UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended: December 31, 2004
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission file number: 333-120431
CHINA DIGITAL WIRELESS, INC.
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(Name of Small Business Issuer in its Charter)
Nevada 90-0093373
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
429 Guangdong Road
Shanghai, China 200001 N/A
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (011) 86-21-6336-8686
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year ended December 31, 2004
were US$24,690,006.
The aggregate market value of the voting stock held by non-affiliates computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of March 31, 2005, is $4,904,968. The number of
shares of common stock outstanding as of March 31, 2005 was 17,018,692.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
CHINA DIGITAL WIRELESS, INC.
FORM 10-KSB
TABLE OF CONTENTS
Page
PART I
Item 1. Description of Business.........................................1
Item 2. Description of Property........................................29
Item 3. Legal Proceedings..............................................29
Item 4. Submission Of Matters To A Vote Of Security Holders............29
PART II
Item 5. Market For Common Equity And Related Stockholder Matters.......29
Item 6. Management's Discussion And Analysis Or Plan Of Operation......30
Item 7. Financial Statements...........................................37
Item 8. Changes In And Disagreements With Accountants On Accounting
And Financial Disclosure.......................................37
Item 8A. Controls And Procedures........................................38
Item 8B. Other Information..............................................38
PART III
Item 9. Directors And Executive Officers...............................38
Item 10. Executive Compensation.........................................38
Item 11. Security Ownership Of Certain Beneficial Owners And Management
And Related Stock Holder Matters...............................38
Item 12. Certain Relationships And Related Transactions.................38
Item 13. Exhibits.......................................................39
Item 14. Principal Accountant Fees and Services.........................40
Consolidated Financial Statements............................................F-1
PART I
When we use the terms "we," "us," "our" and "the company," we mean
China Digital Wireless, Inc., a Nevada corporation, and its subsidiary. Our
principal subsidiary is our wholly-owned subsidiary, Sifang Holdings Company
Limited. Sifang Holdings Company Limited has a wholly-owned subsidiary, Shanghai
TCH Data Technology Co., Ltd.
The information set forth in this Report on Form 10-KSB including,
without limitation, that contained in Item 6, Management's Discussion and
Analysis or Results of Operation, 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 statements
relate to future events or our future financial performance, and involve risks
and uncertainties. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "could," "expect," "plan," "intend,"
"anticipate," "believe," "estimate," "predict," "potential," or "continue," or
the negative of such terms or other comparable terminology. These statements are
only predictions. Actual results may materially differ from those projected in
the forward-looking statements as a result of certain risks and uncertainties
set forth in this report. Although management believes that the assumptions made
and expectations reflected in the forward-looking statements are reasonable,
there is no assurance that the underlying assumptions will, in fact, prove to be
correct or that actual future results will not be different from the
expectations expressed in this report. In evaluating these statements, you
should specifically consider various factors, including the risks outlined in
the "Risk Factors" section below.
ITEM 1. DESCRIPTION OF BUSINESS
General
Our current operations include providing value added information
services and cellular phone distribution through our Chinese operating
subsidiary.
Overview
Value-Added Information Services. We render value-added information
services in China by purchasing content from third-party providers and
reformatting that content. Our value-added information services enable wireless
receiver (mobile phone and pager) users in China to access financial information
and various entertainment-related services. We contract with our affiliated
wireless service providers to transmit the reformatted content to customers of
China's various network operators.
The primary focus of our value-added information services is on
providing wireless receiver users in China with access to financial information.
We derive the vast majority of our value-added information services revenue from
our financial information business. Our financial information software, Sifang
Gutong, allows our customers to access stock and currency exchange information
and execute stock trades. We are one of the largest stock information and
trading value-added information service providers in China.
We began providing our entertainment-related services, including icons,
screen savers, multiplayer games, Western horoscopes, jokes, and sports and
entertainment news during the latter part of 2003. These services are ancillary
to our financial information services and they represent only a small portion of
our value-added information services revenue at the present time.
Leveraging our experience and understanding of the wireless value-added
services market in China, we have consistently purchased and reformatted
content, applications and technologies that are popular in the Chinese wireless
market. To further enhance and differentiate our services, we have entered into,
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and will continue to actively pursue, collaborative relationships with third
parties to customize, market and provide access to their content through various
wireless technologies to Chinese consumers. In addition, all of our services are
promoted by our sales force and supported by our customer service team, each of
which is strategically based in Shanghai.
In order to meet ownership requirements under Chinese law that restrict
us, as a foreign company, from operating in certain industries such as
value-added telecommunication and Internet services, we have entered into
information service and cooperation agreements with two of our affiliates that
are incorporated in the People's Republic of China: Sifang Information and
Tianci. We hold no ownership interest in Sifang Information or Tianci. Sifang
Information and Tianci contract with China Mobile Communications Corporation, or
China Mobile, and China United Telecommunications Corporation, or China Unicom,
respectively, to provide wireless value-added information services to wireless
receiver customers in China via China Mobile and China Unicom. Sifang
Information transmits those services to customers of China Mobile and China
Unicom on behalf of itself and Tianci pursuant to a signed agreement between
Sifang Information and Tianci.
Business History. We originally began operations as a Colorado
corporation known as Boulder Brewing Company ("Boulder Brewing"). We were
incorporated in Colorado on May 8, 1980 and operated as a microbrewery of
various beers. Boulder Brewing was unable to become profitable within any
segment of its core business, became illiquid, and was forced to divest itself
of all of its assets. Boulder Brewing became dormant without any operations or
assets in the second quarter of 1990.
In September 2001, Boulder Brewing changed its state of incorporation
from Colorado to Nevada and changed its name to Boulder Acquisitions, Inc.
("Boulder Acquisitions"). The articles of incorporation and bylaws of the Nevada
corporation became the articles of incorporation and bylaws of the surviving
corporation. From the date of reincorporation until June 23, 2004, Boulder
Acquisitions had no material operations or assets.
On June 23, 2004, we completed a stock exchange transaction with the
stockholders of Sifang Holdings Co., Ltd. ("Sifang Holdings"). The exchange was
consummated under Nevada and Cayman Islands law pursuant to the terms of a
Securities Exchange Agreement dated effective as of June 23, 2004 by and among
Boulder Acquisitions, Sifang Holdings and the stockholders of Sifang Holdings.
Pursuant to the Securities Exchange Agreement, we issued 13,782,636 shares of
our common stock, par value $0.001 per share, to the stockholders of Sifang
Holdings, representing approximately 89.7% of our post-exchange issued and
outstanding common stock, in exchange for 100% of the outstanding capital stock
of Sifang Holdings. We presently carry on the business of Sifang Holdings'
wholly-owned subsidiary, Shanghai TCH Data Technology Co., Ltd., a Chinese
corporation, or TCH.
Effective August 6, 2004, we changed our name from Boulder
Acquisitions, Inc. to China Digital Wireless, Inc. The name change was
undertaken in order to provide us with a name that is more indicative of the
business operations we conduct.
Our business is primarily conducted through our wholly-owned subsidiary
Sifang Holdings and its wholly-owned subsidiary TCH Data Technology Co., Ltd.
("TCH Sifang Holdings"), which was established under the laws of the Cayman
Islands on February 9, 2004 for the purpose of holding 100% of the equity
interest in TCH. TCH was established as a foreign investment enterprise in
Shanghai under the laws of the People's Republic of China ("PRC") on May 25,
2004, with registered capital of $7.2 million. Our current operations were
originally a business division of Shanghai Sifang Information Technology Co.
("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 with a mark-up. In the
process of providing value-added information services through 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.
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Distribution. We distribute various mobile phone brands in the
Shanghai, China region. We distribute mobile phones manufactured primarily by
SAMSUNG Electronics Co., Ltd. ("Samsung"), and to a lesser extent, by Motorola,
Inc. ("Motorola"). We began distributing Motorola mobile phones in early 2002
and Samsung mobile phones in November 2002. We began discontinuing our Motorola
mobile phone distribution business on June 30, 2004. We will remain a
distributor, for the Shanghai region, of nine different mobile phone models
manufactured by Samsung, and plan to increase our sales of Samsung mobile
phones.
Six of the Samsung models we distribute are compatible with the CDMA
network and three of the Samsung models we distribute are compatible with the
GSM network. We plan to pre-install the end-user portion of our Sifang Gutong
software in all of the Samsung mobile phones we distribute, and market our stock
information, stock trading, and currency exchange services by placing brochures
touting those services in the packaging of those Samsung mobile phones before we
distribute the phones to retailers. We believe this process will increase name
recognition of our financial information and stock trading services with
wireless receiver users.
There are three main first-tier wholesalers of Samsung phones in China:
Shanghai Taili Communication Equipment Co., Ltd., Shenzhen Tianyin Communication
Development Co., Ltd., and Guangzhou Yingtai Data Power Technology Co., Ltd.
These wholesalers contract, through local branches, with sub-wholesalers to
distribute each model in a defined area. We have contracts with Shanghai branch
offices of the three main first-tier wholesalers on whom we rely, making us a
sub-wholesaler distributor of nine Samsung mobile phone models in the Shanghai
region. We sell approximately 52% of our mobile phones to three retailers.
We have rebate programs with Shanghai Taili Communication Equipment
Co., Ltd. and Shenzhen Tianyin Communication Development Co., Ltd. whereby we
are credited a certain portion of the sales price we paid to the first-tier
wholesaler if we are able to fulfill certain sales volume prescribed by that
first-tier wholesaler. As a result, we are entitled to receive certain rebates
and credits for the inventory held and sold by us within a specified period of
time as set by the first-tier wholesaler offering the rebate program.
Our Business Strategy
Our objective is to maintain and strengthen our position both as a
provider of wireless value-added information services and as a distributor of
mobile phones in the Shanghai region. In order to achieve our objective, we plan
to, among other things, increase the number of subscribers to our value-added
information services by increasing the number of mobile phones we distribute and
pre-installing those phones with the end-user portion of our Sifang Gutong
software. Key strategies for achieving our goal are to:
o Continue to expand and diversify our portfolio of wireless
value-added information services, including new SMS, 2.5G and
other next generation services such as those compatible with
3G,
o Increase investment in sales, marketing and branding, both in
conjunction with network operators and through independent
activities, in order to promote customer awareness of our
wireless value-added information services in China,
o Continue to strengthen our relationships with China Mobile and
China Unicom by increasing our sales presence at the national
and local levels and through joint marketing and promotion
activities,
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o Expand our marketing channels by continuing to develop
integrated marketing campaigns with traditional media outlets,
o Continue to be a sub-wholesaler of Samsung mobile phones and
increase the number of models of mobile phones that we
distribute, and
o Work on establishing relationships with new mobile phone
manufacturers and wholesalers in order to diversify our
distribution business.
Our Value-Added Information Services
Financial Services
Our primary focus with regard to value-added information services is
the provision of financial information services utilizing our Sifang Gutong
software. This software, developed by Chengao, utilizes the JAVA and BREW
platforms. JAVA and BREW utilize the more advanced 2.5G technology standard,
which enables high-capacity wireless data transmissions. As a result, services
offered over these platforms are more sophisticated and offer users higher
quality graphics and richer content and interactivity, commanding a premium
price over our other services. Our Sifang Gutong software enables our mobile
phone and pager customers to access quotes and retrieve customized
investment-related information, as well as access our currency exchange
information.
Sifang Gutong provides our mobile phone and pager customers with the
ability to receive streaming real-time quotes, including stocks, most active
issues, largest gainers and losers, and mutual funds for securities trading on
the Shenzhen and Shanghai stock exchanges. Our Sifang Gutong software available
to mobile phone users includes a stock trading function that enables our mobile
phone customers to directly place orders to buy and sell securities listed on
the two aforementioned stock exchanges. Our trading window corresponds with the
hours that securities markets are open from 9:30 a.m. to 11:30 a.m., and from
1:00 p.m. to 3:00 p.m., Beijing Time.
We receive a continuous direct feed of detailed quote data, market
information and news. Our customers can create customized lists of stocks for
quick access to current trading information. Through our relationships with
financial information companies such as Shanghai Stock Information Company, we
also provide access to breaking news, charts, market commentary and analysis.
The value-added financial information we offer can only be accessed by
a customer on whose mobile phone or pager the end-user portion of our Sifang
Gutong software has been installed. We plan to pre-install the end-user portion
of our Sifang Gutong software in all of the Samsung mobile phones that we
distribute. With regard to mobile phones and pagers not distributed by us, we
will provide installation of our Sifang Gutong software free of charge upon
request.
Pursuant to the request of a Beijing retailer, we entered into an
agreement with Chengao and Sifang Information whereby Chengao installs the
end-user portion of our Sifang Gutong software into mobile phones owned by the
retailer. The retailer sells these phones at a premium price to consumers. In
return for the premium price, the consumers receive our value-added information
services for six months free of charge. The retailer passes the premium back to
Chengao, who retains a small installation fee and then passes the remainder on
to us. This relationship helps us market our value-added information services
and enables us to establish relationships with new customers.
Other Services
We also provide icons and screen savers, multiplayer action games,
Western horoscopes, jokes and event-driven or entertainment news updates. These
services represent only a small portion of our value-added information services
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revenues at the present time. However, we believe that providing wireless
receiver users in China access to entertainment-related services increases our
ability to retain our financial information subscribers and expand our
subscriber base, and we expect the entertainment-related services portion of our
value-added information services business will grow over time.
o Horoscopes. With this service, users can obtain daily Western
horoscopes via their mobile phones or pagers.
o Games. We offer interactive SMS, JAVA and WAP-based games that
can be played on the screens of mobile phones. These games are
designed to be easy to play on the dial pad of a mobile phone
and to maximize the graphics available on mobile phone
screens. Our current game offerings include our popular titles
Ant Kingdom and English Island. Ant Kingdom, designed for the
WAP platform, is a role-playing game set in the kingdom of
Ant. Players begin play as a soldier, and as they gain
experience in the game, gradually build their character to
higher levels such as captain, officer and eventually, king.
The goal of the game is to be the king. In English Island, a
JAVA-based educational game, players are given English words
and must spell them correctly. Every time a player spells a
word correctly, the player's score increases. The faster a
player can spell words correctly, the higher the score he can
achieve.
o Jokes. We send users of this service a variety of jokes on
demand or via automatic daily messages.
o News. We automatically send periodic SMS messages on recent
event-driven news, sports (especially soccer), or
entertainment events to subscribers of this service. Mobile
phone users can also download desired information on demand.
We obtain our news content from government affiliated media
companies, such as XinhuaNet and other local media.
Content Relationships
Our content collaborators authorize the inclusion of their content in
one or more of our value-added information services for a fixed fee which we pay
directly to the provider. Our agreements with our content collaborators usually
have a one-year term, and are non-exclusive. Currently, our key content
collaborators are:
o Shanghai Stock Information Company.
o Xinhua News Agency (Shanghai).
o Shanghai Wanguo Stock Information Company.
o Shanghai Yibang Stock Information Company.
o Shanghai Shiji Stock Information Company.
o Korea Techall Co., Ltd. (which provides game content).
o Shanghai Shenfa Software Co., Ltd. (which provides game content).
Marketing Relationships
Sifang Information and Tianci, our affiliated value-added mobile phone
service providers, have marketing relationships with China Mobile and China
Unicom. We sell and market our services principally through China Mobile and
China Unicom. We also sell and market through Sifang Information's Web site,
www.sifang.net, and promotional events, direct marketing, media advertising and
other activities.
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We are also focused on expanding our marketing channels by developing
integrated marketing campaigns with traditional media outlets and multinational
corporations. For example, we have been involved in several marketing campaigns
with Motorola whereby our wireless value-added services are promoted in their
in-store and media advertising in China, and Motorola is in turn promoted
through our services.
We sell all of our paging value-added information services through our
affiliated value-added paging service provider, Sifang Information. We contract
directly with end users to settle all payments from pager users. We market our
paging value-added information services through traditional media outlets,
including newspapers and magazines, and directly to end-users.
Operator Channels
General. All of our paging value-added information services are
provided through the paging network owned by Sifang Information. We contract
directly with the pager users to collect all fees generated from our value-added
information services. We have an information service and cooperation agreement
with Sifang Information that provides us exclusive access to their paging
network for ten years. This agreement is automatically renewable for additional
one year terms unless we decide to terminate. All of our mobile phone
value-added information services are provided to mobile phone users by Sifang
Information through the networks of China Mobile and China Unicom. Previously,
mobile phone users paid for our services by purchasing pre-paid services cards.
Now, our services are billed to mobile phone customers in one of two ways: (1)
certain of our customers pay for our services in advance when they purchase our
services and a mobile phone together in a premium package (through our
relationship with Chengao and Sifang Information), and (2) our other customers
(who do not purchase our services as part of any such premium package) are
billed by the mobile operators, who collect the fees for our services, including
both our data access and short message services, from their mobile phone
subscribers. The mobile operators then pass those fees (net of fees charged by
the mobile operator) to our affiliated value-added service providers, Sifang
Information and Tianci, who in turn pass those fees to us in return for a small
fee pursuant to the terms of information service and cooperation agreements
between us and each of them.
Our management team utilizes our experience in China to develop close
ties with the key personnel of the mobile operators at the central and
provincial levels. As of December 31, 2004, we had approximately two sales
professionals strategically located in provinces and municipalities concentrated
in the eastern and southern regions of China to work closely with the mobile
operators at the local level, where pricing and important marketing and
operational decisions are made. Our sales network enables us to work closely
with operators to facilitate the approval required for new service offerings and
for related pricing and to enjoy enhanced marketing and promotional support. We
are also able to gain insight into developments in the local markets and the
competitive landscape, as well as new market opportunities. Our sales
professionals are well-incentivized; most of their compensation is tied to usage
of our services in the applicable region.
Coordinated Marketing Campaigns. Our affiliated wireless service
providers cooperate in marketing campaigns with China Mobile and China Unicom.
These network operators distribute literature marketing us and our affiliates.
