing and product development activities are
supported by our five-member customer research department. This department
focuses our sales efforts in the following three distinct phases:
Customer Acquisition. Our customer research department analyzes the
success rates of various national and local marketing campaigns in which we are
involved, including by user segment and cost per user, in order to determine
which campaigns are the most effective. Using phone surveys, focus groups and
analyses of usage patterns, the department also considers demographic and other
market factors to identify product mixes and product categories which are
suitable for the current market environment.
Customer Conversion. To enhance our ability to convert one-time or
occasional customers into regular users of our services, our customer research
department analyzes customer and product churn rates across the market, average
revenue per user data and other information. In this way, it can identify
different customer segments and develop targeted marketing campaigns for those
segments, including cross-selling and up-selling marketing campaigns.
48
Customer Retention. Our customer research department evaluates ways to
maximize user interest in our services through, for example, providing feedback
to our product developers to improve product features based on customer
information and bundling older services with newly launched services. It also
creates various reward programs designed to enhance customer loyalty.
Customer Services
We pride ourselves in providing high quality customer service. Our
dedicated customer service center based in Shanghai provides our users real-time
support and is staffed by 20 full-time professionals. The center currently
operates everyday from 7:00 a.m. to 10:00 p.m. We strive to achieve the fastest
response times and highest customer satisfaction levels in the industry.
Competitive Landscape
There are currently three broad categories of wireless service
providers in China:
o Portal service providers, which have established expertise in
Internet content and have subsequently branched into mobile
space. The portals serve as content aggregators offering a
variety of wireless value-added services. These national
portal operators include Sohu, NetEase, SINA, and Tom.com.
o Dedicated service providers, whose businesses focus on
offering a variety of wireless content directly to mobile
users. These providers include Linktone, Newpalm and Mtone
Wireless.
o Niche service providers, which focus on a particular market
segment or application that often builds on a pre-existing
sector competency. These providers include Tencent, Enorbus,
and Solute. We belong in this category because of our focus on
financial information services.
We may also face competition from international wireless service
providers.
As the mobile operators are becoming more selective in choosing their
service providers to promote high quality content, ensure high levels of
customer service and limit the number of providers with which they have to deal,
scale is becoming more important, and we believe the industry will likely
experience consolidation with the leading nationwide providers gaining more
market share at the expense of smaller local providers. Nationwide providers may
also acquire some of their smaller competitors to gain access to local
relationships with the mobile operators in China or new product expertise.
We estimate that we compete with between ten and 20 other
sub-wholesalers for the rights to distribute Samsung phones in the Shanghai
region. The three main competitive factors the wholesalers consider in granting
a sub-wholesaler the rights to distribute a particular model include:
Available Cash Flow. Sub-wholesalers must be able to pay for the mobile
phones they desire to purchase from first-tier wholesalers. First-tier
wholesalers will be hesitant to grant rights to distribute a particular model to
a sub-wholesaler if that sub-wholesaler does not have sufficient capital to make
large purchases. We believe that having adequate cash flow gives us a
competitive advantage.
Relationships with Retailers. The wholesalers look to the types of
relationships sub-wholesalers have with large retailers when deciding which
sub-wholesaler to utilize. We have strong relationships with three large
retailers in Shanghai and sell approximately 52% of our mobile phones to these
three retailers.
Relationships with Wholesalers. We have relationships with the three
major wholesalers of Samsung phones in China and have been sub-wholesalers for
those three wholesalers for more than a year.
49
Employees
The following table summarizes the functional distribution of our
employees as of December 31, 2004 and 2005:
December 31,
Department 2004 2005
Business Development 5 10
Customer Research 5 10
Customer Service 20 20
Finance 3 3
Human Resources 2 2
Investor Relations 2 2
Legal and Administrative 2 2
Sales and Marketing 25 30
Product Development 20 25
Technical Support 10 5
Total 94 109
All of our personnel are employed full-time and none of them are
represented under collective bargaining agreements. We consider our relations
with our employees to be good.
Facilities
We currently occupy two office spaces in the Shanghai region. We lease
the first office space, located at 429 Guangdong Road, Shanghai, People's
Republic of China 200001, for approximately $49,000 a year, pursuant to an
operating lease that expires in December 2006. This office space contains our
corporate headquarters, and is approximately 250 square meters. We own the
second office space, located at 689 Laoshandong Road, Shanghai, People's
Republic of China 200120, which houses our administration, technical team and
servers, and is approximately 800 square meters. We believe that these two
properties are adequately covered by insurance. In addition, we believe that we
will be able to obtain adequate facilities, principally through the leasing of
appropriate properties, to accommodate our future expansion plans.
Legal Proceedings
No legal proceedings have been or are currently being undertaken for or
against the company, nor are we aware of any contemplated proceedings.
Wireless Technology Standards in China
Several different wireless technology standards have been developed
which operate at different frequencies with both analog and digital radio
signals. First generation wireless telephone systems employ analog technology,
while newer systems employ digital technology. Digital wireless technology,
commonly referred to as second generation technology, or 2G, multiplies the
number of users that can be served by the same band of spectrum using analog
technology. The wireless technologies most relevant in China currently include:
o Global System for Mobile Communications, or GSM - initially
developed in order to facilitate unification and integration
of telecommunications within the European Union has become
widespread throughout most Asian countries. GSM technology
breaks audio signals into sequential pieces of data of a
defined length, places each piece into an information conduit
at specific intervals and then reconstructs the pieces at the
end of the conduit. A key component of the GSM system is the
50
SIM card. Data stored on the card identifies the subscriber to
the mobile network as well as the service authorized for that
subscriber. Since the identity of the subscriber is held on
the card, any mobile phone can be used in conjunction with the
SIM card.
o Code Division Multiple Access, or CDMA - a digital technology
standard which has been used in commercial operation by
several operators in certain countries such as the United
States and Korea. Unlike GSM, CDMA technology is a continuous
transmission technology which uses a coding system to mix
discrete audio signals together during transmission and then
separates those signals at the end of transmission.
Prior to the commercial rollout of third generation, or 3G, networks,
2.5G technology standards have been developed for both the GSM and CDMA
technologies to offer higher data transmission speeds, enabling the use of more
data intensive products. Current 2.5G wireless technologies include:
o General Packet-Switched Radio Service, or GPRS - offers faster
data transmission with speeds ranging from 56 kilobits per
second, or Kbps, to 114 Kbps via a GSM network. GPRS supports
a wide range of bandwidths and is particularly suited for
sending and receiving small bursts of data, such as e-mail and
Web browsing, as well as large volumes of data. GPRS also
makes it possible for users to make telephone calls and
transmit data simultaneously.
o CDMA 1x RTT - an advanced CDMA-based technology which allows
transmission of data at speeds of up to 144 Kbps, compared to
a maximum of 64 Kbps for second generation CDMA networks.
3G represents several technology standards developed by The
International Telecommunications Union. Third generation technology has been
developed for both the GSM standard and CDMA standard.
Wireless value-added services can be offered through all of these
technology standards and most commonly include:
o Short Messaging Services, or SMS - a service that enables a
user to send and receive text messages comprised of words or
numbers or an alphanumeric combination. SMS was created when
it was incorporated into the GSM standard.
o Wireless Application Protocol, or WAP - a software protocol
standard that defines a standardized means of transmitting
Internet-based content and data to handheld devices such as
mobile phones and pagers with secure access to e-mail and
text-based Web pages. WAP supports most wireless networks
including GSM and CDMA.
o Multimedia Messaging Services, or MMS - a method of
transmitting graphics, video clips, sound files and short text
messages over wireless networks using the WAP protocol. MMS,
however, is not the same as e-mail in that MMS is based on the
concept of multimedia messaging. An MMS message is coded so
that the images, sounds and text are displayed in a
predetermined order as one singular message. Furthermore, MMS
does not support attachments as e-mail does.
o JAVA - a general programming environment that creates
applications for the Internet or any other distributed
networks. JAVA applications are intended to be independent of
the hardware platform.
Market Overview
Wireless Value-Added Services as a Revenue Driver for the Mobile Operators
As the wireless market in China continues to develop, an increasing
portion of the mobile operators' users have relatively low per capita incomes.
These subscribers generally yield lower levels of average revenue per user, or
ARPU, because they are primarily users of pre-paid services. In addition,
China's wireless market is becoming increasingly competitive, as demonstrated by
the recent CDMA promotions by China Unicom, as well as the intra-city wireless
offerings by China's two fixed-line operators, China Telecom and China Netcom,
which offer users limited mobile services within a city based on Personal
Handyphone Service or Personal Access System technology. In addition, China
Telecom, China Netcom and possibly other parties are expected to be awarded two
51
wireless licenses, although the timing of such grants is unclear. Both China
Telecom and China Netcom are large, established companies with significant
assets and the entry by them or other companies into the Chinese wireless market
could lead to further competition among the mobile operators. Due to these
pressures on the traditional voice-related businesses of the mobile operators,
SMS and other wireless value-added services have become a key differentiator and
increasingly important driver for the growth prospects of China Mobile and China
Unicom. We believe wireless value-added services will play a key role in the
mobile operators' competitive positioning when attracting and retaining users as
well as in their efforts to reverse declining ARPU levels.
Against this competitive backdrop, the market for wireless value-added
services in China has expanded significantly and is expected to continue to grow
at a fast pace. Currently, SMS services continue to represent the bulk of the
wireless value-added services market in China. This market is increasingly
shifting towards next generation technologies, with mobile operators upgrading
their networks to GPRS and CDMA 1x RTT and users upgrading to next generation
mobile phones that can operate with technologies such as MMS and WAP. China
Mobile and China Unicom have recognized this opportunity and are collaborating
with select service providers, including us, to further develop 2.5G
applications and services.
Operators' Wireless Value-Added Services Initiatives in China
China Mobile was the first to enter the market by introducing a popular
trial SMS program in connection with the Sydney Olympic Games in August 2000.
China Mobile later established its Monternet(TM) platform in November 2000.
China Unicom started its Uni-Info platform in May 2001. Monternet(TM) and
Uni-Info offer mobile phone users a single access point to order and pay for
wireless value-added services.
From the inception of Monternet(TM) and Uni-Info, China Mobile and
China Unicom have outsourced almost all content and applications for their
platforms, meaning that these operators, much like NTT DoCoMo and SK Telecom,
rely almost entirely upon third-party service providers to drive their network
traffic, supply attractive wireless services and increase revenue from their
wireless value-added services. In turn, the operators focus on the operation of
their networks. For their part, wireless value-added service providers in China
rely on the two operators, China Mobile and China Unicom, for the network
distribution of their content and services, billing and collection, and
remittance of revenues. Both operators have established similar fee
arrangements.
In addition to their working relationships with third-party service
providers, China's mobile operators will likely form closer alliances with
mobile phone vendors in order to standardize user friendly access to and
functionality for wireless value-added services in all mobile phones.
Government Regulation
The following is a summary of the principal governmental laws and
regulations that are or may be applicable to wireless service providers like us
in China. The scope and enforcement of many of the laws and regulations
described below are uncertain. We cannot predict the effect of further
developments in the Chinese legal system, including the promulgation of new
laws, changes to existing laws or the interpretation or enforcement of laws,
particularly with regard to wireless value-added services, which is an emerging
industry in China.
Regulation of Telecommunication Services
The telecommunications industry, including certain wireless value-added
services, is highly-regulated in China. Regulations issued or implemented by the
State Council, the Ministry of Information Industries, and other relevant
government authorities cover many aspects of telecommunications network
operation, including entry into the telecommunications industry, the scope of
permissible business activities, interconnection and transmission line
arrangements, tariff policy and foreign investment.
52
The principal regulations governing the telecommunications services
business in China include:
o Telecommunications Regulations (2000), or the Telecom
Regulations. The Telecom Regulations categorize all
telecommunications businesses in China as either
infrastructure telecommunications businesses or value-added
telecommunications businesses. The latter category includes
SMS and other wireless value-added services. Under the Telecom
Regulations, certain services are classified as being of a
value-added nature and require the commercial operator of such
services to obtain an operating license, including
telecommunication information services, online data processing
and translation processing, call centers and Internet access.
The Telecom Regulations also set forth extensive guidelines
with respect to different aspects of telecommunications
operations in China.
o Regulations for the Administration of Foreign-Invested
Telecommunications Enterprises (2002), or the FI Telecom
Regulations. The FI Telecom Regulations set forth detailed
requirements with respect to capitalization, investor
qualifications and application procedures in connection with
the establishment of a foreign-invested telecom enterprise.
Under the FI Telecom Regulations, a foreign entity is
prohibited from owning more than 50% of the total equity in
any value-added telecommunications business in China, subject
to certain geographic limitations.
o Administrative Measures for Telecommunications Business
Operating License (2001), or the Telecom License Measures.
Under the Telecom License Measures, an approved value-added
telecommunications service provider must conduct its business
in accordance with the specifications recorded on its Telecom
Business Operating License.
In addition to regulations promulgated at the national level by the
Chinese government, the Shanghai municipal government has issued provisional
regulations requiring SMS service providers to obtain licenses from or register
with the local Ministry of Information Industries branch office before providing
SMS service within the city. At this time, it is unclear whether national
regulations will be promulgated regulating SMS services.
Our affiliates, Sifang Information and Tianci, each have a value-added
telecommunication services license issued by the Shanghai Municipal
Telecommunications Administration Bureau, which is the local office of the
Ministry of Information Industries. They are each also in the process of
applying for an inter-provincial value-added telecommunication license with the
Ministry of Information Industries.
Other Laws and Their Application
Regulation of Internet Content Services. As a wireless value-added
information services provider, we do not engage in the Internet portal business
which typically involves the provision of extensive Internet content services,
including Chinese language Web navigational and search capabilities, content
channels, web-based communications and community services and a platform for
e-commerce, such as auction houses. Sifang Information registered with the
Shanghai Telecommunication Administration Bureau in January 2001 to provide
commercial services at the www.sifang.net web site.
As a commercial ICP provider, Sifang Information is prohibited from
posting or displaying any content that:
o opposes the fundamental principles determined in China's
Constitution;
o compromises state security, divulges state secrets, subverts
state power or damages national unity;
o harms the dignity or interests of the state;
o incites ethnic hatred or racial discrimination or damages
inter-ethnic unity;
o sabotages China's religious policy or propagates heretical
teachings or feudal superstitions;
o disseminates rumors, disturbs social order or disrupts social
stability;
o propagates obscenity, pornography, gambling, violence, murder
or fear or incites the commission of crimes;
o insults or slanders a third party or infringes upon the lawful
rights and interests of a third party; or
o includes other content prohibited by laws or administrative
regulations.
53
Failure to comply with these prohibitions may result in the closing of Sifang
Information's Web site.
Regulation of News Dissemination through SMS Services. Pursuant to a
circular issued by the Shanghai Communications Administration, distribution of
news content through wireless applications like SMS must be approved by relevant
government agencies. Both Sifang Information and Tianci have all necessary
approvals.
Regulation of Advertisements. The State Administration of Industry and
Commerce, or the SAIC, is the government agency responsible for regulating
advertising activities in China. The SAIC has not promulgated regulations
specifically aimed at wireless advertising through a media other than the
Internet, such as through SMS services. One provisional regulation issued by
Shanghai municipal government prohibits service providers from sending SMS
advertisements without the client's consent.
As part of our non-mobile operator marketing activities, we have
developed integrated marketing campaigns with traditional media outlets such as
magazines and newspapers and multinational corporations through certain
cross-selling efforts with companies, including Motorola and Samsung. If the
SAIC were to treat our integrated marketing campaigns or other activities as
being advertising activities, we would need to apply to the local SAIC for an
advertising license to conduct wireless advertising business (through SMSs, for
example). We can give no assurance that such application would be approved by
the SAIC. Failure to obtain such approval could result in penalties including
being banned from engaging in online advertising activities, confiscation of
illegal earnings and fines.
Foreign Exchange Controls. The principal regulations governing foreign
exchange in China are the Foreign Exchange Control Regulations (1996) and the
Administration of Settlement, Sale and Payment of Foreign Exchange Regulations
(1996), or the Foreign Exchange Regulations. Under the Foreign Exchange
Regulations, Renminbi is freely convertible into foreign currency for current
account items, including the distribution of dividends. Conversion of Renminbi
for capital account items, such as direct investment, loans and security
investment, however, is still subject to the approval of the State
Administration of Foreign Exchange, or SAFE.
Under the Foreign Exchange Regulations, foreign-invested enterprises
are required to open and maintain separate foreign exchange accounts for capital
account items (but not for other items). In addition, foreign-invested
enterprises may only buy, sell and/or remit foreign currencies at those banks
authorized to conduct foreign exchange business after providing valid commercial
documents and, in the case of capital account item transactions, obtaining
approval from SAFE.
Intellectual Property and Proprietary Rights
We rely primarily on a combination of copyright laws and contractual
restrictions to establish and protect our intellectual property rights. We
require our employees to enter into agreements requiring them to keep
confidential all information relating to our customers, methods, business and
trade secrets during and after their employment with us. Our employees are
required to acknowledge and recognize that all inventions, trade secrets, works
of authorship, developments and other processes, whether or not patentable or
copyrightable, made by them during their employment are our property. They also
sign agreements to substantiate our sole and exclusive right to those works and
to transfer any ownership that they may claim in those works to us.
While we actively take steps to protect our proprietary rights, such
steps may not be adequate to prevent the infringement or misappropriation of our
intellectual property. This is particularly the case in China where the laws may
not protect our proprietary rights as fully as in the United States.
Infringement or misappropriation of our intellectual property could materially
harm our business. Sifang Information has registered the following Internet and
WAP domain name www.sifang.net.
54
Shanghai Sifang Communication Company, or Sifang Communication, has
registered one trademark with China's Trademark Office. That trademark is our
logo, a square (the English translation of "Sifang" is "square"). China's
trademark law utilizes a "first-to-file" system for obtaining trademark rights.
As a result, the first applicant to file an application for registration of a
mark will preempt all other applicants. Prior use of unregistered marks, except
"well known" marks, is generally not a basis for legal action in China. We may
not be able to successfully defend or claim any legal rights in any trademarks
for which we apply in the future.
