U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
(Amendment No. 1)
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: June 30, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________________ to __________________
Commission File Number: 001-31954
CITY NETWORK, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 88-0467944
(State or other jurisdiction of (I.R.S. Employer Identification No)
incorporation or organization)
2F-1, No. 16, Jian Ba Road, Jhonghe City
Taipei County 235, Taiwan, ROC
(Address of principal executive offices)
011-886-2-8226-5566
(Issuer's telephone number)
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period) that the issuer was required to file such reports, and (2) has
been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of the issuer's common stock, $0.001 par
value, as of the close of business on January 23, 2006 was 32,967,183.
Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X]
EXPLANATORY NOTE
The purpose of this Amendment No. 1 to Quarterly Report on Form 10-QSB/A of City
Network, Inc. (the "Company," "we" or "our") for the fiscal period ended June
30, 2005, filed with the Securities and Exchange Commission ("SEC") on August
22, 2005, is to (i) re-classify the outstanding obligations and liabilities;
(ii) reflect commitments due to a contract between City Construction Co., Ltd
and three individuals for the construction of property in Keelung, Taiwan; (iii)
reflect complete information on credit facility arrangements; (iv) reflect the
settlement with a vendor litigation; (v) reflect the construction contract in
Vietnam pursuant to which the Company will procure construction materials for
approximately US$14 million; and (vi) reflect the purchase contract with a
company in Samoa for approximately US$3 million for the purchase of the
construction materials.
The Items which are amended and restated herein are:
1. Part I, Item 1 - Financial Statements;
2. Part I, Item 2 - Management's Discussion and Analysis or Plan of Operation
(only the Liquidity Section); and
3. Part II, Item 1 - Legal Proceedings.
Except as otherwise expressly noted herein, this Amendment No. 1 to Quarterly
Report on Form 10-QSB/A does not reflect events occurring after the August 22,
2005 filing of our Quarterly Report on Form 10-QSB in any way, except as those
required to reflect the effects of this restatement of our financial statements
for the periods presented, as deemed necessary in connection with the completion
of the restated financial statements and the revised notes to the financial
statements.
The remaining Items contained within this Amendment No. 1 to our Quarterly
Report on Form 10-QSB/A consist of all other Items originally contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 in
the form filed with the SEC on August 22, 2005. These remaining Items are not
amended hereby, but are included for the convenience of the reader. In order to
preserve the nature and character of the disclosures set forth in such Items as
originally filed, except as expressly noted herein, this report continues to
speak as of the date of the original filing, and we have not updated the
disclosures in this report to speak as of a later date. While this report
primarily relates to the historical periods covered, events may have taken place
since the original filing that might have been reflected in this report if they
had taken place prior to the original filing.
i
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION............................................. 2
Item 1. Financial Statements......................................... 2
Item 2. Management's Discussion and Analysis......................... 20
Item 3. Controls And Procedures...................................... 24
PART II. OTHER INFORMATION................................................ 25
Item 1. Legal Proceedings............................................ 25
Item 2. Changes in Securities and Use of Proceeds.................... 26
Item 3. Defaults Upon Senior Securities.............................. 26
Item 4. Submission of Matters to a Vote of Security Holders.......... 26
Item 5. Other Information............................................ 26
Item 6. Exhibits and Reports on Form 8-K............................. 26
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2005 December 31, 2004
------------- -----------------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 696,789 $ 2,010,644
Investment 72,931 0
Accounts receivable, net 2,622,809 3,333,990
Inventory 783,129 732,027
Other receivables 22,816 6,863
Prepaid expenses 511,715 102,896
------------ ------------
Total Current Assets 4,710,189 6,186,420
------------ ------------
Fixed Assets, net 2,265,830 2,586,872
------------ ------------
Total Fixed Assets 2,265,830 2,586,872
------------ ------------
Other Assets
Deposits 1,791,459 1,724,542
Construction in progress 30,316 0
Trademarks 1,740 1,812
Equity in net assets of affiliated company 818,885 829,008
Intangible assets 926,730 961,053
Other assets 20,459 8,255
------------ ------------
Total Other Assets 3,589,589 3,524,670
------------ ------------
Total Assets $ 10,565,608 $ 12,297,962
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses $ 1,890,939 $ 3,335,286
Due to related party 100,344 80,083
Deferred revenue 48,368 14,566
Current portion, long-term debt 3,263,906 3,226,181
------------ ------------
Total Current Liabilities 5,303,557 6,656,116
Long-term debt, net of current portion 789,550 246,330
------------ ------------
Total Liabilities 6,093,107 6,902,446
------------ ------------
Stockholders' Equity
Common stock, $.001 par value, 100,000,000 shares
authorized, 27,500,000 issued and outstanding 27,500 27,500
Additional paid in capital 5,937,946 5,937,946
Cumulative foreign-exchange translation adjustment 363,044 142,453
Retained earnings (1,855,989) (712,383)
------------ ------------
Total Stockholders' Equity 4,472,501 5,395,516
------------ ------------
Total Liabilities and Stockholders' Equity $ 10,565,608 $ 12,297,962
============ ============
2
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
------------------------------ ------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Sales, net $ 3,599,366 $ 5,943,514 $ 4,892,716 $ 12,230,607
Cost of sales 3,377,970 5,599,690 4,633,010 11,297,569
------------ ------------ ------------ ------------
Gross profit 221,396 343,824 259,706 933,038
General and administrative expenses 376,241 467,480 699,386 849,920
------------ ------------ ------------ ------------
Income (loss) from operations (154,845) (123,656) (439,680) 83,118
------------ ------------ ------------ ------------
Other (Income) Expense
Interest income (1,688) (890) (2,087) (1,018)
Rental income (47,910) (7,900) (95,580) (11,054)
Commission income (31,870) (2) (35,791) (1,181)
(Gain) loss on currency exchange 4,977 (3,029) 13,235 (206)
Other income (20,371) (53,710) (56,239) (54,965)
Reserve for bad debt 11,154 49,688 696,154 49,688
Equity in earnings of investee (531) 0 10,123 0
Miscellaneous 10,318 51,553 12,657 51,553
Loss on sale of fixed assets (2,280) 0 79,980 0
Interest expense 42,898 23,312 81,296 40,402
------------ ------------ ------------ ------------
Total Other (Income) Expense (35,303) 59,022 703,748 73,219
------------ ------------ ------------ ------------
Income (loss) before income taxes (119,542) (182,678) (1,143,428) 9,899
Provison for income taxes 178 19,516 178 19,516
------------ ------------ ------------ ------------
Net income (loss) $ (119,720) $ (202,194) $ (1,143,606) $ (9,617)
============ ============ ============ ============
Net income (loss) per share (basic and diluted)
Basic $ (0.004) $ (0.008) $ (0.042) $ (0.0004)
Diluted $ (0.004) $ (0.008) $ (0.042) $ (0.0004)
Weighted average number of shares
Basic 27,500,000 26,666,667 27,500,000 25,833,333
Diluted 27,500,000 26,666,667 27,500,000 25,833,333
3
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
-------------------------------
June 30, June 30,
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (loss) $(1,143,606) $ (9,617)