Non-Operator Channels
We also focus on non-mobile operator sales and marketing activities,
such as:
o promoting Sifang Information's Web site, www.sifang.net, to
potential users as a fun, easy-to-access place to request our
wireless content and applications,
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o engaging in direct marketing to mobile phone users by, for
example, including advertising inserts in users' bills from
Shanghai Mobile and Shanghai Unicom,
o engaging in direct marketing to stock market investors by, for
example, including advertising inserts in investors' bills
from brokerage companies such as GF Securities Co., Ltd.,
Guotai Junan Securities Co., Ltd., Everbright Securities Co.,
Ltd. and Guoxin Securities Co., Ltd.,
o utilizing our database of users to create targeted marketing
campaigns,
o advertising in traditional media outlets such as newspapers
and magazines, and
o we plan to pre-install the Samsung mobile phones we distribute
with the end-user portion of our Sifang Gutong software, and
place brochures touting our stock information, stock trading
and currency exchange services in the packaging of those
phones, before distributing them to retailers.
Customer Research
We spent $18,909 and $60,092 on marketing and advertising fees for our
mobile phone distribution and value-added service business in fiscal 2003 and
2004, respectively. Our sales, marketing and product development activities are
supported by our five-member customer research department. This department
focuses our sales efforts in the following three distinct phases:
Customer Acquisition. Our customer research department analyzes the
success rates of various national and local marketing campaigns in which we are
involved, including by user segment and cost per user, in order to determine
which campaigns are the most effective. Using phone surveys, focus groups and
analyses of usage patterns, the department also considers demographic and other
market factors to identify product mixes and product categories which are
suitable for the current market environment.
Customer Conversion. To enhance our ability to convert one-time or
occasional customers into regular users of our services, our customer research
department analyzes customer and product churn rates across the market, average
revenue per user data and other information. In this way, it can identify
different customer segments and develop targeted marketing campaigns for those
segments, including cross-selling and up-selling marketing campaigns.
Customer Retention. Our customer research department evaluates ways to
maximize user interest in our services through, for example, providing feedback
to our product developers to improve product features based on customer
information and bundling older services with newly launched services. It also
creates various reward programs designed to enhance customer loyalty.
Customer Services
We pride ourselves in providing high quality customer service. Our
dedicated customer service center based in Shanghai provides our users real-time
support and is staffed by 20 full-time professionals. The center currently
operates everyday from 7:00 a.m. to 10:00 p.m. We strive to achieve the fastest
response times and highest customer satisfaction levels in the industry.
Competitive Landscape
There are currently three broad categories of wireless service
providers in China:
7
o Portal service providers, which have established expertise in
Internet content and have subsequently branched into mobile
space. The portals serve as content aggregators offering a
variety of wireless value-added services. These national
portal operators include Sohu, NetEase, SINA, and Tom.com.
o Dedicated service providers, whose businesses focus on
offering a variety of wireless content directly to mobile
users. These providers include Linktone, Newpalm and Mtone
Wireless.
o Niche service providers, which focus on a particular market
segment or application that often builds on a pre-existing
sector competency. These providers include Tencent, Enorbus,
and Solute. We belong in this category because of our focus on
financial information services.
We may also face competition from international wireless service
providers.
As the mobile operators are becoming more selective in choosing their
service providers to promote high quality content, ensure high levels of
customer service and limit the number of providers with which they have to deal,
scale is becoming more important, and we believe the industry will likely
experience consolidation with the leading nationwide providers gaining more
market share at the expense of smaller local providers. Nationwide providers may
also acquire some of their smaller competitors to gain access to local
relationships with the mobile operators in China or new product expertise.
We estimate that we compete with between ten to twenty other
sub-wholesalers for the rights to distribute Samsung phones in the Shanghai
region. The three main competitive factors the wholesalers consider in granting
a sub-wholesaler the rights to distribute a particular model include:
Available Cash Flow. Sub-wholesalers must be able to pay for the mobile
phones they desire to purchase from first-tier wholesalers. First-tier
wholesalers will be hesitant to grant rights to distribute a particular model to
a sub-wholesaler if that sub-wholesaler does not have sufficient capital to make
large purchases. We believe that having adequate cash flow gives us a
competitive advantage.
Relationships with Retailers. The wholesalers look to the types of
relationships sub-wholesalers have with large retailers when deciding which
sub-wholesaler to utilize. We have strong relationships with three large
retailers in Shanghai and sell approximately 52% of our mobile phones to these
three retailers.
Relationships with Wholesalers. We have relationships with the three
major wholesalers of Samsung phones in China and have been sub-wholesalers for
those three wholesalers for more than a year.
Employees
The following table summarizes the functional distribution of our
employees as of December 31, 2003 and 2004:
December 31,
Department 2003 2004
Business Development 5 5
Customer Research 5 5
Customer Service 20 20
Finance 3 3
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December 31,
Department 2003 2004
Human Resources 2 2
Investor Relations 2 2
Legal and Administrative 2 2
Sales and Marketing 25 25
Product Development 20 20
Technical Support 10 10
Total 94 94
All of our personnel are employed full-time and none of them are
represented under collective bargaining agreements. We consider our relations
with our employees to be good.
Wireless Technology Standards in China
Several different wireless technology standards have been developed
which operate at different frequencies with both analog and digital radio
signals. First generation wireless telephone systems employ analog technology,
while newer systems employ digital technology. Digital wireless technology,
commonly referred to as second generation technology, or 2G, multiplies the
number of users that can be served by the same band of spectrum using analog
technology. The wireless technologies most relevant in China currently include:
o Global System for Mobile Communications, or GSM -- initially
developed in order to facilitate unification and integration
of telecommunications within the European Union has become
widespread throughout most Asian countries. GSM technology
breaks audio signals into sequential pieces of data of a
defined length, places each piece into an information conduit
at specific intervals and then reconstructs the pieces at the
end of the conduit. A key component of the GSM system is the
SIM card. Data stored on the card identifies the subscriber to
the mobile network as well as the service authorized for that
subscriber. Since the identity of the subscriber is held on
the card, any mobile phone can be used in conjunction with the
SIM card.
o Code Division Multiple Access, or CDMA -- a digital technology
standard which has been used in commercial operation by
several operators in certain countries such as the United
States and Korea. Unlike GSM, CDMA technology is a continuous
transmission technology which uses a coding system to mix
discrete audio signals together during transmission and then
separates those signals at the end of transmission.
Prior to the commercial rollout of third generation, or 3G, networks,
2.5G technology standards have been developed for both the GSM and CDMA
technologies to offer higher data transmission speeds, enabling the use of more
data intensive products. Current 2.5G wireless technologies include:
o General Packet-Switched Radio Service, or GPRS -- offers
faster data transmission with speeds ranging from 56 kilobits
per second, or Kbps, to 114 Kbps via a GSM network. GPRS
supports a wide range of bandwidths and is particularly suited
for sending and receiving small bursts of data, such as e-mail
and Web browsing, as well as large volumes of data. GPRS also
makes it possible for users to make telephone calls and
transmit data simultaneously.
o CDMA 1x RTT -- an advanced CDMA-based technology which allows
transmission of data at speeds of up to 144 Kbps, compared to
a maximum of 64 Kbps for second generation CDMA networks.
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3G represents several technology standards developed by The
International Telecommunications Union. Third generation technology has been
developed for both the GSM standard and CDMA standard.
Wireless value-added services can be offered through all of these
technology standards and most commonly include:
o Short Messaging Services, or SMS -- a service that enables a
user to send and receive text messages comprised of words or
numbers or an alphanumeric combination. SMS was created when
it was incorporated into the GSM standard.
o Wireless Application Protocol, or WAP -- a software protocol
standard that defines a standardized means of transmitting
Internet-based content and data to handheld devices such as
mobile phones and pagers with secure access to e-mail and
text-based Web pages. WAP supports most wireless networks
including GSM and CDMA.
o Multimedia Messaging Services, or MMS -- a method of
transmitting graphics, video clips, sound files and short text
messages over wireless networks using the WAP protocol. MMS,
however, is not the same as e-mail in that MMS is based on the
concept of multimedia messaging. An MMS message is coded so
that the images, sounds and text are displayed in a
predetermined order as one singular message. Furthermore, MMS
does not support attachments as e-mail does.
o JAVA -- a general programming environment that creates
applications for the Internet or any other distributed
networks. JAVA applications are intended to be independent of
the hardware platform.
Market Overview
Wireless Value-Added Services as a Revenue Driver for the Mobile Operators
As the wireless market in China continues to develop, an increasing
portion of the mobile operators' users have relatively low per capita incomes.
These subscribers generally yield lower levels of average revenue per user, or
ARPU, because they are primarily users of pre-paid services. In addition,
China's wireless market is becoming increasingly competitive, as demonstrated by
the recent CDMA promotions by China Unicom, as well as the intra-city wireless
offerings by China's two fixed-line operators, China Telecom and China Netcom,
which offer users limited mobile services within a city based on Personal
Handyphone Service or Personal Access System technology. In addition, China
Telecom, China Netcom and possibly other parties are expected to be awarded two
wireless licenses, although the timing of such grants is unclear. Both China
Telecom and China Netcom are large, established companies with significant
assets and the entry by them or other companies into the Chinese wireless market
could lead to further competition among the mobile operators. Due to these
pressures on the traditional voice-related businesses of the mobile operators,
SMS and other wireless value-added services have become a key differentiator and
increasingly important driver for the growth prospects of China Mobile and China
Unicom. We believe wireless value-added services will play a key role in the
mobile operators' competitive positioning when attracting and retaining users as
well as in their efforts to reverse declining ARPU levels.
Against this competitive backdrop, the market for wireless value-added
services in China has expanded significantly and is expected to continue to grow
at a fast pace. Currently, SMS services continue to represent the bulk of the
wireless value-added services market in China. This market is increasingly
shifting towards next generation technologies, with mobile operators upgrading
10
their networks to GPRS and CDMA 1x RTT and users upgrading to next generation
mobile phones that can operate with technologies such as MMS and WAP. China
Mobile and China Unicom have recognized this opportunity and are collaborating
with select service providers, including us, to further develop 2.5G
applications and services.
Operators' Wireless Value-Added Services Initiatives in China
China Mobile was the first to enter the market by introducing a popular
trial SMS program in connection with the Sydney Olympic Games in August 2000.
China Mobile later established its Monternet(TM) platform in November 2000.
China Unicom started its Uni-Info platform in May 2001. Monternet(TM) and
Uni-Info offer mobile phone users a single access point to order and pay for
wireless value-added services.
From the inception of Monternet(TM) and Uni-Info, China Mobile and
China Unicom have outsourced almost all content and applications for their
platforms, meaning that these operators, much like NTT DoCoMo and SK Telecom,
rely almost entirely upon third-party service providers to drive their network
traffic, supply attractive wireless services and increase revenue from their
wireless value-added services. In turn, the operators focus on the operation of
their networks. For their part, wireless value-added service providers in China
rely on the two operators, China Mobile and China Unicom, for the network
distribution of their content and services, billing and collection, and
remittance of revenues. Both operators have established similar fee
arrangements.
In addition to their working relationships with third-party service
providers, China's mobile operators will likely form closer alliances with
mobile phone vendors in order to standardize user friendly access to and
functionality for wireless value-added services in all mobile phones.
Government Regulation
The following is a summary of the principal governmental laws and
regulations that are or may be applicable to wireless service providers like us
in China. The scope and enforcement of many of the laws and regulations
described below are uncertain. We cannot predict the effect of further
developments in the Chinese legal system, including the promulgation of new
laws, changes to existing laws or the interpretation or enforcement of laws,
particularly with regard to wireless value-added services, which is an emerging
industry in China.
Regulation of Telecommunication Services
The telecommunications industry, including certain wireless value-added
services, is highly-regulated in China. Regulations issued or implemented by the
State Council, the Ministry of Information Industries, and other relevant
government authorities cover many aspects of telecommunications network
operation, including entry into the telecommunications industry, the scope of
permissible business activities, interconnection and transmission line
arrangements, tariff policy and foreign investment.
The principal regulations governing the telecommunications services
business in China include:
o Telecommunications Regulations (2000), or the Telecom
Regulations. The Telecom Regulations categorize all
telecommunications businesses in China as either
infrastructure telecommunications businesses or value-added
telecommunications businesses. The latter category includes
SMS and other wireless value-added services. Under the Telecom
Regulations, certain services are classified as being of a
value-added nature and require the commercial operator of such
services to obtain an operating license, including
telecommunication information services, online data processing
and translation processing, call centers and Internet access.
The Telecom Regulations also set forth extensive guidelines
with respect to different aspects of telecommunications
operations in China.
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o Regulations for the Administration of Foreign-Invested
Telecommunications Enterprises (2002), or the FI Telecom
Regulations. The FI Telecom Regulations set forth detailed
requirements with respect to capitalization, investor
qualifications and application procedures in connection with
the establishment of a foreign-invested telecom enterprise.
Under the FI Telecom Regulations, a foreign entity is
prohibited from owning more than 50% of the total equity in
any value-added telecommunications business in China, subject
to certain geographic limitations.
o Administrative Measures for Telecommunications Business
Operating License (2001), or the Telecom License Measures.
Under the Telecom License Measures, an approved value-added
telecommunications service provider must conduct its business
in accordance with the specifications recorded on its Telecom
Business Operating License.
In addition to regulations promulgated at the national level by the
Chinese government, the Shanghai municipal government has issued provisional
regulations requiring SMS service providers to obtain licenses from or register
with the local Ministry of Information Industries branch office before providing
SMS service within the city. At this time, it is unclear whether national
regulations will be promulgated regulating SMS services.
Our affiliates, Sifang Information and Tianci, each have a value-added
telecommunication services license issued by the Shanghai Municipal
Telecommunications Administration Bureau, which is the local office of the
Ministry of Information Industries. They are each also in the process of
applying for an inter-provincial value-added telecommunication license with the
Ministry of Information Industries.
Other Laws and Their Application
Regulation of Internet Content Services. As a wireless value-added
information services provider, we do not engage in the Internet portal business
which typically involves the provision of extensive Internet content services,
including Chinese language Web navigational and search capabilities, content
channels, web-based communications and community services and a platform for
e-commerce, such as auction houses. Sifang Information registered with the
Shanghai Telecommunication Administration Bureau in January 2001 to provide
commercial services at the www.sifang.net web site.
As a commercial ICP provider, Sifang Information is prohibited from
posting or displaying any content that:
o opposes the fundamental principles determined in China's
Constitution;
o compromises state security, divulges state secrets, subverts
state power or damages national unity;
o harms the dignity or interests of the state;
o incites ethnic hatred or racial discrimination or damages
inter-ethnic unity;
o sabotages China's religious policy or propagates heretical
teachings or feudal superstitions;
o disseminates rumors, disturbs social order or disrupts social
stability;
o propagates obscenity, pornography, gambling, violence, murder
or fear or incites the commission of crimes;
o insults or slanders a third party or infringes upon the lawful
rights and interests of a third party; or
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o includes other content prohibited by laws or administrative
regulations.
Failure to comply with these prohibitions may result in the closing of Sifang
Information's Web site.
Regulation of News Dissemination through SMS Services. Pursuant to a
circular issued by the Shanghai Communications Administration, distribution of
news content through wireless applications like SMS must be approved by relevant
government agencies. Both Sifang Information and Tianci have all necessary
approvals.
Regulation of Advertisements. The State Administration of Industry and
Commerce, or the SAIC, is the government agency responsible for regulating
advertising activities in China. The SAIC has not promulgated regulations
specifically aimed at wireless advertising through a media other than the
Internet, such as through SMS services. One provisional regulation issued by
Shanghai municipal government prohibits service providers from sending SMS
advertisements without the client's consent.
As part of our non-mobile operator marketing activities, we have
developed integrated marketing campaigns with traditional media outlets such as
magazines and newspapers and multinational corporations through certain
cross-selling efforts with companies, including Motorola and Samsung. If the
SAIC were to treat our integrated marketing campaigns or other activities as
being advertising activities, we would need to apply to the local SAIC for an
advertising license to conduct wireless advertising business (through SMSs, for
example). We can give no assurance that such application would be approved by
the SAIC. Failure to obtain such approval could result in penalties including
being banned from engaging in online advertising activities, confiscation of
illegal earnings and fines.
Foreign Exchange Controls. The principal regulations governing foreign
exchange in China are the Foreign Exchange Control Regulations (1996) and the
Administration of Settlement, Sale and Payment of Foreign Exchange Regulations
(1996), or the Foreign Exchange Regulations. Under the Foreign Exchange
Regulations, Renminbi is freely convertible into foreign currency for current
account items, including the distribution of dividends. Conversion of Renminbi
for capital account items, such as direct investment, loans and security
investment, however, is still subject to the approval of the State
Administration of Foreign Exchange, or SAFE.
Under the Foreign Exchange Regulations, foreign-invested enterprises
are required to open and maintain separate foreign exchange accounts for capital
account items (but not for other items). In addition, foreign-invested
enterprises may only buy, sell and/or remit foreign currencies at those banks
authorized to conduct foreign exchange business after providing valid commercial
documents and, in the case of capital account item transactions, obtaining
approval from SAFE.
Intellectual Property and Proprietary Rights
We rely primarily on a combination of copyright laws and contractual
restrictions to establish and protect our intellectual property rights. We
require our employees to enter into agreements requiring them to keep
confidential all information relating to our customers, methods, business and
trade secrets during and after their employment with us. Our employees are
required to acknowledge and recognize that all inventions, trade secrets, works
of authorship, developments and other processes, whether or not patentable or
copyrightable, made by them during their employment are our property. They also
sign agreements to substantiate our sole and exclusive right to those works and
to transfer any ownership that they may claim in those works to us.
While we actively take steps to protect our proprietary rights, such
steps may not be adequate to prevent the infringement or misappropriation of our
intellectual property. This is particularly the case in China where the laws may
not protect our proprietary rights as fully as in the United States.
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Infringement or misappropriation of our intellectual property could materially
harm our business. Sifang Information has registered the following Internet and
WAP domain name www.sifang.net.
Shanghai Sifang Communication Company ("Sifang Communication") has
registered one trademark with China's Trademark Office. That trademark is our
logo, a square (the English translation of "Sifang" is "square"). China's
trademark law utilizes a "first-to-file" system for obtaining trademark rights.
As a result, the first applicant to file an application for registration of a
mark will preempt all other applicants. Prior use of unregistered marks, except
"well known" marks, is generally not a basis for legal action in China. We may
not be able to successfully defend or claim any legal rights in any trademarks
for which we apply in the future.
