UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2005
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from __________ to __________
Commission File Number 000-12536
CHINA DIGITAL WIRELESS, INC.
========================================================
(Exact name of small business issuer as specified in its charter)
NEVADA 90-0093373
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
429 Guangdong Road
Shanghai, People's Republic of China 200001
(Address of principal executive offices)
(86 21) 6336-8686
(Issuer's telephone number)
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 registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of August 10, 2005, 17,018,692 of the issuer's $.001 par value common stock
were outstanding.
Transitional Small Business Issuer Format Yes [ ] No [X]
================================================================================
FORM 10-QSB
For the Quarter Ended June 30, 2005
Table of Contents
Page
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2005 and 2004 (unaudited).... 3
Consolidated Statements of Income and Comprehensive Income for the
Six Months Ended June 30, 2005 and 2004 (unaudited)................. 4
Consolidated Statements of Shareholders' Equity (unaudited)............. 5
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2005 and 2004 (unaudited)................................. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS.......................... 19
ITEM 3. CONTROLS AND PROCEDURES....................................... 26
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS........................................................... 27
SIGNATURES.................................................................. 28
2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, June 30,
2004 2005
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 75,511 $ 1,719,410
Accounts receivable, net of allowance for doubtful accounts of
$47,922 and $22,705 4,619,809 3,169,887
Inventories 101,696 582,842
Deferred tax assets 28,772 10,655
VAT recoverable -- 4,105
Common stock proceeds held in escrow 1,500,000 --
Prepaid consulting fee -- 175,000
Amounts due from related parties 4,987,956 3,642,070
Advances & deposits to suppliers 150,412 2,872,941
------------ ------------
Total current assets 11,464,156 12,176,910
------------ ------------
Property and equipment, net 1,198,509 1,308,719
Deposit for equipment purchase -- 153,353
------------ ------------
Total assets $ 12,662,665 $ 13,638,982
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 55,839 $ 696,755
Deferred revenue 617,694 18,124
VAT payable 213,535 --
Income tax payable 312,763 308,979
Due to related parties 100,260 --
Other liabilities 287,025 271,630
------------ ------------
Total current liabilities 1,587,116 1,295,488
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value, 100,000000 shares authorized,
17,018,692 shares issued and outstanding 17,019 17,019
Additional paid-in capital 4,229,974 4,229,974
Retained earnings 6,828,281 8,096,230
Accumulated other comprehensive income 275 271
------------ ------------
Total shareholder's equity 11,075,549 12,343,494
------------ ------------
Total liabilities and shareholders' equity $ 12,662,665 $ 13,638,982
============ ============
See accompanying notes to consolidated financial statements.
3
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Three Months ended June 30 Six Months ended June 30
---------------------------- ---------------------------
2004 2005 2004 2005
------------ ------------ ------------ ------------
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues:
Products sales $ 2,815,589 $ 803,693 $ 4,914,465 $ 1,472,884
Products sales to related parties 2,498,019 3,748,031 4,273,019 7,808,545
Information service revenue, net 790,201 301,987 1,659,031 959,689
Advertising service revenue, net -- 736,787 -- 1,124,742
------------ ------------ ------------ ------------
Total revenues 6,103,809 5,590,498 10,846,515 11,365,860
Cost of goods sold 2,586,342 815,660 4,526,396 1,421,548
Cost of goods sold to related parties 2,266,305 3,613,279 4,005,730 7,577,184
Cost of service 250,422 158,381 504,246 329,189
------------ ------------ ------------ ------------
5,103,069 4,587,320 9,036,372 9,327,921
Gross profit 1,000,740 1,003,178 1,810,143 2,037,939
Operating expenses:
Selling 48,849 51,736 85,085 95,025
General and administrative 1,089,071 210,328 1,215,252 402,367
------------ ------------ ------------ ------------
Total operating expenses 1,137,920 262,064 1,300,337 497,392
------------ ------------ ------------ ------------
(Loss) Income from operations (137,180) 741,114 509,806 1,540,547
Other revenue -- 127 -- 127
Interest income (expense) 13,592 (4,130) 13,592 (3,665)
------------ ------------ ------------ ------------
(Loss) Income before income taxes (123,588) 737,111 523,398 1,537,009
Income tax provision 66,813 135,570 115,337 269,060
------------ ------------ ------------ ------------
Net (loss) income $ (190,401) $ 601,541 $ 408,061 $ 1,267,949
============ ============ ============ ============
Other comprehensive income (loss):
Translation adjustments $ 482 $ (2) $ 152 $ (4)
Comprehensive (loss) income $ (189,919) $ 601,539 $ 408,213 $ 1,267,945
============ ============ ============ ============
Basic (loss) earnings per share $ (0.01) $ 0.04 $ 0.03 $ 0.07
Weighted average common shares outstanding 13,959,267 17,018,692 13,871,440 17,018,692
See accompanying notes to consolidated financial statements.