Adjustments to reconcile net income (loss) to net cash
provided by (used) in operating activities:
Depreciation and amortization 87,730 82,449
Equity in earning of investee 10,123 0
Loss on disposal of assets 79,980 0
(Gain) loss on foreign currency exchange 13,235 (206)
Translation adjustment 192,578 (13,359)
Decrease (Increase) in receivables 711,181 (739,909)
Decrease (Increase) in inventory (51,102) (839,993)
Decrease (Increase) in other receivables (15,953) 1,035,968
Decrease (Increase) in prepaid expenses (408,819) (246,822)
Decrease (Increase) in deposit (66,917) 445,826
Decrease (Increase) in other current assets (12,204) 183,462
(Decrease) Increase in accounts payable
and accrued expenses (164,439) 1,232,347
(Decrease) Increase in deferred revenue 33,802 (425,749)
(Decrease) Increase in deposits payable 0 0
----------- -----------
Total Adjustments 409,195 714,014
----------- -----------
Net cash (used in) provided by operations (734,411) 704,397
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of fixed assets 397,222 0
Purchase on investment (72,931) 0
Construction in progress (30,316) 0
Purchase of fixed assets (194,717) (24,259)
----------- -----------
Net cash (used in) provided by investing activities 99,258 (24,259)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment on notes payable (4,249,488) (2,554,801)
Payment of loan from related party (6,293) (1,524,926)
Loan from related party 26,554 248,127
Issuance of short-term debt 3,550,525 2,970,242
----------- -----------
Net cash (used in) financing activities (678,702) (861,358)
----------- -----------
Net change in cash and cash equivalents (1,313,855) (181,220)
----------- -----------
Cash and cash equivalents at beginning of period 2,010,644 1,148,457
----------- -----------
Cash and cash equivalents at end of period $ 696,789 $ 967,237
=========== ===========
Supplemental cash flows disclosures:
Income tax payments $ 178 $ 21,757
----------- -----------
Interest payments $ 81,296 $ 40,402
----------- -----------
Non cash transaction:
Conversion of short term liability to long term debt $ 789,550 $ 0
----------- -----------
Conversion of debt to equity $ 0 $ 1,680,329
----------- -----------
4
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
June 30, 2005 December 31, 2004
------------- -----------------
(Unaudited)
Common stock, number of shares outstanding
Balance at beginning of period 27,500,000 25,000,000
Common stock issued 0 2,500,000
------------ ------------
Balance at end of period 27,500,000 27,500,000
------------ ------------
Common stock, par value $.001
Balance at beginning of period $ 27,500 $ 25,000
Common stock issued 0 2,500
------------ ------------
Balance at end of period 27,500 27,500
------------ ------------
Additional paid in capital
Balance at beginning of period 5,937,946 4,260,117
Issuance of stock 0 1,677,829
------------ ------------
Balance at end of period 5,937,946 5,937,946
------------ ------------
Cumulative foreign-exchange translation adjustment
Balance at beginning of period 142,453 29,663
Foreign currency translation 220,591 112,790
------------ ------------
Balance at end of period 363,044 142,453
------------ ------------
Retained (deficits)
Balance at beginning of period (712,383) 252,277
Net income (loss) (1,143,606) (964,660)
------------ ------------
Balance at end of period (1,855,989) (712,383)
------------ ------------
Total stockholders' equity at end of period $ 4,472,501 $ 5,395,516
============ ============
5
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 1 - NATURE OF OPERATIONS
City Network, Inc., formerly Investment Agents, Inc., was incorporated on August
8, 1996 under the laws of the State of Nevada. City Network Technology, Inc.,
formerly Gelcrest Investments Limited, was incorporated under the laws of the
British Virgin Islands on March 1, 2002. City Network, Inc. - Taiwan, formerly
City Engineering, Inc., was incorporated under the laws of Republic of China on
September 6, 1994. City Construction was incorporated under the laws of Republic
of China on October, 10, 2003. City Network, Inc. owns 100% of the capital stock
of City Network Technology, Inc., and City Network Technology, Inc. owns 100% of
the capital stock of City Network, Inc. - Taiwan, and City Construction.
Collectively, the four corporations are referred to herein as the "Company".
On November 14, 2002, City Network Technology, Inc. became a wholly-owned
subsidiary of City Network, Inc. through an Exchange Agreement, dated November
14, 2002 and amended on December 4, 2002 whereby City Network, Inc. acquired all
of the issued and outstanding capital stock of City Network Technology, Inc. in
exchange for 12,000,000 shares of City Network, Inc. to the shareholders of City
Network Technology, Inc.
The Company designs, manufactures and markets a comprehensive line of broadband
communication and wireless Internet access product and solutions. The Company's
product lines are used in residential building and hospitality markets and
include the simple DSL bridge/ modem for the home and small business user. The
Company is also pursuing work in the business construction field.
On December 16, 2004, the Company changed its fiscal year end from February 28
to December 31.
6
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unaudited Interim Financial Information - The accompanying financial statements
have been prepared by City Network, Inc. pursuant to the rules and regulations
of the Securities and Exchange Commission (the "SEC") for Form 10-QSB and Item
310 of Regulation S-B and generally accepted accounting principles for interim
financial reporting. These financial statements are unaudited and, in the
opinion of management, include all adjustments (consisting of normal recurring
adjustments and accruals) necessary for a fair presentation of the statement of
financial position, operations, and cash flows for the periods presented.
Operating results for the six months ended June 30, 2005 and 2004 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2005, or any future period, due to seasonal and other factors.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting policies
have been omitted in accordance with the rules and regulations of the SEC. These
financial statements should be read in conjunction with the audited consolidated
financial statements and accompanying notes, included in the Company's Annual
Report on Form 10-KSB for the ten months ended December 31, 2004.
Basis of Consolidation - The consolidated financial statements for 2005 and 2004
include the accounts of City Network, Inc. and its wholly owned subsidiaries
City Network Technology, Inc., City Network, Inc. - Taiwan and City Construction
Co., Ltd. All material intercompany accounts, transactions and profits have been
eliminated in consolidation.
Revenue Recognition - Revenue from sales of products to customers is recognized
upon shipment or when title passes to customers based on the terms of the sales
and is recorded net of returns, discounts, and allowances.
Cash and Cash Equivalents - Cash equivalents are stated at cost. Cash
equivalents are highly liquid investments readily convertible into cash with an
original maturity of three months or less and consist of time deposits with
commercial banks.
Allowance for Doubtful Accounts - The Company establishes an allowance for
doubtful accounts on a case-by-case basis when it believes the required payment
of specific amounts owed is unlikely to occur after a review of historical
collection experience, subsequent collections, and management's evaluation of
existing economic conditions.
7
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fixed Assets - Property and equipment are stated at cost less accumulated
depreciation. Expenditures for major additions and improvements are capitalized
and minor replacements; maintenance and repairs are expensed as incurred.
Whenever an asset is retired or disposed of, its cost and accumulated
depreciation or amortization are removed from the respective accounts and the
resulting gain or loss is credited or charged to income.