Pursuant to a license agreement between our affiliate, Sifang
Communication, and us, we have the right to use our registered trademark, our
square logo, whenever necessary. We also acquired all of Sifang Information's
interest in the Sifang Gutong software pursuant to the terms of the spin-off of
Sifang Information's business divisions focusing on value-added information
services and distribution of mobile phones. We have the right to use the word
"Sifang" and to market ourselves through www.sifang.net with regard to both of
the spun-off divisions.
Many parties are actively developing and seeking patent protection for
wireless services-related technologies. We expect these parties to continue to
take steps to protect these technologies, including seeking patent protection.
There may be patents issued or pending that are held by others and that cover
significant parts of our technology, business methods or services. Disputes over
rights to these technologies are likely to arise in the future. We cannot be
certain that our products do not or will not infringe valid patents, copyrights
or other intellectual property rights held by third parties. We may be subject
to legal proceedings and claims from time to time relating to the intellectual
property of others.
RISK FACTORS
In addition to the other information contained in this annual report,
including the reports we incorporate by reference, you should consider the
following factors that may affect our future results and financial condition
before investing in our securities. Although we believe that the expectations
reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. We are under no
duty to update any of the forward-looking statements after the date of this
prospectus to conform such statements to actual results or to changes in our
expectations.
RISKS RELATED TO OUR WIRELESS VALUE-ADDED INFORMATION SERVICES BUSINESS
WE DEPEND UPON CONTRACTUAL ARRANGEMENTS WITH OUR AFFILIATED VALUE-ADDED MOBILE
PHONE SERVICE PROVIDERS, SIFANG INFORMATION AND TIANCI, FOR THE SUCCESS OF OUR
BUSINESS. THESE ARRANGEMENTS MAY NOT BE AS EFFECTIVE IN PROVIDING OPERATIONAL
CONTROL AS DIRECT OWNERSHIP OF THESE BUSINESSES AND MAY BE DIFFICULT TO ENFORCE.
Because we conduct our business only in China, and because we are
restricted by the Chinese government from owning telecommunications or Internet
operations in China, we depend on our affiliated value-added mobile phone
service providers, Sifang Information and Tianci, in which we have no direct
ownership interest, but with which we have entered into information service and
cooperation agreements, to provide those services to mobile phone users in China
through contractual agreements with the mobile operators, China Mobile and China
Unicom. These arrangements may not be as effective in providing control over our
value-added information services to mobile phone users in China as would be
direct ownership of these businesses. For example, Sifang Information or Tianci
could fail to take actions required to operate our business, such as entering
into service contracts with China Mobile or China Unicom. Moreover, a portion of
14
the fees for our services are paid by the mobile operators directly to Sifang
Information and Tianci, which are then obligated to transfer all of those fees
to us, in return for a small fee. If Sifang Information or Tianci fails to
perform their obligations under these agreements, we may have to rely on legal
remedies under Chinese law, which we cannot assure you would be effective or
sufficient.
In the opinion of our Chinese counsel, Grandall Legal Group (Shanghai),
Sifang Information and Tianci each possess such licenses, permits, certificates,
authorities and approvals, issued by appropriate governmental agencies or bodies
in the People's Republic of China, as are necessary to conduct its business as
presently conducted as well as to perform its obligations under any contracts
between it and China Mobile and China Unicom, respectively. In addition, to the
best knowledge of Grandall Legal Group (Shanghai), TCH is not in breach of or in
default under any laws of the People's Republic of China or any approval,
consent, waiver, authorization, exemption, permission, endorsement or license
granted by any People's Republic of China governmental agencies. There are,
however, substantial uncertainties regarding the interpretation and application
of current and future Chinese laws and regulations, as discussed below.
WE DEPEND ON ONE SOFTWARE DEVELOPER FOR A SIGNIFICANT PORTION OF OUR SOFTWARE
DEVELOPMENT, AS WELL AS FOR IMPORTANT MARKETING RELATIONSHIPS.
We rely on Shanghai Chengao Industrial Co., Ltd., or Chengao, to
develop a significant portion of our software, including our Sifang Gutong
software. We also rely on Chengao to provide us with an important marketing
relationship regarding the mobile phone version of our Sifang Gutong software.
If we lose our relationship with Chengao, we could have a difficult time finding
a suitable replacement in the short term.
OUR CORPORATE STRUCTURE COULD BE DEEMED TO BE IN VIOLATION OF CURRENT OR FUTURE
CHINESE LAWS AND REGULATIONS WHICH COULD ADVERSELY AFFECT OUR ABILITY TO OPERATE
OUR BUSINESS EFFECTIVELY OR AT ALL.
In connection with China's entry into the World Trade Organization, or
WTO, foreign investment in telecommunications and Internet services in China was
liberalized to allow for 30.0% foreign ownership in value-added
telecommunication and Internet services in 2002, 49.0% in 2003, and 50.0%
thereafter. In order to meet these ownership requirements, we have entered into
information service and cooperation agreements with Sifang Information and
Tianci. We do not have any direct ownership interest in Sifang Information or
Tianci. The original stockholder structure of Sifang Holdings was identical to
the current stockholder structure of Sifang Information, and each of Sifang
Information and Tianci are beneficially owned 69% by Tai Caihua, our president
and the chairman of our board of directors. It is possible that the relevant
Chinese authorities could, at any time, assert that any portion or all of TCH's,
Sifang Information's, or Tianci's existing or future ownership structure and
businesses violate existing or future Chinese laws, regulations or policies. It
is also possible that the new laws or regulations governing the
telecommunication or Internet sectors in China that have been adopted or may be
adopted in the future will prohibit or restrict foreign investment in, or other
aspects of, TCH's, Sifang Information's or Tianci's current or proposed
businesses and operations. In addition, these new laws and regulations may be
retroactively applied. In any such case, we could be required to restructure our
operations, which could adversely affect our ability to operate our business
effectively or at all.
WE DEPEND ON CHINA MOBILE AND CHINA UNICOM FOR DELIVERY OF OUR VALUE-ADDED
INFORMATION SERVICES TO MOBILE PHONE USERS IN CHINA, AND THE TERMINATION OR
ALTERATION OF SIFANG INFORMATION'S AND TIANCI'S VARIOUS CONTRACTS WITH EITHER OF
THEM OR THEIR PROVINCIAL OR LOCAL AFFILIATES COULD MATERIALLY AND ADVERSELY
IMPACT OUR BUSINESS.
Our affiliated value-added mobile phone service providers, Sifang
Information and Tianci, contract with the two principal mobile phone operators
in China, China Mobile and China Unicom, to offer our wireless value-added
information services to mobile phone users through these mobile phone operators,
15
which service nearly all of China's approximately 282.2 million mobile phone
subscribers. Given their dominant market position, our affiliated value-added
mobile phone service providers' negotiating leverage with these operators is
limited. If our affiliated value-added mobile phone service providers' various
contracts with either operator are terminated or adversely altered, it may be
impossible for our affiliated value-added mobile phone service providers to find
appropriate replacement operators with the requisite licenses and permits,
infrastructure and customer base to offer our services, and our business would
be significantly impaired.
Our value-added information services are provided to mobile phone users
in China pursuant to contracts with Sifang Information and Tianci have with
China Mobile and China Unicom and their provincial or local affiliates. Each of
these contracts is non-exclusive, and has a limited term (generally one year).
Our affiliates usually renew these contracts or enter into new ones when the
prior contracts expire, but on occasion the renewal or new contract can be
delayed by periods of one month or more. The terms of these contracts vary, but
the operators are generally entitled to terminate them in advance for a variety
of reasons or, in some cases, for no reason in their discretion. For example,
several of our affiliates' contracts with the mobile operators can generally be
terminated if:
o our affiliate fails to achieve performance standards which are
established by the applicable operator from time to time,
o our affiliate breaches its obligations under the contracts,
which include, in many cases, the obligation not to deliver
content that violates the operator's policies and applicable
law,
o the operator receives high levels of customer complaints about
our affiliate's services, or
o the operator sends written notice to our affiliate that it
wishes to terminate the contract at the end of the applicable
notice period.
Our affiliates may also be compelled to alter their arrangements with
these mobile operators in ways which adversely affect our business. China Mobile
and China Unicom have unilaterally changed their policies as applied to
third-party service providers in the past, and may do so again in the future. We
may not be able to adequately respond to negative developments in the
contractual relationships between our affiliates and China Mobile or China
Unicom in the future because we do not have a contractual relationship with
China Mobile or China Unicom.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF CHINA MOBILE OR CHINA UNICOM OR BOTH
BEGIN PROVIDING THEIR OWN WIRELESS VALUE-ADDED SERVICES.
Our wireless value-added information services business may be adversely
affected if China Mobile or China Unicom or both decide to begin providing their
own wireless value-added services to mobile phone users. In that case, we would
face enhanced competition, and our services could be fully or partially denied
access to their networks.
WE DEPEND IN PART ON CHINA MOBILE AND CHINA UNICOM TO MAINTAIN ACCURATE RECORDS
AND THEIR WILLINGNESS TO PAY OUR AFFILIATED VALUE-ADDED WIRELESS SERVICE
PROVIDERS.
We depend in part on China Mobile and China Unicom to maintain accurate
records of the fees paid by mobile phone users and their willingness to pay our
affiliated value-added wireless service providers. Specifically, the mobile
operators provide our affiliates with monthly statements that do not provide
itemized information regarding which of our services are being paid for. Our
business and results of operation could be adversely affected if these mobile
phone companies miscalculate the revenue generated from our services and our
affiliates' portion of that revenue, or refuse to pay our affiliates altogether.
16
OUR REVENUES AND COST OF SERVICES ARE AFFECTED BY BILLING AND TRANSMISSION
FAILURES WHICH ARE OFTEN BEYOND OUR CONTROL.
Our affiliates do not collect fees for our services owed to them by
China Mobile and China Unicom in a number of circumstances, including if:
o the delivery of our service to a customer is prevented because
his or her phone is turned off for an extended period of time,
the customer's prepaid phone card has run out of value or the
customer has ceased to be a customer of the applicable
operator,
o China Mobile or China Unicom experiences technical problems
with their networks which prevent the delivery of our services
to the customer,
o we experience technical problems with our technology platform
that prevent delivery of our services,
o our affiliates experience technical problems with their
technology platforms that prevent delivery of our services, or
o the customer refuses to pay for our service due to quality or
other problems.
These situations are known in the industry as billing and transmission
failures, and we do not recognize any revenue for services which are
characterized as billing and transmission failures. The failure rate can vary
among the operators, and by province, and also has fluctuated significantly in
the past. If actual billing and transmission failures exceed our estimates, our
revenues could be materially adversely affected.
CHINA MOBILE AND CHINA UNICOM MAY IMPOSE HIGHER SERVICE OR NETWORK FEES ON OUR
AFFILIATED VALUE-ADDED SERVICE PROVIDERS IF WE ARE UNABLE TO SATISFY CUSTOMER
USAGE AND OTHER PERFORMANCE CRITERIA.
Fees for our wireless value-added information services are charged on a
monthly subscription or per use basis. Based on our contractual arrangement and
those of our wireless value-added service providers, we rely on China Mobile and
China Unicom to bill and collect fees for our services from mobile phone users.
China Mobile and China Unicom generally charge our affiliated
value-added service providers service fees of 15% and 30% of the revenues
generated by their services, respectively. To the extent that the number of
messages sent by Sifang Information over China Mobile's network exceeds the
number of messages their customers send to it, Sifang Information must pay per
message network fees, which decrease in several provinces as the volume of
customer usage of our services increases. The number of messages sent by Sifang
Information will exceed those sent by end-users, for example, if a user sends
Sifang Information a single message to order a game but Sifang Information in
turn must send that user several messages to confirm his or her order and
deliver the game itself. Tianci's service fees owed to China Unicom could also
rise if Tianci fails to meet certain customer usage, revenue and other
performance criteria. We cannot be certain that our affiliates will be able to
continue to satisfy these criteria in the future or that the mobile operators
will keep the criteria at their current levels. Any increase in China Mobile's
or China Unicom's network fees and service charges could reduce our gross
margins.
17
CHINA MOBILE AND CHINA UNICOM MAY TERMINATE THEIR RELATIONSHIPS WITH OUR
AFFILIATES IF OUR AFFILIATES FAIL TO ACHIEVE MINIMUM CUSTOMER USAGE, REVENUE AND
OTHER CRITERIA.
Our business could be adversely affected if our affiliated value-added
mobile phone service providers fail to achieve minimum customer usage, revenue
and other criteria imposed or revised by China Mobile and China Unicom at their
discretion from time to time. China Mobile and China Unicom, through their
national and local offices, have historically preferred to work only with a
small group of the best performing wireless value-added service providers, based
upon the uniqueness of the service offered by each provider, total number of
users, usage and revenue generated in the applicable province or municipality,
the rate of customer complaints, and marketing expenditures in the applicable
province or municipality.
THE SERVICES OUR AFFILIATED VALUE-ADDED MOBILE PHONE SERVICE PROVIDERS OFFER AND
THE PRICES THEY CHARGE ARE SUBJECT TO APPROVAL BY CHINA MOBILE AND CHINA UNICOM,
AND IF REQUESTED APPROVALS ARE NOT GRANTED IN A TIMELY MANNER, OUR BUSINESS
COULD BE ADVERSELY AFFECTED.
Our affiliated value-added mobile phone service providers must obtain
approval from China Mobile and China Unicom with respect to each service that
they propose to offer to their customers and the pricing for each such service.
In addition, any changes in the pricing of our affiliates' existing services
must be approved in advance by these operators. There can be no assurance that
such approvals will be granted in a timely manner or at all. Moreover, under
some of our affiliates' contracts with the operators, prices cannot be changed
more than once every six months and prices must be within fixed parameters,
depending on the service. Any failure of our affiliates to obtain, or any delay
in obtaining, such approvals could place us at a competitive disadvantage in the
market and adversely affect our business.
WE OPERATE IN A RAPIDLY EVOLVING INDUSTRY, WHICH MAKES IT DIFFICULT FOR
INVESTORS TO EVALUATE OUR BUSINESS.
We began commercially offering wireless value-added information
services to mobile phone and pager users in China in January 2002, and since
that time, the technologies and services used in the wireless value-added
information services industry in China have developed rapidly. As a result of
this rapid and continual change in the industry, the prospects of our
value-added information service business should be considered in light of the
risks and difficulties frequently encountered by businesses in an early stage of
development. These risks include our ability to:
o attract and retain users for our wireless value-added
information services,
o expand the content and services that we offer and, in
particular, develop and aggregate innovative new content and
service offerings,
o respond effectively to rapidly evolving competitive and market
dynamics and address the effects of mergers and acquisitions
among our competitors,
o build relationships with strategic partners, and
o increase awareness of our brand and user loyalty.
Due to these factors, there can be no certainty that we will maintain
or increase our current share of the highly competitive wireless value-added
information services market in which we operate.
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THE SUCCESS OF MUCH OF OUR WIRELESS VALUE-ADDED INFORMATION SERVICES IS
SIGNIFICANTLY DEPENDENT ON OUR ABILITY TO OBTAIN AND REFORMAT DESIRABLE CONTENT
AND TECHNOLOGY FROM THIRD PARTIES.
We obtain much of our content, including financial information, games,
logos, music, news and other information, from third parties. Furthermore, we
expect that we will develop and purchase technology in connection with our
development of next generation services such as MMS, JAVA and BREW. As the
market for wireless value-added information services develops, content and
technology providers may attempt to increase their profits from distribution
arrangements by demanding greater fees or a share of revenues, which would
adversely affect our financial performance. Many of our arrangements with
content and technology providers are non-exclusive, have a term of one year, and
are subject to renewal. If our competitors are able to obtain such content in a
similar or superior manner or to develop, purchase or license the same
technologies, it could adversely affect the popularity of our services and our
negotiating leverage with third-party providers.
If we fail to establish and maintain economically attractive
relationships with content and technology providers and to thereafter
successfully reformat their products, we may not be able to attract and retain
customers or maintain or improve our financial performance.
WE DEPEND ON OUR SIFANG GUTONG SOFTWARE CONTINUING TO BE COMPATIBLE WITH NEW
MOBILE PHONE MODELS.
There can be no assurance that our Sifang Gutong software will be
compatible with new mobile phones developed by manufacturers such as Samsung. If
the software is no longer compatible, we will be forced to engage Chengao or an
alternative software developer to develop software that is compatible with the
new mobile phones or we will have to develop the software ourselves. If we are
unable to either engage a software developer or develop software in house that
is compatible with new mobile phones, we will lose a significant portion of our
value-added information services revenue, including all of the pre-charged
subscription fee revenues we receive pursuant to our information services and
cooperation agreement among us, Chengao, and Sifang Information.
WE FACE INTENSE COMPETITION.
The Chinese market for wireless value-added services is intensely
competitive. We believe there are more than 800 service providers (including the
three groups discussed below) as of June 30, 2004. We compete directly or
indirectly with three groups of wireless value-added service providers in China:
o portal service providers, which have established expertise in
Internet content and have subsequently branched into mobile
space. The portals serve as content aggregators offering a
variety of wireless value-added services,
o dedicated service providers, whose businesses focus on
offering a variety of wireless content directly to mobile
phone users, and
o niche service providers, which focus primarily on a particular
market segment or application that often builds on a
pre-existing sector competency.
We have faced direct or indirect competition from all three groups
since our entry into this market. Moreover, there are low barriers to entry for
new competitors in the wireless value-added services market. As a result, our
existing or potential competitors may in the future achieve greater market
acceptance and gain additional market share, which in turn could reduce our
revenues.
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MOST OF OUR VALUE-ADDED INFORMATION SERVICES REVENUES ARE DERIVED FROM THE
SHANGHAI MUNICIPAL AREA AND SURROUNDING PROVINCES, AND THE TERMINATION OR
ALTERATION OF OUR AFFILIATES' CONTRACTS WITH THE MOBILE OPERATORS, OR A GENERAL
ECONOMIC DOWNTURN IN THOSE AREAS, COULD HAVE A PARTICULARLY ADVERSE EFFECT ON
OUR BUSINESS.