4
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In U.S. dollars, except share data)
Additional Other Total
Common Stock Paid-in Retained Comprehensive Shareholders
Shares Amount Capital Earnings Income (Loss) Equity
------------ ------------ ------------ ------------ ------------- ------------
Balance at December 31, 2003 13,782,636 $ 13,783 $ 1,436,217 $ 5,233,652 $ 12 $ 6,683,664
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
Translation adjustment -- -- -- -- 263 263
------------ ------------ ------------ ------------ ------------- ------------
Balance at December 31, 2004 17,018,692 $ 17,019 $ 4,229,974 $ 6,828,281 $ 275 $ 11,075,549
Net income (unaudited) -- -- -- 1,267,949 -- 1,267,949
Translation adjustment
(unaudited) -- -- -- -- (4) (4)
------------ ------------ ------------ ------------ ------------- ------------
Balance at June 30, 2005 17,018,692 $ 17,019 $ 4,229,974 $ 8,096,230 $ 271 $ 12,343,494
============ ============ ============ ============ ============= ============
See accompanying notes to consolidated financial statements.
5
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months ended June 30,
--------------------------
2004 2005
----------- -----------
(unaudited) (unaudited)
Cash flows from operating activities:
Net income $ 408,061 $ 1,267,949
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 138,845 121,692
Bad debt expenses 4,257 (25,217)
Issuance of common stock to consultants for services 1,014,423 0
Deferred tax assets (3,453) 18,117
Changes in assets and liabilities:
Accounts receivable 48,348 1,475,139
Inventories 1,058,427 (481,146)
Other current assets (216,235) (3,050,882)
Accounts payable (105,043) 640,916
Deferred revenue (16,242) (599,570)
VAT recoverable and payable 83,414 (217,640)
Income tax payable -- (3,784)
Due to related parties -- (100,260)
Due from a related company -- (1,234,218)
Other liabilities 206,190 (15,395)
----------- -----------
Net cash flows provided by (used in) operating activities 2,620,992 (2,204,299)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (42,333) (231,902)
Amounts due from related parties (1,449,871) 2,580,104
----------- -----------
Net cash flows (used in) provided by investing activities (1,492,204) 2,348,202
----------- -----------
Cash flows from financing activities:
Recapitalization and reorganization 310,051 --
Proceeds from issuing redeemable common stock 1,690,000 --
Issuing cost (217,481) --
Escrow receivable (1,500,000) 1,500,000
----------- -----------
Net cash flows provided by financing activities 282,570 1,500,000
----------- -----------
Foreign currency translation 162 (4)
----------- -----------
Net increase in cash and cash equivalents 1,411,520 1,643,899
Cash and cash equivalents, beginning of the period 1,713,748 75,511
----------- -----------
Cash and cash equivalents, end of the period $ 3,125,268 $ 1,719,410
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ -- $ --
Income taxes 118,790 254,728
See accompanying notes to consolidated financial statements.
6
NOTE 1 - ORGANIZATION AND BUSINESS BACKGROUND
China Digital Wireless, Inc. ("CDW"), formerly known as Boulder Acquisitions,
Inc., sells mobile phones to retailers, distributors, and related parties and
provides information services to users of mobile phones and pagers.
Substantially all of CDW's operations are in Shanghai, People's Republic of
China (the "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 subsidiaries have entered into
information service and cooperation agreements with two of CDW's affiliates that
are incorporated in the PRC, Shanghai Sifang Information Technology Co. ("Sifang
Information") and Shanghai Tianci Industrial Group Co., Ltd. ("Tianci"). CDW
holds no ownership interest in Sifang Information or Tianci. Sifang Information
and Tianci contract with China Mobile Communications Corporation ("China
Mobile") and China United Telecommunications Corporation ("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.
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.
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. Please see
the shareholders' equity statement for the period from January 1, 2004 to March
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.
7
Business History
CDW's business is primarily conducted through its wholly-owned subsidiary Sifang
Holdings Co., Ltd., ("Sifang Holdings") and its wholly-owned subsidiary TCH Data
Technology Co., Ltd. ("TCH"). Sifang Holdings was established under the laws of
the Cayman Islands on February 9, 2004 for the purpose of acquiring 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 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, TCH 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 our services for either three or
six-month subscription periods.
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.
8
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 ("GAAP") for interim financial information and the instructions to Form
10-QSB and Regulation S-B. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete 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-Q 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-K for the year ended December 31, 2004.
The Company's consolidated financial statements for the six months ended June
30, 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 accounting principles generally accepted in the
United States of America. 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 for the six months ended June 30, 2005
include the accounts of CDW, its wholly owned subsidiary Sifang Holdings, and
its wholly owned subsidiary TCH (collectively "the Company"). 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 June 30,
2005. 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 TCH are conducted. The
Company uses the United States dollar ("U.S. dollars") for financial reporting
purposes.