Depreciation is computed using the straight-line and declining-balance methods
over the following estimated useful lives:
Furniture and Fixtures 5 years
Equipment 5 years
Computer Hardware and Software 3 years
Building and Improvements 50 years
Intangible Assets - Effective July 2002, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets." The adoption of SFAS No. 142 required an initial impairment assessment
involving a comparison of the fair value of trademarks, patents and other
intangible assets to current carrying value. No impairment loss was recognized
for the period ended June 30, 2005.
Trademarks and other intangible assets determined to have indefinite useful
lives are not amortized. The Company tests such trademarks and other intangible
assets with indefinite useful lives for impairment annually, or more frequently
if events or circumstances indicate that an asset might be impaired. Trademarks
and other intangible assets determined to have definite lives are amortized over
their useful lives or the life of the trademark and other intangible asset,
whichever is less.
Inventory - Inventory is valued at the lower of cost or market; cost is
determined on the weighted average method. As of June 30, 2005, inventory
consisted only of finished goods.
8
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Contingencies - Certain conditions may exist as of the date the financial
statements are issued which may result in a loss to the Company but which will
only be resolved when one or more future events occur or fail to occur. The
Company's management and legal counsel assess such contingent liabilities, and
such assessment inherently involves an exercise of judgment. In assessing loss
contingencies related to legal proceedings that are pending against the Company
or unasserted claims that may result in such proceedings, the Company's legal
counsel evaluates the perceived merits of any legal proceedings or unasserted
claims, as well as the perceived merits of the amount of relief sought or
expected to be sought.
If the assessment of a contingency indicates that it is probable that a material
loss has been incurred and the amount of the liability can be estimated, then
the estimated liability would be accrued in the Company's financial statements.
If the assessment indicates that a potential material loss contingency is not
probable but is reasonably possible, or is probable but cannot be estimated,
then the nature of the contingent liability, together with an estimate of the
range of possible loss, if determinable and material, would be disclosed.
Loss contingencies considered to be remote by management are generally not
disclosed unless they involve guarantees, in which case the guarantee would be
disclosed. As of June 30, 2005, there are no matters that warrant disclosure in
the financial statements.
Advertising - Advertising costs are expensed in the period incurred.
Estimates - The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain 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 from those estimates. Significant
estimates include collectibility of accounts receivable, accounts payable, sales
returns, and recoverability of long-term assets.
Concentration of Credit Risk - Financial instruments, which subject the Company
to credit risk, consist primarily of cash equivalents and trade accounts
receivable arising from its normal business activities. The Company places its
cash in what it believes to be credit-worthy financial institutions.
Concentration of credit risk with respect to trade accounts receivable is
primarily from customers located in Asia. The Company actively evaluates the
creditworthiness of the customers with which it conducts business through credit
approvals, credit limits and monitoring procedures.
9
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impairment of Long-Lived Assets - On January 1, 2002 the Company adopted SFAS
No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". The
Company evaluates long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If the estimated future cash flows (undiscounted and without
interest charges) from the use of an asset are less than the carrying value, a
write-down would be recorded to reduce the related asset to its estimated fair
value. There have been no such impairments to date.
Earnings Per Share - Earnings per share are based on the weighted average number
of shares of common stock and common stock equivalents outstanding during each
period. Earnings per share are computed using the treasury stock method. The
options to purchase common shares are considered to be outstanding for all
periods presented, but are not calculated as part of the earnings per share.
Income Taxes - Income taxes have been provided based upon the tax laws and rates
in the countries in which operations are conducted and income is earned. The
income tax rates imposed by the taxing authorities vary. Taxable income may vary
from pre-tax income for financial accounting purposes. There is no expected
relationship between the provision for income taxes and income before income
taxes, because the countries have different taxation rules, which vary not only
to nominal rates but also in terms of available deductions, credits and other
benefits. Deferred tax assets and liabilities are recognized for the anticipated
future tax effects of temporary differences between the financial statement
basis and the tax basis of the Company's assets and liabilities using the
applicable tax rates in effect at year end as prescribed by SFAS No. 109
"Accounting for Income Taxes".
Exchange Gain (Loss) - As of June 30, 2005 and 2004, the transactions of City
Network, Inc. - Taiwan and City Construction Co., Ltd. were denominated in a
foreign currency and are recorded in New Taiwan Dollars ("NTD") at the rates of
exchange in effect when the transactions occur. Exchange gains and losses are
recognized for the different foreign exchange rates applied when the foreign
currency assets and liabilities are settled.
10
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Translation Adjustment - As of June 30, 2005 and 2004, the accounts of City
Network, Inc. - Taiwan and City Construction Co., Ltd. were maintained, and
their financial statements were expressed, in NTD. Such financial statements
were translated into U.S. Dollars (USD) in accordance with SFAS No. 52, "Foreign
Currency Translation", with the NTD as the functional currency. According to
SFAS No. 52, all assets and liabilities were translated at the current exchange
rate, stockholder's equity are translated at the historical rates and income
statement items are translated at the weighted average exchange rate for the
period. The resulting translation adjustments are reported under other
comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive
Income".
As of June 30, 2005 and 2004 the exchange rates between NTD and the USD was
NTD$1=USD$0.03182 and NTD$1=USD$0.02995, respectively. The weighted-average rate
of exchange between NTD and USD was NTD$1 = USD$0.03186 and NTD$1=USD$0.02967,
respectively. Total translation adjustment recognized for the period ended June
30, 2005 is $363,044.
New Accounting Pronouncements - In January 2003, FASB issued FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN46"). This
interpretation of Accounting Research Bulletin No. 51, requires companies to
consolidate the operations of all variable interest entities ("VIE's") for which
they are the primary beneficiary. The term "primary beneficiary" is defined as
the entity that will absorb a majority of expected losses, receive a majority of
the expected residual returns, or both. This interpretation was later revised by
the issuance of Interpretation No. 46R ("FIN 46R"). The revision was issued to
address certain implementation issues that had arisen since the issuance of the
original interpretation and to provide companies with the ability to defer the
adoption of FIN46 to period after March 15, 2004. The implementation of FIN46
and FIN 46R had no material impact on the Company's financial statements.
On July 16, 2004 the FASB ratified the Emerging Issues Task Force ("EITF")
consensus of Issue 02-14, "Whether the Equity Method of Accounting Applies when
an Investor Does Not Have an Investment in Voting Stock of an Investee but
Exercises Significant Influence through Other Means" ("EITF 02-14"). The
consensus concluded that an investor should apply the equity method of
accounting when it can exercise significant influence over an entity through a
means other than holding voting rights. The consensus is effective for reporting
periods beginning after September 2004. The adoption of EITF 02-14 did not have
a material impact on the Company's financial statements.
11
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 3 - CONCENTRATION
The Company had ten major customers during the six months ended June 30, 2005.
Those customers comprise 91% of the total sales during the six months ended June
30, 2005. Sales to these customers were approximately $4,449,227. Included in
accounts receivable is $1,863,874 from these customers as of June 30, 2005.
NOTE 4 - CASH
The Company maintains its cash balances at various banks in Taiwan and Hong
Kong. All balances are insured by the Central Deposit Insurance Corporation
(CDIC). As of June 30, 2005 and 2004, there were no uninsured portions of the
balances held at the bank.