Per capita income levels and mobile phone penetration rates (i.e., the
number of mobile subscribers divided by the population of China) in China are
generally higher in the coastal and southern provinces, and most of our revenues
are derived from those areas, including the municipality of Shanghai and the
provinces of Beijing and Jiangsu.
WE DEPEND ON KEY PERSONNEL FOR THE SUCCESS OF OUR BUSINESS. OUR BUSINESS MAY BE
SEVERELY DISRUPTED IF WE LOSE THE SERVICES OF OUR KEY EXECUTIVES AND EMPLOYEES
OR FAIL TO ADD NEW SENIOR AND MIDDLE MANAGERS TO OUR MANAGEMENT.
Our future success is heavily dependent upon the continued service of
our key executives, particularly Tai Caihua, our president and chairman of our
board of directors, Fu Sixing, our chief executive officer, Lu Qin, our chief
financial officer, and Qian Fang, our chief technology officer. Our future
success is also dependent upon our ability to attract and retain qualified
senior and middle managers to our management team. If one or more of our current
or future key executives and employees are unable or unwilling to continue in
their present positions, we may not be able to easily replace them, and our
business may be severely disrupted. In addition, if any of these key executives
or employees joins a competitor or forms a competing company, we could lose
customers and suppliers and incur additional expenses to recruit and train
personnel. Each of our executive officers has entered into non-competition
agreements with TCH. We do not maintain key-man life insurance for any of our
key executives. Management will spend approximately 30% of its time managing
Sifang Information.
We also rely on a number of key technology staff for the operation of
our company. Given the competitive nature of our industry, the risk of key
technology staff leaving our company is high and could disrupt our operations.
RAPID GROWTH AND A RAPIDLY CHANGING OPERATING ENVIRONMENT STRAIN OUR LIMITED
RESOURCES.
As our value-added information services customer base increases, we
will need to increase our investment in our technology infrastructure,
facilities and other areas of operations, in particular our product development,
customer service and sales and marketing departments, which are important to our
future success. If we are unable to manage our growth and expansion effectively,
the quality of our services and our customer support could deteriorate and our
business may suffer. Our future success will depend on, among other things, our
ability to:
o develop and quickly introduce new services, adapt our existing
services and maintain and improve the quality of all of our
services, particularly as new mobile technologies such as 3G
are introduced,
o expand the percentage of our value-added information services
revenues which are recurring and are derived from monthly
subscription based services,
o continue to enter into and maintain relationships with
desirable content providers,
o continue training, motivating and retaining our existing
employees and attract and integrate new employees, including
our senior management, most of whom have been with our company
for less than one year,
o develop and improve our operational, financial, accounting and
other internal systems and controls, and
20
o maintain adequate controls and procedures to ensure that our
periodic public disclosure under applicable laws, including
U.S. securities laws, is complete and accurate.
ANY FAILURES OF THE MOBILE TELECOMMUNICATIONS NETWORK, THE INTERNET OR OUR
TECHNOLOGY PLATFORM MAY REDUCE USE OF OUR SERVICES.
Both the continual accessibility of China Mobile's and China Unicom's
mobile networks and the performance and reliability of China's Internet
infrastructure are critical to our ability to attract and retain our value-added
information services customers . Moreover, our business depends on our ability
to maintain the satisfactory performance, reliability and availability of our
technology platform. The servers which constitute the principal system hardware
for our operations are located in one location in Shanghai. Any server
interruptions, break-downs or system failures, including failures caused by
sustained power shutdowns, floods or fire causing loss or corruption of data or
malfunctions of software or hardware equipment, or other events outside our
control that could result in a sustained shutdown of all or a material portion
of the mobile networks, the Internet or our technology platform, could adversely
impact our ability to provide our services to our value-added information
services customers and decrease our revenues.
COMPUTER VIRUSES AND HACKING MAY CAUSE DELAYS OR INTERRUPTIONS ON OUR SYSTEMS
AND MAY REDUCE USE OF OUR SERVICES AND HARM OUR REPUTATION.
Computer viruses and hacking may cause delays or other service
interruptions on our systems. "Hacking" involves efforts to gain unauthorized
access to information or systems or to cause intentional malfunctions or loss or
corruption of data, software, hardware or other computer equipment. In addition,
the inadvertent transmission of computer viruses could expose us to a material
risk of loss or litigation and possible liability. We may be required to expend
significant capital and other resources to protect our systems against the
threat of such computer viruses and hacking and to rectify any damage to our
systems. Moreover, if a computer virus or hacking which affects our systems is
highly publicized, our reputation could be materially damaged and usage of our
services may decrease.
WE MAY BE HELD LIABLE FOR INFORMATION WE PURCHASE AND REFORMAT.
We may face liability for defamation, negligence, copyright, patent or
trademark infringement and other claims based on the reformatted content to
which we provide access through our wireless value-added information services.
For example, SMS news updates provided by us could possibly be deemed to contain
state secrets in violation of applicable Chinese law. In addition, third parties
could assert claims against us for losses incurred in reliance on information
distributed by us. We may incur significant costs in investigating and defending
these claims, even if they do not result in liability.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, AND WE MAY
BE EXPOSED TO INFRINGEMENT CLAIMS BY THIRD PARTIES.
We rely on contractual restrictions on disclosure to protect our
intellectual property rights. Monitoring unauthorized use of our information
services is difficult and costly, and we cannot be certain that the steps we
take will effectively prevent misappropriation of our technology and content.
Our management may determine in the future to make application for copyright,
trademark or trade secret protection if management determines that such
protection would be beneficial and cost-effective.
From time to time, we may have to resort to litigation to enforce our
intellectual property rights, which could result in substantial costs and
diversion of our resources. In addition, third parties may initiate litigation
against us for alleged infringement of their proprietary rights. In the event of
a successful claim of infringement and our failure or inability to develop
non-infringing technology or content or license the infringed or similar
technology or content on a timely basis, our business could suffer. Moreover,
even if we are able to license the infringed or similar technology or content,
license fees that we pay to licensors could be substantial or uneconomical.
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WE HAVE LIMITED BUSINESS INSURANCE COVERAGE.
The insurance industry in China is still at an early stage of
development. Insurance companies in China offer limited business insurance
products, and do not, to our knowledge, offer business liability insurance. As a
result, we do not have any business liability insurance coverage for our
operations. Moreover, while business disruption insurance is available, we have
determined that the risks of disruption and cost of the insurance are such that
we do not require it at this time. Any business disruption, litigation or
natural disaster might result in substantial costs and diversion of resources.
RISKS RELATED TO THE WIRELESS VALUE-ADDED SERVICES INDUSTRY
OUR ABILITY TO GENERATE REVENUES COULD SUFFER IF THE CHINESE MARKET FOR WIRELESS
VALUE-ADDED SERVICES DOES NOT DEVELOP AS ANTICIPATED.
The wireless value-added services market in China has evolved rapidly
over the last four years, with the introduction of new services, development of
consumer preferences, market entry by new competitors and adaptation of
strategies by existing competitors. We expect each of these trends to continue,
and we must continue to adapt our strategy to successfully compete in our
market.
In particular, we currently offer a wide range of wireless value-added
information services for mobile phones using 2.5G technologies. There can be no
assurance, however, that these 2.5G technologies and any services compatible
with them will be accepted by consumers or promoted by the mobile operators.
Moreover, there are numerous other technologies in varying stages of
development, such as third generation mobile technologies, which could radically
alter or eliminate the market for SMS or 2.5G services.
Accordingly, it is extremely difficult to accurately predict consumer
acceptance and demand for various existing and potential new offerings and
services, and the future size, composition and growth of this market.
Furthermore, given the limited history and rapidly evolving nature of our
market, we cannot predict the price that wireless subscribers will be willing to
pay for our services or the services of our affiliated value-added service
providers or whether subscribers will have concerns about security, reliability,
cost and quality of service associated with wireless services. If acceptance of
our wireless value-added information services is different than anticipated, our
ability to maintain or increase our revenue and profits could be materially and
adversely affected.
THE POPULARITY OF OUR SERVICES WHICH OPERATE WITH NEXT GENERATION TECHNOLOGY
STANDARDS ARE NECESSARILY DEPENDENT ON THE MARKET PENETRATION OF MOBILE PHONES
THAT ARE COMPATIBLE WITH THOSE STANDARDS, WHICH IS BEYOND OUR CONTROL.
Mobile phone users can access our MMS, WAP, JAVA, BREW and other
services which operate with next generation technology standards only if they
purchase mobile phones that are compatible with those standards. In particular,
mobile phones that are 2.5G-compatible have historically been significantly more
expensive in China than mobile phones using older technology such as GSM.
Although the prices of 2.5G-compatible mobile phones have been dropping rapidly
in recent quarters, we cannot be certain whether this trend will continue or the
extent to which existing users will be willing to upgrade their mobile phones to
obtain the latest technology. The pricing, marketing and other factors which
affect the sales of more sophisticated mobile phones are all outside of our
control, and weak sales of mobile phones for which we have developed services
could adversely affect our business.
22
THE TELECOMMUNICATION LAWS AND REGULATIONS IN CHINA ARE EVOLVING AND SUBJECT TO
INTERPRETATION AND WILL LIKELY CHANGE IN THE NEAR FUTURE. IF WE ARE FOUND TO BE
IN VIOLATION OF CURRENT OR FUTURE CHINESE LAWS OR REGULATIONS, WE COULD BE
SUBJECT TO SEVERE PENALTIES.
Although wireless value-added services are subject to general
regulations regarding telecommunication services, we believe that currently
there are no Chinese laws at the national level explicitly governing wireless
value-added services, such as our services related to MMS, WAP, JAVA, and BREW,
and no Chinese government authority has been specifically designated to regulate
these services. Many providers of wireless value-added services have obtained
various value-added telecommunication services licenses, such as the licenses
possessed by our Chinese affiliates, Sifang Information and Tianci. These
value-added telecommunication licenses were issued by the local Shanghai
Municipal Telecommunications Administration Bureau, and may not be sufficient to
offer wireless value-added services on a national basis. Sifang Information and
Tianci are in the process of applying with the Ministry of Information
Industries for an inter-provincial value-added telecommunication license in
accordance with the Ministry's general regulations regarding telecommunication
services. However, we cannot predict whether either will be granted that
license. Moreover, we cannot be certain that any local or national value-added
telecommunication license requirements will not conflict with one another or
that any given license will be deemed sufficient by the relevant governmental
authorities for the provision of this category of service. It is also possible
that new national legislation might be adopted to regulate such services.
If we or our affiliates are found to be in violation of any existing or
future Chinese laws or regulations regarding wireless value-added services or
Internet access, the relevant Chinese authorities have the power to, among other
things:
o levy fines;
o confiscate our income or the income of our affiliated
value-added service providers;
o revoke our business license or the business licenses of our
affiliated value-added service providers;
o shut down our servers or the servers of our affiliated
value-added service providers or block any Web sites that we
or our affiliated value-added service providers may operate;
o require us to discontinue any portion or all of our wireless
value-added information services business; or
o require our affiliated value-added service providers to
discontinue any portion or all of their wireless value-added
services business.
THE CHINESE GOVERNMENT, CHINA MOBILE OR CHINA UNICOM MAY PREVENT US FROM
DISTRIBUTING, AND WE MAY BE SUBJECT TO LIABILITY FOR, CONTENT THAT ANY OF THEM
BELIEVE IS INAPPROPRIATE.
China has enacted regulations governing telecommunication service
providers, Internet access and the distribution of news and other information.
In the past, the Chinese government has stopped the distribution of information
over the Internet that it believes violates Chinese law, including content that
is obscene, incites violence, endangers national security, is contrary to the
national interest, or is defamatory. In addition, our affiliated value-added
service providers may not publish certain news items, such as news relating to
national security, without permission from the Chinese government. Furthermore,
the Ministry of Public Security has the authority to cause any local Internet
service provider to block any Web site maintained outside China at its sole
discretion.
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China Mobile and China Unicom also have their own policies regarding
the distribution of inappropriate content by wireless value-added service
providers and have recently punished certain providers for distributing content
deemed by them to be obscene. Such punishments have included censoring of
content, delaying payments of fees by the mobile operators to the offending
service provider, forfeiture of fees owed by the mobile operators to the
offending service provider and suspension of the service on the mobile
operators' networks. Accordingly, even if our affiliated wireless value-added
service providers comply with Chinese governmental regulations relating to
licensing and foreign investment prohibitions, if the Chinese government, China
Mobile or China Unicom were to take any action to limit or prohibit the
distribution of information or to limit or regulate any current or future
content or services available to users, our revenues could be reduced and our
reputation harmed.
The Chinese government is expected to grant licenses to offer wireless
services in China to China Telecom, China Netcom and possibly other parties with
which our affiliated wireless value-added service providers have not yet
developed close relationships. If those parties receive licenses and are
successful in the market but our affiliates are unable to develop cooperative
relationships with them, our business could be adversely affected.
It is also possible that China Telecom, China Netcom and any other
parties receiving wireless licenses may decide to offer wireless value-added
services created by them, rather than by third-party service providers such as
our affiliated wireless value-added service providers. In that case, our
business could be adversely affected.
RISKS RELATED TO DOING BUSINESS IN CHINA
A DOWNTURN IN THE CHINESE ECONOMY MAY SLOW DOWN OUR GROWTH AND PROFITABILITY.
The growth of the Chinese economy has been uneven across geographic
regions and economic sectors. There can be no assurance that growth of the
Chinese economy will be steady or that any downturn will not have a negative
effect on our business. Our profitability, will decrease if expenditures for
wireless value-added services decrease due to a downturn in the Chinese economy.
More specifically, increased penetration of wireless value-added services in the
less economically developed central and western provinces of China will depend
on those provinces achieving certain income levels so that mobile phones and
related services become affordable to a significant portion of the population.
GOVERNMENT REGULATION OF THE TELECOMMUNICATIONS AND INTERNET INDUSTRIES MAY
BECOME MORE COMPLEX.
Government regulation of the telecommunications and Internet industries
is highly complex. New regulations could increase our costs of doing business
and prevent us from efficiently delivering our services. These regulations may
stop or slow down the expansion of our wireless value-added information services
customer base and limit access to our services.
THE UNCERTAIN LEGAL ENVIRONMENT IN CHINA COULD LIMIT THE LEGAL PROTECTIONS
AVAILABLE TO YOU.
The Chinese legal system is a civil law system based on written
statutes. Unlike common law systems, it is a system in which decided legal cases
have little precedential value. In the late 1970s, the Chinese government began
to promulgate a comprehensive system of laws and regulations governing economic
matters. The overall effect of legislation enacted over the past 20 years has
significantly enhanced the protections afforded to foreign invested enterprises
in China. However, these laws, regulations and legal requirements are relatively
recent and are evolving rapidly, and their interpretation and enforcement
involve uncertainties. These uncertainties could limit the legal protections
available to foreign investors, such as the right of foreign invested
enterprises to hold licenses and permits such as requisite business licenses.
24
ANY RECURRENCE OF SEVERE ACUTE RESPIRATORY SYNDROME, OR SARS, OR ANOTHER
WIDESPREAD PUBLIC HEALTH PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS AND
RESULTS OF OPERATIONS.
A renewed outbreak of SARS or another widespread public health problem
in China, where all of our revenue is derived, and in Shanghai, where our
operations are headquartered, could have a negative effect on our operations.
Our operations may be impacted by a number of health-related factors, including
the following:
o quarantines or closures of some of our offices which would
severely disrupt our operations,
o the sickness or death of our key officers and employees, and
o a general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
CHANGES IN CHINA'S POLITICAL AND ECONOMIC POLICIES COULD HARM OUR BUSINESS.
The economy of China has historically been a planned economy subject to
governmental plans and quotas and has, in certain aspects, been transitioning to
a more market-oriented economy. Although we believe that the economic reform and
the macroeconomic measures adopted by the Chinese government have had a positive
effect on the economic development of China, we cannot predict the future
direction of these economic reforms or the effects these measures may have on
our business, financial position or results of operations. In addition, the
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD. These
differences include:
o economic structure;
o level of government involvement in the economy;
o level of development,
o level of capital reinvestment;
o control of foreign exchange;
o methods of allocating resources; and
o balance of payments position.
As a result of these differences, our business may not develop in the
same way or at the same rate as might be expected if the Chinese economy were
similar to those of the OECD member countries.
RESTRICTIONS ON CURRENCY EXCHANGE MAY LIMIT OUR ABILITY TO RECEIVE AND USE OUR
REVENUES EFFECTIVELY.
Because almost all of our future revenues may be in the form of
Renminbi, any future restrictions on currency exchanges may limit our ability to
use revenue generated in Renminbi to fund any future business activities outside
China or to make dividend or other payments in U.S. dollars. Although the
Chinese government introduced regulations in 1996 to allow greater
convertibility of the Renminbi for current account transactions, significant
restrictions still remain, including primarily the restriction that
25
foreign-invested enterprises may only buy, sell or remit foreign currencies,
after providing valid commercial documents, at those banks authorized to conduct
foreign exchange business. In addition, conversion of Renminbi for capital
account items, including direct investment and loans, is subject to governmental
approval in China, and companies are required to open and maintain separate
foreign exchange accounts for capital account items. We cannot be certain that
the Chinese regulatory authorities will not impose more stringent restrictions
on the convertibility of the Renminbi, especially with respect to foreign
exchange transactions.
THE VALUE OF OUR SECURITIES WILL BE AFFECTED BY THE FOREIGN EXCHANGE RATE
BETWEEN U.S. DOLLARS AND RENMINBI.
The value of our common stock will be affected by the foreign exchange
rate between U.S. dollars and Renminbi. For example, to the extent that we need
to convert U.S. dollars into Renminbi for our operational needs and should the
Renminbi appreciate against the U.S. dollar at that time, our financial position
and the price of our common stock may be adversely affected. Conversely, if we
decide to convert our Renminbi into U.S. dollars for the purpose of declaring
dividends on our common stock or for other business purposes and the U.S. dollar
appreciates against the Renminbi, the U.S. dollar equivalent of our earnings
from our subsidiaries in China would be reduced.
RISKS RELATED TO THE MOBILE PHONE DISTRIBUTION INDUSTRY
WE ARE DEPENDENT ON THREE MAIN FIRST-TIER WHOLESALERS TO SUPPLY ALL OF OUR
MOBILE PHONES.