Pursuant to a license agreement between our affiliate, Sifang
Communication, and us, we have the right to use our registered trademark, our
square logo, whenever necessary. We also acquired all of Sifang Information's
interest in the Sifang Gutong software pursuant to the terms of the spin-off of
Sifang Information's business divisions focusing on value-added information
services and distribution of mobile phones. We have the right to use the word
"Sifang" and to market ourselves through www.sifang.net with regard to both of
the spun-off divisions.
Many parties are actively developing and seeking patent protection for
wireless services-related technologies. We expect these parties to continue to
take steps to protect these technologies, including seeking patent protection.
There may be patents issued or pending that are held by others and that cover
significant parts of our technology, business methods or services. Disputes over
rights to these technologies are likely to arise in the future. We cannot be
certain that our products do not or will not infringe valid patents, copyrights
or other intellectual property rights held by third parties. We may be subject
to legal proceedings and claims from time to time relating to the intellectual
property of others.
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides information about our executive officers
and directors and their respective ages and positions as of April 17, 2006. Each
director listed below will serve until his or her successor is elected and
qualified, he or she resigns or is removed from office, or his or her earlier
death.
Name Age Positions Held
---- --- --------------
Tai Caihua 49 President and Chairman of the Board
Huang Tianqi 34 Director, Chief Technology Officer
Jing Weiping 42 Director
Mao Ming 44 Director
Song Jing 30 Director
Fu Sixing 45 Director, Chief Executive Officer
Yu Ruijie 43 Director
Zhang Xiaodong 38 Director
Huang Wei 43 Director
Qian Fang 47 Chief Financial Officer
Jiang Hong Ming 51 Director
Mao Wenxing 38 Director
Zhang Xinpeng 30 Director
Tai Caihua has served as our president, chairman of our board of
directors and a member of our board of directors since June 23, 2004. Mr. Tai
has been (i) the president and sole director of our wholly owned subsidiary,
Sifang Holdings, since February 2004; (ii) chairman of the board of directors of
Sifang Holdings' wholly owned subsidiary, TCH, since our inception in May 2004;
(iii) director and general manager of Shanghai Tianci Industry (Group) Co.,
Ltd., one of our affiliates, since January 1994 and (iv) a director of Sifang
Information, one of our affiliates, since December 2001. Mr. Tai holds a Masters
of Business Administration from the Macau University of Science and Technology.
55
Huang Tianqi has served as our chief technology officer since June 23,
2004 and a member of our board of directors since June 24, 2004. Mr. Huang has
served as chief technology officer of Sifang Holdings and vice-general manager,
chief technology officer and a director of TCH since their inception in February
2004 and May 2004, respectively. Mr. Huang also serves as the vice-general
manager and a member of the board of directors of Sifang Information. Before
becoming vice-general manager, Mr. Huang was the chief technology officer at
Sifang Information for seven years. Mr. Huang graduated from Nanjing University
of Posts and Telecommunications with a Bachelors Degree and from Shanghai Jiao
Tong University with a Masters of Science Degree.
Jing Weiping has served as a member of our board of directors since
June 24, 2004. Mr. Jing has served as a member of the board of directors of TCH
since our inception in May 2004 and as a Director of Sifang Information since
2001. Mr. Jing has served as the manager of the technology assurance department
of Sifang Information for the past nine years. Mr. Jing received his Bachelors
Degree from Dong Hua University.
Mao Ming serves as a member of our board of directors. He was elected
to our board of directors June 24, 2004. He has been (i) the general manager and
a member of the board of directors of TCH since our inception in May 2004; and
(ii) the general manager and a director of Sifang Information since January
1998. Mr. Mao graduated from China PLA Measurement College with a Bachelors
Degree and from the Macau University of Science and Technology with a Masters of
Business Administration.
Song Jing has served as a member of our board of directors since June
24, 2004. Mr. Song has served as vice-general manager and a member of the board
of directors of TCH since our inception in May 2004 and as general manager of
Shanghai Shan Tian Telecommunication Co., Ltd., an affiliate of ours, since
November 2003. Previously, Mr. Song served as director and general manager of
Shanghai Zhong Si Hua Hao Co., Ltd. for one year and assistant general manager
of both Shanghai Hua Si Trading Co., Ltd. and Shanghai Qi Shi Trading Co., Ltd
for five years. Mr. Song holds a Masters of Business Administration from Joseph
L. Rotman School of Management, University of Toronto.
Fu Sixing has served as our chief executive officer since June 23, 2004
and a member of our board of directors since June 24, 2004. Mr. Fu has served as
executive manager of Sifang Holdings and as the head of the research and
development department and a director of TCH since their inception in February
2004 and May 2004, respectively. During the past seven years, Mr. Fu has served
as (i) the assistant to general manager of Shanghai Tianci Industry (Group) Co.,
Ltd.; (ii) a director and the general manager of Shanghai Sifang Health
Technology Co., Ltd. and (iii) directorate secretary of Sifang Information. Mr.
Fu received a Bachelors of Science in Physics from Nanjing University, a Masters
of Social Science in Economics from Huadong Normal University and a Doctorate of
Business Administration from the University of Southern California.
Yu Ruijie has served as a member of our board of directors since June
24, 2004. Mr. Yu has served (i) as head of the Systems Department and a director
of TCH since our inception in May 2004 and (ii) as the head of the Systems
Department of Sifang Information since January 1994. Mr. Yu received a Bachelors
Degree in Computer Science from Shanghai University of Engineering Science.
Zhang Xiaodong has served as a member of our board of directors since
June 24, 2004. Mr. Zhang has served as the head of the projection department of
TCH since our inception in May 2004. Mr. Zhang also serves as a director and the
head of the projection department of Sifang Information. For the past nine
years, Mr. Zhang has served as head of the wireless engineering department at
Sifang Information. Mr. Zhang graduated from Shanghai Jiao Tong University with
a Bachelors Degree and received a Masters Degree from the Macao University of
Science and Technology.
Huang Wei has served as a member of our board of directors since June
24, 2004. Mr. Huang has served as (i) the vice-general manager of TCH since our
inception in May 2004 and (ii) vice-general manager and a director of Sifang
Information since 1993. Mr. Huang graduated from Nanjing University of Air Force
and Politics with a Bachelors Degree in Logistics.
56
Qian Fang has served as our Chief Financial Officer since January 1,
2005. Ms. Fang has served as Manager of Accounting of TCH since 1999. Ms. Fang
graduated from China Cable-TV University with a Bachelors Degree in Accounting
and is a Certified Public Accountant.
Jiang Hong Ming has served as a member of our board of directors and a
member of the audit committee of the board of directors since April 2005. Mr.
Jiang worked as a certified public accountant at Shanghai Hua Cheng Certified
Public Accountants from 1998 to 2003 and has been a director at Shanghai Hua
Cheng Certified Public Accountants since 2003. Mr. Jiang received a Bachelors
Degree from Shanghai TV Cable University.
Mao Wenxing has served as an independent director of our board of
directors and a member of the audit committee of the board of directors since
January 2006. Mr. Mao has served as manager of Zhongfang Real Estate Exchange
Co. since November 1999. Mr. Mao earned a Masters Degree in Economics from
Shanghai Finance & Economics University.
Zhang Xinpeng has served as an independent director of our board of
directors and a member of the audit committee of the board of directors since
January 2006. Mr. Zhang has worked as the assistant to the CEO of Shanghai Kena
Technology Co., Ltd. since July 2002. Mr. Zhang earned a Masters Degree from
Shanghai Jiaotong University in June 2002.
Executive Compensation
The following table sets forth all cash compensation paid to our chief
executive officer for services rendered in all capacities to the Company during
the noted periods. No other executive officers received salary and bonus
compensation in excess of $100,000 during the 2005 fiscal year.
Summary Compensation Table
Annual Compensation
-----------------------
Securities
All Other Underlying
Name and Principal Position Year Salary ($) Bonus ($) Compensation ($) Options
--------------------------- ---- ---------- --------- ---------------- ----------
Fu Sixing(1) 2005 $5,536 -- -- --
Chief Executive Officer and 2004 1,795
Director
Timothy P. Halter (2) 2004 -- -- -- 131,722 (3)
Chief Executive Officer and
Director
Glenn Little (4) 2004 -- -- -- --
Chief Executive Officer and 2003 -- -- -- --
Director
------------------------
(1) Appointed Chief Executive Officer and a director of the Company in June
2004.
(2) Appointed Chief Executive Officer in March 2004 and resigned as an
officer and director of the Company in June 2004.
(3) On February 23, 2004, the company sold 987,915 shares of restricted
common stock for gross proceeds of $300,000, pursuant to a subscription
agreement, to Halter Financial Group, Inc., an entity owned by Timothy
P. Halter, a former member of the Board of Directors and the Company's
former Chief Executive Officer. Additionally, in consideration for
agreeing to serve as an officer and director of the Company, Timothy P.
Halter was granted a warrant to purchase up to 131,722 shares of common
stock of the company (as adjusted for stock splits).
(4) Resigned as Chief Executive Officer and a director of the Company in
March 2004.
57
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of April 17, 2006, the beneficial
ownership of our common stock by (i) each director and executive officer of
China Digital, (ii) each person known to China Digital to be the beneficial
owner of five percent or more of the outstanding shares of our common stock, and
(iii) all directors and officers of China Digital as a group. Unless otherwise
indicated, the person or entity listed in the table is the beneficial owner of,
and has sole voting and investment power with respect to, the shares indicated.
Amount and Nature of Beneficial Ownership (1)
---------------------------------------------
Number Percent of
Name and Address(2) of Shares (3) Voting Stock (4)
------------------- --------- ------------
Tai Caihua (5) 10,430,963 60.8%
Shi Ying 1,791,743 10.5%
Mao Ming 413,480 2.4%
Song Jing 413,480 2.4%
Huang Tianqi 275,652 1.6%
Jing Weiping 275,652 1.6%
Fu Sixing 275,652 1.6%
Yu Ruijie 275,652 1.6%
Zhang Xiaodong 275,652 1.6%
Huang Wei 275,652 1.6%
Hiang Hong Ming 0 --
Zhang Xinpeng 0 --
Mao Wenxing 0 --
Qian Fang 0 --
Directors and executive officers
as a group (13 persons) 12,911,835 75.2%
---------------------------
(1) On April 17, 2006, there were 17,147,268 shares of our common stock
outstanding. Each person named above has sole investment and voting
power with respect to all shares of our common stock shown as
beneficially owned by the person, except as otherwise indicated below.
(2) Unless otherwise indicated, the address of each stockholder is c/o
China Digital Wireless, Inc., 429 Guangdong Road, Shanghai, China
200001.
(3) Under applicable rules promulgated by the SEC pursuant to the
Securities Exchange Act of 1934, as amended, or the Exchange Act, a
person is deemed the "beneficial owner" of a security with regard to
which the person, directly or indirectly, has or shares (a) the voting
power, which includes the power to vote or direct the voting of the
security, or (b) the investment power, which includes the power to
dispose or direct the disposition of the security, in each case
irrespective of the person's economic interest in the security. Under
these SEC rules, a person is deemed to beneficially own securities
which the person has the right to acquire within 60 days, including
through (x) the exercise of any option or warrant or (y) the conversion
of another security.
(4) In determining the percent of our common stock owned by a person (a)
the numerator is the number of shares of our common stock beneficially
owned by the person, including shares the beneficial ownership of which
may be acquired within 60 days upon the exercise of options or warrants
or conversion of convertible securities, and (b) the denominator is the
total of (i) the 17,147,268 shares of our common stock outstanding on
December 31, 2005 and (ii) any shares of our common stock which the
person has the right to acquire within 60 days upon the exercise of
options or warrants or conversion of convertible securities. Neither
the numerator nor the denominator include shares which may be issued
upon the exercise of any other options or warrants or the conversion of
any other convertible securities.
(5) Includes 1,791,743 shares held by Mr. Tai's wife, Shi Ying. Mr. Tai
disclaims beneficial ownership of those shares.
58
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
During the year ended December 31, 2005, there were no purchases from
related parties. During the year ended December 31, 2004, TCH purchased local
brand mobile phones from Sifang Telecom valued at $390,340, and all these mobile
phones were sold to retailers in 2004.
During the year ended December 31, 2005, TCH sold Samsung GSM mobile
phones valued at $10,608,287 at a gross profit margin of 4% to Shantian,
compared to $9,178,674 at gross profit margin of 4% for the prior year. Accounts
receivable includes $1,583,512 and nil due from Shantian, for 2004 and 2005,
respectively. During the year ended December 31, 2004, TCH also sold mobile
phones to other related parties, which included Tianci Industy and Tianci Group
for $136,310 and $576,707 at gross profit margins of 14% and 14% respectively.
There were no mobile phones sold to Tianci Industry and Tianci Group during the
year ended December 31, 2005.
On July 16, 2004, the Tianci Group entered into an agency agreement
with TCH to sell CDMA mobile phones owned by China Unicom. TCH obtains the same
commission structure that Tianci Group earns from China Unicom. For each phone
sold, TCH receives $15.70 per unit, sales commission of $3.62 per SIM card. TCH
recognized commission income of $204,214 in the year ended December 31, 2004
from the Tianci Group, which is recorded in service revenues, net on the income
statement. There was no agency income in the year ended December 31, 2005.
In accordance with terms contained in signed service agreements between
TCH and Sifang Information giving TCH the right to use Sifang Information's
facility (which may not be owned by foreign investors at the present time) to
transmit the reformatted information, the Company paid service fees annually in
each of the years ended December 31, 2004 and 2005. The service agreements are
in effect for ten years and became effective on June 1, 2004. The annual
payments for the services have declined from approximately $567,000 to
approximately $366,000 since January 1, 2005. During the year ended December 31,
2005, Sifang Information also provided other management support and marketing
services to TCH for $61,352, compared to $36,462 for the prior year. TCH earned
information service revenues net of costs from China Mobile / China Unicom that
were passed through from Sifang Information and are recorded in service revenue,
net on the income statement. For the year ended December 31, 2005, the total
revenue generated was $634,728 and the total cost of services was $410,898,
compared to $2,592,392 of total revenue generated and $498,194 of total cost of
services for the prior year. TCH earned paging service revenues net of costs
that were passed through from Sifang Information and are recorded in service
revenue, net on the income statement. For the year ended December 31, 2005, the
total revenue generated was $639,340 and the total cost of services was $368,614
compared to $979,469 of total revenue generated and $547,799 of total cost of
services for the prior year. TCH launched a smart card project as a joint
cooperation project with Sifang Information in June 2004. However, the project
was abandoned in the fourth quarter of 2004 due to government regulations. No
revenue was generated from the project in either 2004 or 2005 fiscal years.
In January 2005, Sifang Media and TCH entered into the "Bank Digital
TV's Cooperation Agreement", where TCH will assist in the promotion of TV ads
for various customers, including Tianci Real Estate. TCH received a net fee of
$1,879,965 for providing the service during the year ended December 31, 2005.
There was an "Advertisement Agency Contract" between Tianci Real Estate and
Sifang Media, which expired in November 2005. In June and September 2005, Sifang
Media, TCH and two unrelated customers, entered into certain agreements, where
TCH will assist in the promotion of TV ads for these customers. TCH received a
fee of $881,633 for providing the service via Sifang Media during the fiscal
year of 2005.
Sifang signed a leasing agreement with the Tianci Real Estate for
leasing its apartment for office use, which was assumed by TCH as a part of the
carve-out transaction. The original leasing term was from May 1, 2003 to April
30, 2008. The original lease agreement was terminated on September 30, 2004, but
was reinstated on January 1, 2005, for an additional term from January 1, 2005
to December 31, 2005. The related rental expense for the year ended December 31,
2005 was $49,565, compared to $30,810 for the prior year.
59
Cash collections received and payments made to Sifang Information on
behalf of TCH, resulted in a net receivable of $2,165,624 due from Sifang
Information at December 31, 2005. The amount due from related party also
consists of $122,677 relating to the value added information services provided
to Sifang Information and sold to China Unicom and another $664,722 relating to
the paging revenues that are collected by Sifang Information on behalf of TCH.
In January and February 2006, TCH collected $247,825 from Sifang Information.
The Company's management believes that the collection of the remaining balance
from Sifang Information is reasonably assured and accordingly, no allowance has
been recorded as of December 31, 2005. The Company also advanced $1,205,000 to
provide Sifang Information's needs for working capital in order to complete
spin-off procedures in the PRC. The outstanding balance was fully collected in
March 2005.
In December 2005, TCH entered into a series of agreements to purchase
(i) 95% of the equity interests of Shanghai Kena Energy Saving Electric Co Ltd
("Kena") for an aggregate purchase price of RMB 28,500,000 (approximately
$3,532,000); (ii) a related patent from one of the shareholders of Kena for RMB
11,000,000 (approximately $1,363,000); and (iii) related rights to make a patent
application from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000). The purchase price for both the equity interests in
Kena and the consideration for purchase of the patent and the right to apply for
registration of the patent shall be paid by Sifang Information on behalf of TCH.
It is expected the transaction will be closed upon the completion of the
business registration in April 2006.
On February 23, 2004, we sold 987,915 shares of restricted common stock
for gross proceeds of $300,000, pursuant to a subscription agreement, to Halter
Financial Group, Inc., an entity owned by Timothy P. Halter, a former member of
the Board of Directors and the Company's former Chief Executive Officer.
Additionally, in consideration for agreeing to serve as an officer and director
of the Company, Timothy P. Halter was granted a warrant to purchase up to
131,722 shares of common stock of the Company (as adjusted for stock splits).
The warrant was exercised on June 14, 2004, and we received gross proceeds of
$40,000 upon exercise.
On February 23, 2004, we agreed to pay Little and Company Investment
Securities, an entity owned by Glenn A. Little, our former controlling
stockholder, officer and director, $30,000 in consulting fees related to the
transaction discussed in the previous paragraph and in consideration for
maintaining the corporate entity. To formalize this obligation, we issued a
$30,000 non-interest bearing promissory note maturing on February 23, 2005.