NOTE 5 - FIXED ASSETS
Fixed assets consist of the following:
June 30, 2005 December 31, 2004
------------- -----------------
Land $ 1,774,623 $ 1,916,328
Building -- 283,977
Machinery and equipment 464,943 430,880
Furniture and fixtures 198,182 143,655
----------- -----------
$ 2,437,748 $ 2,774,840
Accumulated depreciation (171,918) (187,968)
----------- -----------
$ 2,265,830 $ 2,586,872
=========== ===========
NOTE 6 - INTANGIBLE ASSETS
Intangible assets consist of the following:
June 30, 2005 December 31, 2004
------------- -----------------
Trademarks $ 2,150 $ 2,150
Intangible asset 1,000,000 1,000,000
----------- -----------
$ 1,002,150 $ 1,002,150
Accumulated depreciation (73,679) (39,285)
----------- -----------
$ 928,471 $ 962,865
=========== ===========
12
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 7 - COMPENSATED ABSENCES
Employees earn annual vacation leave at the rate of seven (7) days per year for
the first three years of employment with the Company. Upon completion of the
third year of employment, employees earn annual vacation leave at the rate of
ten (10) days per year. At termination, employees are paid for any accumulated
annual vacation leave. As of June 30, 2005 vacation liability exists in the
amount of $1,498.
NOTE 8 - COMMITMENTS
A Best Information Technology, Inc. - City Network, Inc. - Taiwan, signed an
agreement with A Best Information Technology, Inc. in 2002 for the exclusive
right to sell A Best Information's products. The rights are perpetual and
transferable. The Company paid $1,000,000 for these rights.
Reseller Agreements - City Network, Inc. - Taiwan has several signed reseller
agreements with various customers. These resellers are given special sales
prices and are paid commissions for their sales orders.
Co-Construction Agreements - In April 2004, City Construction Co., Ltd. placed a
refundable performance bond in the amount of $227,240 with the court in Taiwan
for the rights to complete an unfinished building in Keelung, Taiwan with the
owners of the land. The Company is currently in discussion with the land owner
regarding the terms of the project.
In March 2005, City Construction Co., Ltd. entered into a Co-Construction
Agreement with three individuals which own a tract of land in Keelung, Taiwan.
Under the agreement, the Company will finance, construct and own 60% of the
completed building project. The Company has agreed to a refundable security
deposit totaling approximately $95,500 dollars payable at various agreed upon
phases of the construction. The deposits will be returned within 2 years after
the construction is completed. As of June 30, 2005, the Company has paid $63,310
as part of the refundable security deposit.
Operating Leases - The Company leases office facilities under operating leases
that terminate on various dates. Rental expense for these leases consisted of
$12,116 for the three months ended June 31, 2005. The Company has future minimum
lease obligations as follows:
2005 $22,910
2006 45,821
-------
Total $68,731
=======
13
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 9 - LONG-TERM INVESTMENT
On August 31, 2003, the Company purchased approximately twenty-five percent
(25%) of Beijing Putain Hexin Network Technology Co., Ltd for $325,000. On
December 4, 2003 the Company purchased an additional fifteen percent (15%) for
$398,500. Beijing Putain Hexin Network Technology Co., Ltd is not publicly
traded or listed. The Company is using the complete equity method to record its
share of the subsidiary's net income and loss. As of June 30, 2005 the Company
recognized a $10,123 loss from their acquisition.
14
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 10 - DEBT
At of June 30, 2005, the Company had three separate revolving secured lines of
credit agreements, renewable annually, with three banks in Taiwan. The lines of
credit are secured either by the Company's deposits with the bank and accounts
receivable or by an officer of the Company.
At June 30, 2005, the Company had borrowings outstanding in the aggregate amount
of $4,053,456, of which $2,662,038 are against these lines of credit. Payable as
follows:
June 30, 2005 December 31, 2004
------------- -----------------
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.828% per annum, due
by July 31, 2005 $ 25,456 by February 13, 2005 $ 125,120
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by August 26, 2005 60,458 by February 15, 2005 60,761
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by September 8, 2005 41,495 by March 2, 2005 35,121
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.35% per annum, due interest at 3.616% per annum, due
by September 15, 2005 409,670 by March 8, 2005 141,511
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.35% per annum, due interest at 3.616% per annum, due
by September 15, 2005 69,049 by March 10, 2005 196,563
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by September 23, 2005 56,651 by March 11, 2005 13,085
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.26% per annum, due
by September 23, 2005 352,553 by March 11, 2005 312,752
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by September 30, 2005 309,782 by March 15, 2005 43,498
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 4.42% per annum, due
by October 12, 2005 260,606 by March 15, 2005 68,004
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 4.42% per annum, due
by October 25, 2005 418,155 by March 29, 2005 246,921
15
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 10 - DEBT (CONTINUED)
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by October 26, 2005 28,363 by April 9, 2005 591,192
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by October 5, 2005 503,840 by April 9, 2005 53,895
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.773% per annum, due interest at 3.616% per annum, due
by February 13, 2006 125,960 by April 9, 2005 59,521
Note payable to a corporation in Note payable to a bank in Taiwan,
Taiwan, interest at 6.265% per 111,510 interest at 4.42% per annum, due
annum, due by November 20, 2005, by April 10, 2005 54,995
personally guaranteed by an
officer of the Company Note payable to a bank in Taiwan,
interest at 4.42% per annum, due
Note payable to a corporation by April 11, 2005 76,548
in Taiwan, no interest, due
by January 10, 2010 1,279,908 Note payable to a bank in Taiwan,
interest at 3.26% per annum, due
by April 22, 2005 121,866
Note payable to a bank in Taiwan,
interest at 4.42% per annum, due
by May 29, 2005 233,493
Note payable to a bank in Taiwan,
interest at 3.616% per annum, due
by October 8, 2005 500,480
Note payable to a corporation in
Taiwan, interest at 6.265% per
annum, due by November 20, 2005,
personally guaranteed by an
officer of the Company 256,496
Note payable to a bank in Taiwan,
interest at 3.175% per annum, due
by May 29, 2016 280,689
----------- -----------
Total 4,053,456 Total 3,472,511
Current portion $ 3,263,906 Current portion $ 3,226,181
----------- -----------
Long-term portion $ 789,550 Long-term portion $ 246,330
=========== ===========
16
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 11 - RELATED PARTY TRANSACTIONS
Throughout the history of the Company, certain members of the Board of Directors
and general management have made loans to the Company to cover operating
expenses or operating deficiencies.
As of June 30, 2005, the Company has a non interest-bearing loan from Tiao-Tsan
Lai, the Company's Chief Executive Officer and Chairman, in the amount of
$100,344. Mr. Lai has also personally guaranteed a note payable of the Company
in the amount of $477,953. As of June 30, 2005, the balance for the note was
approximately $111,510.
NOTE 12 - LITIGATION
The Company is party to certain litigation that has arisen in the normal course
of its business and that of its subsidiary.