Our performance depends on whether we can continue to secure contracts
with the three first-tier wholesalers of Samsung mobile phones on whom we rely.
We have no long-term purchase contracts or other contracts that provide
continued supply, pricing or access to new mobile phone models and any of the
first-tier wholesalers on whom we rely could discontinue selling to us at any
time. We may not be able to acquire new Samsung models in the future and we may
not be able to acquire the models that we need in sufficient quantities or on
terms that are acceptable to us in the future. As a result, our revenues may
decrease.
OUR PERFORMANCE IS DEPENDENT ON THE POPULARITY OF SAMSUNG'S MOBILE PHONE MODELS.
We primarily distribute mobile phones manufactured by Samsung and thus
are dependant on Samsung's ability to create and deliver high quality mobile
phone models in a cost effective and timely manner. Samsung is a leading
manufacturer of mobile phones based on both the CDMA network and the GSM network
in China. There can be no assurance that Samsung will continue to create high
quality mobile phone models that are popular with consumers. As a result, our
revenues may decrease. In addition, our success depends on our ability to
anticipate and respond to changing mobile phone model trends and consumer
demands in a timely manner. The models we distribute must appeal to a broad
range of consumers whose preferences cannot always be predicted with certainty
and may change between sales seasons. If we misjudge which mobile phone models
will be popular or the market for the models we distribute, our sales may
decline or we may be required to sell our models at lower prices.
CASH FLOW.
It is important that we have sufficient cash flow to purchase enough
mobile phones from the first-tier wholesalers on whom we rely. If our cash flow
decreases significantly, we will not be able to purchase a sufficient quantity
of inventory to meet our customers' demands, which would have a negative impact
on our sales, and may cause the first-tier wholesalers on whom we rely to look
to other sub-wholesalers to distribute their mobile phones. This development
would have a negative impact on our revenues.
26
CUSTOMERS.
One of the factors the first-tier wholesalers on whom we rely consider
when determining who they will use as a sub-wholesaler is the sub-wholesaler's
relationship with retailers. Currently approximately 67% of our mobile phone
sales are made to five retailers. We have no long-term sales contracts or other
contracts that provide continued selling or pricing and any of the retailers we
supply could discontinue buying from us at any time. If we lose our
relationships with our five largest retailers, we will have a difficult time
finding new large retailers to purchase our Samsung mobile phones and may lose
our relationships with the first-tier wholesalers on whom we rely. This would
have a negative impact on our business.
WE FACE CERTAIN RISKS RELATING TO CUSTOMER SERVICE.
Any material disruption or slowdown in our order processing systems
resulting from labor disputes, mechanical problems, human error or accidents,
fire, natural disasters, or comparable events could cause delays in our ability
to receive and distribute orders and may cause orders to be lost or to be
shipped or delivered late. As a result, customers may cancel orders or refuse to
receive goods on account of late shipments, which would result in a reduction in
our net sales and could result in increased administrative and shipping costs.
WE FACE RISKS ASSOCIATED WITH DISTRIBUTION.
We conduct all of our distribution operations from one facility in
Shanghai, China. Any disruption in the operations at our distribution center
could have a negative impact on our business.
COMPETITION.
Despite the fact that we distribute nine Samsung mobile phone models in
the Shanghai, China region, we face competition from distributors of different
models of mobile phones manufactured by Samsung in the Shanghai region and from
distributors of phones manufactured by companies other than Samsung that
distribute in the Shanghai region.
Competition is based on a variety of factors including maintenance of
product quality, competitive pricing, delivery efficiency, customer service and
satisfaction levels and the ability to anticipate technological changes and
changes in customer preferences. The first-tier wholesalers on whom we rely or
Samsung may acquire, startup, or expand their own distribution systems to sell
directly to our customers.
RISKS RELATED TO OUR COMMON STOCK
THE MARKET PRICE FOR OUR COMMON STOCK MAY BE VOLATILE.
The market price for our common stock is likely to be highly volatile
and subject to wide fluctuations in response to factors including the following:
o actual or anticipated fluctuations in our quarterly operating
results,
o announcements of new services by us or our competitors,
o changes in financial estimates by securities analysts,
o conditions in the wireless value-added services market,
27
o changes in the economic performance or market valuations of
other companies involved in wireless value-added services or
distribution of mobile phones,
o announcements by our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments,
o additions or departures of key personnel,
o potential litigation, or
o conditions in the mobile phone market.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are not related to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
STOCKHOLDERS COULD EXPERIENCE SUBSTANTIAL DILUTION.
We may issue additional shares of our capital stock to raise additional
cash for working capital. If we issue additional shares of our capital stock,
our stockholders will experience dilution in their respective percentage
ownership in the company.
WE HAVE NO PRESENT INTENTION TO PAY DIVIDENDS.
Neither during the preceding two fiscal years nor during the year ended
December 31, 2004 did we pay dividends or make other cash distributions on our
common stock, and we do not expect to declare or pay any dividends in the
foreseeable future. We intend to retain any future earnings for working capital
and to finance current operations and expansion of our business.
A LARGE PORTION OF OUR COMMON STOCK IS CONTROLLED BY A SMALL NUMBER OF
STOCKHOLDERS.
A large portion of our common stock is held by a small number of
stockholders. As a result, these stockholders are able to influence the outcome
of stockholder votes on various matters, including the election of directors and
extraordinary corporate transactions including business combinations. In
addition, the occurrence of sales of a large number of shares of our common
stock, or the perception that these sales could occur, may affect our stock
price and could impair our ability to obtain capital through an offering of
equity securities. Furthermore, the current ratios of ownership of our common
stock reduce the public float and liquidity of our common stock which can in
turn affect the market price of our common stock.
WE MAY BE SUBJECT TO "PENNY STOCK" REGULATIONS.
The Securities and Exchange Commission, or SEC, has adopted rules that
regulate broker-dealer practices in connection with transactions in "penny
stocks." Penny stocks generally are equity securities with a price of less than
$5.00 (other than securities registered on certain national securities exchanges
or quoted on the NASDAQ system, provided that current price and volume
information with respect to transactions in such securities is provided by the
exchange or system). Penny stock rules require a broker-dealer, prior to a
transaction in a penny stock not otherwise exempt from those rules, to deliver a
standardized risk disclosure document prepared by the SEC, which specifies
information about penny stocks and the nature and significance of risks of the
penny stock market. A broker-dealer must also provide the customer with bid and
offer quotations for the penny stock, the compensation of the broker-dealer, and
our sales person in the transaction, and monthly account statements indicating
28
the market value of each penny stock held in the customer's account. In
addition, the penny stock rules require that, prior to a transaction in a penny
stock not otherwise exempt from those rules, the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser's written agreement to the transaction.
These disclosure requirements may have the effect of reducing the trading
activity in the secondary market for stock that becomes subject to those penny
stock rules. Whenever any of our securities become subject to the penny stock
rules, holders of those securities may have difficulty in selling those
securities.
Where You Can Find More Information
We file annual, quarterly and special reports, proxy statements and
other information with the SEC. Our SEC filings are available to the public over
the Internet at the SEC's web site at http://www.sec.gov. You may also read and
copy any document we file at the SEC's public reference room in Washington, D.C.
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms.
ITEM 2. DESCRIPTION OF PROPERTY
We currently occupy two office spaces in the Shanghai region. We lease
the first office space, located at 429 Guangdong Road, Shanghai, People's
Republic of China 200001, for approximately $41,000 a year. This office space
contains our corporate headquarters, and is approximately 250 square meters
under an operating lease which was terminated on September 30, 2004. We own our
office space, located at 689 Laoshandong Road, Shanghai, People's Republic of
China 200120, which houses our administration, technical team and servers, and
is approximately 800 square meters. We believe that these two properties are
adequately covered by insurance. In addition, we believe that we will be able to
obtain adequate facilities, principally through the leasing of appropriate
properties, to accommodate our future expansion plans.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material pending legal
proceedings
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the fiscal year ended December 31, 2004.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the NASD's Over-the-Counter Bulletin
Board under the symbol "CHDW." On August 6, 2004 we changed our name from
Boulder Acquisitions, Inc. to China Digital Wireless, Inc. and changed our
symbol from "BAQI" to "CHDW." On April 19, 2005, the last reported sales price
for our common stock was $2.80 per share.
The following table sets forth, for the quarters indicated, the range
of closing high and low bid prices of our common stock as reported by the NASD
Over-the-Counter Bulletin Board, as adjusted for all previously effected stock
splits.
29
Common Stock
-------------------
By Quarter Ended High Low
---------------- ------ ------
Fiscal 2003
---------------------------------------------------------
March 31, 2003........................................... $0.00 $0.00
June 30, 2003............................................ $0.42 $0.23
September 30, 2003....................................... $0.42 $0.42
December 31, 2003........................................ $0.42 $0.42
Fiscal 2004
---------------------------------------------------------
March 31, 2004........................................... $5.00 $0.42
June 30, 2004............................................ $4.05 $2.30
September 30, 2004....................................... $3.90 $1.98
December 31, 2004........................................ $4.85 $2.80
Fiscal 2005
---------------------------------------------------------
March 31, 2005........................................... $5.45 $3.42
As of April 19, 2005, there were 17,018,692 shares of our common stock
outstanding held by approximately 2,561 stockholders of record.
We did not pay any cash dividends on our common stock in our 2002, 2003
or 2004 fiscal years. We do not anticipate paying any cash dividends on our
common stock in the foreseeable future. We currently intend to retain future
earnings, if any, to finance operations and the expansion of our business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This report contains certain forward-looking statements and information
relating to us that are based on the beliefs and assumptions made by our
management as well as information currently available to the management. When
used in this document, the words "anticipate", "believe", "estimate", and
"expect" and similar expressions, are intended to identify forward-looking
statements. Such statements reflect our current views with respect to future
events and are subject to certain risks, uncertainties and assumptions. Should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated or expected.
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 its forward-looking statements 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 interests in TCH. TCH
was established as a foreign investment enterprise in Shanghai under the laws of
the PRC on May 25, 2004, with a registered capital of $7.2 million.
30
Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business by
presenting a set of carve-out financial statements for the years ended December
31, 2002 and 2003 and three months ended March 31, 2004 as if the spun-off
business had been a stand-alone company for two years and one quarter. On March
31, 2004, Sifang Information transferred the spun-off business into TCH. Being a
receiving entity under common control, TCH initially recognized all the assets
and liabilities transferred at their carrying amounts in the accounts of Sifang
Information at the date of transfer under the guidance of SFAS No. 141, Appendix
D. On May 26, 2004 Sifang Information exchanged 100% of equity interest in TCH
for a 100% equity interest in Sifang Holdings. Since the ultimate owners of the
three entities were the same owners and the three entities remained under common
control, the ownership exchange transaction was accounted for at historical
costs under the guidance of SFAS No. 141, Appendix D. Prior to May 26, 2004,
there were no activities in Sifang Holdings. As a result of exchanging the
ownership between TCH and Sifang Holdings, TCH's historical financial statements
become the historical financial statements of Sifang Holdings.
Sifang Information operates in a business segment that is subject to
certain restrictions imposed by the government of the PRC. For example, paging
facilities, radio transmitting stations and transmitting equipment owned by
Sifang Information are not allowed to be owned by foreign investment enterprises
in accordance with PRC government regulations. Therefore, Sifang Information
still maintains a small part of its business and paging facilities in order to
stay in compliance with relevant regulations and laws in PRC.
As a result of the spin-off, TCH engages in the business of mobile
phone distribution and the provision of pager and mobile phone (collectively
"wireless receiver") users with access to certain information reformatted by
TCH. TCH purchases mobile phones from first tier distributors and sells them to
retailers with a mark-up. In the process of providing value-added information
services through entering into monthly subscription agreements with various
users, TCH purchases trading activity information from stock exchanges, comments
and analysis on PRC stock markets provided by certain reputable security and
investment companies, lottery information, weather forecast, and other
value-added products and reformats the aforementioned information through
decoding and recoding and then has the reformatted information transmitted by
Sifang Information, via service contracts, to pager users. The information is
constantly saved in TCH's server in order for mobile phone users to dial in via
China Mobile or China Unicom. By signing a monthly subscription agreement,
wireless users agree to make advance payments for either three or six-month
subscription periods.
The company was engaged in a smart card project in June, 2004. The
project was delayed due to issues regarding accounting policy in the PRC, and
the company decided to discontinue this project in the 2004 fiscal year.
Discussion and Analysis of Operating Results
Fiscal Year Ended December 31, 2004 Compared to the Fiscal Year Ended December
31, 2003
Revenue
Total Revenues
Total revenues for our 2004 fiscal year increased by approximately
$7,488,572, representing an approximately 44.0% increase, to $24,520,950 as
compared to $17,032,378 for the same period of the prior year. The increase was
due mainly to our marketing effort and further facilitated by Samsung's
marketing promotion. Total revenues consist of product sales, product sales to
related parties and service revenue, net. In the Chinese telecommunication
31
market, mobile phones have rapidly replaced beepers and pagers as the mobile
communication device preferred by consumers, resulting in an increase in mobile
phone distribution. For our 2004 fiscal year, Samsung's mobile phones accounted
for about 97% of our total product sales and other name brands mobile phones
accounted for the remaining 3%, compared to our 2003 fiscal year, in which
Samsung's mobile phones accounted for 99.6% of our total product sales and other
brands accounted for the balance. During 2004 market competition for mobile
phone sales intensified, causing us to decrease our overall mark-up ratio to
6.4% in order to maintain our market position, in comparison to a mark-up ratio
of 8.2% for the same period the prior year.
Product Sales
Revenue from product sales for our 2004 fiscal year decreased by
approximately $2,471,881, representing an approximately 18.3% decrease, to
$11,057,398 as compared to $13,529,279 for the same period of the prior year.
The decrease was due mainly to the spun-off business of THC.
Product sales to related parties
Before January 1, 2004 we only distributed CDMA mobile phones in the
Shanghai area. Beginning in January 2004 we entered into the GSM mobile phone
distribution business. Since the retail market channel related to our GSM mobile
phone distribution was developed and maintained by Shanghai Shantian, in which
Sifang Information holds a 51% equity interest, all of our Samsung GSM mobile
phones were sold to Shanghai Shantian, which made Shanghai Shantian our second
tier distributor in the first half of 2004. During our 2004 fiscal year, we sold
a total of $9,891,691 worth of mobile phones to related parties, including
$9,178,674 worth of mobile phones to Shanghai Shantian, and $713,017 to Shanghai
Tianci Industry Group Co. Ltd and Shanghai Tianci Industry Co.Ltd with a total
competitive mark-up on average of approximately 4.8 % as compared to an average
mark-up ratio of 7.8% for the products sold to all of our other customers.
Service revenue, net
Total service revenue net of related business tax for our 2004 fiscal
year increased by $68,762, representing approximately a 2.0% increase, to
$3,571,861 compared to $3,503,099 for the same period of the prior year. It was
due mainly to the increase of mobile phone value-added services and the revenue
derived from agent service income.
Value-added service revenue from mobile phone users for our 2004 fiscal
year increased by $1,090,855 to $2,388,178 compared to $1,297,323 for the same
period of the prior year, representing a material increase, which resulted in
the overall increase in our service revenue. Approximately $1,973,842 of the
service revenue from mobile phone users was attributable to prepaid service fees
generated by an installing agent, Chengao Industry Co. Ltd, who installed the
software on a retailer's (Beijing Jianghe Communication Co., Ltd) inventories
and collected proceeds from the retailer and transferred the proceeds to the
Company, representing a $745,057 increase compared to the same period of the
prior year. The remaining $404,336 portion of the service revenue was generated
by our SMS service , representing a material increase compared to the same
period of the prior year. The increase was mainly due to the aggressive
expansion of our subscriber base as the result of the Company's marketing
campaigns. In addition, service revenue from pager users for our 2004 fiscal
year decreased by $1,226,307 to $ 979,469 compared to $2,205,776 for the same
period of the prior year, representing approximately a 55.6% decrease. We
believe that service revenue from pager users will continue to decrease given
the increased popularity of mobile phones over beepers and pagers. We project
that the decrease in service revenue from pager users will likely plateau at a
certain level as most lower income pager users still like to use pagers to
access our information services.
Moreover, On July 16, 2004, Tianci Group, a related party to TCH,
entered into an agreement with China Unicom to promote CDMA mobile phones and
agent service for China Unicom. Under the agreement, Tianci Group is entitled to
receive a sales commission from China Unicom of $15.70 per unit, $3.62 per SIM
32
card based on sales to customers who agree to subscribe for monthly service for
a minimum period of two years at a minimum monthly service fee of $3.38. Tianci
Group then entered into an agent agreement with TCH pursuant to which TCH agreed
to sell the CDMA mobile phones, SIM cards and monthly service subscriptions on
behalf of Tianci Group and, consequently, is entitled to receive sales
commissions from Tianci Group based on the terms agreed upon between Tainci
Group and China Unicom. The agent relationship began in August 2004 at the same
time as a sales promotion initiated by China Unicom. We recognized agent service
income of $204,214 during the send half year of our 2004 fiscal year at the TCH
level.
Total cost of goods sold
The total cost of goods sold for our 2004 fiscal year increased by
$8,230,371 to $19,608,832 compared to $12,424,454 for the same period of the
prior year, representing an approximately 57,8% increase. The increase was
consistent with the increases in revenue from product sales.
Cost of service
The cost of service for our 2004 fiscal year increased by $29,675 to
$1,045,993 compared to $1,016,318 for the same period of the prior year,
representing an approximately 2.9% increase. In addition, software amortization
for mobile phone value-added service generated in the 2004 fiscal year
represented a $42,338 increase compared to the prior year. During 2004, we
continued to strive to expand the content offered by our value-added services
while maintaining current fee structures and to establish collaborative
relationships or partnerships with Chinese mobile operators and certain
information content providers.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for our 2004 fiscal year increased by approximately $274,519 to
approximately $3,866,125, representing approximately a 7.6% increase, compared
to gross profit of $3,591,606 for the same period of the prior year. The
increase in gross profit was primarily attributable to the following factors (i)
the gross profit derived from mobile phone distribution and mobile phone
information services increased significantly, which offset the decrease in pager
information service income; (ii) the agent service income generated in the
second half of 2004 .