Concurrent with the transaction discussed in the previous paragraph, we and
Little and Company Investment Securities executed an Exchange Agreement whereby
we issued 98,792 shares of common stock in satisfaction of the outstanding
promissory note.
On June 23, 2004, we entered into a Stock Purchase Agreement with
Halter Financial Group, Inc. pursuant to which we sold 166,667 shares of common
stock of the Company in exchange for $190,000. Timothy P. Halter is the sole
stockholder and President of Halter Financial Group, Inc. Pursuant to the Stock
Purchase Agreement, we granted to Halter Financial Group, Inc. an option to
require the Company to purchase up to 166,667 shares of common stock of the
Company at a price of $1.14 per share, such option being exercisable at any time
after the date that is six months after the Company filed a registration
statement on Form SB-2 with the SEC, (which registration statement was declared
effective on February 8, 2005) registering the shares purchased by Halter
Financial Group, Inc., up to and including the earlier of (i) the date that such
registration statement is declared effective by the SEC or (ii) Halter Financial
Group, Inc.'s shares are eligible for resale under Rule 144 under the Securities
Act of 1933, as amended.
DESCRIPTION OF OUR CAPITAL STOCK
The following description is a summary of the material terms of our
capital stock. This summary is subject to and qualified in its entirety by our
Articles of Incorporation, as amended, and Bylaws, as amended, and by the
applicable provisions of Nevada law.
60
The authorized capital stock of the company consists of 100,000,000
shares of common stock, having a par value of $0.001 per share.
Common Stock. Each outstanding share of common stock entitles the
holder thereof to one vote per share on all matters. The Articles of
Incorporation do not permit cumulative voting for the election of directors,
which means that the holders of more than 50% of such outstanding shares voting
for the election of directors can elect all of the directors to be elected, if
they so choose; in such event, the holders of the remaining shares will not be
able to elect any of our directors. Stockholders do not have preemptive rights
to purchase shares in any future issuance of our common stock.
The holders of shares of our common stock are entitled to dividends out
of funds legally available when and as declared by our board of directors. Our
board of directors has not declared a dividend during the two preceding fiscal
years or during calendar 2005 and does not anticipate declaring a dividend in
the foreseeable future. In the event of liquidation, dissolution or winding up
of the affairs of the company, holders are entitled to receive, ratably, the net
assets available to stockholders after payment of all creditors.
All of the issued and outstanding shares of our common stock are duly
authorized, validly issued, fully paid, and non-assessable. To the extent that
additional shares of our common stock are issued, the relative interests of
existing stockholders will be diluted.
Transfer Agent and Registrar. Our transfer agent is Securities Transfer
Corporation, 2591 Dallas Parkway, Suite 102, Frisco, Texas 75034.
SELLING STOCKHOLDERS
The following table sets forth the names of the selling stockholders
and for each selling stockholder the number of shares and percentage of common
stock beneficially owned as of February 4, 2005, the number of shares being
registered and the percentage to be owned after this offering assuming all of
shares covered by this prospectus are sold and no other purchases of our common
stock are made by the selling stockholders. All information with respect to
share ownership has been furnished by the selling stockholders. The shares being
offered are being registered to permit public secondary trading of the shares
and each selling stockholder may offer all or part of the shares owned for
resale from time to time. A selling stockholder is under no obligation, however,
to sell any shares immediately pursuant to this prospectus, nor is a selling
stockholder obligated to sell all or any portion of the shares at any time. In
addition to selling any shares pursuant to an effective registration statement,
the selling shareholders may, if available, sell their shares pursuant to Rule
144 of the Securities Act of 1933, as amended ("Rule 144"). Therefore, no
estimate can be given as to the number of shares of common stock that will be
sold pursuant to this prospectus or the number of shares that will be owned by
the selling stockholders upon termination of the offering made hereby. The
numbers and percentages are based on 17,147,268 shares of our common stock
outstanding.
Percentage
Shares of Owned
Shares of Common Stock Upon
Common Stock Percentage to be Completion
Selling Stockholders Owned Owned Registered of Offering
Halter Financial Group, Inc............ 1,154,567 6.8 1,154,567 -0-
John Zhang............................. 167,895 * 167,895 -0-
Marat Rosenberg ....................... 57,367 * 34,367 *
Little & Company Investment
Securities............................. 192,259 1.1 64,763 *
Gary Evans............................. 175,439 1.0 175,439 -0-
Chinamerica Acquisition, LLC........... 263,157 1.5 263,157 -0-
Chinamerica Fund, LP................... 877,193 5.2 877,193 -0-
----------------
* Indicates less than 1%
61
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the offering, we will have 17,147,268 shares of
common stock outstanding. A current stockholder who is an "affiliate" of the
company, defined in Rule 144 as a person who directly, or indirectly through one
or more intermediaries, controls, or is controlled by, or is under common
control with, the company, will be required to comply with the resale
limitations of Rule 144.
Purchasers of shares in the offering, other than affiliates, may resell
their shares immediately. Sales by affiliates will be subject to the volume and
other limitations of Rule 144, including certain restrictions regarding the
manner of sale, notice requirements, and the availability of current public
information about the company. The volume limitations generally permit an
affiliate to sell, within any three month period, a number of shares that does
not exceed the greater of one percent of the outstanding shares of common stock
or the average weekly trading volume during the four calendar weeks preceding
his sale. A person who ceases to be an affiliate at least three months before
the sale of restricted securities beneficially owned for at least two years may
sell the restricted securities under Rule 144 without regard to any of the Rule
144 limitations.
PLAN OF DISTRIBUTION
The 2,737,381 shares being offered by the selling stockholders may be
sold or distributed from time to time by the selling stockholders or their
transferees directly to one or more purchasers or through brokers, dealers, or
underwriters who may act solely as agents or may acquire shares as principals.
Such sales or distributions may be made at prevailing market prices, at prices
related to such prevailing market prices, or at variable prices negotiated
between the sellers and purchasers that may vary. The distribution of the shares
may be effected in one or more of the following methods:
o ordinary brokerage transactions, including long or short
sales;
o transactions involving cross or block trades, or otherwise on
the OTC Bulletin Board;
o purchases by brokers, dealers, or underwriters as principals
and subsequent resale by the purchasers for their own accounts
pursuant to this prospectus;
o sales "at the market" to, or through, market makers or into an
existing market for the shares;
o sales not involving market makers or established trading
markets, including direct sales to purchasers or sales
effected through agents;
o transactions involving options, swaps, or other derivatives,
whether exchange-listed or otherwise; or
o transactions involving any combination of the foregoing or any
other legally available means.
In addition, a selling stockholder may enter into hedging transactions
with one or more broker-dealers who may engage in short sales of shares in the
course of hedging the positions they assume with the selling stockholder. A
selling stockholder may also enter into options or other transactions with one
or more broker-dealers requiring the delivery of the shares by such
broker-dealers with the possibility that such shares may be resold thereafter
pursuant to this prospectus.
A broker, dealer, underwriter, or agent participating in the
distribution of the shares may receive compensation in the form of discounts,
concessions, or commissions from the selling stockholders and/or purchasers of
the shares for whom such person may act as an agent, to whom such person may
sell as principal, or both; and such compensation as to a particular person may
be in excess of customary commissions. The selling stockholders and any
broker-dealers acting in connection with the sale of the shares being registered
may be deemed to be underwriters within the meaning of Section 2(11) of the
Securities Act of 1933, as amended, or the Securities Act, and any profit
realized by them on the resale of shares as principals may be deemed
62
underwriting compensation under the Securities Act. We know of no existing
arrangements between any of the selling stockholders and any other stockholder,
broker, dealer, underwriter, or agent relating to the sale or distribution of
the shares, nor can we presently estimate the amount, if any, of such
compensation.
Although we will receive no proceeds from the sale of shares pursuant
to this prospectus, we have agreed to bear the costs and expenses of the
registration of the shares, including legal and accounting fees, and such costs
and expenses are estimated to be approximately $230,000.
We have informed the selling stockholders that while they are engaged
in a distribution of the shares included in this prospectus they will be
required to comply with certain anti-manipulative rules contained in Regulation
M under the Exchange Act. With certain exceptions, Regulation M prohibits any
selling stockholder, any affiliated purchaser, and any broker-dealer or other
person who participates in such distribution from bidding for or purchasing, or
attempting to induce any person to bid for or purchase, any security that is the
subject of the distribution until the entire distribution is complete.
Regulation M also prohibits any bids or purchases made in order to stabilize the
price of a security in connection with the distribution of that security.
INDEPENDENT PUBLIC ACCOUNTANTS
On January 4, 2005, the board of directors approved resolutions to
replace our independent registered public auditors, BDO Shanghai Zhonghua
Certified Public Accountant, with Grobstein, Horwath & Company, LLP, which we
appointed effective as of January 6, 2005.
During June 2004, we completed a stock exchange transaction with the
stockholders of Sifang Holdings Co. Ltd., or Sifang, resulting in Sifang
becoming our wholly owned subsidiary. This stock exchange transaction also
resulted in a recapitalization of the company with Sifang becoming the survivor
of the transaction for accounting purposes. Upon this recapitalization, our
independent public accountant, S.W. Hatfield, CPA, resigned effective July 9,
2004. As a result of S.W. Hatfield's resignation, our board of directors
appointed BDO Shanghai Zhonghua Certified Public Accountant as our independent
public accountant.
Hatfield audited our financial statements for the fiscal year ended
December 31, 2003. Hatfield's report for that period did not contain an adverse
opinion or a disclaimer of opinion, and was not qualified or modified as to
uncertainty, audit scope or accounting principles. During our fiscal year ended
December 31, 2003 and from January 1, 2004 through July 9, 2004, there were no
disagreements with Hatfield on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which, if not
resolved to the satisfaction of Hatfield, would have caused them to make
reference to the subject matter in their report.
BDO Shanghai Zhonghua audited Sifang's financial statements for the
fiscal year ended December 31, 2003. BDO Shanghai Zhonghua's reports for that
period did not contain an adverse opinion or a disclaimer of opinion, and was
not qualified or modified as to uncertainty, audit scope or accounting
principles. During our fiscal year ended December 31, 2003 through January 6,
2005, there were no disagreements with BDO Shanghai Zhonghua Certified Public
Accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which, if not resolved to
the satisfaction of BDO Shanghai Zhonghua Certified Public Accountant, would
have caused them to make reference to the subject matter in their report.
LEGAL MATTERS
Certain legal matters in this offering, including the legality of the
common stock offered pursuant to this prospectus, will be passed upon for us and
the selling stockholders by Kummer Kaempfer Bonner & Renshaw.
63
EXPERTS
The financial statements of the company for the years ended December
31, 2005 and 2004 have been audited by Grobstein, Horwath & Company LLP,
Certified Public Accountants, independent registered public accounting firm, as
stated in the opinion, which has been rendered upon the authority of said firm
as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form SB-2 with the SEC under
the Securities Act of 1933 with respect to the shares of common stock offered in
this offering prospectus. This prospectus, which is a part of the registration
statement, does not contain all of the information set forth in the registration
statement, or the exhibits which are part of the registration statement. You
should refer to the registration statement and its exhibits for additional
information that is not contained in this prospectus. Whenever we make reference
in this prospectus to any of our contracts, agreements or other documents, you
should refer to the exhibits attached to the registration statement for copies
of the actual contract, agreement or other document.
WE ARE SUBJECT TO THE INFORMATIONAL REQUIREMENTS OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED, AND WE ARE REQUIRED TO FILE REPORTS, ANY PROXY
STATEMENTS AND OTHER INFORMATION WITH THE SEC. YOU CAN READ OUR SEC FILES,
INCLUDING THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS FORMS A PART, OVER
THE INTERNET AT THE SEC'S WEB SITE AT WWW.SEC.GOV. YOU MAY ALSO READ AND COPY
ANY DOCUMENTS WE FILE WITH THE SEC AT ITS PUBLIC REFERENCE FACILITY AT 100 F
STREET, N.E., WASHINGTON, D.C. 20549. YOU MAY ALSO OBTAIN COPIES OF THE
DOCUMENTS AT PRESCRIBED RATES BY WRITING TO THE PUBLIC REFERENCE SECTION OF THE
SEC AT 100 F STREET, N.E., WASHINGTON, D.C. 20549. PLEASE CALL THE SEC AT
1-800-SEC-0330 FOR FURTHER INFORMATION ON THE OPERATION OF THE PUBLIC REFERENCE
FACILITY.
64
INDEX TO FINANCIAL STATEMENTS
Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2005
and March 31, 2006 (Unaudited)..........................................F-2
Consolidated Statements of Income and Comprehensive Income (Unaudited)
For the Three Months Ended March 31, 2005 and 2006......................F-3
Consolidated Statements of Cash Flows (Unaudited) for the Three Months
Ended March 31, 2005 and 2006...........................................F-4
Notes to Consolidated Financial Statements (Unaudited).......................F-5
Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm.....................F-15
Consolidated Balance Sheets as of December 31, 2004 and 2005................F-16
Consolidated Statements of Income and Comprehensive Income
for the Twelve Months Ended December 31, 2004 and 2005.................F-17
Consolidated Statements of Shareholders' Equity
for the Twelve Months Ended December 31, 2004 and 2005.................F-18
Consolidated Statements of Cash Flows for the Twelve Months Ended
December 31, 2004 and 2005.............................................F-19
Notes to Consolidated Financial Statements..................................F-20
F-1
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, March 31,
2005 2006
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,578,367 $ 1,094,820
Accounts receivable, net of allowance for doubtful accounts of
$44,472 and $16,750 844,977 784,958
Inventories 62,386 42,972
Deferred tax assets 12,846 3,448
Due from related parties 3,094,969 5,640,199
Advances and deposits to suppliers 19,970 35,665
------------ ------------
Total current assets 7,613,515 7,602,062
Property and equipment, net 1,105,756 1,064,638
Deposit for business acquisition 6,257,590 6,257,590
------------ ------------
Total assets $ 14,976,861 $ 14,924,290
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 881,218 $ 782,433
Advance from customer 6,399 6,441
Deferred revenue 31,598 18,710
VAT payable 92,649 60,235
Income tax payable 193,586 106,121
Due to related parties 223,399 237,355
Other current liabilities 375,960 434,814
------------ ------------
Total current liabilities 1,804,809 1,646,109
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value, 100,000,000 shares
authorized, 17,147,268 shares issued and outstanding at
December 31, 2005 and March 31, 2006 17,148 17,148
Additional paid-in capital 4,229,845 4,229,845
Retained earnings 8,084,922 8,153,056
Restricted reserves 554,466 554,466
Accumulated other comprehensive income 285,671 323,666
------------ ------------
Total shareholders' equity 13,172,052 13,278,181
------------ ------------
Total liabilities and shareholders' equity $ 14,976,861 $ 14,924,290
============ ============
See accompanying notes to consolidated financial statements.
F-2
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
Three Months ended March 31,
----------------------------
2005 2006
------------ ------------
Revenues:
Product sales $ 669,191 $ 349,997
Product sales to related parties 4,060,514 890,744
Information service revenue, net 609,215 261,785
Advertising service revenue, net 459,131 177,159
------------ ------------
Total revenues 5,798,051 1,679,685
Cost of goods sold 605,888 333,734
Cost of goods sold to related parties 3,963,905 777,884
Cost of information service 170,678 189,319
Cost of advertising service 22,819 40,056
------------ ------------
4,763,290 1,340,993
Gross profit 1,034,761 338,692
Operating expenses:
Sales and marketing 43,289 26,967
General and administrative 192,039 207,614
------------ ------------
Total operating expenses 235,328 234,581
------------ ------------
Income from operations 799,433 104,111
Other revenue -- 204
Interest income, net 465 115
------------ ------------
Income before income taxes 799,898 104,430
Income tax provision 133,490 36,296
------------ ------------
Net income $ 666,408 $ 68,134
============ ============
Other comprehensive income (loss):
Foreign currency translation adjustment $ (2) $ 37,995
Comprehensive income $ 666,406 $ 106,129
============ ============
Basic and diluted earnings per share $ 0.04 $ 0.00
Weighted average shares of common stock
outstanding 17,018,692 17,147,268
See accompanying notes to consolidated financial statements.
F-3
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months ended March 31,
----------------------------
2005 2006
------------ ------------
Cash flows from operating activities:
Net income $ 666,408 $ 68,134
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 67,684 48,296
Bad debt expenses (20,685) (27,722)
Deferred tax assets 17,437 9,398
Changes in assets and liabilities:
Accounts receivable 1,596,154 87,741
Inventories (793,574) 19,414
Due from related parties -- (50,531)
Advances and deposits to suppliers (1,321,604) (15,695)
Accounts payable 873,462 (98,785)
Advance from customer -- 42
Deferred revenue (445,419) (12,888)
VAT payable (125,617) (32,414)
Income tax payable (102,186) (87,465)
Due to related parties (48,910) 13,956
Other current liabilities (51,942) 58,854
------------ ------------
Net cash flows provided by (used in) operating activities 311,208 (19,665)
Cash flows from investing activities:
Purchase of property and equipment (50,452) --
Loan to related parties (1,432,023) (2,494,699)
------------ ------------
Net cash flows used in investing activities (1,482,475) (2,494,699)
------------ ------------
Cash flows from financing activities:
Escrow receivable 1,500,000 --
------------ ------------
Net cash flows provided by financing activities 1,500,000 --
------------ ------------
Foreign currency translation adjustment (2) 30,817
------------ ------------
Net increase (decrease) in cash and cash equivalents 328,731 (2,483,547)
Cash and cash equivalents, beginning of the period 75,511 3,578,367
------------ ------------
Cash and cash equivalents, end of the period $ 404,242 $ 1,094,820
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ -- $ --
Income taxes $ 218,239 $ 114,309
See accompanying notes to consolidated financial statements.
F-4
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - ORGANIZATION AND BUSINESS BACKGROUND
China Digital Wireless, Inc. ("CDW") through its subsidiary sells mobile phones
to retailers, distributors, and related parties, provides advertising services
and provides information services to users of mobile phones and pagers.
Substantially all operations are conducted in Shanghai, People's Republic of
China ("PRC").