Hwa-Ching - In August 2004, a customer closed business and did not pay the
remaining balance due to City Network - Taiwan on outstanding receivables in the
amount of $880,649. City Network - Taiwan has filed criminal and civil
litigation against the customer for fraud. The Company has recorded a reserve
against this account in the amount of $695,280. This case is currently ongoing.
In August 2004, City Network Inc.-Taiwan filed a lawsuit against the owner of
Hwa-Ching Co., as well as the following eight individuals in Taiwan, alleging
fraud for closing down Hwa-Ching Co. without payment for the delivered
merchandise. City Network Inc.-Taiwan sought approximately NT$27 million or
approximately US$900,000. To date, the court has not yet reached a verdict on
this case.
In December 2004, the Company filed a lawsuit against Tain-Kang Co., a customer
of Hwa-Ching Co. in Taipei District Court claiming damages owed to Hwa-Ching
from Tain-Kang in the amount of approximately NT$5,796,000 or US$172,963 to
cover the outstanding account payable owed by Hwa-Ching to the Company. To date,
the court has not yet reached a verdict on this case.
RPPI International Ltd. - As of June 21, 2005, City Network Inc.-Taiwan settled
a litigation with RPPI International Ltd. (or Rong-Dian), a vendor of the
Company.
On October 10, 2004, Rong-Dian filed a lawsuit against City Network Inc.-Taiwan
in the Taiwan Taipei district court of Taiwan, in Taipei, Taiwan, alleging
breach of contract for two different purchase agreements that City Network
Inc.-Taiwan entered with them and two third-parties. Rong-Dian sought the
aggregate amount of approximately NT$40.2 million or US$1.2 million for the
alleged breaches. One purchase agreement was for an order that City Network
Inc.-Taiwan sold to Hwa-Ching Co. in the amount of approximately NT$27.3 million
or US$900,000 and the other purchase agreement was for an order City Network
Inc.-Taiwan sold to a separate customer of the Company in the amount of
approximately NT$12.9 million or US$390,909.
17
NOTE 12 - LITIGATION (Continued)
On June 21, 2005, City Network Inc.-Taiwan entered a settlement agreement with
Rong-Dian and on June 29, 2005, the district court lifted the lawsuit against
us. In the June 2005 settlement agreement, City Network Inc.-Taiwan agreed to
pay Rong-Dian a total of approximately NT$40.2 million or US$1.2 million, to
cover the full amount City Network Inc.-Taiwan owed under the two purchase
agreements. In August 2005, City Network Inc.-Taiwan paid Rong-Dian
approximately NT$12.9 million or US$390,909 of the total amount owed upon
receipt of such amount from our customer. City Network Inc.-Taiwan intends to
pay the balance of approximately NT$27.3 million or US$827,272 to Rong-Dian in
54 separate checks, issued and payable by Tai-Wang Technology Co., Ltd. These
checks will be in increments of NT$500,000 or US$15,910 and payable for 53
consecutive months, beginning on August 10, 2005 with the last and 54th payment
being in the amount of NT$813,003 or US$25,870 instead of NT$500,000 or
US$15,910. To date approximately NT$2 million. or approximately US$60,000, has
been paid on this liability.
Pursuant to the June 2005 settlement agreement, City Network Inc.-Taiwan agreed
to pay Rong-Dian the balance of NT$27.3 million in monthly payments. However, as
a result of its relationship with Tai-Wang and the fact that Tai-Wang is the
vendor who introduced City Network Inc.-Taiwan to Rong-Dian, Tai-Wang assumed
the responsibility for the payment of NT$27.3 million or US$827,272 to
Rong-Dian. Tai-Wang wrote each monthly check in advance and thereafter provided
all 54 checks to Rong-Dian. Rong-Dian will cash one check each month until it
receives payment of the full NT$27.3 million. However, as Tai-Wang has no
written obligation with City Network Inc.-Taiwan to make each monthly payment,
beyond an oral promise to do so, there is no assurance that each monthly check
will be properly cashed by Rong-Dian. Therefore the Company continues to report
the total liability to Rong-Dian. As each payment is successfully paid by
Tai-Wang the Company will reduce the liability accordingly and recognize other
income as the benefit provided by Tai-Wang.
Additionally, as part of the June 2005 settlement agreement, we secured our
obligation that Tai-Wang would pay Rong-Dian the outstanding balance of NT$27.3
million or US$827,272 by giving Rong-Dian a first priority mortgage on certain
property including lots 701-4 and 701-6 in Jay-hou-xiao-duan, Xi-zhi Duan, Xixhi
City, Taipei County, Taiwan. The value of the first priority mortgage on the
property is approximately NT$27.3 million or US$827,272, the aggregate amount
owed to Rong-Dian. City Network Inc.-Taiwan agreed with Rong Dian that this
mortgage will expire in 2010.
Shanghai Bank - On January 24, 2005, Shanghai Commercial and Savings Bank
("Shanghai Bank") filed a lawsuit with the Taipei District Court against the
Company claiming approximately NT$12 million or approximately US$387,000 for the
payment of an unpaid purchase price for goods. The Company purchased such goods
from Chin Shin and Chin Shin assigned the account receivable to Shanghai Bank.
As such, Shanghai Bank sued the Company for the payment of those goods. However,
the Company returned the said goods because they were defective. The Company and
Shanghai Bank are currently in negotiations for a settlement agreement in this
matter. The Company deposited a bond in the amount of approximately NT$3 million
or approximately US$90,000 with the court at the commencement of the lawsuit.
NOTE 13 - SUBSEQUENT EVENTS
On July 20, 2005, amended on September 22, 2005, the Company entered into a
construction contract with a company in Vietnam in which the Company agreed to
procure materials and equipment related to the project. The estimated amount of
gross revenue from this agreement is approximately $14,000,000. Based on certain
criteria of the contract the Company is to receive a deposit of up to
$3,500,000.
18
RESTATED
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004
NOTE 13 - SUBSEQUENT EVENTS (CONTINUED)
On July 25, 2005 the Company entered into a purchase contract with a company in
Samoa for approximately $3,000,000. The Company agreed to pay a deposit of
approximately $750,000 to this company. Purchases are related to items required
by the above construction contract.
On August 10, 2005 the Company entered into a Securities Purchase Agreement (the
"Securities Purchase Agreement') with Highgate House Funds, Ltd. ("Highgate
House"), a Standby Equity Distribution Agreement with Cornell Capital Partners,
L.P. ("Cornell Capital"), an affiliate of Highgate house, and related
agreements.
Under the terms of the Securities Purchase Agreement, the Company will issue
secured convertible debentures (the "Notes") in the aggregate principal amount
of $250,000 to Highgate House. $125,000 in principal amount of the Notes were
issued on August 17, 2005 (the "First Closing Date"). $125,000 in principal
amount of the Notes will be issued at a later closing date.