The Company translates TCH's assets and liabilities into U.S. dollars using the
rate of exchange prevailing at the balance sheet date (at June 30, 2005, the
prevailing exchange rate of the US dollar against the RMB was 8.2765), and the
statement of income is translated at an average rate during the reporting period
(the average rate of the US dollar against the RMB, during the reporting period,
was 8.2765). Adjustments resulting from the translation of TCH's 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 service and the provision of wireless information services that are
used on cell 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
9
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 Service 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 and/or when the services have been provided to the end user. The
Company records the revenue from Shanghai Sifang Media Co. Ltd on a net basis 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,
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
subscriptions 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 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 fee 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 of 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
Since April 2004, the revenue generated from selling pre-charged cards has
gradually decreased while the revenue generated through monthly subscriptions
with China Mobile and/or China Unicom (collectively, "Mobile Operators") has
gradually increased as the Mobile Operators' billing systems have been enhanced.
The Company's affiliates, Sifang Information and Tianci, contract with the
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 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
10
not covered by a monthly service subscription and the Company has no control
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 China Mobile / China Unicom 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 because 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 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 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.
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 June 30, 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, June 30,
------------ ------------
2004 2005
------------ ------------
(Unaudited)
Beginning balance $ 28,158 $ 47,922
Additions charged to expense 19,764 --
Recovered -- (25,217)
------------ ------------
Ending balance $ 47,922 $ 22,705
============ ============
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.
11
Prepaid Consulting Fee
Prepaid consulting fees consisted of the following at June 30, 2005 and December
31, 2004:
December 31, June 30,
------------ ------------
2004 2005
------------ ------------
(Unaudited)
Fee for public relations and sourcing of financing $ -- $ 175,000
============ ============
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, through
affiliates, by the Company and enables mobile phone users to dial into the
Company's server. The software is 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.
Impairment of Long-Lived Assets
The Company applies the provisions of Statement of Financial Accounting Standard
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
No. 144"), 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 six months ended June 30, 2004 and 2005.
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.
12
Stock Based Compensation
The Company utilizes FAS 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 incurred.
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 ranges from 13% to 17%, depending on the types of products
purchased and sold. The input VAT can be offset against the output VAT.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No 109, "Accounting for Income Taxes" ("SFAS No. 109").
SFAS No. 109 requires an entity to recognize deferred tax liabilities and
assets. 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. However, 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 qualifies 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 historical actual income tax rates of SFT at 7.5% for the six
months ended June 30, 2004. The income tax provision presented for the six
months ended June 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, the Company's 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.
Comprehensive (Loss) Income
The Company has adopted Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income" ("SFAS No. 130"), issued by the FASB. SFAS No.
130 establishes standards for reporting and presentation of comprehensive income
(loss) and its components in a full set of general-purpose financial statements.
The Company has chosen to report comprehensive income (loss) in the statements
of income and comprehensive income. Comprehensive income (loss) is comprised of
net income and all changes to stockholders' equity except those due to
investments by owners and distributions to owners.
13
(Loss) Earnings Per Share
The Company presents earnings per share in accordance with the Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128").
Basic earnings (loss) per share includes no dilution and is computed by dividing
income (loss) available to common shareholders by the weighted average number of
shares outstanding during the period. Diluted earnings (loss) per share reflects
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 June 30, 2004 and 2005.
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, and 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 six 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 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
selling shareholders. On February 8, 2005, the SEC declared the registration
statement effective 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 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 the 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
the aggregate, of common stock 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
files a Registration Statement on Form SB-2 with the SEC, registering the shares
purchased by the existing stockholder, 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 issuance costs of $217,481 and accounted for it as a reduction of
additional paid-in capital.
14
NOTE 4 - RELATED PARTY TRANSACTIONS
Related Party Relationships
The following parties are related through common ownership with the major
shareholder of the Company.
Merchandise Sold to Related Parties
Six months Ended June 30,
2004 2005
----------- -----------
(Unaudited) (Unaudited)
Shanghai Shantian Telecommunication Co. Ltd. 4,273,019 7,808,545
----------- -----------
4,273,019 7,808,545
=========== ===========
During the six months ended June 30, 2005, TCH sold Samsung GSM mobile phones
valued at $7,808,545 (2004 - $4,273,019) at a 3% (2004 - 6%) gross profit margin
to Shantian. Accounts receivable include $2,738,498 (2004 $812,550) due from
Shantian.