In order to meet ownership requirements under Chinese law that restrict a
foreign company from operating in certain industries such as value-added
telecommunication, advertising service and Internet services, CDW's subsidiary
has entered into information service and cooperation agreements with two of
CDW's affiliates that are incorporated in China: Shanghai Sifang Information
Technology Co. ("Sifang Information") and Shanghai Tianci Industry Co. Ltd
("Tianci Industry"). CDW holds no ownership interest in Sifang Information or
Tianci Industry. Sifang Information and Tianci Industry contract with China
Mobile Communications Corporation ("China Mobile"), and China United
Telecommunications Corporation ("China Unicom"), to provide wireless value-added
information services to wireless receiver customers in China via China Mobile
and China Unicom. Sifang Information transmits those services to customers of
China Mobile and China Unicom on behalf of itself and Tianci Industry pursuant
to a signed agreement between Sifang Information and Tianci Industry.
Business History
CDW's business is primarily conducted through its wholly-owned subsidiary Sifang
Holdings and its wholly-owned subsidiary TCH Data Technology Co., Ltd. ("TCH"),
that collectively with CDW are referred to as the "Company". Sifang Holdings was
established under the laws of the Cayman Islands on February 9, 2004 for the
purpose of holding a 100% equity interest in TCH. TCH was established as a
foreign investment enterprise in Shanghai under the laws of the PRC on May 25,
2004, with registered capital of $7.2 million.
CDW's current operations were originally a business division of Sifang
Information. Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business to
TCH. As the acquiring entity under common control, TCH initially recognized all
the assets and liabilities transferred at their carrying amounts in the accounts
of Sifang Information at the date of transfer under the guidance of Statements
of Financial Accounting Standards ("SFAS") No. 141, Appendix D.
On May 26, 2004, Sifang Information exchanged 100% of the equity interest in TCH
for 100% of the equity interest in Sifang Holdings. Since the ultimate owners of
the three entities were the same owners and the three entities remained under
common control, the ownership exchange transaction was accounted for at
historical costs under the guidance of SFAS No. 141, Appendix D. Prior to May
26, 2004, there were no activities in Sifang Holdings. As a result of the
exchange of ownership between TCH and Sifang Holdings, TCH's historical
financial statements became the historical financial statements of Sifang
Holdings.
As a result of the spin-off, the Company engages in the business of mobile phone
distribution and provides pager and mobile phone users with access to certain
value-added information reformatted by TCH. TCH purchases mobile phones from
first tier distributors and sells them to retailers and distributors with a
mark-up. In the process of providing value-added information services through
entering into monthly subscription agreements with various users, TCH purchases
trading activity information from stock exchanges, comments and analysis on PRC
stock markets provided by certain reputable security and investment companies,
lottery information, weather forecast, and other value-added products and
reformats the aforementioned information through decoding and recoding and then
has the reformatted information transmitted by Sifang Information, via service
contracts, to pager users. The value-added information is constantly saved on
TCH's server in order for mobile phone users to dial in via China Mobile or
China Unicom. By signing a monthly subscription agreement, wireless receiver
users agree to make advance payments for its services for either three or
six-month subscription periods.
F-5
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("U.S.GAAP") for interim financial information and the instructions to
Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include
all of the information and footnotes required by U.S.GAAP for a complete
presentation of financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the Company's financial condition and results of operations
for the interim periods presented in this Form 10-QSB have been included.
Operating results for the interim periods are not necessarily indicative of
financial results for the full year. These unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of CDW, its
wholly-owned subsidiary, Sifang Holdings, and its wholly-owned subsidiary, TCH.
Substantially all of CDW's revenues are derived from the operations of TCH,
which represents substantially all of CDW's consolidated assets and liabilities
as of March 31, 2006. All significant intercompany accounts and transactions
have been eliminated.
Foreign Currency Translations and Transactions
The Renminbi ("RMB"), the national currency of the PRC, is the primary currency
of the economic environment in which the operations of the Company are
conducted. The Company uses the United States dollar ("U.S. dollars") for
financial reporting purposes.
The Company translates its financial statements into U.S. dollars in accordance
with SFAS No. 52, "Foreign Currency Translation." All asset and liability
accounts have been translated using the exchange rate prevailing at the balance
sheet date (at March 31, 2006, the prevailing exchange rate of the U.S. dollar
against the RMB was 8.0170), and the statement of income is translated at
average rate during the reporting period (the average rate of the U.S. dollar
against the RMB, during the quarter ended March 31, 2006 were 8.0436). Equity
items are translated at historical rates. Adjustments resulting from the
translation of the Company's financial statements from RMB into U.S. dollars are
recorded in shareholders' equity as part of accumulated other comprehensive
income. Gains or losses resulting from transactions in currencies other than RMB
are reflected in the statement of income for the reporting periods.
Revenue Recognition
The Company derives revenues from the sale of mobile phones, advertisement
designing service and the provision of wireless information services that are
used on mobile phones, pagers and prepaid phone cards. The Company additionally
earns commission income ("Agency Income") from the sale of CDMA mobile phones on
the behalf of a related party. The Company recognizes its revenues net of
related business taxes and value-added taxes.
Mobile Phone Sales:
Revenues generated from the sale of mobile phones are recognized when the
products are shipped to the distributor or retailer and when persuasive evidence
of an arrangement exists, delivery of the products has occurred, customer
acceptance has been obtained, which means the significant risks and rewards of
ownership have been transferred to the customer, the price is fixed or
determinable and collectibility is reasonably assured.
Advertising Servicing Revenue, Net:
Advertising revenues are derived from advertisement designing, masterminding and
producing services. The Company recognizes service revenues over the term of the
noted agreement at the time of completion of the services. The Company records
the revenue from Shanghai Sifang Media Co., Ltd. ("Sifang Media") on a net basis
F-6
in compliance with EITF 99-19, "Reporting Revenue Gross as a Principle versus
Net as an Agent" because the Company is not the primary obligor in the
arrangement and they receive a fixed fee from Shanghai Sifang Media Co., Ltd.
and they have no latitude in determining prices.
Information Services:
The Company recognizes service revenues over the term of the noted agreement
and/or when the services have been provided to the end user.
i) Information Services - TCH:
By signing a subscription agreement, wireless receiver users agree to make
payments for three to six-month subscriptions in advance. TCH records the
proceeds as deferred revenue and amortizes the deferred revenue over the
subscription period. When customers buy a pre-charged service card, the Company
records the proceeds as deferred revenue. When a customer starts to use this
card to access the Company's server and starts to use a pager to access the
aforementioned information, the Company identifies the subscription period and
amortizes the deferred revenue over the subscription period.
ii) Information Services - Installing Agent:
In response to a retailer's request, the Company has an installing agent who
installs the Company's software on mobile phones, which are owned by the
retailer. The retailer sells these phones for a premium covering a fee to be
paid to the installing agent and pre-charged six-month subscription fees to be
paid to the Company. After a customer using such a phone dials into the server
to access the desired information, the server records a unique identification
number installed on the mobile phone, which indicates that a specific phone user
starts his or her subscription period. After the Company receives a detailed
list from the installing agent regarding the number of phones that have been
installed with the Company's software, the Company matches this information with
a detailed list from the retailer setting forth how many such phones have been
sold. Based on the number of such phones sold, the Company records accounts
receivable and deferred revenue correspondingly. At the date on which a customer
starts to dial into the server, the six-month subscription period begins and the
Company amortizes deferred revenue accordingly.
iii) Information Services - China Mobile and/or Unicom:
The Company's affiliates, Sifang Information and Shanghai Tianci Industrial
Group Co., Ltd. ("Tianci Group"), contract with China Mobile and/or China Unicom
(collectively, "Mobile Operators") for the transmission of the Company's
value-added information services. The Mobile Operators bill and collect from
customers and then pass those fees (net of billing and collection service fees
charged by the Mobile Operators) to Sifang Information and Tianci Group who in
turn pass those fees to the Company. The Company recognizes net revenues based
on the total amount paid by its customers, for which the Mobile Operators bill
and collect on behalf of the Company. There is a time lag ranging from 10 days
to 45 days between the end of the service period and the date the Mobile
Operators send out their billing statements due to the segregated billing
systems of each of the provincial subsidiaries of the Mobile Operators. The
Company has not recognized service revenue based on the records provided by its
own server but has performed a reconciliation on a monthly basis of the revenues
recognized by the Company's server to the Mobile Operator's billing statement.
In addition, the Mobile Operators charge a network usage fee based on a fixed
per message fee multiplied by the excess of messages sent over messages
received. (This type of service is not covered by a monthly service subscription
and the Company has no control over whether it will occur or not.) Network usage
fees charged by the Mobile Operators are reduced for messages received by the
Company because the Mobile Operators separately charge the sender a fee for
these transmissions.
The Company records the revenue from the Mobile Operators on a net basis in
compliance with EITF 99-19, "Reporting Revenues Gross as a Principle versus Net
as an Agent" because the Company:
o Is not the primary obligor in the arrangement, as it relies on Sifang
Information to transmit the information services to the end user,
o Has limited ability to adjust the cost of services by adjusting the
design or marketing of the service,
F-7
o Has limited ability to determine prices, the Company must follow the
price policy within ranges prescribed by Mobile Operators, and
o Has limited ability to assume risk of non-payment by customers.
The Company's dependence on the substance and timing of the billing systems of
the mobile telecommunications operators may require the Company to estimate
portions of its reported revenue for information services from time to time. As
a result, subsequent adjustments may be made to the information service revenue
in the Company's consolidated financial statements. As the Company does not bill
its information services users directly, the Company depends on the billing
systems and records of the mobile telecommunications operators to record the
volume of its information services provided, to charge its users through mobile
telephone bills, to collect payments from its users, and to pay the Company.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less to be cash equivalents. The Company maintains its cash accounts
at credit worthy financial institutions.
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to
retailers and distributors who are mainly located in the Shanghai metropolitan
area. Typically, for mobile phone distributors, credit terms require payment to
be made within 30 days of the sale. The Company does not require collateral from
its customers. The Company's policy is to provide for an allowance for doubtful
accounts that is based on 5% of total trade accounts receivable less amounts due
from related parties and from the installing agent. Total trade accounts
receivable due from related parties was nil and $567,307 as of December 31, 2005
and March 31, 2006, respectively.
The Company regularly evaluates and monitors the creditworthiness of each
customer on a case-by-case basis. The Company includes any account balances that
are determined to be uncollectible in the overall allowance for doubtful
accounts. After all attempts to collect a receivable have failed, the receivable
is written off against the allowance. The Company believes that its allowance
for doubtful accounts was adequate as of March 31, 2005 and 2006. However,
actual write-offs might exceed the recorded allowance.
The following table presents activities in the allowance for doubtful accounts:
December 31, March 31,
2005 2006
------------ ------------
(Unaudited)
Beginning balance $ 47,922 $ 44,472
Additions charged to expense -- --
Recovered (3,450) (27,722)
Actual write off -- --
------------ ------------
Ending balance $ 44,472 $ 16,750
============ ============
Inventories
Inventories consist principally of mobile phones manufactured by name brand
manufacturers with various features and are stated at the lower of cost
(weighted-average) or market.
Rebates and Credits Receivable
In 2004, the Company's major vendor began providing rebates and credits if the
Company meets certain sales volume levels prescribed by the vendor. As a result,
the Company is entitled to receive certain rebates and credits for the inventory
held and sold by the Company within the specified period of time as defined by
its vendor through submitting the necessary application forms. In general, once
the vendor approves the applications, the amounts of these rebates and credits
will be deducted from the Company's accounts payable to its vendor and decrease
the cost of goods sold or inventory held correspondingly.
F-8
Capitalization of Software Costs
The Company's software is developed by an independent third party to enable
pager users to accept certain recoded information which is transmitted by the
Company, through affiliates, and enables mobile phone users to dial into the
Company's server. The software is developed for internal use and gives the
Company the ability to provide value added information services. In accordance
with SOP 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," the Company capitalizes the external cost incurred
to develop this internal-use software by an engineering company at the
application development stage and amortizes that cost over the estimated
economic life of the software (two or three years) which is consistent with the
expected life of a particular type of mobile phone.
Property and equipment
Property and equipment are recorded at cost and are stated net of accumulated
depreciation. Depreciation expense is determined using the straight-line method
over the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
Maintenance and repairs are charged directly to expense as incurred, whereas
betterment and renewals are generally capitalized in their respective property
accounts. When an item is retired or otherwise disposed of, the cost and
applicable accumulated depreciation are removed and the resulting gain or loss
is recognized and reflected as an item before operating income.
Impairment of Long-Lived Assets
The Company applies the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", issued by the Financial Accounting
Standards Board ("FASB"). SFAS No. 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value. There was no impairment of long-lived assets during the year ended
December 31, 2005 and three months ended March 31, 2006.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, advances
and deposits to supplier, accounts payable and other current liabilities are
reasonable estimates of their fair value because of the short maturity of these
items.
Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payment". SFAS No. 123R requires companies to estimate the fair
value of share-based payment awards on the date of grant using an option-pricing
model. The value of the portion of the award that is ultimately expected to vest
is recognized as expense ratably over the requisite service periods. Currently,
the Company does not have a stock option plan.
Value Added Tax
TCH is subject to value added tax ("VAT") imposed by the PRC on TCH's domestic
product sales. The output VAT is charged to customers who purchase mobile phones
from TCH and the input VAT is paid when TCH purchases mobile phones from its
vendors. The VAT rate applied for TCH is 17%. The input VAT can be offset
against the output VAT.
F-9
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires an entity to recognize
deferred tax liabilities and assets. Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the difference between
the tax bases of assets and liabilities and their reported amounts in the
financial statements. Deferred tax assets and liabilities are measured using the
enacted tax rate expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The Company establishes a
valuation when it is more likely than not that that the assets will not be
recovered.
The Company's Chinese subsidiary, TCH, is registered at Pudong District in
Shanghai and subject to a favorable income tax rate of 15% compared to a normal
income tax rate of 33% (30% for the central government and 3% for the local
government) under current PRC tax laws. Sifang Information is registered in the
Shanghai downtown and the area has been treated by the Shanghai Municipal
Administration of Labor as an enterprise that provides unemployed and
handicapped people with jobs. Accordingly, Sifang Information is entitled to a
favorable income tax rate of 15% and qualified for an income tax exemption for
three years from January 1, 2000 to December 31, 2002, and a 50% income tax
reduction for three years from January 1, 2003 to December 31, 2005. The income
tax provisions presented in the Company's consolidated financial statements for
the three months ended March 31, 2005 and 2006 are based on 15% of income
taxable to TCH. The deferred tax assets are determined based on the historical
income tax rates applicable at the TCH level.
There is no income tax for companies domiciled in the Cayman Islands.
Accordingly, the Company's consolidated financial statements do not present any
income tax provisions related to Cayman Islands tax jurisdiction.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S.GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
materially from those estimates.
Comprehensive Income
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", issued by
the FASB. SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company has chosen to report comprehensive income in
the statements of income and comprehensive income. Comprehensive income is
comprised of net income and all changes to shareholders' equity except those due
to investments by shareholders and distributions to shareholders.
Earnings Per Share
The Company computes earnings per share in accordance with the SFAS No. 128,
"Earnings per Share". Basic earnings per share includes no dilution and is
computed by dividing net income available to common shareholders by the weighted
average number of shares outstanding during the period. Diluted earnings per
share reflect the potential dilution of securities that could share in the
earnings of an entity if they were converted. The Company did not have any
potentially dilutive common share equivalents as of March 31, 2005 or 2006.
Reclassifications
Certain amounts included in the prior period's consolidated financial statements
have been reclassified to conform to the current period presentation. Such
reclassifications did not have any effect on reported net income and are
immaterial to the consolidated financial statements as a whole.
F-10
NOTE 3 - EQUITY TRANSACTIONS
On August 9, 2005, the Company announced its intent to apply for listing on the
American Stock Exchange ("AMEX"). In connection with the AMEX application,
certain persons who held more than 200,000 shares of the Company's common stock
entered in lockup agreements with the Company where they generally agreed to not
offer, sell, assign or otherwise transfer a portion of their shares or other
equity securities of the Company without prior written consent of the Company
until the earlier of (i) 180 days after the date of the lockup agreements or
(ii) the date that AMEX has approved the Company's listing application. The
lockup agreements became effective on September 21, 2005, and were executed by
ten of the Company's officers and directors and three additional shareholders.
Under the lockup agreements with the non-officer/director shareholders, the
Company issued an aggregate of 128,576 shares of common stock in consideration
thereof.
NOTE 4 - RELATED PARTY TRANSACTIONS
Related Party Relationships
The following related parties are related through common ownership with the
major shareholders of the Company:
Shanghai Sifang Information Technology Co. ("Sifang Information")
Shanghai Tianci Industry Co. Ltd. ("Tianci Industry")
Shanghai Tianci Industry Group Co. Ltd. ("Tianci Group")
Shanghai Shantian Telecommunication Co. Ltd. ("Shantian")
Shanghai Sifang Telecommunication Co. Ltd. ("Sifang Telecom")
Shanghai Tianci Real Estate Co. Ltd. ("Tianci Real Estate")
Shanghai Sifang Media Co., Ltd. ("Sifang Media")
Merchandise Sold to Related Parties
Three months Ended March 31,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Shantian $ 4,060,514 $ 890,744
------------ ------------
During the three months ended March 31, 2006, TCH sold Samsung GSM mobile phones
valued at $890,744 at a gross profit margin of 12.7% or $112,860 to Shantian,
compared to $4,060,514 at a gross profit margin of 2.4% or $96,609 for the same
period of the prior year. Accounts receivable includes nil and $567,307 due from
Shantian, as of December 31, 2005 and March 31, 2006, respectively.
Advertising Services Rendered to Related Party
Three months Ended March 31,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Tianci Real Estate $ 459,131 $ 177,159
------------ ------------
In January 2005, Sifang Media and TCH entered into the "Bank Digital TV's
Cooperation Agreement", where TCH will assist in the promotion of TV ads for
various customers, including Tianci Real Estate. TCH received a fee of $177,159
for providing the service during the three months ended March 31, 2006, compared
to $459,131 for the same period of the prior year. There was an "Advertisement
Agency Contract" between Tianci Real Estate and Sifang Media, which terminated
in November 2005.