The following table presents in summary certain information related to
the various components of revenue.
Information
Service - Information
Agency Mobile Phone Mobile Service -
Income Distribution Phone Pager Total
----------- ------------ ----------- ----------- -----------
For the year ended December 31,
2004
Revenue $ 204,214 $ 20,949,089 $ 2,388,178 $ 979,469 $24,520,950
----------- ------------ ----------- ----------- -----------
Cost -- 19,608,832 498,194 547,799 20,654,825
----------- ------------ ----------- ----------- -----------
Gross profit 204,214 1,340,257 1,889,984 431,670 3,866,125
----------- ------------ ----------- ----------- -----------
Gross profit ratio 100.0% 6.4% 79.1% 44.1% 15.8%
----------- ------------ ----------- ----------- -----------
33
For the year ended December 31,
2003
----------- ------------- ----------- ----------- -----------
Revenue $ -- 13,529,279 $ 1,297,323 $ 2,205,776 $17,032,378
----------- ------------- ----------- ----------- -----------
Cost -- 12,424,454 287,464 728,854 13,440,772
----------- ------------- ----------- ----------- -----------
Gross profit -- 1,104,825 1,009,859 1,476,922 3,591,606
----------- ------------- ----------- ----------- -----------
Gross profit ratio -- 8.2% 77.8% 67.0% 21.1%
----------- ------------- ----------- ----------- -----------
Other income, net
On July 16, 2004, Tianci Group, a related party to TCH, entered into an
agreement with China Unicom to promote CDMA mobile phones and agent service for
China Unicom. Under the agreement, Tianci Group is entitled to receive a sales
commission from China Unicom of $15.70 per unit, $3.62 per SIM card based on
sales to customers who agree to subscribe for monthly service for a minimum
period of two years at a minimum monthly service fee of $3.38. Tianci Group then
entered into an agent agreement with TCH pursuant to which TCH agreed to sell
the CDMA mobile phones, SIM cards and monthly service subscriptions on behalf of
Tianci Group and, consequently, is entitled to receive sales commissions from
Tianci Group based on the terms agreed upon between Tainci Group and China
Unicom. The agent relationship began in August 2004 at the same time as a sales
promotion initiated by China Unicom. As the sales commission revenue from this
business is more uncertain in nature, we reported this revenue as other income
instead of regular revenue. We recognized agency income of $204,214 in the 2004
fiscal year at the TCH level.
Selling expenses
Selling expenses for our 2004 fiscal year increased by $93,202 to
$246,639 compared to $153,437 for the same period of the prior year,
representing approximately a 61% increase. This increase was due to promotion
expenses for value-added information services related to mobile phone users.
Advertising fees and expenses for a series of marketing campaigns increased by
$41,183 in our 2004 fiscal year, from $18,909 to $60,092, representing a
material increase in comparison to the prior year. We have moved our marketing
focus from beeper and pager users to mobile phone users in line with changing
consumer demands. Salaries paid to the Company's marketing team in the 2004
fiscal year rose from $33,836 to $84,946, representing a 151% increase in
comparison to the prior year.
General and administrative expenses
General and administrative expenses for our 2004 fiscal year increased
by $1,365,428 to $1,656,841 compared to $291,413 for the same period of the
prior year, representing a material increase. The increase was due mainly to the
reorganization and recapitalization transaction and related audit and legal
fees.
General and administrative expenses incurred at the TCH level in the
2004 fiscal year increased from $286,058 to $456,445, representing a 52.5%
increase. These general and administrative expenses were comprised of salaries
paid to the management, which increased from $94,437 to $117,800, representing a
$23,363 increase, and office expenses, which rose from $11,888 to $20,015,
representing a $8,127 increase.
During our 2004 fiscal year there was stock-based compensation of
$1,014,000 related to the reverse merger generated at parent level, consisting
of 167,895 shares issued to a consultant in lieu of cash payment at a fair
market value of $604,000 and the issuance of 166,667 redeemable shares pursuant
34
to a stock purchase agreement resulting in a charge of $410,000 representing the
premium between the trading price ($3.60 per share) and the pre-negotiated stock
purchase price ($1.14 per share) of the purchased shares. The other cash-based
expenses incurred in the 2004 fiscal year of $205,376, represented payments for
the audit fees, a retainer fee and other consultant fees.
Interest income (expense)
During our 2003 fiscal year, we borrowed funds from Sifang Information
for temporary working capital and mobile phone distribution. As a result, we
paid interest totaling $12,082 to Sifang Information during the 2003 fiscal
year.
During our 2004 fiscal year, the interest income derived from deposits
in banks was $1,955.
Income tax
TCH is subject to taxation under the laws of the PRC, and the statutory
income tax rate for 2003 and 2004 fiscal years was 33%. The income tax
provisions presented on our financial statements are based on the historical
actual income tax rates of Sifang Information at 7.5% for the 2003 fiscal year
and the six months ended June 30, 2004. The income tax provision presented for
the six months ended December 31, 2004 are based on a 15% effective rate. In our
2003 and 2004 fiscal years, income tax expense was $246,694 and $369,971,
respectively, based on pretax income of $3,134,674 and $1,964,600 (which
included the stock compensation of $1,014,000 incurred in the U.S.). Since the
loss of approximately $1,014,000 incurred in the U.S. did not offset the taxable
income in China, a portion of income tax expense totaling $169,643, which was
incurred in China, was based on taxable income of approximately $2,979,023.
Net income
We recorded net income of $1,594,629 for our 2004 fiscal year, a
$1,293,351 decrease in net income compared to net income of $2,887,980 for the
same period of the prior year, representing approximately a 45% decrease. The
decrease in net income was attributable to (i) the increase in general and
administrative expenses for the period compared to general and administrative
expenses for the same period of the prior year (we incurred a $1,014,423 charge
for services performed by consultants related to the reverse merger and related
activites, and the issuance of common stock in 2004), and (ii) the decrease of
the gross profit generated from mobile phone distribution and our pager service
business.
Earnings per share
Earnings per share for our 2004 fiscal year decreased by $0.11 to $0.10
compared to $0.21for the same period of the prior year. The decrease was due
mainly to the decrease in our net income and the increase in the total
outstanding shares of our common stock, as the weighted average number of shares
of common stock outstanding for the 2004 fiscal year increased by approximately
12.1%, compared the weighted average number of common stock outstanding for the
same period of the prior year.
Liquidity and Capital Resources
Our cash balance decreased from approximately $1,713,748 as of December
31, 2003 to approximately $75,511 as of December 31, 2004. This decrease in cash
and cash equivalents was due primarily to the decrease in net income and the
increase in the amount due from parent.
Net cash used in operating activities was $1,788,915 during 2004,
compared to net cash provided by operating activities of $1,383,597 during the
prior year. We believe that the decrease of net cash provided by operating
activities was due mainly to the decrease of $1,293,351 in net income and the
increase of $4,497,420 in cash due from and advanced to a related party,
partially offset by cash generated from a non-cash expense of $1,014,423 and a
change of $1,911,527 in inventories. Net income of $1,594,629 for the 2004
fiscal year compared to net income of $2,887,980 for the 2003 fiscal year
represented a decrease of $1,293,351. The amount due from a related party
increased from $0 to $4,742,688 in the 2004 fiscal year compared to the prior
year, representing a large portion of cash used in operating activities. The
cash used in accounts receivable increased by $2,276,245 in the 2004 fiscal year
compared to net cash used of $1,790,616 in the 2003 fiscal year, representing a
change of $485,629. However, the change in accounts payable was in a net cash
used position ended the year December 31, 2004, representing an increase of
approximately $55,730 compared to positive cash inflow of $111,569 for the same
period of the prior year. The change in deferred revenue at December 31, 2004
was less than the change in deferred revenue for the same period of the prior
year. The cash generated in the change of other current liabilities increased to
$404,769 compared to $25,737 in the prior year, representing a $379,032
increase.
Net cash used in investing activities for the 2004 fiscal year
increased to $132,155 compared to $259,858 for the same period of the prior
year, representing a $ 127,703 decrease. The decrease in cash used in investing
activities was due mainly to the decrease of $127,703 cash used in the purchase
of property and equipment
35
Net cash provided by financing activities for the 2004 fiscal year was
$282,570 compared to cash used in $604,062 for the 2003 fiscal year. We believe
that the increase was due mainly to the proceeds from issuing redeemable common
stocks and restricted common stocks in the 2004 fiscal year.
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.
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 our 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;
however, the disclosure requirements remain effective and have been adopted by
the Company (see Note 6. Short-term investments). 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 financial statements.
In December 2004, the FASB issued SFAS No. 123-R, Share Based Payment,
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
36
value of the equity or liability instruments issued. SFAS 123-R covers a wide
range of share-based compensation arrangement including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans.
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 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 7. FINANCIAL STATEMENTS
The consolidated financial statements of China Digital Wireless, Inc.
and its subsidiaries including the notes thereto, together with the reports
thereon of Grobstein, Horwath & Company, LLP and BDO Shanghai Zhonghua are
presented beginning at page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On January 4, 2005, we approved resolutions to replace our independent
registered public accounting firm, BDO Shanghai Zhonghua Certified Public
Accountant, with Grobstein, Horwath & Company, LLP, which we appointed effective
as of January 6, 2005.
During June 2004, we completed a stock exchange transaction with the
shareholders of Sifang Holdings Co. Ltd. ("Sifang") resulting in Sifang becoming
a wholly owned subsidiary of the Company. This stock exchange transaction also
resulted in a recapitalization of the Company with Sifang becoming the survivor
of the transaction for accounting purposes. BDO Shanghai Zhonghua audited
Sifang's financial statements for the fiscal years ended December 31, 2002 and
2003. BDO Shanghai Zhonghua's reports for those periods did not contain an
adverse opinion or a disclaimer of opinion, and were not qualified or modified
as to uncertainty, audit scope or accounting principles.
During the Company's fiscal year ended December 31, 2003, for which
audit services were provided by BDO Shanghai Zhonghua, and through January 6,
2005, there were no disagreements with BDO Shanghai Zhonghua on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedures, which, if not resolved to the satisfaction of BDO Shanghai
Zhonghua, would have caused them to make reference to the subject matter in
their report.
Prior to Grobstein, Horwath & Company becoming our independent
registered public accounting firm, neither we, nor anyone on our behalf,
consulted with Grobstein, Horwath & Company regarding either the application of
accounting principles to a specific or contemplated transaction or the type of
audit opinion that might be rendered on our financial statements.
37
ITEM 8A. 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
subsidiary) required to be included in our periodic SEC filings.
Additionally, there were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to the Evaluation Date. We have not identified any significant
deficiencies or material weaknesses in our internal controls, and therefore
there were no corrective actions taken.
ITEM 8B. OTHER INFORMATION
None.
PART III
Item 9. Directors and Executive Officers
The following table provides information about our executive officers
and directors and their respective ages and positions as of March 31, 2005. The
directors listed below will serve until the next annual meeting of the China
Digital stockholders:
Name Age Title
-------------- ------- ------------------------------------------
Tai Caihua 48 Director, President, Chairman of the Board
Shi Ying 45 Director
Huang Tianqi 33 Director, Chief Technology Officer
Jing Weiping 41 Director
Mao Ming 43 Director
Song Jing 29 Director
Fu Sixing 44 Director, Chief Executive Officer
Yu Ruijie 42 Director
Zhang Xiaodong 37 Director
Huang Wei 42 Director
Qian Fang 46 Chief Financial Officer
Jiang Hong Ming Director
Jachen Li Director
Yuan Feng Director
Tai Caihua has served as our president, chairman of our board of
directors and a member of our board of directors since June 23, 2004. Mr. Tai
has been (i) the president and sole director of our wholly owned subsidiary,
Sifang Holdings, since February 2004; (ii) chairman of the board of directors of
Sifang Holdings' wholly owned subsidiary, TCH, since our inception in May 2004;
(iii) director and general manager of Shanghai Tianci Industry (Group) Co.,
Ltd., one of our affiliates, since January 1994 and (iv) a director of Sifang
Information, one of our affiliates, since December 2001. Mr. Tai holds a Masters
of Business Administration from the Macau University of Science and Technology.
Shi Ying has served as a member of our board of directors since June
24, 2004. Ms. Shi has been the head of operations and a member of the board of
directors of TCH since our inception in May 2004. For the past eight years she
has headed the operations department of Sifang Information. Ms. Shi graduated
from the Shanghai Sports College with a Bachelors degree.
Huang Tianqi has served as our chief technology officer since June 23,
2004 and a member of our board of directors since June 24, 2004. Mr. Huang has
served as chief technology officer of Sifang Holdings and vice-general manager,
chief technology officer and a director of TCH since their inception in February
2004 and May 2004, respectively. Mr. Huang also serves as the vice-general
manager and a member of the board of directors of Sifang Information. Before
becoming vice-general manager, Mr. Huang was the chief technology officer at
Sifang Information for seven years. Mr. Huang graduated from Nanjing University
of Posts and Telecommunications with a Bachelors Degree and from Shanghai Jiao
Tong University with a Masters of Science Degree.
Jing Weiping has served as a member of our board of directors since
June 24, 2004. Mr. Jing has served as a member of the board of directors of TCH
since our inception in May 2004 and as a Director of Sifang Information since
2001. Mr. Jing has served as the manager of the technology assurance department
of Sifang Information for the past nine years. Mr. Jing received his Bachelors
Degree from Dong Hua University.
Mao Ming serves as a member of our board of directors. He was elected
to our board of directors June 24, 2004. He has been (i) the general manager and
a member of the board of directors of TCH since our inception in May 2004; and
(ii) the general manager and a director of Sifang Information since January
1998. Mr. Mao graduated from China PLA Measurement College with a Bachelors
Degree and from the Macau University of Science and Technology with a Masters of
Business Administration.
Song Jing has served as a member of our board of directors since June
24, 2004. Mr. Song has served as vice-general manager and a member of the board
of directors of TCH since our inception in May 2004 and as general manager of
Shanghai Shan Tian Telecommunication Co., Ltd., an affiliate of ours, since
November 2003. Previously, Mr. Song served as director and general manager of
Shanghai Zhong Si Hua Hao Co., Ltd. for one year and assistant general manager
of both Shanghai Hua Si Trading Co., Ltd. and Shanghai Qi Shi Trading Co., Ltd
for five years.
Fu Sixing has served as our chief executive officer since June 23, 2004
and a member of our board of directors since June 24, 2004. Mr. Fu has served as
executive manager of Sifang Holdings and as the head of the research and
development department and a director of TCH since their inception in February
2004 and May 2004, respectively. During the past seven years, Mr. Fu has served
as (i) the assistant to general manager of Shanghai Tianci Industry (Group) Co.,
Ltd.; (ii) a director and the general manager of Shanghai Sifang Health
Technology Co., Ltd. and (iii) directorate secretary of Sifang Information. Mr.
Fu received a Bachelors of Science in Physics from Nanjing University, a Masters
of Social Science in Economics from Huadong Normal University and a Doctorate of
Business Administration from the University of Southern California.
Yu Ruijie has served as a member of our board of directors since June
24, 2004. Mr. Yu has served (i) as head of the Systems Department and a director
of TCH since our inception in May 2004 and (ii) as the head of the Systems
Department of Sifang Information since January 1994. Mr. Yu received a Bachelors
Degree in Computer Science from Shanghai University of Engineering Science.
Zhang Xiaodong has served as a member of our board of directors since
June 24,2004. Mr. Zhang has served as the head of the projection department of
TCH since our inception in May 2004. Mr. Zhang also serves as a director and the
head of the projection department of Sifang Information. For the past nine
years, Mr. Zhang has served as head of the wireless engineering department at
Sifang Information. Mr. Zhang graduated from Shanghai Jiao Tong University with
a Bachelors Degree and received a Masters Degree from the Macao University of
Science and Technology.
Huang Wei has served as a member of our board of directors since June
24, 2004. Mr. Huang has served as (i) the vice-general manager of TCH since our
inception in May 2004 and (ii) vice-general manager and a director of Sifang
Information since 1993. Mr. Huang graduated from Nanjing University of Air Force
and Politics with a Bachelors Degree in Logistics.
Qian Fang has served as our Chief Financial Officer since January 1,
2005. Ms. Fang has served as Manager of Accounting of TCH since 1999. Ms. Fang
graduated from China Cable-TV University with a Bachelors Degree in Accounting
and is a Certified Public Accountant.
Jiang Hong Ming has served as a member of our board of directors and a
member of the audit committee of the board of directors since April 2005. Mr.
Ming is a director of Shanghai Hua Cheng Certified Public Accountants.
Yuan Feng has served as a member of our board of directors and a member
of the audit committee of the board of directors since April 2005. Mr. Feng is
the General Manager of Shanghai Guan Tong Telecommunication Technology Ltd.
Jachen Li has served as a member of our board of directors and a member
of the audit committee of the board of directors since April 2005. Mr. Li is an
executive with Beijing Mon Long Software Developing Ltd.
Family Relationships
Except as set forth herein, there are no family relationships among our
directors or officers. Mr. Tai Caihua, President and a member of our Board of
Directors is married to Ms. Shi Ying, a member of our Board of Directors and Ms.
Ying is also a sibling of Huang Wei, a member of our Board of Directors.
Section 16(a) Beneficial Ownership Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers, directors and certain other stockholders to file reports of ownership
and changes in ownership with the Securities and Exchange Commission. Officers,
directors and certain other stockholders are required by regulation to furnish
us with copies of all Section 16(a) forms they file. To the best of our
knowledge (based solely upon a review of the Forms 3, 4 and 5 filed), during
2004, no individual or entity was late with any Form 3, 4 or 5 filings.
Code of Ethics
We have adopted a corporate code of ethics. We believe our code of
ethics is reasonably designed to deter wrongdoing and promote honest and ethical
conduct; provide full, fair, accurate, timely and understandable disclosure in
public reports; comply with applicable laws; ensure prompt internal reporting of
code violations; and provide accountability for adherence to the code. A copy of
our corporate code of ethics is attached to this annual report.