Advertising Services Rendered to Related Party
Six months Ended June 30,
2004 2005
----------- -----------
(Unaudited) (Unaudited)
Shanghai Tianci Real Estate Co. Ltd. -- 1,124,742
----------- -----------
1,124,742
=========== ===========
In January 2005, Shanghai Sifang Media Co., Ltd and TCH entered into the "Bank
Digital TV's Cooperation Agreement", where TCH will assist in the promotion of
TV ads for Shanghai Tianci Real Estate Co. Ltd. ("Tianci Real Estate"). TCH
received a net fee of approximately $1,125,000 for providing the service from
January 2005 to June 30, 2005. There is an "Advertisement Agency Contract"
between Tianci Real Estate and Shanghai Sifang Media Co., Ltd, which continues
until November 2005 and it is expected that TCH will earn additional advertising
service revenue during the term of the Advertising Agency Contract.
As of June 30, 2005 the accounts balance due from Tianci Real Estate was
$1,234,218. In early July 2005, TCH collected $483,296 from Tianci Real Estate.
Service Provided by Related Party
Six months Ended June 30,
2004 2005
----------- -----------
(Unaudited) (Unaudited)
Shanghai SFT Co., Ltd. 283,920 229,608
----------- -----------
283,920 229,608
=========== ===========
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 approximately
$283,920 and $ 181,236 for the six months ended June 30, 2004 and 2005,
respectively. The annual payments for the services have decline from
approximately $567,000 to approximately $362,472 from January 1, 2005.
During the six months ended June 30, 2005, Sifang Information also provided
other management support and marketing services to TCH for $48,372.
15
Amounts Due from Related Parties
December 31, 2004 June 30, 2005
----------------- -----------------
(unaudited)
Shanghai SFT Co., Ltd. $ 4,987,956 2,407,852
Shanghai Tianci Real Estate Co. Ltd. -- 1,234,218
----------------- -----------------
4,987,956 3,642,070
================= =================
In order to develop the Company's mobile phone distribution business, the
Company has signed an agreement to become Nokia's distributor (provincial level)
of mobile phones. On March 20, 2005 TCH signed agreement with Sifang Information
for cooperation on Nokia mobile phone's distribution, as TCH will act as an
agent to sell Nokia phones on Sifang Information's behalf. As of June 30, 2005,
TCH advanced $2,407,852 (RMB19,900,000) to Sifang Information in order to help
Sifang Information maintain enough working capital to purchase Nokia mobile
phones and to establish marketing for channel distribution.
Deposit for Business Acquisition
In March 2005, TCH signed an agreement with Tianci that appointed Tianci as an
agent for assisting with TCH's proposal to acquire assets and a related business
from Shanghai Oriental New Window Company Limited ("Shanghai ONW"), whose main
business was digital mobile television and digital media services. To initiate
the acquisition, TCH advanced Tianci RMB20,000,000 (approximately $2,418,000).
In June 2005, the acquisition was finalized , and the Tianci repaid the advance
to TCH and all related assets and business were transferred from Tianci to TCH
with no mark up.
Due to Related Parties
December 31, 2004 June 30, 2005
----------------- -----------------
(unaudited)
Shanghai Tianci Real Estate Co. Ltd $ 51,350 --
Shanghai Tianci Industry Group Co. Ltd. 48,910 --
----------------- -----------------
100,260 --
================= =================
16
NOTE 5 - SEGMENT REPORTING
The Company currently operates in four principal business segments. Management
believes that the following table presents useful information to decision makers
for measuring the Company's business performance and financing needs. As most of
the Company's customers are located in the Shanghai metropolitan area and the
Company's revenues are generated in Shanghai, no geographical segment
information is presented.
Advertising
Service Mobile Phone Beep Pagers
Revenue Phone Sales Service Service Corporate Total
------------ ------------ ------------ ------------ ------------ ------------
Six months ended June 30,
2004
Revenue $ -- $ 9,187,484 $ 1,050,200 $ 608,831 $ -- $ 10,846,515
Gross profit -- 655,358 832,562 322,223 -- 1,810,143
Depreciation -- -- 110,220 -- 28,625 138,845
Interest income -- -- -- -- 13,592 13,592
Net income -- 425,583 616,824 145,940 780,286 408,061
Expenditures for long-lived -- -- 42,333 -- -- 42,333
assets
Total Assets, as of -- 2,721,741 2,443,657 -- 7,497,267 12,662,665
December 31, 2004
Six months ended June 30,
2005
Revenue $ 1,124,742 $ 9,281,429 $ 620,606 $ 339,083 $ -- $ 11,365,860
Gross profit 1,124,742 282,697 405,470 225,030 -- 2,037,939
Depreciation -- -- 93,065 -- 28,627 121,692
Interest (expense) -- -- -- -- (3,665) (3,665)
Net income 927,851 160,548 261,829 152,171 (234,450) 1,267,949
Expenditures for long-lived 157,264 -- 74,638 -- -- 231,902
assets
Total Assets, as of June 30,
2005 157,264 6,665,011 297,021 -- 6,519,686 13,638,982
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
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 $14,849 and $ 12,782 to these
funds as part of selling, general and administrative expenses for the six months
ended June 30, 2004 and 2005, respectively.