Simultaneously with the Company's entry into the Securities Purchase Agreement,
the Company entered into the Standby Equity Distribution Agreement (the "SEDA")
whereby the Company may, over twenty four months after the date of the
agreement, issue and sell its common stock to Cornell Capital in $300,000
installments (each an "Advance") totaling up to $15,000,000, subject to the
terms of the SEDA. The Company's ability to issue and sell common stock pursuant
to the SEDA remains subject to, and the Company intend to obtain, (1) the
effectiveness of a registration statement covering such shares of common stock,
(2) stockholder approval of the issuance of such shares of common stock, and (3)
approval by the American Stock Exchange for the additional listing of such
shares of common stock. Additionally, any availability under the SEDA will be
subject to the Company's continued compliance with the terms of SEDA.
NOTE 14 - GOING CONCERN
The Company has suffered recurring losses from operations, cash deficiencies and
the inability to meet its maturing obligations without selling operating assets
or restructuring debts. These issues may raise substantial concern about its
ability to continue as a going concern.
Management has prepared the following statement to address these and other
concerns:
The Company is currently are engaged in discussions with a number of companies
regarding strategic acquisitions or investments. Although these discussions are
ongoing, there can be no assurance that any of these discussions will result in
actual acquisitions or investment. See Note 13 to the financial statements.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Form 10-QSB. The information in this discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These forward-looking statements involve risks and uncertainties, including
statements regarding our capital needs, business strategy and expectations,
including but not limited to the following:
* our ability to raise funds in the future through public or private
financings;
* the timing of our introduction of products or product enhancements;
* our ability to manage costs associated with our product or technology
acquisitions;
* our ability to keep pace with rapidly changing technology, evolving
industry standards and new product and services in our industry;
* customers' acceptance of our product designs;
* our ability to integrate businesses, products and technologies and in
joint ventures and strategic relationships with other companies;
* our business expenses being greater than anticipated due to
competitive factors or unanticipated developments;
* changes in political and economic conditions in the Asian and European
countries where we do business;
* our ability to retain management and key personnel;
* our ability to protect our developed technologies, know-how,
trademarks and related intellectual properties; and
* our ability to comply with the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002.
Any statements contained herein that are not statements of historical facts may
be deemed to be forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as "may", "will", "should",
"expect", "plan", "intend", "anticipate", "believe", estimate", "predict",
"potential" or "continue", the negative of such terms or other comparable
terminology. Actual events or results may differ materially. We disclaim any
obligation to publicly update these statements, or disclose any difference
between its actual results and those reflected in these statements. The
information constitutes forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995.
BACKGROUND OF THE COMPANY
City Network, Inc. ("City Network," "we," "our" or "us") was incorporated
on August 8, 1996 as Investment Agents, Inc. under the laws of the State of
Nevada. City Network Technology, Inc. ("CNT") was incorporated under the laws of
20
the British Virgin Islands on March 1, 2002. On November 14, 2002, CNT became a
wholly owned subsidiary of our company through an Exchange Agreement, dated
November 14, 2002 and amended on December 11, 2002, whereby our company acquired
all of the issued and outstanding capital stock of CNT in exchange for
12,000,000 shares of common stock of our company, which represented 49% of our
issued and outstanding stock at that time. In connection with the exchange and
change in control, the name of our company was changed from Investment Agents,
Inc. to City Network, Inc. the officers and directors of City Network resigned
and new officers and directors were appointed. Upon the effective date of the
exchange and change in control, we ceased our relationship with the company for
whom we previously acted as referral agent.
CNT owns all of the issued and outstanding common stock of City Network,
Inc.-Taiwan, which was incorporated under the laws of the Republic of China on
September 6, 1994, and all of the issued and outstanding common stock of company
of City Construction Co., Ltd., which was incorporated under the laws of
Republic of China on October, 10, 2003.
On December 16, 2004, our board of directors determined to change our
fiscal year end from February 28 to December 31.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial conditions and results of
operations is based upon our financial statements, which have been prepared in
accordance with generally accepted accounting principles in the United States of
America ("GAAP"). The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. See "Summary of Significant Accounting Policies" in the Notes
to Consolidated Financial Statements in Item to this Report for our critical
accounting policies. No significant changes in our critical accounting policies
have occurred since December 31, 2004.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2005 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2004
NET SALES. Net sales for the three months ended June 30, 2005 were
$3,599,366 compared to $5,943,514 for the three months ended June 30, 2004. The
decrease in net sales for the three months ended June 30, 2005 was due to a
decrease in demand for our old products. Our new products, introduced in 2004,
are in the early stages of selling. During the three months ended June 30, 2005,
the sales volume for our new products was low compared to the sales volume for
our old products. We have, however, increased net sales in the second quarter of
2005 over net sales in the first quarter of 2005, primarily due to an increase
in sales of our new products.
We design, manufacture and market a comprehensive line of broadband
communication and wireless Internet access solutions, including home PNA and
xDSL broadband access equipment and related accessories, which comprise our
older, established products. In 2004 we introduced new products such as VoIP,
GSP and wireless Internet access products.
We believe that an increase in competition over the market for our older
products has contributed to a decline in the unit price of those products.
Additionally, we believe that the introduction of more technologically advanced
products to the marketplace have diminished consumer demand for our older
products. We intend to continue upgrading our older products to meet customer
expectations.
21
We believe that sales for our new products, such as VoIP and GSP products,
can increase with improved brand name recognition and increased sales channels.
We had higher sales of the new products in the second quarter of 2005 compared
to the first quarter of 2005, but we have not reached our goals in sales volume
for the new products. We intend to continue promoting and marketing our new
products to improve brand name recognition as well as work on increasing sales
channels.
COST OF SALES. Cost of sales for the three months ended June 30, 2005 was
$3,377,970 or 93.8% of net sales, as compared to $5,599,690 or 94.2% of net
sales, during the three months ended June 30, 2004. The decrease in cost of
sales is associated with the decrease in sales. The decrease in the cost of
sales as a percentage of revenue is due to the higher gross margin of new
products, as compared to the gross margin on our old products sold in 2004.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $376,241, or 10.5% of net sales, for the three months ended June 30, 2005,
as compared to $467,480 or 7.9% of net sales, for the three months ended June
30, 2004. The decrease was due to the decrease in sales and an associated
decrease in related expenses. The increase in general and administrative
expenses as a percentage of net sales is attributable to fixed overhead costs
which remain constant for all levels of sales.
LOSS FROM OPERATIONS. Loss from operations for the three months ended June
30, 2005 was $(154,845), compared to loss from operations for the three months
ended June 30, 2004 of $(123,656). The increase in loss from operations for the
three months ended June 30, 2005 compared with loss from operations for the
three months ended June 30, 2004 was due to a decrease in sales without a
proportionate decrease in the cost of sales and general and administrative
expenses.
OTHER (INCOME) EXPENSE. Other (income) expense was $(35,303) for the three
months ended June 30, 2005, as compared to $59,022 for the three months ended
June 30, 2004. This change was the result of additional income recognized on
rent and export sales commissions received in the three months ended June 30,
2005.
NET LOSS. Net loss for three months ended June 30, 2005 was $(119,542)
compared to net loss of $(182,678) for the three months ended June 30, 2004. The
decrease in net loss was due to the reasons described above.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2004
NET SALES. Net sales for the six months ended June 30, 2005 were $4,892,716
compared to $12,230,607 for the six months ended June 30, 2004. The decrease in
net sales for the six months ended June 30, 2005 was due to a decrease in demand
for our old products. Our new products, introduced in 2004, are in the early
stages of selling.