Board Composition and Committees
The board of directors is currently composed of thirteen members,
including Tai Caihua, Song Jin, Shi Ying, Mao Ming, Fu Sixing, Huang Tianqi,
Huang Wei, Jing Weiping, Yu Ruijie, Zhang Xiaodong, Jiang Hong Ming, Jachen Li
and Yuan Fong. All Board action requires the approval of a majority of the
directors in attendance at a meeting at which a quorum is present.
We currently do not have standing nominating or compensation
committees. We intend, however, to establish d a compensation committee of the
board of directors as soon as practicable. We envision that the compensation
committee will be primarily responsible for reviewing and approving our salary
and benefits policies (including stock options), including compensation of
executive officers. We established an audit committee of the board of directors
in April 2005. The audit committee is primarily responsible fo reviewing the
services performed by our independent auditors, evaluating our accounting
policies and our system of internal controls. The charter of the audit committee
is an exhibit to this annual report.
ITEM 10. EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth all cash
compensation paid to our chief executive officer for services rendered in all
capacities to the company during the noted periods. No other executive officers
received salary and bonus compensation in excess of $100,000 during the 2004
fiscal year.
Summary Compensation Table
Annual Compensation
------------------- Securities
Name and Principal All Other Underlying
Position Year Salary ($) Bonus ($) Compensation ($) Options
--------------------- ---- ---------- --------- ---------------- ----------
Tai Caihua(1) 2004 $28,992 --
Timothy P. Halter (2) 2004 $-0- 131,722(4)
Chief Executive
Officer/Director
Glenn Little (3) 2004 $-0- --
Chief Executive
Officer/Director
(1) Began service as Chief Executive Officer and a director of the Company
in June 2004. Reported salary information is as of August 31, 2004.
(2) Appointed Chief Executive Officer in February 2004 and resigned as an
officer and director of the Company in June 2004.
(3) Resigned as Chief Executive Officer and a director of the Company in
March 2004.
(4) Represents 131,722 shares of common stock underlying the identical
number of warrants granted to Mr. Halter on February 23, 2004, which
warrants were exercised in full on June 14, 2004.
38
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCK HOLDER MATTERS
The following table sets forth, as of March 31, 2005, the number and
percentage of our 17,018,692 outstanding shares of common stock that were
beneficially owned by (i) each director and executive officer of China Digital,
(ii) each person known to China Digital to be the beneficial owner of five
percent or more of the outstanding shares of common stock of China Digital, and
(iii) all directors and officers of China Digital as a group. Unless otherwise
indicated, the person or entity listed in the table is the beneficial owner of,
and has sole voting and investment power with respect to, the shares indicated.
Amount and Nature of Beneficial Ownership (1)
---------------------------------------------
Number Percent of
Name and Address of Shares (2) Voting Stock (3)
---------------- ------------- ----------------
Tai Caihua (4) 11,301,764 66.4%
Shi Ying (5) 11,301,764 66.4%
Halter Financial Group, Inc. (6) 1,271,287 7.5%
Chinamerica Fund, LP 877,193 5.2%
Mao Ming 413,480 2.4%
Song Jing 413,480 2.4%
Huang Tianqi 275,652 1.6%
Jing Weiping 275,652 1.6%
Fu Sixing 275,652 1.6%
Yu Ruijie 275,652 1.6%
Zhang Xiaodong 275,652 1.6%
Huang Wei 275,652 1.6%
Directors and executive officers 13,782,636 81.0%
as a group (10 persons)
(1) On March 31, 2005, there were 17,018,692 shares of China Digital common
stock outstanding. Each person named below has sole investment and
voting power with respect to all shares of our common stock shown as
beneficially owned by the person, except as otherwise indicated below.
(2) Under applicable rules promulgated by the SEC pursuant to the
Securities Exchange Act of 1934, as amended, or the Exchange Act, a
person is deemed the "beneficial owner" of a security with regard to
which the person, directly or indirectly, has or shares (a) the voting
power, which includes the power to vote or direct the voting of the
security, or (b) the investment power, which includes the power to
dispose or direct the disposition of the security, in each case
irrespective of the person's economic interest in the security. Under
these SEC rules, a person is deemed to beneficially own securities
which the person has the right to acquire within 60 days through (x)
the exercise of any option or warrant or (y) the conversion of another
security.
(3) In determining the percent of our common stock owned by a person (a)
the numerator is the number of shares of our common stock beneficially
owned by the person, including shares the beneficial ownership of which
may be acquired within 60 days upon the exercise of options or warrants
or conversion of convertible securities, and (b) the denominator is the
total of (i) the 17,018,692 shares of our common stock outstanding on
March 31, 2005 and (ii) any shares of our common stock which the person
has the right to acquire within 60 days upon the exercise of options or
warrants or conversion of convertible securities. Neither the numerator
nor the denominator include shares which may be issued upon the
exercise of any other options or warrants or the conversion of any
other convertible securities.
(4) Includes 1,791,743 shares held by Mr. Tai's wife, Shi Ying. Mr. Tai
disclaims beneficial ownership of those shares.
(5) Includes 9,510,021 shares held by Ms. Shi's husband, Tai Caihua. Ms.
Shi disclaims beneficial ownership of those shares.
(6) Includes 116,720 shares held by Timothy P. Halter, the president and
sole stockholder of Halter Financial Group, Inc.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the 2004 fiscal year, TCH purchased local brand mobile phones
from Shanghai Sifang Telecommunication Co. Ltd. ("Sifang Telecom") valued at
$390,340, and all these mobile phones were sold to retailers in 2004.
During the 2004 fiscal year, TCH sold Samsung GSM mobile phones valued
at $9,178,674 at a 4% gross profit margin to Shantian. Accounts receivable
include $1,583,512 due from Shantian. During the 2004 fiscal year, TCH also sold
mobile phones to other related parties, which included Tianci Industy and Tianci
Group for $136,310 and $576,707 at gross profit margins of 17% and 16%
respectively.
On July 16, 2004, the Tianci Group entered into an agency agreement
with TCH to sell CDMA mobile phones owned by China Unicom. TCH obtains the same
commission structure that Tianci Group earns from China Unicom. For each phone
sold, TCH receives $15.70 per unit, sales commission of $3.62 per SIM card. TCH
recognized commission income of $204,214 in the year ended December 31, 2004
from the Tianci Group, which is recorded in service revenues, net on the income
statement.
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 under
Chinese law) to transmit the reformatted information we paid service fees of
approximately $567,000 in each of the 2003 and 2004 fiscal years. The service
agreements are in effect for ten years and became effective on June 1, 2004. The
annual payments for the services should continue to approximate $567,000 per
year. During the 2004 fiscal year, Sifang Information also provided other
management support and marketing services to TCH for $36,462 and none for the
year ended December 31, 2003. TCH earned information service revenues net of
costs from China Mobile / China Unicom that were passed through from Sifang
Information and are recorded in Service revenue, net on the income statement.
For the 2004 fiscal year, the total revenues generated were $846,416 and total
cost of services were $421,476 and none for the 2003 fiscal year. TCH earned
paging service revenues net of costs that were passed through from Sifang
Information and are recorded in Service revenue, net on the income statement.
For the 2004 fiscal year, the total revenues generated were $964,869 and total
cost of services were $533,199 and none for the year ended December 31, 2003.
TCH launched a smart card project as a joint cooperation project with Sifang
Information in June 2004. However, the project was abandoned in the fourth
quarter of 2004 due to government regulations. No revenue was generated from the
project in 2004.
Sifang signed a lease agreement with Tianci Real Estate to lease its
apartment for office use, which was assumed by TCH as a part of the carve out
transaction. The original lease term was from May 1, 2003 to April 30, 2008. The
lease agreement was terminated on September 30, 2004. The related rental expense
for the years ended December 31, 2003 and 2004 was $20,540 and $30,810,
respectively.
As a result of the spin-off transaction, cash collections received and
payments made Sifang Information on behalf of TCH, resulted in a net receivable
of $2,910,956 due from Sifang Information at December 31, 2004. The amount due
from related party also consists of $501,000 relating to the value added
information services provided to Sifang Information and sold to China Unicom and
another $371,000 relating to the paging revenues that are collected by Sifang
Information on behalf of TCH. In the first quarter of 2005, TCH has collected
$3.2 million from Sifang Information subsequent to March 31, 2005. We believe
that the collection of the remaining balance of $582,956 from Sifang Information
is reasonably assured and accordingly, no allowance has been recorded as of
December 31, 2004. We also advanced US$1,205,000 to provide Sifang Information's
needs for working capital in order to complete spin-off procedures in the PRC.
The outstanding balance was fully collected in March 2005.
On February 23, 2004, we sold 987,915 shares of restricted common stock
for gross proceeds of $300,000, pursuant to a subscription agreement, to Halter
Financial Group, Inc., an entity owned by Timothy P. Halter, a former member of
the Board of Directors and the Company's former Chief Executive Officer.
Additionally, in consideration for agreeing to serve as an officer and director
of the Company, Timothy P. Halter was granted a warrant to purchase up to
131,722 shares of common stock of the Company. The warrant was exercised on June
14, 2004, and we received gross proceeds of $40,000 upon exercise.
On February 23, 2004, we agreed to pay Little and Company Investment
Securities, an entity owned by Glenn A. Little, our former controlling
stockholder, officer and director, $30,000 in consulting fees related to the
transaction discussed in the previous paragraph and in consideration for
maintaining the corporate entity. To formalize this obligation, we issued a
$30,000 non-interest bearing promissory note maturing on February 23, 2005.
Concurrent with the transaction discussed in the previous paragraph, we and
Little and Company Investment Securities executed an Exchange Agreement whereby
we issued 98,792 shares of common stock in satisfaction of the outstanding
promissory note.
On June 23, 2004, we entered into a Stock Purchase Agreement with
Halter Financial Group, Inc. pursuant to which we sold 166,667 shares of common
stock of the Company in exchange for $190,000. Timothy P. Halter is the sole
stockholder and President of Halter Financial Group, Inc. Pursuant to the Stock
Purchase Agreement, we granted to Halter Financial Group, Inc. an option to
require the Company to purchase up to 166,667 shares of common stock of the
Company at a price of $1.14 per share, such option being exercisable at any time
after the date that is six months after the Company filed a registration
statement on Form SB-2 with the SEC, (which registration statement was declared
effective on February 8, 2005) registering the shares purchased by Halter
Financial Group, Inc., up to and including the earlier of (i) the date that such
registration statement is declared effective by the SEC or (ii) Halter Financial
Group, Inc.'s shares are eligible for resale under Rule 144 under the Securities
Act of 1933.
ITEM 13. EXHIBITS
Exhibit
Number Description
3.1* Articles of Incorporation of the Registrant.
3.2** Second Amended and Restated Bylaws of the Registrant.
4.1**** Common Stock Specimen.
10.1** Securities Exchange Agreement by and among Boulder
Acquisitions, Inc., Sifang Holdings Co., Ltd. and the
stockholders of Sifang Holdings Co., Ltd. dated
effective as of June 23, 2004.
10.2*** Information Service and Cooperation Agreement by and
among Shanghai Sifang Information Technology Co. Ltd.
and Shanghai TCH Data Technology Co. Ltd. dated as of
June 1, 2004.
10.3*** Information Service and Cooperation Agreement by and
among Shanghai Sifang Information Technology Co. Ltd.
and Shanghai TCH Data Technology Co. Ltd. dated as of
June 1, 2004.
10.4*** Information Service and Cooperation Agreement by and
among Shanghai Sifang Information Technology Co.
Ltd., Shanghai Chengao Industrial Co. Ltd. and
Shanghai TCH Data Technology Co. Ltd. dated as of
June 1, 2004.
10.5*** Information Service and Cooperation Agreement by and
among Shanghai Tianci Industrial (Group), Co. Ltd.
and Shanghai TCH Data Technology Co. Ltd. dated as of
June 1, 2004.
10.6*** Business and Related Assets Transfer Agreement
between Shanghai Sifang Information Technology Co.
Ltd. and Shanghai TCH Data Technology Co. Ltd. dated
as of May 26, 2004.
10.7** Stock Purchase Agreement by and between Halter
Financial Group, Inc. and Boulder Acquisitions, Inc.
dated as of June 23, 2004.
10.8** Stock Purchase Agreement by and between Chinamerica
Fund, LP and Boulder Acquisitions, Inc. dated as of
June 28, 2004.
10.9** Stock Purchase Agreement by and between Chinamerica
Acquisition, LLC and Boulder Acquisitions, Inc. dated
as of June 28, 2004.
10.10** Stock Purchase Agreement by and between Gary Evans
and Boulder Acquisitions, Inc. dated as of June 28,
2004.
14.0 Code of Ethics
21.1**** Subsidiaries of the Registrant.
39
Exhibit
Number Description
24.1**** Power of Attorney Reference is made to page II-5 of
the Registration Statement.
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
99.1 Audit Committee Charter
-----------------------------------------
* Previously filed as an exhibit to the Registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 2001, which was
filed with the Commission on January 28, 2002, and which is
incorporated herein by reference.
** Previously filed as an exhibit to the Registrant's Current Report on
Form 8-K dated July 8, 2004, and which is incorporated herein by
reference.
*** Previously filed as an exhibit to the Registrant's Quarterly Report on
Form 10-QSB for the period ended June 30, 2004 as filed with the
Commission on August 23, 2004, and which is incorporated herein by
reference.
**** Previously filed as an exhibit to the Registrant's Registration
Statement on Form SB-2 as filed with the Commission on November 12,
2004, and which is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Board Meetings
Our board of directors held six meetings in 2004. During 2004, all
directors attended at least 75 percent of the meetings of our board of
directors. We did not have any committees of the board of directors established
in 2004.
Committees
The board of directors has a standing audit committee. We do not have a
standing nominating or compensation committee. Instead, the whole board of
directors performs the functions of a nominating committee and participates in
the consideration of director nominees, as well as the functions of a
compensation committee and participates in the determination of executive
compensation. We do not have a nominating committee because we feel that the
entire board of Directors can best perform this function. We plan to establish a
compensation committee as soon as practicable. The members of the audit
committee and the functions performed thereby are described below:
Audit Committee. The audit committee is currently comprised of three
independent members. At least one member of the audit committee is a financial
expert, as that term is defined for purposes of the American Stock Exchange,
Inc. Listed Company Manual. The members of the audit committee are as follows :
Jiang Hong Ming (Financial Expert), Jachen Li and Yuan Feng. The audit committee
reviews and recommends to the directors the independent auditors to be selected
to audit the financial statements of the Company; meets with the independent
auditors and financial management of the Company to review the scope of the
proposed audit procedures to be utilized; reviews with the independent auditors,
the Company's internal auditor, and financial and accounting personnel, the
internal accounting and financial controls of the company, and elicits any
recommendations for the improvement thereof; reviews the financial statements of
the Company and reports the results of the annual audit to the board of
directors. The audit committee was established in the first quarter of 2005 and
held one meeting in April 2005.
The board of directors has adopted a charter for the audit committee,
which is included as an exhibit to this annual report. The audit committee
charter provides that the audit committee will conduct quarterly meetings with
management and the auditors of the Company to review operating results and
financial reporting issues.
Our Bylaws provide that the board of directors should meet annually for
the election of the Company's officers and hold regular meetings.
REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS
The audit committee serves as the representative of the board of
directors for general oversight of our financial accounting and reporting,
systems of internal control, audit process, and compliance with standards of
business conduct. The board of directors has adopted a charter for the audit
committee, which can be found in Appendix A to this Proxy Statement. Management
of the Company has primary responsibility for preparing financial statements of
the Company as well as the Company's financial reporting process. Grobstein,
Horwath & Company, LLP, acting as independent auditors, is responsible for
expressing an opinion on the conformity of the Company's audited financial
statements with generally accepted accounting principles.
In this context, the audit committee hereby reports as follows:
(1) The audit committee has reviewed and discussed the audited
financial statements for the 2004 fiscal year with the Company's management.
(2) The audit committee has discussed with the independent auditors the
matters required to be discussed by Statement on Auditing Standards No. 61,
Communications with audit committees.
(3) The audit committee has received the written disclosures and the
letter from the independent auditors required by Independence Standards Board
No. 1, Independence Discussions with audit committees, and has discussed with
Grobstein, Horwath & Company, LLP the matter of that firm's independence.
(4) Based on the review and discussion referred to in paragraphs (1)
through (3) above, the audit committee recommended to the board of directors of
the Company, and the board of directors has approved, that the audited financial
statements be included in the Company's Annual Report on Form 10-KSB for the
2004 fiscal year, for filing with the Securities and Exchange Commission.
Biographical information on each member of the audit committee is set forth
above.
Audit Committee
---------------
Jiang Hong Ming
Jachen Li
Yuan Feng
Fees Paid to Independent Public Accountants for 2004 and 2003
Audit Fees
The aggregate audit fees for 2004 were approximately $160,695. The
amounts include fees of approximately $56,483 for professional services rendered
by Grobstein, Horwath & Company, LLP in connection with the audit of our
consolidated financial statements as of and for the 2004 fiscal year and fees of
approximately $110,212 for professional services rendered by BDO Shanghai
Zhonghua in connection with reviews of our unaudited consolidated interim
financial statements for the third quarter of 2004.
The aggregate audit fees for 2003 were approximately $149,509. The
amounts include fees for professional services rendered by BDO Shanghai Zhonghua
in connection with the audit of our consolidated financial statements for the
2003 fiscal year and reviews of our unaudited consolidated interim financial
statements for the first, second and third quarters of 2003.
Audit-Related Fees
There were no audit-related fees billed by Grobstein, Horwath &
Company, LLP or BDO Shanghai Zhonghua for other services rendered to the Company
for the 2003 or 2004 fiscal years.
Tax Fees
There were no fees for tax services billed by Grobstein, Horwath &
Company, LLP or BDO Shanghai Zhonghua for other services rendered to the Company
for the 2003 or 2004 fiscal years.
All Other Fees
There were no additional aggregate fees billed by Grobstein, Horwath &
Company, LLP and BDO Shanghai Zhonghua for other services rendered to the
Company for the 2003 or 2004 fiscal years.