17
NOTE 7 - CAPITAL COMMITMENT
In May 2005, TCH signed contracts with two main providers for purchase of liquid
crystal displays (LCDs) for TCH's digital wireless media services; the value of
the contracts was about $469,000. By the end of June 30, 2005, these purchase
contracts were still carried out in process; there were about $208,192 of LCDs,
which TCH committed to purchase in July 2005 according to the purchase
contracts.
NOTE 8 - SUBSEQUENT EVENT
At 19:00 on July 21, 2005, the People's Bank of China (the "PBoC") announced a
revaluation of the Chinese currency Renminbi (RMB) or yuan, which immediately
jolted international finance markets. The PBoC said that the RMB yuan will no
longer be pegged to the US dollar, and at the same time it will be traded at a
rate of 8.11 for the US dollar. According to the RMB's revaluation, as of June
30, 2005, the net assets of the Company would increase by about $220,000 using
the exchange rate of 8.11.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
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. In addition to historical information, the
following discussion and other parts of this document contain certain
forward-looking information. When used in this discussion, the words "believes,"
"anticipates," "expects," and similar expressions are intended to identify
forward-looking statements. Such statements 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. We do not undertake to
publicly update or revise any of the forward-looking statements herein even if
experience or future changes show that the indicated results or events will not
be realized. You are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof.
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 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 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 six months ended June 30, 2004 as if the spun-off business
had been a stand-alone company for two years and one quarter. On June 30, 2004,
Sifang Information transferred the spun-off business into TCH. Being a receiving
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 SFAS No. 141, Appendix
D. On May 26, 2004, Sifang Information exchanged 100% of its 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 provides 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.
Discussion and Analysis of Operating Results
Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004
Revenue
Total Revenues
19
Total sales revenues for the six months ended June 30, 2005 increased
by $519,345, representing an approximately 4.8% increase, to $11,365,860 as
compared to $10,846,515 for the same period of the prior year. The increase was
mainly due to our marketing effort and further facilitated by Samsung's
marketing promotion. Total sales revenues consist of product sale, product sales
to related parties, and net of information and advertising service revenue. In
the Chinese telecommunication market, mobile phones have rapidly replaced
beepers and pagers, resulting in an increase in mobile phone distribution. In
the six months ended June 30, 2005, 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 the same period of the prior year, in which
Samsung's mobile phones accounted for 95% of our total product sales and other
brands accounted for the balance. During 2005, market competition for mobile
phone sales intensified, causing us to decrease our overall mark-up ratio to
3.0% in order to maintain our market position, in comparison with a mark-up
ratio of 7.1% for the same period of the prior year.
Product Sales
Revenue for product sales in the six months ended June 30, 2005
decreased by approximately $3,441,581, representing a material decrease to
$1,472,884 as compared to $4,914,465 for the same period of the prior year.
Since 2004, we have cultivated our related party, Shanghai Shantian, to be in a
good position to distribute mobile phones by establishing its market channel and
facility. In focusing our marketing efforts on Shanghai Shantian, there has been
a decline in mobile phone sales directly to customers.
We entered an agreement to exclusively distribute select Nokia mobile
phones 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. We believe that
this agreement will enhance both our market share and profitability. In June, we
distributed approximately $62,000 worth of Nokia mobile phones to our customers
with a mark-up of approximately 8% compared to the other brands we have been
selling. We continue to strengthen our relationship with Nokia and diversify the
mobile phone portfolio to be responsive to market changes and product
innovation. The relationship will allow us to benefit from Nokia's position as
the leading manufacturer of mobile phones worldwide and Nokia's leadership in
the rapidly growing mobile phone market in China.
Product sales to a related party
We distribute Samsung mobile phones to our related party, Shanghai
Shantian, in which Sifang Information holds a 51% equity interest, for its
retail market channel and facility. During the six month period ended June 30,
2005, we sold $7,808,545 worth of mobile phones to Shantian, with an average
mark-up of approximately 3.0%.
Information service revenue, net
Total information service revenue net of related business tax and
surcharge for the six months ended June 30, 2005 increased by $699,342,
representing an approximately 42.1% decrease, to $959,689 compared to $1,659,031
for the same period of the prior year. Value-added service revenue from mobile
phone users for the six months ended June 30, 2005 decreased by $429,594 to
$620,606 compared to $1,050,200 for the same period of the prior year,
representing a 40.9% decrease. 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 six months ended June 30,
2005 dropped by $269,748 to $339,083 compared to $608,831 for the same period of
the prior year, representing an approximately 44.3% 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 prefer 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 and placed
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.