F-11
Service Provided by Related Party
Three months Ended March 31,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Sifang Information $ 121,556 $ 33,966
------------ ------------
In accordance with terms contained in signed service agreements between TCH and
Sifang Information giving TCH the right to use Sifang Information's facility
(which may not be owned by foreign investors at the present time) to transmit
the reformatted information, the Company paid service fees of $90,618 and
$19,898 for the three months ended March 31, 2005 and 2006, respectively. The
service agreements are in effect for ten years and became effective on June 1,
2004.
During the three months ended March 31, 2006, Sifang Information also provided
other management support and marketing services to TCH for $14,068, compared to
$30,938 for the three months ended March 31, 2005.
Due from Related Parties
December 31, 2005 March 31, 2006
----------------- -----------------
(unaudited)
Sifang Information $ 2,165,624 $ 4,779,528
Sifang Media 929,345 860,671
----------------- -----------------
$ 3,094,969 $ 5,640,199
================= =================
In order to develop the Company's mobile phone distribution business, the
Company applied to become a distributor of Nokia mobile phones (on the
provincial level). On March 20, 2005, TCH signed an agreement with Sifang
Information with respect to the distribution of Nokia mobile phones and under
which TCH will act as an agent to sell Nokia phones on Sifang Information's
behalf. In May 2005, Sifang Information obtained the final approval from Nokia.
In order to develop the Company's advertising service business, in January 2006,
the Company entered into an agreement with Sifang Information for the
establishment of a new joint cooperation entity with a third party. The joint
cooperation entity will act as the sole advertising agent of TCH. The Company
has advanced RMB20,000,000 (equivalent to $2,494,699) to Sifang Information to
contribute to the joint cooperation entity. The remaining outstanding advances
of $2,284,829 to Sifang Information was for the mobile phone and information
services business. These advances will be repaid by December 31, 2006.
As of March 31, 2006, Sifang Media has collected $929,345 from TCH's advertising
customers on its behalf and settled $68,674 to TCH.
Deposit for Business Acquisition
In December 2005, TCH entered into a series of agreements to purchase (i) 95% of
the equity interests of Shanghai Kena Energy Saving Electric Co Ltd ("Kena") for
an aggregate purchase price of RMB 28,500,000 (approximately $3,532,000); (ii) a
related patent from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000); and (iii) related rights to make a patent
application from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000). The purchase price for both the equity interests in
Kena and the consideration for purchase of the patent and the right to apply for
registration of the patent shall be paid by Sifang Information on behalf of TCH.
On February 10, 2006, these agreements were amended to impose an additional
condition on Mr. Zhang Naiyao, the transferor of the patent and holder of the
right to make the patent application, that if he fails to provide the necessary
technical assistance services to enable TCH to use the patented technology in
producing products on a large scale that meet the standards set by the Company
within one year, TCH shall have the right to demand the return of the relevant
F-12
payment received by him in full and to terminate the agreement for the
assignment of the patent and the right to apply for registration of the patent.
The amendments also set forth the arrangement for payment of the purchase price
between TCH and Sifang Information. The purchase price for both the equity
interests in Kena and the consideration for purchase of the patent and the right
to apply for registration of the patent shall be paid by Sifang Information on
behalf of TCH. According to the amended agreements, the amount of the purchase
consideration paid by Sifang Information on behalf of TCH will be applied to
offset the trade receivables owed to TCH by Sifang Information.
Kena was established on April 26, 2005 and it specializes in the research,
development and manufacture of energy-saving products, as well as illumination
projects in China. The patent and patent application mentioned above relate to a
"three phase transformer" which is used in connection with a power supply system
and utilizes technology that allows manufacturers to produce transformers with
high energy transfer efficiency at a low costs. This technology is expected to
be available for mass production within one year.
The transactions are subject to regulatory approval in the PRC.
Due to Related Parties
December 31, 2005 March 31, 2006
----------------- -----------------
(unaudited)
Tianci Real Estate $ 123,467 $ 136,759
Shantian 99,932 100,596
----------------- -----------------
$ 223,399 $ 237,355
================= =================
The balance owed to Tianci Real Estate represented rental payments since 2004
and the expenses paid by Tianci Real Estate on behalf of the Company during the
three months ended March 31, 2006 and the year ended December 31, 2005,
respectively. The balance owed to Shantian represents the advances received from
Shantian for mobile phone sales. All of the above amounts due to related parties
are unsecured, non-interest bearing and due on demand.
NOTE 5 - SEGMENT REPORTING
The Company currently operates in four principal business segments. Management
believes that the following table presents the useful information to the chief
operation decision makers for measuring business performance and financing needs
and preparing the corporate budget, etc. As most of the Company's customers are
located in the Shanghai metropolitan area and the Company's revenues are
generated in Shanghai, the PRC, no geographical segment information is
presented.
Advertising
Service Mobile Phone Beep Pagers
Revenue Phone Sales Service Service Corporate Total
------------ ------------ ------------ ------------ ------------ ------------
Three months ended
March 31, 2005
Revenues $ 459,131 $ 4,729,705 $ 401,610 $ 207,605 $ -- $ 5,798,051
Gross profit 436,312 159,912 298,413 140,124 -- 1,034,761
Depreciation -- -- 53,371 -- 14,313 67,684
Interest income, net -- -- -- -- 465 465
Net income 363,499 75,768 213,177 88,588 (74,624) 666,408
Expenditures for long-lived
assets -- -- 50,452 -- -- 50,452
Total assets, as at March
31, 2005 -- 8,626,642 288,170 -- 4,513,647 13,428,459
F-13
Three months ended
March 31, 2006
Revenues $ 177,159 $ 1,240,741 $ 132,557 $ 129,228 $ -- $ 1,679,685
Gross profit 137,103 129,123 9,842 62,624 -- 338,692
Depreciation -- -- 38,637 -- 9,659 48,296
Interest income, net -- -- -- -- 115 115
Net income 73,402 68,195 (9,628) 24,809 (88,644) 68,134
Expenditures for long-lived
assets -- -- -- -- -- --
Total assets, as at March
31, 2006 -- 850,219 139,055 -- 13,935,016 14,924,290
NOTE 6 -EMPLOYEE WELFARE AND RETIREMENT BENEFITS
The PRC has been undergoing significant reforms with regard to its employee
welfare and fringe benefits administration. Any enterprise operating in the PRC
is subject to government-mandated employee welfare and retirement benefit
contribution. In accordance with PRC laws and regulations, TCH participates in a
multi-employer defined contribution plan pursuant to which TCH is required to
provide employees with certain retirement, medical and other fringe benefits.
PRC regulations require TCH to pay the local labor administration bureau a
monthly contribution at a stated contribution rate based on the monthly basic
compensation of qualified employees. The local labor administration bureau,
which manages various investment funds, will take care of employee retirement,
medical and other fringe benefits. TCH has no further commitments beyond its
monthly contribution. TCH contributed a total of $12,782 and $11,934 to these
funds as part of selling, general and administrative expenses for the three
months ended March 31, 2005 and 2006, respectively.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments--an amendment of FASB Statements No. 133 and 140," to
permit fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation in
accordance with the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 155 is effective for all financial
instruments acquired, issued, or subject to a remeasurement event occurring
after the beginning of an entity's fiscal year that begins after September 15,
2006. We will adopt SFAS No. 155 in fiscal year beginning January 1, 2007. The
adoption of this Statement is not expected to have a material effect on our
consolidated financial statements.
In March 2006, FASB issued SFAS No. 156, "Accounting for Servicing of Financial
Assets--an amendment of FASB Statement No. 140," that provides guidance on
accounting for separately recognized servicing assets and servicing liabilities.
In accordance with the provisions of SFAS No. 156, separately recognized
servicing assets and servicing liabilities must be initially measured at fair
value, if applicable. Subsequent to initial recognition, the company may use
either the amortization method or the fair value measurement method to account
for servicing assets and servicing liabilities within the scope of this
Statement. SFAS No. 156 is effective as of the beginning of an entity's fiscal
year that begins after September 15, 2006. The Company will adopt SFAS No. 156
in fiscal year beginning January 1, 2007. The adoption of this Statement is not
expected to have a material effect on our consolidated financial statements.
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)", that will become effective beginning July 2006. FSP FIN No. 46(R)-6
clarifies that the variability to be considered in applying Interpretation 46(R)
shall be based on an analysis of the design of the variable interest entity. The
adoption of this FSP is not expected to have a material effect on our
consolidated financial statement.
F-14
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To the Shareholders and Board of Directors
China Digital Wireless, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of China Digital
Wireless, Inc. and Subsidiary (the "Company") as of December 31, 2004 and 2005
and the related consolidated statements of income and comprehensive income,
shareholders' equity and cash flows for each of the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal controls over financial reporting. Our audits included consideration of
internal controls over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, 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. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of China
Digital Wireless, Inc. and Subsidiary as of December 31, 2004 and 2005, and the
consolidated results of their operations and cash flows for each of the years
then ended in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 5 to the consolidated financial statements, the Company has
had numerous significant transactions with businesses controlled by, and with
people who are related to, the officers and directors of the Company.
GROBSTEIN, HORWATH & COMPANY LLP
Sherman Oaks, California
March 31, 2006
F-15
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2004 2005
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 75,511 $ 3,578,367
Accounts receivable, net of allowance for doubtful accounts
of $47,922 and $44,472 4,619,809 844,977
Inventories 101,696 62,386
Deferred tax assets 28,772 12,846
Common stock proceeds held in escrow 1,500,000 --
Amounts due from related parties 4,987,956 3,094,969
Advances and deposits to suppliers 150,412 19,970
------------ ------------
Total current assets 11,464,156 7,613,515
------------ ------------
Property and equipment, net 1,198,509 1,105,756
Deposit for business acquisition -- 6,257,590
------------ ------------
Total assets $ 12,662,665 $ 14,976,861
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 55,839 $ 881,218
Advance from customers -- 6,399
Deferred revenue 617,694 31,598
VAT payable 213,535 92,649
Income tax payable 312,763 193,586
Amounts due to related parties 100,260 223,399
Other current liabilities 287,025 375,960
------------ ------------
Total current liabilities 1,587,116 1,804,809
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value, 100,000 000 shares
authorized, 17,147,268 (2004 - 17,018,692) shares issued
and outstanding 17,019 17,148
Additional paid-in capital 4,229,974 4,229,845
Retained earnings 6,828,281 8,084,922
Restricted reserves -- 554,466
Accumulated other comprehensive income 275 285,671
------------ ------------
Total shareholders' equity 11,075,549 13,172,052
------------ ------------
Total liabilities and shareholders' equity $ 12,662,665 $ 14,976,861
============ ============
See accompanying notes to consolidated financial statements
F-16
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Years Ended December 31,
---------------------------
2004 2005
------------ ------------
Revenues:
Product sales $ 11,057,398 $ 5,775,069
Product sales to related parties 9,891,691 10,608,287
Information service revenue, net 3,571,861 1,274,068
Advertising service revenue, net -- 2,761,598
------------ ------------
Total revenue 24,520,950 20,419,022
------------ ------------
Cost of goods sold 10,196,443 5,800,878
Cost of goods sold to related parties 9,412,389 10,224,081
Cost of information service 1,045,993 681,624
Cost of advertising service -- 141,554
------------ ------------
Total cost of goods sold 20,654,825 16,848,137
------------ ------------
Gross profit 3,866,125 3,570,885
------------ ------------
Operating expenses:
Sales and marketing 246,639 134,639
General and administrative 1,656,841 1,251,166
------------ ------------
Total operating expenses 1,903,480 1,385,805
------------ ------------
Income from operations 1,962,645 2,185,080
Other revenue -- 8,387
Governmental subsidy -- 108,476
Interest income (expense) 1,955 (9,093)
------------ ------------
Income before income taxes 1,964,600 2,292,850
Income tax provision 369,971 481,743
------------ ------------
Net income $ 1,594,629 $ 1,811,107
============ ============
Other comprehensive income
Translation adjustments $ 263 $ 285,396
Comprehensive income $ 1,594,892 $ 2,096,503
============ ============
Basic and diluted earnings per share $ 0.10 $ 0.11
Weighted average shares of common stock outstanding 15,458,000 17,054,368
See accompanying notes to consolidated financial statements.
F-17
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In U.S. dollars, except share data)
Other
Common Stock Additional Comprehensive Total
Paid-in Retained Restricted Income Shareholders'
Shares Amount Capital Earnings Reserves (Loss) Equity
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 13,782,636 $ 13,783 $ 1,436,217 $ 5,233,652 $ -- $ 12 $ 6,683,664
2003
Recapitalization and
reorganization 1,585,705 1,586 308,465 -- -- -- 310,051
Shares issued for
consulting services 167,895 168 604,254 -- -- -- 604,422
Shares issued for proceeds
of $190,000 and consulting
services 166,667 167 599,834 -- -- -- 600,001
Shares issued for net
proceeds of $1.5 million 1,315,789 1,315 1,498,685 -- -- -- 1,500,000
Offset by issuing cost -- -- (217,481) -- -- -- (217,481)
Net income -- -- -- 1,594,629 -- -- 1,594,629
Foreign currency
translation adjustment -- -- -- -- -- 263 263
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31,
2004 17,018,692 $ 17,019 $ 4,229,974 $ 6,828,281 $ -- $ 275 $ 11,075,549
Issuance of common stock in
exchange for lock up
agreements 128,576 129 (129) -- -- -- --
Net income -- -- -- 1,811,107 -- -- 1,811,107
Transfer from retained
earnings to restricted
reserves (note 11) -- -- -- (554,466) 554,466 -- --
Foreign currency
translation adjustment -- -- -- -- -- 285,396 285,396
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31,
2005 17,147,268 $ 17,148 $ 4,229,845 $ 8,084,922 $ 554,466 $ 285,671 $ 13,172,052
============ ============ ============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
F-18
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
--------------------------
2004 2005
----------- -----------
Cash flows from operating activities:
Net income $ 1,594,629 $ 1,811,107
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 287,232 239,716
Bad debt expenses 19,764 (3,450)
Issuance of common stock to consultants for services 1,014,423 --
Deferred taxes (23,817) 15,926
(Gain) loss on disposal of fixed assets 652 (8,914)
Changes in assets and liabilities:
Accounts receivable (2,276,245) 3,778,282
Inventories 1,489,527 39,310
Amounts due from related parties -- (929,345)
Other current assets 25,438 130,442
Accounts payable (55,730) 825,379
Advance from customers -- 6,399
Deferred revenue 80,648 (586,096)
VAT payable 213,535 (120,886)
Income tax payable 312,763 (119,177)
Amounts due to related parties 79,720 123,139
Other current liabilities 191,234 88,935
----------- -----------
Net cash provided by operating activities 2,953,773 5,290,767
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (132,155) (425,525)
Proceeds on disposal of property and equipment -- 309,214
Amounts due from related parties (4,742,688) (3,435,258)
----------- -----------
Net cash used in investing activities (4,874,843) (3,551,569)
----------- -----------
Cash flows from financing activities:
Recapitalization and reorganization 310,051 --
Proceeds from issuing common stock 1,690,000 --
Common stock proceeds held in escrow (1,500,000) 1,500,000
Issuing cost (217,481) --
----------- -----------
Net cash provided by financing activities 282,570 1,500,000
----------- -----------
Foreign currency translation 263 263,658
----------- -----------
Net increase (decrease) in cash and cash equivalents (1,638,237) 3,502,856
Cash and cash equivalents, beginning of the year 1,713,748 75,511
----------- -----------
Cash and cash equivalents, end of the year $ 75,511 $ 3,578,367
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the yearfor:
Interest $ -- $ --
Income taxes $ 76,339 $ 590,481
Non-cash investing and financing activities:
Deposit for business acquisition in exchange for reduction in accounts
receivable $ -- $ 6,257,590
=========== ===========
Issuance of common stock to consultants for consulting services $ 1,014,423 $ --
=========== ===========
See accompanying notes to consolidated financial statements.
F-19
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS BACKGROUND
China Digital Wireless, Inc. ("CDW," formerly known as Boulder Acquisitions,
Inc.) through its subsidiary sells mobile phones to retailers, distributors, and
related parties, provides advertising services and provides information services
to users of mobile phones and pagers. Substantially all operations are conducted
in Shanghai, People's Republic of China ("PRC").
In order to meet ownership requirements under Chinese law that restrict a
foreign company, from operating in certain industries such as value-added
telecommunication and Internet services, CDW's subsidiary has entered into
information service and cooperation agreements with two of CDW's affiliates that
are incorporated in China: Shanghai Sifang Information Technology Co. ("Sifang
Information") and Shanghai Tianci Industry Co. Ltd ("Tianci Industry"). CDW
holds no ownership interest in Sifang Information or Tianci Industry. Sifang
Information and Tianci Industry contract with China Mobile Communications
Corporation, or China Mobile, and China United Telecommunications Corporation,
or China Unicom, respectively, to provide wireless value-added information
services to wireless receiver customers in China via China Mobile and China
Unicom. Sifang Information transmits those services to customers of China Mobile
and China Unicom on behalf of itself and Tianci Industry pursuant to a signed
agreement between Sifang Information and Tianci Industry.
Recapitalization and Reorganization
On June 23, 2004, Boulder Acquisitions, Inc. ("Boulder Acquisitions") entered
into a stock exchange agreement with Sifang Holdings Co. Ltd. ("Sifang
Holdings") and certain shareholders. Pursuant to the stock exchange agreement,
Boulder Acquisitions issued 13,782,636 shares of its common stock in exchange
for a 100% equity interest in Sifang Holdings, making Sifang Holdings a wholly
owned subsidiary of Boulder Acquisitions.
Boulder Acquisitions was incorporated under the laws of the State of Colorado on
May 8, 1980 as Boulder Brewing Company ("Boulder Brewing"). Boulder Brewing was
the successor to a general partnership formed in 1979. From the initial
inception of the original partnership through 1990, Boulder Brewing was in the
business of operating a microbrewery in Boulder, Colorado. During 1990, as a
result of various debt defaults, Boulder Brewing's assets were foreclosed upon
and all business operations were ceased. Boulder Brewing has effectively had no
operations, assets or liabilities since its fiscal year ended December 31, 1990.