COST OF SALES. Cost of sales for the six months ended June 30, 2005 was
$4,633,010 or 94.7% of net sales, as compared to $11,297,569 or 92.4% of net
sales, during the six months ended June 30, 2004. The decrease in cost of sales
is associated with the decrease in sales. The decrease in our cost of sales as a
percentage of net sales is attributable to a decrease in the sale price of our
old products, which is due to increased competition in the market for our old
products, while the cost of producing such products has remained constant.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $699,386, or 14.3% of net sales, for the six months ended June 30, 2005, as
compared to $849,920 or 6.9% of net sales, for the six months ended June 30,
2004. The decrease was due to the decrease in sales and an associated decrease
in related expenses. The increase in general and administrative expenses as a
22
percentage of net sales is attributable to fixed overhead costs which remain
constant for all levels of sales.
INCOME (LOSS) FROM OPERATIONS. Loss from operations for the six months
ended June 30, 2005 was $(439,680), compared to income from operations for the
six months ended June 30, 2004 of $83,118. The loss from operations for the six
months ended June 30, 2005 compared with income from operations for the six
months ended June 30, 2004 was due to a decrease in sales without a
proportionate decrease in the cost of sales and general and administrative
expenses.
OTHER EXPENSE. Other expense was $703,748 for the six months ended June 30,
2005, as compared to $73,219 for the six months ended June 30, 2004. This
increase in other expense was the result of additional reserves made on accounts
receivable and losses we incurred on the sale of fixed assets, offset by
additional income recognized on rent and export sales commissions.
NET LOSS. Net loss for six months ended June 30, 2005 was $(1,143,606)
compared to income of $(9,617) for the six months ended June 30, 2004. The net
loss for the three months ended June 30, 2005 compared with income for the three
months ended June 30, 2004 was due to the reasons described above, including the
additional reserves made on accounts receivable.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2005 and December 31, 2004, we had cash and cash equivalents of
$696,789 and $2,010,644, respectively. Our current assets totaled $4,710,189 at
June 30, 2005 as compared to $6,186,420 at December 31, 2004. Our total current
liabilities were $5,303,557 at June 30, 2005 as compared to $6,656,116 at
December 31, 2004. Working capital at June 30, 2005 was $(593,368) and
$(469,696) at December 31, 2004. For the six months ended June 30, 2005, total
cash used in operations was $(734,411) as compared to net cash provided by
operations of $704,397 during the same period in 2004. Net cash used in
financing activities was $(678,702), which consisted of the payment on notes
payable and issuance of short-term debt, as compared with net cash used in
financing activities of $(861,358) during the six months ended June 30, 2004.
We deployed a large amount of cash in the six months ended June 30, 2005
for developing new products. Therefore there is a deficiency in working capital
at the end of such period. We have, however, increased the sales of our new
products in the second quarter of 2005 as compared to the first quarter of 2005.
Our operations and short term financing does not currently meet our cash
needs. We believe we will be able to generate revenues from sales and raise
capital through private placement offerings of its equity securities to provide
the necessary cash flow to meet anticipated working capital requirements. Our
actual working capital needs for the long and short term will depend upon
numerous factors, including our operating results, competition, and the
availability of credit facilities, none of which can be predicted with
certainty. Our future expansion will depend on operating results and will be
limited by its ability to enter into financings and raise capital.
Our liquidity is currently dependent on our ability to strengthen our
accounts receivable collection time period and our ability to continue to raise
cash from financing sources to fund our expansion. Our short-term and long-term
liquidity may be influenced by uncollected accounts receivables. If the amount
of bad debt is high, it will severely affect our ability to continue operations.
Therefore, we are taking precautions to manage this risk, including diversifying
its customer base and controlling credit risk through credit approvals, credit
limits and monitoring procedures. There can be no assurance that these measures
will prove successful. Our inability to manage this risk will have a material
adverse effect upon its business, financial condition and results of operations.
23
CAPITAL EXPENDITURES. Total capital expenditures during the six months ended
June 30, 2005 were $194,717 compared to $24,259 for the six months ended June
30, 2004. We currently have no plans or commitments for significant equipment
acquisitions or capital expenditures.
RECENT DEVELOPMENTS
On August 10, 2005, we entered into a Securities Purchase Agreement (the
"Securities Purchase Agreement") with Highgate House Funds, Ltd. ("Highgate
House"), a Standby Equity Distribution Agreement with Cornell Capital Partners,
L.P. ("Cornell Capital"), an affiliate of Highgate House, and related
agreements.
Under the terms of the Securities Purchase Agreement, we will issue secured
convertible debentures (the "Notes") in the aggregate principal amount of
$250,000 to Highgate House. $125,000 in principal amount of the Notes were
issued on August 17, 2005 (the "First Closing Date"). $125,000 in principal
amount of the Notes will be issued at a later closing date.
Simultaneously with our entry into the Securities Purchase Agreement, we
entered into the Standby Equity Distribution Agreement (the "SEDA") whereby we
may, over twenty-four months after the date of the agreement, issue and sell our
common stock to Cornell Capital in $300,000 installments (each an "Advance")
totaling up to $15,000,000, subject to the terms of the SEDA. Our ability to
issue and sell common stock pursuant to the SEDA remains subject to, and we
intend to obtain, (1) the effectiveness of a registration statement covering
such shares of common stock, (2) stockholder approval of the issuance of such
shares of common stock, and (3) approval by the American Stock Exchange for the
additional listing of such shares of common stock. Additionally, any
availability under the SEDA will be subject to our continued compliance with the
terms of the SEDA.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
ITEM 3. CONTROLS AND PROCEDURES
We maintain "disclosure controls and procedures," as such term is defined
under Exchange Act Rule 13a-15(e), that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed,
summarized, and reported within the time periods specified in the SEC's rules
and forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosures. In
designing and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives and in reaching a reasonable level of assurance our management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. We have carried out an
evaluation under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of June 30, 2005. Based upon their evaluation and subject to the
foregoing, the Chief Executive Officer and Chief Financial Officer concluded
that as of June 30, 2005 our disclosure controls and procedures were effective
at the reasonable assurance level in ensuring that material information relating
to us, is made known to the Chief Executive Officer and Chief Financial Officer
by others within our company during the period in which this report was being
prepared.
There were no changes in our internal controls or in other factors
during the most recent quarter that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HWA-CHING CO. AND RELATED LAWSUITS
In April 2004, Hwa-Ching Co. made purchases from City Network Inc.-Taiwan
for products in the aggregate amount of approximately NT$19 million or
US$575,757. In June 2004, Hwa-Ching Co. wrote a check to City Network
Inc.-Taiwan paying for such products and City Network Inc.-Taiwan successfully
cashed this check. Also in June 2004, Hwa-Ching Co. made purchases from City
Network Inc.-Taiwan for additional products in the aggregate amount of
approximately NT$18 million or US$545,454 and paid for such products with a
check that City Network Inc.-Taiwan also successfully cashed.