During the six months ended June 30, 2005, TCH rendered advertisement
designing and producing services to Tianci Real Estate for publicity and
promoting its apartment. Net service revenue of $ 1,124,742 was derived from
this service. We have placed more than 400 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
20
expand our network to penetrate other large and mid-sized developed cities
throughout the PRC. 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 Word Exposition in 2010 to be held in Shanghai.
Cost of goods sold
The cost of goods sold for the six months ended June 30, 2005 increased
by $466,606 to $8,998,732 compared to $8,532,126 for the same period of the
prior year, representing an approximately 5.5 % increase. The increase was
consistent with the increases of revenue from product sales.
Cost of service
The cost of service for the six months ended June 30, 2005 decreased by
$175,057 to $329,189 compared to $504,246 for the same period of the prior year,
representing an approximately 34.7% decrease. 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 service has decreased, resulting in
a decrease in associated costs pertaining to the securities information fee
paid. During 2005, we have continued to maintain current fee structures and
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 the six months ended June 30, 2005 increased by
approximately $227,796 to $2,037,939, representing a 12.5% increase, compared to
gross profit of $1,810,143 for the same period of the prior year. The increase
in gross profit was primarily attributable to the proceeds generated from the
new advertising service during the first half of 2005.
The following table summarizes certain information related to the
various components of revenue
Advertising Information Information
Service Service - Service -
Revenue Phone Sales Mobile Phone Pager Total
------------- -------------- -------------- -------------- ------------
For six months ended June 30, 2005
Revenue $ 1,124,742 $ 9,281,429 $ 620,606 $ 339,083 $ 11,365,860
8,998,732 9,327,921
Cost 195,369 133,820
Gross profit 1,124,742 282,697 425,237 205,263 2,037,939
Gross profit ratio 100% 3.0% 68.5% 60.5% 17.9%
For six months ended June 30, 2004
Revenue $ - 9,187,484 $ 1,050,200 $ 608,831 $ 18,983,799
Cost - 8,532,126 217,638 286,608 17,350,860
Gross profit - 655,358 832,562 322,223 1,632,939
Gross profit ratio - 7.1% 79.3% 52.9% 8.6%
21
Selling expenses
Selling expenses for the six months ended June 30, 2005 increased by
$9,940 to $95,025 compared to $85,085 for the same period of the prior year,
representing an increase of 11.7%. The increase was primarily due to the office
expenses and fringe benefits attributable to our marketing department.
Furthermore, the commission fees paid to the salesmen for mobile phones
increased, which was offset by the decline in the advertising expenses.
General and administrative expenses
General and administrative expenses for the six months ended June 30,
2005 decreased by $812,885 to $402,367 compared to $1,215,252 for the same
period of the prior year, representing a 66% decrease. The higher expenses in
2004 were mainly due to a one time non-cash compensation of $1,014,000 related
to the reverse merger that was 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 shares.
General and administrative expenses incurred at the TCH level for the
six months ended June 30, 2005 decreased from $200,830 to $186,648, representing
a slight 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 led to the decline of utility expenses
and communication fees.
The other cash-based expenses incurred at the parent level in the six
months ended June 30, 2005 of $215,719 represent payments for the audit fees,
retainer fees and other consultant fees.
Interest income (expense)
During the six months ended June 30, 2004, interest income derived from
bank deposits was $13,592.
During the six months ended June 30, 2004, interest income derived from
banks deposits was $1,800, while the finance expense incurred in discounting
bank drafts from our clients was $5,465.
Income tax
The income tax provisions presented in the Company's financial
statements are based on the historical actual income tax rates of Sifang
Information at 7.5% for the six months ended June 30, 2004 and 15% for the six
months ended June 30, 2005. For the six months ended June 30, 2004 and 2005,
income tax expense was $115,337 and $269,060 respectively, based on pretax
income of $523,398 (which included the stock compensation of $1,014,000 incurred
in the U.S.) and pretax income $1,537,009, respectively. Because the loss of
approximately $1,014,000 incurred in the U.S. cannot offset the taxable income
in the PRC, the income tax expense of $115,337incurred in the PRC was based on
the taxable income of approximately $1,537,000 during the six months ended June
30, 2004.
Comprehensive income
We recorded comprehensive income of $1,267,945 for the six months ended
June 30, 2005, a $859,732 increase in net income compared to net income of
$408,213 for the same period of the prior year, representing a significant
increase. The increase in net income was attributable to (i) the non-cash
expenses that offset the net profit generated in the six months ended June 30,
2004, and (ii) the contribution of our new advertising business that was
initiated in the first six months of 2005.
Earnings per share
The earnings per share for the six months ended June 30, 2005 was $0.07
compared to $0.03 for the same period of the prior year.
Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004
22
Revenue
Product Sales
Revenue from product sales for the three months ended June 30, 2005
decreased by approximately $2,011,000, representing an approximately 8.1%
decrease, to $803,693 as compared to $2,815,589 for the same period of the prior
year. Since 2004, we have cultivated our related party, Shanghai Shantian, to be
in a good position to distribute mobile phones by establishing its market
channel and facility. In focusing our marketing efforts on Shanghhai Shantian
there has been a decline in direct sales.
We entered an agreement to exclusively distribute select Nokia mobile
phones in the Shanghai region of the PRC in May 2005 and have now obtained the
right to distribute two popular models of Nokia's mobile phones. We believe that
this agreement will enhance both our market share and profitability. In June, we
took the initiative to distribute approximately $62,000 worth of Nokia's mobile
phone to our customers with a mark-up of approximately 8% more than the other
brands we have been selling. We will continue to strengthen our relationship
with Nokia and diversify the mobile phone portfolio to be responsive to market
changes and product innovation. The relationship will allow us to benefit from
Nokia's position as the leading manufacturer of mobile phones worldwide and
Nokia's leadership in the rapidly growing mobile phone market in the PRC.
Product sales to a related party
We distribute Samsung mobile phones to our related party, Shanghai
Shantian, in which Sifang Information holds a 51% equity interest, for its
retail market channel and facility. During the three month period ended June 30,
2005, we sold $3,748,031 worth of mobile phones to Shanghai Shantian, with an
average mark-up of approximately 3.6%.
Information service revenue, net
Total information service revenue net of related business tax and
surcharge for the three months ended June 30, 2005 decreased by $488,214
representing approximately a 61.8% decrease, to $301,987 compared to $790,201
for the same period of the prior year. Value-added service revenue from mobile
phone users for the three months ended June 30, 2005 decreased by $358,727 to
$170,509 compared to $529,235 for the same period of the prior year,
representing a 67.8% decrease. The decrease was due mainly 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 June 30,
2005 decreased by $129,488 to $131,478 compared to $260,966 for the same period
of the prior year, representing approximately a 49.6% 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.
Advertising service revenue, net
During the three months ended June 30, 2005, TCH rendered advertisement
designing and producing services to Tianci Real Estate for publicity and
promoting its business. Net advertising service revenue of $736,787 was derived
from this source.
Cost of goods sold
The cost of goods sold for the three months ended June 30, 2005
decreased by $423,708 to $4,428,939 compared to $4,852,647 for the same period
of the prior year, representing a slight decrease. The decrease was consistent
with the decreases in revenue from product sales.
Cost of service
The cost of service for the three months ended June 30, 2005 decreased
by $92,041 to $158,381 compared to $250,422 for the same period of the prior
year, representing an approximately 36.7% decrease. The costs of service consist
of value-added service costs and advertising service costs. The decline was due
mainly to the decrease of information fees paid to content providers for the
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value-added service. The breakdown of our service business has changed and the
proportion of beep services that are related to financial service has decreased,
resulting in a decrease in associated costs pertaining to the securities
information fee paid. During 2005, we have continued to maintain current fee
structures and 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 the three months ended June 30, 2005 increased by
approximately $2,438 to approximately $1,034,761, representing a slight
increase, compared to gross profit of $1,000,740 for the same period of the
prior year. The increase in gross profit was primarily attributable to the
proceeds generated in the new advertising service which offset the decrease in
information service during the first half of 2005.
The following table summarizes certain information related to the
various components of revenue
Advertising Information Information
Service Service - Service -
Revenue Phone Sales Mobile Phone Pager Total
------------ ------------ ------------ ------------ ------------
For the quarter ended June 30, 2005
Revenue $ 736,787 $ 4,551,724 $ 170,509 $ 131,478 $ 5,590,498
Cost 4,428,939 92,043 66,338 4,587,320
Gross profit 736,787 122,785 78,466 65,140 1,003,178
Gross profit ratio 100% 2.7% 46.0% 49.5% 17.9%
For the quarter ended June 30, 2004
Revenue $ -- 5,313,608 $ 529,235 $ 260,966 $ 6,103,809
Cost -- 4,852,647 145,620 104,802 5,103,069
Gross profit -- 460,961 383,615 156,164 1,000,740
Gross profit ratio -- 8.7% 72.5% 59.8% 16.4%
Selling expenses
Selling expenses for the three months ended June 30, 2005 increased by
$2,888 to $51,736 compared to $48,849 for the same period of the prior year,
representing a 5.9% increase. The increase was mainly due to the increase of
commission fees paid to the salesmen for mobile phones. This was offset by the
decline of advertising expense.