In September 2001, Boulder Brewing changed its state of incorporation from
Colorado to Nevada by means of a merger with and into Boulder Acquisitions, a
Nevada corporation formed on September 6, 2001 solely for the purpose of
effecting the reincorporation. The Articles of Incorporation and Bylaws of the
Nevada corporation are the Articles of Incorporation and Bylaws of the surviving
corporation. Such Articles of Incorporation eliminated the provision for Boulder
Acquisitions to issue preferred stock.
The above stock exchange transaction resulted in those shareholders of Sifang
Holdings obtaining a majority voting interest in Boulder Acquisitions. Generally
accepted accounting principles in the United States of America require that the
company whose shareholders retain the majority interest in a combined business
be treated as the acquirer for accounting purposes. Consequently, the stock
exchange transaction has been accounted for as a recapitalization of Sifang
Holdings as Sifang Holdings acquired a controlling equity interest in Boulder
Acquisitions, as of June 23, 2004. The reverse acquisition process utilizes the
capital structure of Boulder Acquisitions and the assets and liabilities of
Sifang Holdings recorded at historical cost.
F-20
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Sifang Holdings is the continuing operating entity for financial reporting
purposes, and the financial statements prior to June 23, 2004 represent Sifang
Holdings' financial position and results of operations. As of June 23, 2004,
Boulder Acquisitions had only cash of $310,051, and shareholders' equity of
$310,051 with 1,585,705 shares of common stock outstanding, all of which were
included in the consolidated financial statements of Sifang Holdings. See the
shareholders' equity statements for the period from January 1, 2004 to December
31, 2005. Although Sifang Holdings is deemed to be the acquiring corporation for
financial accounting and reporting purposes, the legal status of Boulder
Acquisitions as the surviving corporation did not change. Subsequent to June 30,
2004, Boulder Acquisitions changed its name to China Digital Wireless, Inc.
Business History
CDW's business is primarily conducted through its wholly-owned subsidiary Sifang
Holdings and its wholly-owned subsidiary TCH Data Technology Co., Ltd. ("TCH"),
that collectively with CDW are referred to as the "Company". Sifang Holdings was
established under the laws of the Cayman Islands on February 9, 2004 for the
purpose of holding a 100% equity interest in TCH. TCH was established as a
foreign investment enterprise in Shanghai under the laws of the PRC on May 25,
2004, with registered capital of $7.2 million.
CDW's current operations were originally a business division of Sifang
Information. Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business to
TCH. As the acquiring entity under common control, TCH initially recognized all
the assets and liabilities transferred at their carrying amounts in the accounts
of Sifang Information at the date of transfer under the guidance of Statements
of Financial Accounting Standards ("SFAS") No. 141, Appendix D.
On May 26, 2004, Sifang Information exchanged 100% of the equity interest in TCH
for 100% of the equity interest in Sifang Holdings. Since the ultimate owners of
the three entities were the same owners and the three entities remained under
common control, the ownership exchange transaction was accounted for at
historical costs under the guidance of SFAS No. 141, Appendix D. Prior to May
26, 2004, there were no activities in Sifang Holdings. As a result of the
exchange of ownership between TCH and Sifang Holdings, TCH's historical
financial statements became the historical financial statements of Sifang
Holdings.
As a result of the spin-off, the Company engages in the business of mobile phone
distribution and provides pager and mobile phone users with access to certain
value-added information reformatted by TCH. TCH purchases mobile phones from
first tier distributors and sells them to retailers and distributors with a
mark-up. In the process of providing value-added information services through
entering into monthly subscription agreements with various users, TCH purchases
trading activity information from stock exchanges, comments and analysis on PRC
stock markets provided by certain reputable security and investment companies,
lottery information, weather forecast, and other value-added products and
reformats the aforementioned information through decoding and recoding and then
has the reformatted information transmitted by Sifang Information, via service
contracts, to pager users. The value-added information is constantly saved on
TCH's server in order for mobile phone users to dial in via China Mobile or
China Unicom. By signing a monthly subscription agreement, wireless receiver
users agree to make advance payments for the services for either three or
six-month subscription periods.
F-21
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the spin-off process, the cost of sales included in the Company's financial
statements is directly related to the product revenue and the cost of services
is directly related to different types of service. The business taxes (similar
to sales taxes in the U.S.) are related only to service revenue at a tax rate of
approximately 3.3%. The selling expenses are allocated based on the relationship
between expense and revenue (such as commission) and payroll records. The
general and administrative expenses are allocated based on management hours
spent and payroll records. The income tax provision has been calculated on a
separate company basis and is in line with the historical actual income tax
provision at the Sifang Information level assuming that all income taxes had
been paid by Sifang Information and no income tax liability was in existence in
the periods reported in the accompanying financial statements. Management
believes that the costs, operating expenses, interest expense, and income tax
provision included in the Company's financial statements are a reasonable
representation of the costs and expenses that would have been incurred if the
Company had performed these functions as a stand-alone company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") for annual financial statements. The consolidated
financial statements, in the opinion of management, include all adjustments
necessary for a fair statement of the consolidated results of operations,
financial position and cash flows for each period presented.
The Company's consolidated financial statements for the year ended December 31,
2004 have been derived from the historical financial statements and accounting
records of Sifang Information using the historical operating results and the
historical basis of the assets and liabilities transferred to the Company in
accordance with GAAP. Management believes that the assumptions underlying the
accompanying financial statements are reasonable. However, the financial
statements that are derived from Sifang Information's financial records may not
necessarily reflect the Company's results of operations and cash flows had the
Company been a stand-alone company.
Principles of Consolidation
The consolidated financial statements include the accounts CDW, its wholly owned
subsidiary, Sifang Holdings, and its wholly owned subsidiary TCH. Substantially
all of the Company's revenues are derived from the operations of TCH, which
represents substantially all of the Company's consolidated assets and
liabilities. All significant intercompany accounts and transactions have been
eliminated.
Foreign Currency Translations and Transactions
The Renminbi ("RMB"), the national currency of the PRC, is the primary currency
of the economic environment in which the operations of the Company are
conducted. The Company uses the United States dollar ("U.S. dollars") for
financial reporting purposes.
The Company translates its financial statements into U.S. dollars in accordance
with SFAS No. 52, "Foreign Currency Translation." All asset and liability
accounts have been translated using the rate of exchange prevailing at the
balance sheet date (at December 31, 2005, the prevailing exchange rate of the US
dollar against the RMB was 8.0702), and the statement of income is translated at
average rates during the reporting period. Equity items are translated at
historical rates. Adjustments resulting from the translation of the Company's
F-22
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial statements from RMB into U.S. dollars are recorded in shareholders'
equity as part of accumulated comprehensive income. Gains or losses resulting
from transactions in currencies other than RMB are reflected in the statement of
income for the reporting periods.
Revenue Recognition
The Company derives revenues from the sale of mobile phones, advertisement
designing services and the provision of wireless information services that are
used on mobile phones, pagers and prepaid phone cards. The Company additionally
earns commission income ("Agency Income") from the sale of CDMA mobile phones on
the behalf of a related party. The Company recognizes its revenue net of related
business taxes and value added taxes.
Mobile Phone Sales:
Revenues generated from the sale of mobile phones are recognized when the
products are shipped to the distributor or retailer and when persuasive evidence
of an arrangement exists, delivery of the products has occurred, customer
acceptance has been obtained, which means the significant risks and rewards of
ownership have been transferred to the customer, the price is fixed or
determinable and collectibility is reasonably assured.
Advertising Servicing Revenue, Net:
Advertising revenues are derived from advertisement designing, masterminding and
producing services. The Company recognizes service revenue over the term of the
noted agreement at the time of completion of the services. The Company records
the revenue from Shanghai Sifang Media Co., Ltd. ("Sifang Media") on a net basis
in accordance with EITF 99-19, "Reporting Revenue Gross as a Principle versus
Net as an Agent" because the Company is not the primary obligor in the
arrangements, receives a fixed fee from Sifang Media, and has no latitude in
determining prices.
Information Services:
The Company recognizes service revenues over the term of the noted agreement
and/or when the services have been provided to the end user.
i) Information Services - TCH:
By signing a subscription agreement, wireless receiver users agree to make
payments for three to six-month subscriptions in advance. TCH records the
proceeds as deferred revenue and amortizes the deferred revenue over the
subscription period. When customers buy a pre-charged service card, the Company
records the proceeds as deferred revenue. When a customer starts to use this
card to access to the Company's server and starts to use a pager to access the
aforementioned information, the Company identifies the subscription period and
amortizes the deferred revenue over the subscription period.
ii) Information Services - Installing Agent:
In response to a retailer's request, the Company has an installing agent install
the Company's software on mobile phones, which are owned by the retailer. The
retailer sells these phones for a premium covering a fee to be paid to the
installing agent and pre-charged six-month subscription fees to be paid to the
Company. After a customer using such a phone dials into the server to access the
desired information, the server records a unique identification number installed
on the mobile phone, which indicates that a specific phone user starts his or
her subscription period. After the Company receives a detailed list from the
installing agent regarding the number of phones that have been installed with
F-23
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the Company's software, the Company matches this information with a detailed
list from the retailer setting forth how many such phones have been sold. Based
on the number of such phones sold, the Company records accounts receivable and
deferred revenue correspondingly. At the date on which a customer starts to dial
into the server, the six-month subscription period begins and the Company
amortizes deferred revenue accordingly.
iii) Information Services - China Mobile and/or China Unicom:
The Company's affiliates, Sifang Information and Shanghai Tianci Industrial
Group Co., Ltd. ("Tianci Group"), contract with China Mobile and/or China Unicom
(collectively, "Mobile Operators") for the transmission of the Company's
value-added information services. The Mobile Operators bill and collect from
customers and then pass those fees (net of billing and collection service fees
charged by the Mobile Operators) to Sifang Information and Tianci Group who in
turn pass those fees to the Company. The Company recognizes net revenues based
on the total amount paid by its customers, for which the Mobile Operators bill
and collect on behalf of the Company. There is a time lag ranging from 10 days
to 45 days between the end of the service period and the date the Mobile
Operators send out their billing statements due to the segregated billing
systems of each of the provincial subsidiaries of the Mobile Operators. The
Company has not recognized service revenue based on the records provided by its
own server but has performed a reconciliation on a monthly basis of the revenues
recognized by the Company's server to the Mobile Operator's billing statement.
In addition, the Mobile Operators charge a network usage fee based on a fixed
per message fee multiplied by the excess of messages sent over messages
received. (This type of service is not covered by a monthly service subscription
and the Company has no control over whether it will occur or not.) Network usage
fees charged by the Mobile Operators are reduced for messages received by the
Company because the Mobile Operators separately charge the sender a fee for
these transmissions.
The Company records the revenue from the Mobile Operators on a net basis in
compliance with EITF 99-19, "Reporting Revenues Gross as a Principle versus Net
as an Agent" because the Company:
o Is not the primary obligor in the arrangement, as it relies on Sifang
Information to transmit the information services to the end user,
o Has limited ability to adjust the cost of services by adjusting the
design or marketing of the service,
o Has limited ability to determine prices, and the Company must follow
the price policy within ranges prescribed by Mobile Operators, and
o Has limited ability to assume risk of non-payment by customers.
The Company's dependence on the substance and timing of the billing systems of
the mobile telecommunications operators may require us to estimate portions of
their reported revenue for information services from time to time. As a result,
subsequent adjustments may be made to our information service revenue in our
consolidated financial statements. As we do not bill their information services
users directly, we depend on the billing systems and records of the mobile
telecommunications operators to record the volume of their information services
provided, to charge our users through mobile telephone bills, to collect
payments from our users, and to pay us.
F-24
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less to be cash equivalents. The Company maintains its cash accounts
at credit worthy financial institutions.
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to
retailers and distributors who are mainly located in the Shanghai metropolitan
area. Typically, for mobile phone distributors, credit terms require payment to
be made within 30 days of the sale. The Company does not require collateral from
its customers. The Company's policy is to provide for an allowance for doubtful
accounts that is based on 5% of total trade accounts receivable less amounts due
from related parties and from the installing agent.
The Company regularly evaluates and monitors the creditworthiness of each
customer on a case-by-case basis. The Company includes any account balances that
are determined to be uncollectible in the overall allowance for doubtful
accounts. After all attempts to collect a receivable have failed, the receivable
is written off against the allowance. The Company believes that its allowance
for doubtful accounts was adequate as of December 31, 2004 and 2005. However,
actual write-offs might exceed the recorded allowance.
The following table presents activities in the allowance for doubtful accounts.
December 31
-----------------------
2004 2005
---------- ----------
Beginning balance $ 28,158 $ 47,922
Additions charged to expense 19,764 --
Recovered -- (3,450)
Actual write off -- --
---------- ----------
Ending balance $ 47,922 $ 44,472
========== ==========
Inventories
Inventories consist principally of mobile phones manufactured by name brand
manufacturers with various features and are stated at the lower of cost
(weighted-average) or market.
Rebates and Credits Receivable
In 2004, the Company's major vendor began providing rebates and credits if the
Company meets certain sales volume levels prescribed by the vendor. As a result,
the Company is entitled to receive certain rebates and credits for the inventory
held and sold by the Company within the specified period of time as defined by
its vendor through submitting the necessary application forms. In general, once
the vendor approves these applications the amounts of these rebates and credits
will be deducted from the Company's accounts payable to its vendor and decrease
the cost of goods sold or inventory held correspondingly.
Capitalization of Software Costs
The Company's software is developed by an independent third party to enable
pager users to accept certain recoded information which is transmitted by the
Company, through affiliates, and enables mobile phone users to dial into the
Company's server. The software is for internal use and gives the Company the
F-25
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ability to provide value added information services. In accordance with SOP 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," the Company capitalizes the external cost incurred to develop
this internal-use software by an engineering company at the application
development stage and amortizes that cost over the estimated economic life of
the software (two or three years) which is consistent with the expected life of
a particular type of mobile phone.
Property and equipment
Property and equipment are recorded at cost and are stated net of accumulated
depreciation. Depreciation expense is determined using the straight-line method
over the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
Maintenance and repairs are charged directly to expense as incurred, whereas
betterment and renewals are generally capitalized in their respective property
accounts. When an item is retired or otherwise disposed of, the cost and
applicable accumulated depreciation are removed and the resulting gain or loss
is recognized and reflected as an item before operating income.
Impairment of Long-Lived Assets
The Company applies the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", issued by the Financial Accounting
Standards Board ("FASB"). SFAS No. 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value. There was no impairment of long-lived assets in the years ended
December 31, 2004 and 2005.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, advances
and deposits to suppliers, accounts payable and other current liabilities are
reasonable estimates of their fair value because of the short maturity of these
items.
Advertising Expenses:
Advertising expenses are expensed in the period incurred. Advertising expenses
for the years ended December 31, 2004 and 2005 were $60,092 and $17,468,
respectively.
F-26
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Based Compensation
The Company utilizes SFAS No. 123 "Accounting for Stock-Based Compensation",
when accounting for stock based compensation and recognizes the fair value
impact of the compensation granted to employees and consultants as a charge to
net income in the period that the services associated with the compensation are
provided. The Company does not currently have a stock option plan.
Value Added Tax
TCH is subject to value added tax ("VAT") imposed by the PRC on TCH's domestic
product sales. The output VAT is charged to customers who purchase mobile phones
from TCH and the input VAT is paid when TCH purchases mobile phones from its
vendors. The VAT rate applied for TCH is 17%. The input VAT can be offset
against the output VAT.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No 109,
"Accounting for Income Taxes". SFAS No. 109 requires an entity to recognize
deferred tax liabilities and assets. Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the difference between
the tax bases of assets and liabilities and their reported amounts in the
financial statements. Deferred tax assets and liabilities are measured using the
enacted tax rate expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The Company establishes a
valuation when it is more likely than not that that the assets will not be
recovered.
The Company's Chinese subsidiary, TCH, is registered at Pudong District in
Shanghai and subject to a favorable income tax rate of 15% compared to a normal
income tax rate of 33% (30% for the central government and 3% for the local
government) under current PRC tax laws. Sifang Information is registered in the
Shanghai downtown area and has been treated by the Shanghai Municipal
Administration of Labor as an enterprise that provides unemployed and
handicapped people with jobs. Accordingly, Sifang Information is also entitled
to a favorable income tax rate of 15% and qualified for an income tax exemption
for three years from January 1, 2000 to December 31, 2002, and a 50% income tax
reduction for three years from January 1, 2003 to December 31, 2005. The income
tax provisions presented in the Company's financial statements are based on the
actual income tax rates of TCH at 15% for the year ended December 31, 2005. The
income tax provision presented for the year ended December 31, 2004 is based on
7.5% for the months of January to June and 15% for the months of July to
December. The deferred tax assets are determined based on the income tax rates
applicable at the TCH level.
There is no income tax for companies domiciled in the Cayman Islands.
Accordingly, the Company's consolidated financial statements do not present any
income tax provisions related to Cayman Islands tax jurisdiction.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ materially from those estimates.
F-27
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive Income
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", issued by
the FASB. SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company has chosen to report comprehensive income in
the statements of income and comprehensive income. Comprehensive income is
comprised of net income and all changes to shareholders' equity except those due
to investments by shareholders and distributions to shareholders.
Earnings Per Share
The Company presents earnings per share in accordance with the SFAS No. 128,
"Earnings per Share". Basic earnings per share includes no dilution and is
computed by dividing net income available to common shareholders by the weighted
average number of shares outstanding during the period. Diluted earnings per
share reflect the potential dilution of securities that could share in the
earnings of an entity if they were converted. The Company did not have any
potentially dilutive common share equivalents as of December 31, 2004 or 2005.