During June to August 2004, Hwa-Ching Co. requested additional products
from City Network Inc.-Taiwan in the aggregate amount of approximately NT$27
million or US$818,181. City Network Inc.-Taiwan filled these orders with
confidence as Hwa-Ching had paid for the prior orders from April 2004 and June
2004. However, the check, in the amount of approximately NT$27 million or
US$818,181 that Hwa-Ching Co. wrote to City Network, Inc.-Taiwan bounced upon
deposit with the bank. Immediately thereafter, Hwa-Ching Co. closed down with
this remaining account payable balance of approximately NT$27 million or
US$818,181 outstanding and payable to City Network Inc.-Taiwan.
In August 2004, City Network Inc.-Taiwan filed a lawsuit against Yune-Chang
Tsuo, the owner of Hwa-Ching Co., as well as the following eight individuals
including, Yong-Zhang Zhuo, Shu-Tao Lu, Yong-Yi Zhuo, Zhuan-Xuan Dai, Ya-Hui
Qiu, Mei-Zhen Huang, Zong-Ya Wu, Yao-Guo Cen in Taiwan Taipei district court of
Taiwan, in Taipei, Taiwan, alleging fraud for closing down Hwa-Ching Co. without
payment for the delivered merchandise. City Network Inc.-Taiwan sought
approximately NT$27 million or approximately US$900,000 from Yune-Chang Tsuo to
cover the outstanding account payable. To date, the court has not yet reached a
verdict on this case.
RPPI INTERNATIONAL LTD.
As of June 21, 2005, City Network Inc.-Taiwan settled a litigation with
RPPI International Ltd. (or Rong-Dian), a vendor of the Company.
On October 10, 2004, Rong-Dian filed a lawsuit against City Network
Inc.-Taiwan in the Taiwan Taipei district court of Taiwan, in Taipei, Taiwan,
alleging breach of contract for two different purchase agreements that City
Network Inc.-Taiwan entered with them and two third-parties. Rong-Dian sought
the aggregate amount of approximately NT$40.2 million or US$1.2 million for the
alleged breaches. One purchase agreement was for an order that City Network
Inc.-Taiwan sold to Hwa-Ching Co. in the amount of approximately NT$27.3 million
or US$900,000 and the other purchase agreement was for an order City Network
Inc.-Taiwan sold to a separate customer of the Company in the amount of
approximately NT$12.9 million or US$390,909.
On June 21, 2005, City Network Inc.-Taiwan entered a settlement agreement
with Rong-Dian and on June 29, 2005, the district court lifted the lawsuit
against us. In the June 2005 settlement agreement, City Network Inc.-Taiwan
agreed to pay Rong-Dian a total of approximately NT$40.2 million or US$1.2
million, to cover the full amount City Network Inc.-Taiwan owed under the two
purchase agreements. In August 2005, City Network Inc.- Taiwan paid Rong-Dian
approximately NT$12.9 million or US$390,909 of the total amount owed upon
receipt of such amount from our customer. City Network Inc.- Taiwan intends to
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pay the balance of approximately NT$27.3 million or US$827,272 to Rong-Dian in
54 separate checks, issued and payable by Tai-Wang Technology Co., Ltd. These
checks will be in increments of NT$500,000 or US$15,910 and payable for 53
consecutive months, beginning on August 10, 2005 with the last and 54th payment
being in the amount of NT$813,003 or US$25,870 instead of NT$500,000 or
US$15,910. To date, approximately NT$2 million or approximately US$60,000 was
paid.
Pursuant to the June 2005 settlement agreement, City Network Inc.-Taiwan
agreed to pay Rong-Dian the balance of NT$27.3 million in monthly payments.
However, as a result of its relationship with Tai-Wang and the fact that
Tai-Wang is the vendor who introduced City Network Inc.-Taiwan to Rong-Dian,
Tai-Wang assumed the responsibility for the payment of NT$27.3 million or
US$827,272 to Rong-Dian. Tai-Wang wrote each monthly check in advance and
thereafter provided all 54 checks to Rong-Dian. Rong-Dian will cash one check
each month until it receives payment of the full NT$27.3 million. However, as
Tai-Wang has no written obligation with City Network Inc.-Taiwan to make each
monthly payment, beyond an oral promise to do so, there is no assurance that
each monthly check will be properly cashed by Rong-Dian.
Additionally, as part of the June 2005 settlement agreement, we secured our
obligation that Tai-Wang would pay Rong-Dian the outstanding balance of NT$27.3
million or US$827,272 by giving Rong-Dian a first priority mortgage on certain
property including lots 701-4 and 701-6 in Jay-hou-xiao-duan, Xi-zhi Duan, Xixhi
City, Taipei County, Taiwan. The value of the first priority mortgage on the
property is approximately NT$27.3 million or US$827,272, the aggregate amount
owed to Rong-Dian. City Network Inc.-Taiwan agreed with Rong Dian that this
mortgage will expire in 2010.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Securities Purchase Agreement, dated as of August 10, 2005, by
and between the Company and Highgate House Funds, Ltd. (the
"Investor"). (1)
10.2 Standby Equity Distribution Agreement, dated as of August 10,
2005, by and between the Company and Cornell Capital Partners,
L.P. ("Cornell Capital"). (1)
10.3 Investor Registration Rights Agreement, dated as of August 10,
2005, by and between the Company and the Investor. (1)
10.4 Security Agreement, dated as of August 10, 2005, by and
between the Company and the Investor. (1)
26
10.5 Security Agreement, dated as of August 10, 2005, by and
between City Technology, Inc. ("CTI") and the Investor. (1)
10.6 Security Agreement, dated as of August 10, 2005, by and
between City Network, Inc. - Taiwan and the Investor. (1)
10.7 Security Agreement, dated as of August 10, 2005, by and
between City Construction Co. Ltd. and the Investor. (1)
10.8 Pledge and Escrow Agreement, dated as of August 10, 2005, by
and among the Company, the Investor and David Gonzalez, Esq.,
as escrow agent. (1)
10.9 Secured Convertible Debentures, dated as of August 17, 2005,
executed by the Company in favor of the Investor. (1)
10.10 Warrant, dated as of August 17, 2005, to purchase up to 25,000
shares of Common Stock, executed by the Company in favor of
the Investor. (1)
10.11 Registration Rights Agreement, dated as of August 10, 2005, by
and between the Company and Cornell Capital. (1)
10.12 Placement Agent Agreement, dated as of August 10, 2005 by and
between the Company and Monitor Capital, Inc. (1)
31.1 Certifications of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. (2)
31.2 Certifications of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. (2)
32.1 Certifications of the Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. (2)
----------
(1) Incorporated herein by reference to the Registrant's Form 10-QSB filed with
the SEC on August 22, 2005.
(2) Filed herewith.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITY NETWORK, INC.
Dated: January 27, 2006 By: /s/ Tiao-Tsan Lai
----------------------------------
Tiao-Tsan Lai
Chief Executive Officer
(Principal Executive Officer)
Dated: January 27, 2006 By: /s/ Yun-Yi Tseng
----------------------------------
Yun-Yi Tseng
Chief Financial Officer
(Principal Financial Officer)
28