General and administrative expenses
General and administrative expenses for the three months ended June 30,
2005 decreased by $878,743 to $210,328 compared to $1,089,071 for the same
period of the prior year, representing an 80.6% decrease. The higher expenses in
2004 were mainly due to a one time non-cash compensation of $1,014,000 related
to the reverse merger that was 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 shares.
General and administrative expenses incurred at the TCH level in the
three months ended June 30, 2005 increased from $74,649 to $84,647, representing
a $9,997 increase. The increase was primarily attributable to the increase of
audit fees and consultant fees. This was offset by the decrease of office
expense and other expenses for administration.
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 prepaid $45,000 for consulting fees for
24
the first three months of service. Also in June 2005, we entered an agreement
with Insight Communication Inc., and prepaid $130,000 for its management
consulting and advisory services. These prepaid consulting fees will be recorded
in the next quarter accordingly.
Interest income (expense)
During the three months ended June 30, 2004, interest income derived
from deposits in banks was $13,592.
During the three months ended June 30, 2005, interest income derived
from deposits in banks was $1,335; the finance expense incurred in discounting
the bank draft was $5,465.
Income tax
The income tax provisions presented in the Company's financial
statements are based on the historical actual income tax rates of Sifang
Information at 7.5% for the three months ended June 30, 2004 and 15% for the
three months ended June 30, 2005. In the three months ended June 30, 2004 and
2005, income tax expense was $66,813 and $135,570, respectively, based on pretax
loss of $123,588 (which included the stock compensation of $1,014,000 incurred
in the U.S.) and pretax income $737,111. Because the loss of approximately
$1,014,000 incurred in the U.S. did not offset the taxable income in the PRC,
the income tax expense of $66,813 incurred in the PRC was based on the taxable
income of approximately $1,205,000 during the three months end June 30, 2004.
Net income
We recorded net income of $601,541 for the three months ended June 30,
2005 compared to a net loss of $190,401 for the same period of the prior year,
representing a significant increase. The increase in net income was attributable
to (i) the non-cash expenses offsetting the net profit generated in the three
months ended June 30, 2004, and (ii) the contribution of our new advertising
business.
Earnings per share
The earnings per share for the three months ended June 30, 2005 was
$0.04 compared to negative $0.01 for the same period of the prior year.
Liquidity and Capital Resources
Our net cash generated during the six months ended June 30, 2005
increased from approximately $75,511 as of December 31, 2004 to approximately
$1,719,410 as of June 30, 2005.
Net cash flows used in operating activities was $2,204,299 during the
six months ended by June 30, 2005 compared to cash generated of $2,620,992
during the same period of the prior year. The decrease in cash provided was due
to the cash used in other current assets and the related party despite the cash
generated from net income and the collection of accounts receivable.
Net cash flows generated in investing activities for the six months
ended June 30, 2005 reached $2,348,202 compared to cash flows used $1,492,204
for the same period of the prior year, representing a material positive
increase. The cash generated in investing activities was mainly due to the
return of the money invested in related parties.
Net cash provided by financing activities for the six months ended June
30, 2005 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 the Company filed a Registration Statement on
Form SB-2 with the SEC. The Company 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.
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 its
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.
25
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 December 2003, the FASB issued Interpretation No. 46R ("FIN 46R"), a
revision to FIN 46, "Consolidation of Variable Interest Entities". FIN 46R
clarifies some of the provisions of FIN46 and exempts certain entities from its
requirements. FIN 46R is effective at the end of the first interim period ending
after March 15, 2004. Entities that have adopted FIN 46 prior to this effective
date can continue to apply the provisions of FIN 46 until the effective date of
FIN 46R. The adoption of FIN 46R did not have any effect on the Company's
consolidated financial statements.
In March 2004, the FASB issued EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
("EITF 03-1") which provides new guidance for assessing impairment losses on
debt and equity investments. Additionally, EITF 03-1 includes new disclosure
requirements for investments that are deemed to be temporarily impaired. In
September 2004, the FASB delayed the accounting provisions of EITF 03-1. The
Company will evaluate the effect, if any, of EITF 03-1 when final guidance is
released.
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 estimate 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
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.
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.
ITEM 3. CONTROLS AND PROCEDURES
Prior to the conclusion of the period covered by this report, we 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 pursuant to Exchange Act Rule 13(a)-14(c). Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings.
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the date
we carried out this evaluation.
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PART II OTHER INFORMATION
ITEM 6. EXHIBITS
The following documents are filed as part of this report:
31.1 Chief Executive Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Chief Financial Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Chief Executive Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Chief Financial Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CHINA DIGITAL WIRELESS, INC.
(Registrant)
Date: August 12, 2005 /s/ Fu Sixing
----------------------------------
Fu Sixing, Chief Executive Officer
Date: August 12, 2005 /s/ Qian Fang
----------------------------------
Qian Fang, Chief Financial Officer
28