Reclassifications
Certain amounts included in the prior year's consolidated financial statements
have been reclassified to conform to the current year presentation. Such
reclassifications did not have any effect on reported net income and are
immaterial to the consolidated financial statements as a whole.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, which clarifies
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material. SFAS No. 151 will be effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe
the adoption of SFAS No. 151 will have a material impact on our consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 123-R, Share Based Payments, which
requires that the compensation cost relating to share-based payment transactions
(including the cost of all employee stock options) be recognized in the
financial statements. The cost will be measured based on the estimate fair value
of the equity or liability instruments issued. SFAS No. 123-R covers a wide
range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans. Management believes the adoption of this
pronouncement will not have a material effect on our consolidated financial
statements.
In December 2004, the FASB also issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions". The amendments made by SFAS No. 153 are based on the principle
that the exchange of nonmonetary assets should be measured using the estimated
fair market value of the assets exchanged. SFAS No. 153 eliminates the narrow
exception for nonmonetary exchanges of similar productive assets, and replaces
it with a broader exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has "commercial substance" if the
F-28
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
future cash flows of the entity are expected to change significantly as a result
of the transaction. This pronouncement is effective for monetary exchanges in
fiscal periods beginning after June 15, 2005. Management believes the adoption
of this pronouncement will not have a material effect on our consolidated
financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." This statement requires entities that voluntarily make a change in
accounting principle to apply that change retrospectively to prior periods'
financial statements, unless this would be impracticable. SFAS No. 154
supersedes APB Opinion No. 20, "Accounting Changes", which previously required
that most voluntary changes in accounting principle be recognized by including
in the current period's net income the cumulative effect of changing to the new
accounting principle. SFAS No. 154 also makes a distinction between
"retrospective application" of an accounting principle and the "restatement" of
financial statements to reflect the correction of an error. SFAS No. 154 applies
to accounting changes and error corrections that are made in fiscal years
beginning after December 15, 2005. Management believes the adoption of this
statement will not have an immediate material impact on the consolidated
financial statements of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"),
"Accounting for Conditional Asset Retirement Obligations". FIN 47 clarifies that
the term "conditional asset retirement obligation," which as used in SFAS No.
143, "Accounting for Asset Retirement Obligations", refers to a legal obligation
to perform an asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the
control of the entity. The entity must record a liability for a "conditional"
asset retirement obligation if the fair value of the obligation can be
reasonably estimated. FIN 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. The adoption of this statement does not have an
immediate material impact on the consolidated financial statements of the
Company.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed
by management to have a material impact on the Company's present or future
consolidated financial statements.
NOTE 3 - EQUITY TRANSACTIONS
On June 23, 2004, the Company issued 167,895 shares of its common stock to a
consultant for services relating to the reverse merger that was completed in
fiscal 2004. The trading price of the Company's common stock on June 23, 2004
was $3.60 per share, accordingly, the fair value of 167,895 shares was $604,422.
On June 23, 2004, the Company issued 166,667 shares of its common stock in
exchange for services performed by an existing major shareholder of Boulder
Acquisitions for his consulting services involved with the reverse merger. The
common stock was issued at a price of $1.14 per share in exchange for gross
proceeds of $190,000 based on a stock purchase agreement. The $1.14 per share
price was pre-negotiated between the Company and the shareholder before the
reverse merger had been completed. Pursuant to the stock purchase agreement, the
Company granted the existing shareholder an option which required the Company to
purchase up to the aforementioned 166,667 shares of common stock at a price of
$1.14 per share, such option being exercisable at any time after the date that
is nine months after the Company files a registration statement on Form SB-2
with the SEC, registering the shares purchased by the existing shareholder, up
to and including the earlier of the date that such registration statement is
declared effective by the SEC or the existing shareholder's shares are eligible
for resale under Rule 144 under the Securities Act of 1933. According to Topic
F-29
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
D-98 from the SEC, "Classification and Measurement of Redeemable Securities,"
these shares should be presented outside the permanent equity section. However,
on November 12, 2004, the Company filed a Registration Statement on Form SB-2
with the SEC, for registration of these securities to be sold to the public by
small business issuers. On February 8, 2005, the SEC approved the registration
filing and accordingly, the Company has recorded these shares in shareholders'
equity as the contingency surrounding these shares expired as of February 8,
2005. On June 23, 2004, the trading price of the Company's stock at the end of
the day was $3.60 per share. Due to the relationship between the parties, the
difference between the price of $1.14 per share and the price of $3.60 per share
was recorded as compensation by presenting $410,001 in additional paid-in
capital and in general and administrative expenses.
On June 28, 2004, the Company issued, in aggregate, 1,315,789 shares of its
common stock to three investors at a price of $1.14 per share in exchange for
gross proceeds of $1,500,000 based on a stock purchase agreement. The $1.14 per
share price was pre-negotiated between the Company and the investors before the
reverse merger had been completed. Pursuant to the signed stock purchase
agreement, the Company granted to each of the three investors an option which
requires the Company to purchase up to the aforementioned 1,315,789 shares, in
aggregate, of common stock at a price of $1.14 per share, such option being
exercisable at any time after the date that is nine months after the Company
files a Registration Statement on Form SB-2 with the SEC, registering the shares
purchased by the existing shareholder, up to and including the earlier of the
date that such registration statement is declared effective by the SEC or the
existing shareholder's shares are eligible for resale under Rule 144 under the
Securities Act of 1933. As of December 31, 2004, the proceeds of $1.5 million
were held in an escrow account with an agent who is related to a shareholder. As
of December 31, 2004, the Company has treated the proceeds held in escrow as a
current asset as the entire amount was released from escrow in March 2005 and
paid to the Company. According to Topic D-98 from SEC, "Classification and
Measurement of Redeemable Securities," these shares should be presented outside
the permanent equity section. However, on November 12, 2004, the Company filed a
Registration Statement on Form SB-2 with the SEC, for registration of these
securities to be sold to the public by small business issuers. On February 8,
2005, the SEC declared the registration statement effective. Accordingly, the
Company has recorded these shares in shareholders' equity as the contingency
surrounding these shares expired as of February 8, 2005.
In connection with the June 28, 2004 issuance of common stock, the Company
incurred share issue costs of $217,481 and accounted for it as a reduction of
additional paid-in capital.
On August 9, 2005, the Company announced its intent to apply for listing on the
American Stock Exchange ("AMEX"). In connection with the AMEX application,
certain persons who hold more than 200,000 shares of the Company's common stock
entered into lockup agreements with the Company where they generally agreed to
not offer, sell, assign or otherwise transfer a portion of their shares or other
equity securities of the Company without prior written consent of the Company
until the earlier of (i) 180 days after the date of the lockup agreements or
(ii) the date that AMEX has approved the Company's listing application. The
lockup agreements became effective on September 21, 2005, and were executed by
ten of the Company's officers and directors and three additional shareholders.
Under the lockup agreements with the non-officer/director shareholders, the
Company issued an aggregate of 128,576 shares of common stock in consideration
thereof.
F-30
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - PROPERTY AND EQUIPMENT
A summary of property and equipment at cost is as follows:
December 31,
--------------------------
2004 2005
----------- -----------
Buildings $ 943,391 $ 967,507
Software 489,103 568,704
Vehicles 65,485 89,229
Other equipment 455,453 488,984
----------- -----------
1,953,432 2,114,424
Accumulated depreciation (754,923) (1,008,668)
----------- -----------
$ 1,198,509 $ 1,105,756
=========== ===========
Depreciation expense for the years ended December 31, 2004 and 2005 was $287,232
and $239,716, respectively.
As of December 31, 2005, in accordance with the "Business and Related Assets
Transfer Agreement" signed by TCH and Sifang Information, the ownership of the
building suite and two motor vehicles, (collectively known as "Assets") are
recorded on TCH's books of record. The net book value of the pledged assets was
$829,637. The property is pledged as security for a $2.5 million line of credit
held under the credit facility agreement between Sifang Information and the
bank. The line of credit is recorded on Sifang Information's books and has a
balance of $2,478,253 as of December 31, 2005. However, the two parties have
declared that the ownership of the "Assets" should be TCH's as of the balance
sheet date and have signed a legal agreement, as noted above. Sifang Information
is expected to pay off the line of credit balance in April 2008 and at that
point they will transfer the legal title of the property and the motor vehicles
within one week after the pledge is to be released by the bank.
NOTE 5 - RELATED PARTY TRANSACTIONS
Related Party Relationships
The following related parties are related through common ownership with the
major shareholder of the Company:
--------------------------------------------------------------------------------
Shanghai Sifang Information Technology Co. ("Sifang Information")
Shanghai Tianci Industry Co. Ltd. ("Tianci Industry")
Shanghai Tianci Industry Group Co. Ltd. ("Tianci Group")
Shanghai Shantian Telecommunication Co. Ltd. ("Shantian")
Shanghai Sifang Telecommunication Co. Ltd. ("Sifang Telecom")
Shanghai Tianci Real Estate Co. Ltd. ("Tianci Real Estate")
Shanghai Sifang Media Co., Ltd. ("Sifang Media")
F-31
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Merchandise Sold to Related Parties
Years Ended December 31,
-------------------------
2004 2005
----------- -----------
Shantian $ 9,178,674 $10,608,287
Tianci Group 136,310 --
Tianci Industry 576,707 --
----------- -----------
$ 9,891,691 $10,608,287
=========== ===========
During the year ended December 31, 2005, TCH sold Samsung GSM mobile phones
valued at $10,608,287 at a gross profit margin of 4% or $382,371 to Shantian,
compared to $9,178,674 at a gross profit margin of 4% or $378,061 for the same
period of the prior year. Accounts receivable includes $1,583,512 and nil due
from Shantian, for 2004 and 2005, respectively. During the year ended December
31, 2004, TCH also sold mobile phones to other related parties, which included
Tianci Industry and Tianci Group for $136,310 and $576,707 at gross profit
margins of 14% or $18,587 and 14% or $82,654, respectively. There were no mobile
phones sold to Tianci Industry and Tianci Group during the year ended December
31, 2005.
Agency Income from a Related Party
The Tianci Group entered into an agency agreement on July 16, 2004 with TCH to
sell CDMA mobile phones owned by China Unicom. TCH obtains the same commission
structure that Tianci Group earns from China Unicom. For each phone sold, TCH
receives $15.70 per unit and a sales commission of $3.62 per SIM card. TCH
recognized commission income of $204,214 in the year ended December 31, 2004
from the Tianci Group, which was recorded in information service revenue, net on
the income statement. There was no agency income in the year ended December 31,
2005.
Purchase from Related Party
Years Ended December 31,
2004 2005
----------- -----------
Sifang Telecom $ 390,340 $ --
During the year ended December 31, 2004, TCH purchased local brand mobile phones
from Sifang Telecom valued at $390,340, and all these mobile phones were sold to
retailers in 2004. There were no purchases from related parties during the year
ended December 31, 2005.
Advertising Services Rendered to Related Party
Years Ended December 31,
2004 2005
----------- -----------
Tianci Real Estate $ -- $ 1,879,965
In January 2005, Sifang Media and TCH entered into the "Bank Digital TV's
Cooperation Agreement", where TCH will assist in the promotion of TV ads for
various customers, including Tianci Real Estate. TCH received a net fee of
F-32
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$1,879,965 for providing the service during the year ended December 31, 2005.
There was an "Advertisement Agency Contract" between Tianci Real Estate and
Sifang Media, which terminated in November 2005. In June and September 2005,
Sifang Media, TCH and two unrelated customers, entered into certain agreements,
where TCH will assist in the promotion of TV ads for these customers. TCH
received a net fee of $881,633 for providing the service via Sifang Media during
the fiscal year of 2005.
Service Provided by Related Party
Years Ended December 31,
2004 2005
----------- -----------
Sifang Information $ 604,314 $ 426,009
In accordance with terms contained in signed service agreements between TCH and
Sifang Information giving TCH the right to use Sifang Information's facility
(which may not be owned by foreign investors at the present time) to transmit
the reformatted information, the Company paid service fees annually in each of
the years ended December 31, 2004 and 2005. The service agreements are in effect
for ten years and became effective on June 1, 2004. The annual payments for the
services have declined from approximately $567,000 to approximately $366,000
since January 1, 2005.
During the year ended December 31, 2005, Sifang Information also provided other
management support and marketing services to TCH for $61,352, compared to
$36,462 for the year ended December 31, 2004.
Leasing from Related Parties
Sifang Information signed a leasing agreement with the Tianci Real Estate for
leasing its apartment for office use, which was assumed by TCH as a part of the
carve-out transaction. The original leasing term was from May 1, 2003 to April
30, 2008. The original lease agreement was terminated on September 30, 2004, but
was reinstated on January 1, 2005, for an additional leasing term from January
1, 2005 to December 31, 2005. The related rental expense for the year ended
December 31, 2005 was $49,565, compared to $30,810 for the prior year.
Amounts Due from Related Parties
Years Ended December 31,
2004 2005
----------- -----------
Sifang Information $ 4,987,956 $ 2,165,624
Sifang Media -- 929,345
----------- -----------
$ 4,987,956 $ 3,094,969
=========== ===========
F-33
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In order to develop the Company's mobile phone distribution business, the
Company applied to become Nokia's distributor (on the provincial level) of
mobile phones. On March 20, 2005, TCH signed an agreement with Sifang
Information to cooperate with respect to the distribution of Nokia mobile phones
and under which TCH would act as an agent to sell Nokia phones on Sifang
Information's behalf. In May 2005, the final approval from Nokia was received by
Sifang Information. As of December 31, 2005, TCH had outstanding advances of
$2,165,624 to Sifang Information for working capital to assist Sifang
Information in this business.
In addition, as of December 31, 2005, Sifang Media has collected $929,345 from
TCH's advertising customers on its behalf.
Deposit for Business Acquisition
In December 2005, TCH entered into a series of agreements to purchase (i) 95% of
the equity interests of Shanghai Kena Energy Saving Electric Co Ltd ("Kena") for
an aggregate purchase price of RMB 28,500,000 (approximately $3,532,000); (ii) a
related patent from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000); and (iii) related rights to make a patent
application from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000). The purchase price for both the equity interests in
Kena and the consideration for purchase of the patent and the right to apply for
registration of the patent shall be paid by Sifang Information on behalf of TCH.
(Note 13)
Due to Related Parties
Years Ended December 31,
2004 2005
----------- -----------
Tianci Real Estate $ 51,350 $ 123,467
Shantian -- 99,932
Tianci Group 48,910 --
----------- -----------
$ 100,260 $ 223,399
=========== ===========
The balance owed to Tianci Real Estate represented rental payments for 2004 and
the expenses paid by Tianci Real Estate on behalf of the Company during the year
ended December 31, 2005. The rental agreement was cancelled as of September 30,
2004. The balance owed to Tianci Group represents cash paid in advance for
mobile phone purchases. The balance owed to Shantian represents the advances
received from Shantian for mobile phone sales. All of the above amounts due to
related parties are unsecured, non-interest bearing and due on demand.
F-34
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - INCOME TAXES
The income (loss) generated in the Cayman Islands and China before income taxes
in 2004 and 2005, respectively, was as follows:
Years Ended December 31,
2004 2005
----------- -----------
Loss in Cayman Islands before income taxes $(1,199,738) $ (737,758)
Income in China before income taxes 3,164,338 3,030,608
----------- -----------
$ 1,964,600 $ 2,292,850
=========== ===========
The income tax provision was as follows:
Years Ended December 31,
2004 2005
----------- -----------
Current:
Cayman Islands $ -- $ --
China 389,102 465,343
----------- -----------
Deferred:
Cayman Islands -- --
China (19,131) 16,400
----------- -----------
$ 369,971 $ 481,743
=========== ===========
The difference between the effective income tax rate and the expected statutory
rate was as follows:
Year ended Year ended
December 31, December 31,
2004 2005
------------ ------------
Statutory rate 33.0% 33.0%
Income tax holiday (21.9) (18.0)
Permanent differences 7.7 6.0
Change in valuation allowance -- --
------------ ------------
Effective income tax rate 18.8% 21.0%
============ ============
The primary components of temporary differences which give rise to the Company's
deferred tax assets are as follows:
F-35
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31,
2004 2005
----------- -----------
Allowance for receivables $ 7,188 $ 6,671
Accrued liabilities 21,584 6,176
----------- -----------
28,772 12,847
Valuation allowance -- --
----------- -----------
Net deferred tax assets $ 28,772 $ 12,847
=========== ===========
NOTE 7 - SEGMENT REPORTING
The Company currently operates in four principal business segments. Management
believes that the following table presents useful information to the chief
operation decision makers for measuring business performance and financing needs
and preparing the corporate budget, etc. As most of the Company's customers are
located in the Shanghai metropolitan area and the Company's revenues are
generated in Shanghai, the PRC, no geographical segment information is
presented.
Advertising
Service Mobile Phone Beep Pagers
Revenue Phone Sales Service Service Corporate Total
------------ ------------ ------------ ------------ ------------ ------------
2004
Revenue $ -- $ 20,949,089 $ 2,592,392 $ 979,469 $ -- $ 24,520,950
Gross profit -- 1,340,257 2,094,198 431,670 -- 3,866,125
Depreciation -- -- 229,979 -- 57,253 287,232
Interest expense -- -- -- -- 1,955 1,955
Net income -- 802,854 1,436,835 176,742 821,801 1,594,629
Total assets -- 2,721,741 2,443,657 -- 7,497,267 12,662,665
Expenditures for -- -- 132,155 -- -- 132,155
long-lived assets
2005
Revenue $ 2,761,598 $ 16,383,356 $ 634,728 $ 639,340 $ -- $ 20,419,022
Gross profit 2,620,044 358,397 223,830 368,614 -- 3,570,885
Depreciation -- -- 191,773 -- 47,943 239,716
Interest income (expenses) -- -- -- -- (9,093) (9,093)
Net income 1,940,596 154,136 47,843 162,207 (493,675) 1,811,107
Total assets -- 913,957 139,055 -- 13,923,849 14,976,861
Expenditures for -- -- 71,542 -- 353,983 425,525
long-lived assets
F-36
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - GOVERNMENTAL SUBSIDY
During the year ended December 31, 2005, the Company received a general
government subsidy from the local bureau, which is equivalent to 7% of the
taxable income of TCH throughout the period from September 2004 to December
2004. The subsidy is non-recurring and subject to government approval.
NOTE 9 - CONCENTRATION OF CUSTOMERS AND VENDORS
Customers and vendors who account for 10% or more of revenues, accounts
receivable, purchases and accounts payable are presented as follows:
Customer Revenues Accounts Receivable
2004 2005 2004 2005
A (Shantian, a related party) 37% 52% 34% -
B 11% 3% 7% 27%
C 8% 3% 46% -
D 6% 12% - -
E - 2% - 64%
---- ---- ---- ----
67% 72% 94% 91%
Vendor Purchases Accounts Payable
2004 2005 2004 2005
A 33% 34% 96% -
B - 8% - 12%
C 32% 9% 4% 87%
D 17% 31% - -%
--- --- ---- ----
82% 82% 100% 99%
NOTE 10 - EMPLOYEE WELFARE AND RETIREMENT BENEFITS
The PRC has been undergoing significant reforms with regard to its employee
welfare and fringe benefits administration. Any enterprise operating in the PRC
is subject to government-mandated employee welfare and retirement benefit
contributions. In accordance with PRC laws and regulations, TCH participates in
a multi-employer defined contribution plan pursuant to which TCH is required to
provide employees with certain retirement, medical and other fringe benefits.
PRC regulations require TCH to pay the local labor administration bureau a
monthly contribution at a stated contribution rate based on the monthly basic
compensation of qualified employees. The local labor administration bureau,
which manages various investment funds, will take care of employee retirement,
medical and other fringe benefits. TCH has no further commitments beyond its
monthly contribution. TCH contributed a total of $39,391 and $54,430 to these
funds as part of selling, general and administrative expenses for the years
ended December 31, 2004 and 2005, respectively.
F-37
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - RESTRICTED RESERVES
The Company's PRC subsidiary, TCH, is required to make appropriations to three
restricted reserve funds, comprised of the surplus fund, the staff bonus and
welfare fund, and the company expansion fund, based on after-tax net income
determined in accordance with generally accepted accounting principles of the
People's Republic of China (the "PRC GAAP"). Appropriation to the surplus fund
should be at least 10% of the after tax net income determined in accordance with
the PRC GAAP. Appropriations to the surplus fund and the staff bonus and welfare
fund are made at the discretion of the Board of Directors. The company expansion
fund is established for the purpose of providing employee facilities and other
collective benefits to the employees and is non-distributable other than in
liquidation. Appropriations to the reserves are suspended when the accumulated
balances of the funds reach 50% of the registered capital of TCH.
During 2005 and 2004, the Company appropriated $554,466 and nil, respectively,
to the restricted reserves based on its net income under PRC GAAP.
Appropriations to the staff and welfare fund for the years ended December 31,
2005 and 2004 amounted to $142,288 and $64,174, respectively, and were charged
to general and administrative expense.
NOTE 12 - COMMITMENTS
The Company has entered into commitments for consulting services amounting to a
total of $450,000 to be rendered in 2005 and 2006. As of December 31, 2005, the
Company has paid $200,000 and, therefore, has outstanding commitments of
$250,000 for consulting services in 2006.
NOTE 13 - SUBSEQUENT EVENT
During the first quarter of 2006 the Company began to reduce its reliance on
related party transactions and establish more sustainable non-related party
lines of business. Management anticipates significantly less revenue during the
first quarter of 2006 as a result of the reduction in revenue from related
parties, increased competition and a continuing saturation of the mobile phone
distribution business. In response, management is seeking to align or acquire
new partners to take advantage of the expected increase in demand for value
added and other next generation services.
TCH entered into a series of agreements to purchase (i) 95% of the equity
interests of Kena for an aggregate purchase price of RMB 28,500,000
(approximately $3,532,000); (ii) a related patent from one of the shareholders
of Kena for RMB 11,000,000 (approximately $1,363,000); and (iii) related rights
to make a patent application from one of the shareholders of Kena for RMB
11,000,000 (approximately $1,363,000).
On February 10, 2006, these agreements were amended to impose an additional
condition on Zhang Naiyao, the transferor of the patent and holder of the right
to make the patent application, that if he fails to provide the necessary
technical assistance services to enable TCH to use the patented technology in
producing products on a large scale that meet the standards set by the Company
within one year, TCH shall have the right to demand the return of the relevant
payment received by him in full and to terminate the agreement for the
assignment of the patent and the right to apply for registration of the patent.
The amendments also set forth the arrangement for payment of the purchase price
between TCH and Sifang Information. The purchase price for both the equity
interests in Kena and the consideration for purchase of the patent and the right
to apply for registration of the patent shall be paid by Sifang Information on
behalf of TCH. According to the amended agreements, the amount of the purchase
consideration paid by Sifang Information on behalf of TCH will be applied to
offset the advances owed to TCH by Sifang Information.
F-38
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Kena was established on April 26, 2005 and it specializes in the research,
development and manufacture of energy-saving products, as well as illumination
projects in China. The patent and patent application mentioned above relate to a
"three phase transformer" which is used in connection with a power supply system
and utilizes technology that allows manufacturers to produce transformers with
high energy transfer efficiency at a low cost. This technology is expected to be
available for mass production within one year.
The transactions are subject to regulatory approval in the PRC.
F-39
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Articles of Incorporation provide that we may indemnify
our directors and officers to the fullest extent permitted under Nevada law
against any and all expenses, liabilities or other matters pursuant to which the
company may indemnify such person under Nevada law. The Company's Bylaws, filed
as Exhibit 3.2 hereto, provide that we will indemnify our directors to the
fullest extent permitted under Nevada law and may, if and to the extent
authorized by the Company's board of directors, so indemnify our officers and
any other person whom we have the power to indemnify against any liability,
reasonable expense or other matter whatsoever. The effect of these provisions is
potentially to indemnify the Company's directors and officers from all costs and
expenses of liability incurred by them in connection with any action, suit or
proceeding in which they are involved by reason of their affiliation with the
Company. Pursuant to Nevada law, a corporation may indemnify a director,
provided that such indemnity shall not apply on account of:
(a) acts or omissions of the director finally adjudged to be
intentional misconduct or a knowing violation of the law;
(b) unlawful distributions; or
(c) any transaction with respect to which it was finally adjudged
that such director personally received a benefit in money,
property, or services to which the director was not legally
entitled.
The Company's Bylaws also permit us to maintain insurance on behalf of
any person whom the Company has the power to indemnify under Nevada law or the
company's Articles of Incorporation or Bylaws.
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Expenses incurred or (expected) relating to this Registration Statement
and distribution are as follows:
Amount
SEC registration fee $ 1,529.50
Printing and engraving expenses* 5,000.00
Professional fees and expenses* 200,000.00
Transfer agent's and registrar's fees and expenses* 1,500.00
Miscellaneous* 2,500.00
-----------
Total* $226,529.50
-----------
*Estimates
The Registrant will bear all of the expenses shown above.
RECENT SALES OF UNREGISTERED SECURITIES
Set forth below is information regarding the issuance and sales of the
Company's securities without registration for the past three years from the date
of this Registration Statement. No such sales involved the use of an
underwriter, no advertising or public solicitation were involved, the securities
bear a restrictive legend and no commissions were paid in connection with the
sale of any securities.
On February 23, 2004, the Company sold 987,915 shares of restricted
common stock for gross proceeds of $300,000, pursuant to a subscription
agreement, to Halter Financial Group, Inc., an entity owned by Timothy P.
Halter, a former member of the Board of Directors and the Company's former Chief
Executive Officer. Additionally, in consideration for agreeing to serve as an
officer and director of the Company, Timothy P. Halter was granted a warrant to
purchase up to 131,722 shares of common stock of the Company (as adjusted for
stock splits).
On February 23, 2004, the Company agreed to pay Little and Company
Investment Securities, an entity owned by Glenn A. Little, its former
controlling stockholder, officer and director, $30,000 in consulting fees
II-1
related to the transaction discussed in the previous paragraph and in
consideration for maintaining the corporate entity. To formalize this
obligation, the Company issued a $30,000 non-interest bearing promissory note
maturing on February 23, 2005. Concurrent with the transaction discussed in the
previous paragraph, the Company and Little and Company Investment Securities
executed an Exchange Agreement whereby the Company issued 98,792 shares of
common stock in satisfaction of the outstanding promissory note.
On June 23, 2004 the Company issued 167,895 shares of its common stock
to a consultant in lieu of a cash payment for services relating to the reverse
merger that was completed in fiscal 2004. The trading price of the Company's
common stock on June 23, 2004 was $3.60 per share, accordingly, the fair value
of 167,895 shares was $604,422.
On June 23, 2004, the Company issued 166,667 shares of its common stock
to Halter Financial Group, Inc., an existing stockholder, at a price of $1.14
per share in exchange for gross proceeds of $190,000 based on a stock purchase
agreement.
On June 23, 2004, the Company completed a stock exchange transaction
with the stockholders of Sifang Holdings Co., Ltd. The exchange was consummated
under Nevada and Cayman Islands law pursuant to the terms of a Securities
Exchange Agreement dated effective as of June 23, 2004 by and among Boulder
Acquisitions, Sifang Holdings and the stockholders of Sifang Holdings. Pursuant
to the Securities Exchange Agreement, we issued 13,782,636 shares of our common
stock to the stockholders of Sifang Holdings, representing approximately 89.7%
of our post-exchange issued and outstanding common stock, in exchange for 100%
of the outstanding capital stock of Sifang Holdings.
The Company issued the foregoing shares in private transactions or
private placements intending in reliance upon Regulation D and Section 4(2) of
the Securities Act of 1933, as amended (the "Act"). The investors were not
solicited through any form of general solicitation or advertising, the
transactions being non-public offerings, and the sales were conducted in private
transactions where the investor identified an investment intent as to the
transaction without a view to an immediate resale of the securities; the shares
were "restricted securities" in that they were both legended with reference to
Rule 144 as such and the investors identified they were sophisticated as to the
investment decision and in most cases we reasonably believed the investors were
"accredited investors" as such term is defined under Regulation D based upon
statements and information supplied to us in writing and verbally in connection
with the transactions. We never utilized an underwriter for an offering of our
securities and no sales commissions were paid to any third party in connection
with the above-referenced sales. Other than the securities mentioned above, we
have not issued or sold any securities.
EXHIBITS
Exhibit
Number Description
3.1 Articles of Incorporation of the Registrant. (1)
3.2 Second Amended and Restated Bylaws of the Registrant. (2)
4.1 Common Stock Specimen. (4)
5.1 Legal Opinion of Kummer Kaempfer Bonner & Renshaw. (4)
10.1 Securities Exchange Agreement by and among Boulder
Acquisitions, Inc., Sifang Holdings Co., Ltd. and the
stockholders of Sifang Holdings Co., Ltd. dated effective as
of June 23, 2004. (2)
10.2 Information Service and Cooperation Agreement by and among
Shanghai Sifang Information Technology Co. Ltd. and Shanghai
TCH Data Technology Co. Ltd. dated as of June 1, 2004. (3)
10.3 Information Service and Cooperation Agreement by and among
Shanghai Sifang Information Technology Co. Ltd. and Shanghai
TCH Data Technology Co. Ltd. dated as of June 1, 2004. (3)
10.4 Information Service and Cooperation Agreement by and among
Shanghai Sifang Information Technology Co. Ltd., Shanghai
Chengao Industrial Co. Ltd. and Shanghai TCH Data Technology
Co. Ltd. dated as of June 1, 2004. (3)
II-2
10.5 Information Service and Cooperation Agreement by and among
Shanghai Tianci Industrial (Group), Co. Ltd. and Shanghai TCH
Data Technology Co. Ltd. dated as of June 1, 2004. (3)
10.6 Business and Related Assets Transfer Agreement between
Shanghai Sifang Information Technology Co. Ltd. and Shanghai
TCH Data Technology Co. Ltd. dated as of May 26, 2004. (3)
10.7 Stock Purchase Agreement by and between Halter Financial
Group, Inc. and Boulder Acquisitions, Inc. dated as of June
23, 2004. (2)
10.8 Stock Purchase Agreement by and between Chinamerica Fund, LP
and Boulder Acquisitions, Inc. dated as of June 28, 2004. (2)
10.9 Stock Purchase Agreement by and between Chinamerica
Acquisition, LLC and Boulder Acquisitions, Inc. dated as of
June 28, 2004. (2)
10.10 Stock Purchase Agreement by and between Gary Evans and Boulder
Acquisitions, Inc. dated as of June 28, 2004. (2)
10.11 Selling Stockholders Agreement by and among Boulder
Acquisitions, Inc. and the Selling Stockholders listed on
Schedule A thereto dated as of June 28, 2004. (4)
10.12 English Summary of the Equity Transfer Termsheet for Shanghai
Kena Energy Saving Electric Co., Ltd. by and among Shanghai
TCH Data Technology Co. Ltd., Mr. Zhang Naiyao, Mr. Tai Yi,
and Ms. Zheng Chang dated as of December 29, 2005. (5)
10.13 English Summary of the Agreement relating to the assignment of
debt under the Equity Transfer Agreement by and among Shanghai
TCH Data Technology Co. Ltd., Mr. Zhang Naiyao, Mr. Tai Yi,
Ms. Zheng Chang and Shanghai Sifang Information Technology Co.
Ltd. dated as of December 29, 2005. (5)
10.14 English Summary of an Agreement relating to transfer of patent
ownership by and between Shanghai TCH Data Technology Co. Ltd.
and Mr. Zhang Naiyao dated as of December 29, 2005. (5)
10.15 English Summary of an Agreement relating to transfer of right
to make patent application by and between Shanghai TCH Data
Technology Co. Ltd. and Mr. Zhang Naiyao dated as of December
29, 2005. (5)
10.16 English Summary of an Agreement in relation to assignment of
debt under the Agreements for the transfer of patent rights by
and among Shanghai TCH Data Technology Co. Ltd., Mr. Zhang
Naiyao and Shanghai Sifang Information Technology Co. Ltd.
dated as of December 29, 2005 (as amended by the parties on
February 10, 2006). (5)
21.1 Subsidiaries of the Registrant. (4)
23.1 Consent of Grobstein, Horwath & Company, LLP, registered
public accounting firm.
23.2 Consent of Kummer Kaempfer Bonner & Renshaw (filed as part of
Exhibit 5.1).
24.1 Power of Attorney for all directors other than Mao Wenxing and
Zhang Xinpeng. (4)
24.2 Power of Attorney for Mao Wenxing and Zhang Xinpeng. (4)
--------------------
(1) Filed as an exhibit to the Registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2001, which was filed with the
Commission on January 28, 2002, and which is incorporated herein by
reference.
(2) Filed as an exhibit to the Registrant's Current Report on Form 8-K
dated July 8, 2004, and which is incorporated herein by reference.
II-3
(3) Filed as an exhibit to the Registrant's Quarterly Report on Form 10-QSB
for the period ended June 30, 2004 as filed with the Commission on
August 23, 2004, and which is incorporated herein by reference.
(4) Filed as an exhibit to the Registrant's Amendment No. 3 on Form SB-2 as
filed with the Commission on July 29, 2005, and which is incorporated
herein by reference.
(5) Filed as an exhibit to the Registrant's Current Report on Form 8-K
dated February 17, 2006, and which is incorporated herein by reference.
UNDERTAKINGS
The undersigned registrant hereby undertakes:
1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(a) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(b) To reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in
the information in the registration statement. Notwithstanding
the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum
offering range, may be reflected in the form of prospectus
filed with the Commission pursuant to Rule 424(b) (ss.
230.424(b) of this chapter) if, in the aggregate, the changes
in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation
of Registration Fee" table in the effective registration
statement; and
(c) To include any additional or changed material information on
the plan of distribution.
2) For determining liability under the Securities Act of 1933, to treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
3) To file a post-effective amendment to remove from registration any of the
securities being registered, which remain unsold at the end of the offering.
4) That, for the purpose of determining liability of the undersigned small
business issuer under the Securities Act to any purchaser in the initial
distribution of the securities, the undersigned small business issuer undertakes
that in a primary offering of securities of the undersigned small business
issuer pursuant to this registration statement, regardless of the underwriting
method used to sell the securities to the purchaser, if the securities are
offered or sold to such purchaser by means of any of the following
communications, the undersigned small business issuer will be a seller to the
purchaser and will be considered to offer or sell such securities to such
purchaser:
(a) Any preliminary prospectus or prospectus of the undersigned
small business issuer relating to the offering required to be
filed pursuant to Rule 424 (ss.230.424 of this chapter);
(b) Any free writing prospectus relating to the offering prepared
by or on behalf of the undersigned small business issuer or
used or referred to by the undersigned small business issuer;
(c) The portion of any other free writing prospectus relating to
the offering containing material information about the
undersigned small business issuer or its securities provided
by or on behalf of the undersigned small business issuer; and
(d) Any other communication that is an offer in the offering made
by the undersigned small business issuer to the purchaser.
II-4
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorizes this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Shanghai, People's Republic of China. China Digital
Wireless, Inc.
By: /s/ Fu Sixing Date: June 14, 2006
-----------------------------------------------
Fu Sixing, Chief Executive Officer and Director
By: /s/ Qian Fang Date: June 14, 2006
-----------------------------------------------
Qian Fang, Chief Financial Officer and
Prinicipal Accounting Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date stated.
By: /s/ Tai Caihua Date: June 14, 2006
---------------------------------
Tai Caihua, Director
By: * Date: June 14, 2006
---------------------------------
Huang Tianqi, Director
By: * Date: June 14, 2006
---------------------------------
Jing Weiping, Director
By: * Date: June 14, 2006
---------------------------------
Mao Ming, Director
By: * Date: June 14, 2006
---------------------------------
Song Jing, Director
By: * Date: June 14, 2006
---------------------------------
Fu Sixing, Director
By: * Date: June 14, 2006
---------------------------------
Yu Ruijie, Director
By: * Date: June 14, 2006
---------------------------------
Zhang Xiaodong, Director
By: * Date: June 14, 2006
---------------------------------
Huang Wei, Director
* By: /s/ Tai Caihua Date: June 14, 2006
-------------------------------
Tai Caihua, As Attorney-in-fact
II-5