Policy on audit committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditors
The audit committee pre-approves all audit and non-audit services
provided by the independent auditors prior to the engagement of the independent
auditors with respect to such services. The Company's independent auditors may
be engaged to provide non-audit services only after the audit committee has
first considered the proposed engagement and has determined in each instance
that the proposed services are not prohibited by applicable regulations and the
auditors' independence will not be materially impaired as a result of having
provided these services. In making this determination, the audit committee takes
into consideration whether a reasonable investor, knowing all relevant facts and
circumstances, would conclude that the auditors' exercise of objective and
impartial judgment on all issues encompassed within the auditors' engagement
would be materially impaired. The audit committee may delegate its approval
authority to pre-approve services provided by the independent auditors to one or
more of the members of the audit committee, provided that any such approvals are
presented to the audit committee at its next scheduled meeting.
40
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
By: /s/ Tai Caihua Date: April 29, 2005
------------------------------------------------
Tai Caihua, President and Chairman of the Board
By: /s/ Qian Fang Date: April 29, 2005
------------------------------------------------
Qian Fang, Chief Financial Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date stated.
By: * Date: April 29, 2005
------------------------------------------------
Tai Caihua, Director
By: * Date: April 29, 2005
------------------------------------------------
Shi Ying, Director
By: * Date: April 29, 2005
------------------------------------------------
Huang Tianqi, Director
By: * Date: April 29, 2005
------------------------------------------------
Jing Weiping, Director
By: * Date: April 29, 2005
------------------------------------------------
Mao Ming, Director
By: * Date: April 29, 2005
------------------------------------------------
Song Jing, Director
By: * Date: April 29, 2005
------------------------------------------------
Fu Sixing, Director
By: * Date: April 29, 2005
------------------------------------------------
Yu Ruijie, Director
By: * Date: April 29, 2005
------------------------------------------------
Zhang Xiaodong, Director
By: * Date: April 29, 2005
------------------------------------------------
Huang Wei, Director
By: Date:
------------------------------------------------
Jiang Hong Ming, Director
By: Date:
------------------------------------------------
Jachen Li, Director
By: Date:
------------------------------------------------
Yuan Feng, Director
*By: /s/ Tai Caihua Date: April 29, 2005
------------------------------------------------
Tai Caihua, As Attorney-in-fact
41
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To the Shareholders and Board of Directors
China Digital Wireless, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheet of China Digital
Wireless, Inc. and Subsidiary (the "Company") as of December 31, 2004 and the
related consolidated statements of income and comprehensive income,
shareholders' equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal controls over financial reporting. Our audit included consideration of
internal controls over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of China
Digital Wireless, Inc. and Subsidiary as of December 31, 2004, and the
consolidated results of their operations and cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States
of America.
GROBSTEIN, HORWATH & COMPANY LLP
Sherman Oaks, California
March 14, 2005
[LETTERHEAD OF BDO SHANGHAI ZHONGHUA]
Report of Independent Registered Public Accounting Firm
The Board of Directors
China Digital Wireless, Inc. (formerly, Sifang Holdings Co. Ltd.)
We have audited the accompanying consolidated balance sheets of China Digital
Wireless, Inc. (formerly, Sifang Holdings Co. Ltd.) as of December 31, 2003 and
the related consolidated statements of income and comprehensive income,
stockholders' equity and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatements. An audit
includes examining, on a test basis. evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management. as well
as evaluating the overall financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of China Digital
Wireless, Inc (formerly, Sifang Holdings Co. Ltd.), as of December 31, 2003 and
the results of its operations and its cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ BDO Shanghai Zhonghua
BDO Shanghai Zhonghua
Certified Public Accountants
Shanghai, PRC
June 1, 2004
F-1
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2003 2004
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,713,748 $ 75,511
Accounts receivable, net of allowance for doubtful
accounts of $25,651 and $47,922 2,363,327 4,619,809
Inventories 1,591,223 101,696
Deferred tax assets 4,955 28,772
Common stock proceeds held in escrow 0 1,500,000
Amounts due from a related party -- 4,987,956
Deposits paid 245,268 --
Other current assets 175,850 150,412
------------ ------------
Total current assets 6,094,371 11,464,156
------------ ------------
Property and equipment, net 1,354,238 1,198,509
------------ ------------
Total assets $ 7,448,609 $ 12,662,665
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 111,569 $ 55,839
Deferred revenue 537,046 617,694
VAT payable 0 213,535
Income tax payable 0 312,763
Due to related parties 20,540 100,260
Other current liabilities 95,790 287,025
------------ ------------
Total current liabilities 764,945 1,587,116
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value, 100,000 000 shares
authorized, 17,018,692 (2003 - 13,782,636) shares
issued and outstanding 13,783 17,019
Additional paid-in capital 1,436,217 4,229,974
Retained earnings 5,233,652 6,828,281
Accumulated other comprehensive income 12 275
------------ ------------
Total shareholders' equity 6,683,664 11,075,549
------------ ------------
Total liabilities and shareholders' equity $ 7,448,609 $ 12,662,665
============ ============
See accompanying notes to consolidated financial statements
F-2
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Years Ended December 31,
----------------------------
2003 2004
------------ ------------
Revenues:
Product sales $ 13,529,279 $ 11,057,398
Product sales to related parties 0 9,891,691
Service revenue, net 3,503,099 3,571,861
------------ ------------
Total revenues 17,032,378 24,520,950
------------ ------------
Cost of goods sold 12,424,454 10,196,443
Cost of goods sold to related parties 0 9,412,389
Cost of service 1,016,318 1,045,993
------------ ------------
Total cost of goods sold 13,440,772 20,654,825
------------ ------------
Gross profit 3,591,606 3,866,125
------------ ------------
Operating expenses:
Sales and marketing 153,437 246,639
General and administrative 291,413 1,656,841
------------ ------------
Total operating expenses 444,850 1,903,480
------------ ------------
Income from operations 3,146,756 1,962,645
Interest income (expense) (12,082) 1,955
------------ ------------
Income before income taxes 3,134,674 1,964,600
Income tax provision 246,694 369,971
------------ ------------
Net income $ 2,887,980 $ 1,594,629
============ ============
Other comprehensive income
Translation adjustments $ 381 $ 263
Comprehensive income $ 2,888,361 $ 1,594,892
============ ============
Basic earnings (loss) per share $ 0.21 $ 0.10
Weighted average shares of common stock outstanding 13,782,636 15,458,000
See accompanying notes to consolidated financial statements.
F-3
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, 2002 13,782,636 $ 13,783 $ 1,436,217 $ 2,345,672 $ (369) $ 3,795,303
Net income -- -- -- 2,887,980 -- 2,887,980
Translation adjustment -- -- -- -- 381 381
------------- ------------- ------------- ------------- ------------- -------------
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
service 167,895 168 604,254 -- -- 604,422
Shares issued for proceeds of
$190,000 166,667 167 599,834 -- -- 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
============= ============= ============= ============= ============= =============
See accompanying notes to consolidated financial statements.
F-4
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
--------------------------
2003 2004
----------- -----------
Cash flows from operating activities:
Net income $ 2,887,980 $ 1,594,629
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 234,055 287,232
Bad debt expenses 0 19,764
Issuance of common stock to consultants for services 0 1,014,423
Loss on disposal of fixed assets 5,361 652
Deferred tax assets 601 (23,817)
Changes in assets and liabilities:
Accounts receivable (1,790,616) (2,276,245)
Inventories (422,000) 1,489,527
Amounts due from a related party 0 (4,742,688)
Deposits paid (245,268) 0
Other current assets 62,522 25,438
Accounts payable 111,569 (55,730)
Deferred revenue 493,116 80,648
Income tax payable 0 312,763
Due to related parties 20,540 79,720
Other current liabilities 25,737 404,769
----------- -----------
Net cash provided by (used in) operating activities 1,383,597 (1,788,915)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (259,858) (132,155)
----------- -----------
Net cash used in investing activities (259,858) (132,155)
----------- -----------
Cash flows from financing activities:
Recapitalization and reorganization 0 310,051
Proceeds from issuing common stock 0 1,690,000
Common stock proceeds held in escrow 0 (1,500,000)
Issuing cost 0 (217,481)
Due to a related party (604,062) 0
----------- -----------
Net cash provided by financing activities (604,062) 282,570
----------- -----------
Foreign currency translation 381 263
----------- -----------
Net increase (decrease) in cash and cash equivalents 520,058 (1,638,237)
Cash and cash equivalents, beginning of the period 1,193,690 1,713,748
----------- -----------
Cash and cash equivalents, end of the period $ 1,713,748 $ 75,511
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 12,082 $ 0
Income taxes $ 246,093 $ 76,339
Non-cash financing activity:
Issuance of common stock to consultants for consulting services $ 0 $ 1,014,423
=========== ===========
See accompanying notes to consolidated financial statements.
F-5
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS BACKGROUND
China Digital Wireless, Inc. ("CDW," formerly known as Boulder Acquisitions,
Inc.) through its subsidiary sells mobile phones to retailers, distributors, and
related parties and provides information services to users of mobile phones and
pagers. Substantially all operations are conducted in Shanghai, People's
Republic of China (PRC).
In order to meet ownership requirements under Chinese law that restrict a
foreign company, from operating in certain industries such as value-added
telecommunication and Internet services, CDW's subsidiary has entered into
information service and cooperation agreements with two of CDW's affiliates that
are incorporated in China: Shanghai SFT Co. Ltd. ("Sifang Information") and
Shanghai Tianci Industry Co. Ltd ("Tianci Industry"). CDW holds no ownership
interest in Sifang Information or Tianci Industry. Sifang Information and Tianci
Industry contract with China Mobile Communications Corporation, or China Mobile,
and China United Telecommunications Corporation, or China Unicom, respectively,
to provide wireless value-added information services to wireless receiver
customers in China via China Mobile and China Unicom. Sifang Information
transmits those services to customers of China Mobile and China Unicom on behalf
of itself and Tianci Industry pursuant to a signed agreement between Sifang
Information and Tianci Industry.
Recapitalization and Reorganization
On June 23, 2004, Boulder Acquisitions, Inc. ("Boulder Acquisitions") entered
into a stock exchange agreement with Sifang Holdings Co. Ltd. ("Sifang
Holdings") and certain shareholders. Pursuant to the stock exchange agreement,
Boulder Acquisitions issued 13,782,636 shares of its common stock in exchange
for a 100% equity interest in Sifang Holdings, making Sifang Holdings a wholly
owned subsidiary of Boulder Acquisitions.
Boulder Acquisitions was incorporated under the laws of the State of Colorado on
May 8, 1980 as Boulder Brewing Company ("Boulder Brewing"). Boulder Brewing was
the successor to a general partnership formed in 1979. From the initial
inception of the original partnership through 1990, Boulder Brewing was in the
business of operating a microbrewery in Boulder, Colorado. During 1990, as a
result of various debt defaults, Boulder Brewing's assets were foreclosed upon
and all business operations were ceased. Boulder Brewing has effectively had no
operations, assets or liabilities since its fiscal year ended December 31, 1990.
In September 2001, Boulder Brewing changed its state of incorporation from
Colorado to Nevada by means of a merger with and into Boulder Acquisitions, a
Nevada corporation formed on September 6, 2001 solely for the purpose of
effecting the reincorporation. The Articles of Incorporation and Bylaws of the
Nevada corporation are the Articles of Incorporation and Bylaws of the surviving
corporation. Such Articles of Incorporation eliminated the provision for Boulder
Acquisitions to issue preferred stock.
The above stock exchange transaction resulted in those shareholders of Sifang
Holdings obtaining a majority voting interest in Boulder Acquisitions. Generally
accepted accounting principles in the United States of America require that the
company whose shareholders retain the majority interest in a combined business
be treated as the acquirer for accounting purposes. Consequently, the stock
exchange transaction has been accounted for as a recapitalization of Sifang
Holdings as Sifang Holdings acquired a controlling equity interest in Boulder
Acquisitions, as of June 23, 2004. The reverse acquisition process utilizes the
capital structure of Boulder Acquisitions and the assets and liabilities of
Sifang Holdings recorded at historical cost.
Sifang Holdings is the continuing operating entity for financial reporting
purposes, and the financial statements prior to June 23, 2004 represent Sifang
Holdings' financial position and results of operations. As of June 23, 2004,
Boulder Acquisitions had only cash of $310,051, and shareholders' equity of
$310,051 with 1,585,705 shares of common stock outstanding, all of which were
included in the consolidated financial statements of Sifang Holdings. See the
shareholders' equity statement for the period from January 1, 2004 to December
31, 2004. 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.
F-6
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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 holding a 100% equity
interest in TCH. TCH was established as a foreign investment enterprise in
Shanghai under the laws of the PRC on May 25, 2004, with registered capital of
$7.2 million.
CDW's current operations were originally a business division of Sifang
Information. Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business to
TCH. As the acquiring entity under common control, TCH initially recognized all
the assets and liabilities transferred at their carrying amounts in the accounts
of Sifang Information at the date of transfer under the guidance of SFAS No.
141, Appendix D.
On May 25, 2004, Sifang Information transfered its 100% equity interest in TCH
in exchange for 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 25, 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
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
F-7
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
approximately 3.3%. The selling expenses are allocated based on the relationship
between expense and revenue (such as commission) and payroll records. The
general and administrative expenses are allocated based on management hours
spent and payroll records. The income tax provision has been calculated on a
separate company basis and is in line with the historical actual income tax
provision at the Sifang Information level assuming that all income taxes had
been paid by Sifang Information and no income tax liability was in existence in
the periods reported in the accompanying financial statements. Management
believes that the costs, operating expenses, interest expense, and income tax
provision included in the Company's financial statements are a reasonable
representation of the costs and expenses that would have been incurred if the
Company had performed these functions as a stand-alone company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP)
and pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) for annual financial statements. The consolidated financial
statements, in the opinion of management, include all adjustments necessary for
a fair statement of the consolidated results of operations, financial position
and cash flows for each period presented.
The Company's consolidated financial statements for the year ended December 31,
2003 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 year ended December 31, 2004
include the accounts CDW, its wholly owned subsidiary Sifang Holdings, and its
wholly owned subsidiary TCH (collectively the "Company"). Substantially all of
the Company's revenues are derived from the operations of TCH, which represents
substantially all of the Company's consolidated assets and liabilities as of
December 31, 2004. All significant intercompany accounts and transactions have
been eliminated.
Foreign Currency Translations and Transactions
The Renminbi ("RMB"), the national currency of the PRC, is the primary currency
of the economic environment in which the operations of the Company are
conducted. The Company uses the United States dollar ("U.S. dollars") for
financial reporting purposes.
The Company translates it's assets and liabilities into U.S. dollars using the
rate of exchange prevailing at the balance sheet date, and the statement of
income is translated at average rates during the reporting period. Adjustments
resulting from the translation of its 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.
F-8
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
The Company derives revenues from the sale of mobile phones and the provision of
wireless information services that are used on mobile phones, pagers and prepaid
phone cards. The Company additionally earns commission income ("Agency Income")
from the sale of CDMA mobile phones on the behalf of a related party. The
Company recognizes its revenues net of related business taxes and value added
taxes.
Mobile Phone Sales:
Revenues generated from the sale of mobile phones are recognized when the
products are shipped to the distributor or retailer and when persuasive evidence
of an arrangement exists, delivery of the products has occurred, customer
acceptance has been obtained, which means the significant risks and rewards of
ownership have been transferred to the customer, the price is fixed or
determinable and collectibility is reasonably assured.
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. The Company records
the proceeds as deferred revenue and amortizes the deferred revenue over the
subscription period. When customers buy a pre-charged service card, the Company
records the proceeds as deferred revenue. When a customer starts to use this
card to access to the Company's server and starts to use a pager to access the
aforementioned information, the Company identifies the subscription period and
amortizes the deferred revenue over the subscription period.
ii) Information Services - Installing Agent:
The Company has an installing agent install the Company's software on mobile
phones, which are owned by the retailer. The retailer sells these phones for a
premium covering a fee to be paid to the installing agent and pre-charged
six-month subscription fees to be paid to the Company. After a customer using
such a phone dials into the server to access the desired information, the server
records a unique identification number installed on the mobile phone, which
indicates that a specific phone user starts his or her subscription period.
After the Company receives a detailed list from the installing agent regarding
the number of phones that have been installed with the Company's software, the
Company matches this information with a detailed list from the retailer setting
forth how many such phones have been sold. Based on the number of such phones
sold, the Company records accounts receivable and deferred revenue. 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 Shanghai Tianci Industrial
F-9
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Group Co., Ltd. ("Tianci Group"), 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 Group who in turn pass those fees to the Company. The
Company recognizes net revenues based on the total amount paid by its customers,
for which the Mobile Operators bill and collect on behalf of the Company. There
is a time lag ranging from 10 days to 45 days between the end of the service
period and the date the Mobile Operators send out their billing statements due
to the segregated billing systems of each of the provincial subsidiaries of the
Mobile Operators. The Company received the December invoice before the issuance
of the financial statements to reconcile the monthly revenues to the Mobile
Operators billing statement. The Company has not recognized service revenue
based on the records provided by its own server but has performed a
reconciliation on a monthly basis of the revenues recognized by the Company's
server to the Mobile Operator's billing statement. In addition, the Mobile
Operators charge a network usage fee based on a fixed per message fee multiplied
by the excess of messages sent over messages received. This type of service is
not covered by a monthly service subscription and the Company has no control
whether or not it will occur 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, the Company must
follow the price policy within ranges prescribed by Mobile
Operators, and
o Has limited ability to assume risk of non-payment by
customers.
The Company's dependence on the substance and timing of the billing systems of
the mobile telecommunications operators may require us to estimate portions of
our reported revenue for wireless Internet services from time to time. As a
result, subsequent adjustments may have to be made to our wireless Internet
service revenue in our financial statements. As we do not bill our wireless
Internet services users directly, we depend on the billing systems and records
of the mobile telecommunications operators to record the volume of our wireless
Internet services provided, charge our users through mobile telephone bills and
collect payments from our users and pay us.
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 delinquent accounts
F-10
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
receivable balances as an allowance for doubtful accounts that is based on 5% of
total trade accounts receivable less amounts due from related parties and from
the installing agent.
The Company regularly evaluates and monitors the creditworthiness of each
customer on a case-by-case basis. The Company includes any account balances that
are determined to be uncollectible in the overall allowance for doubtful
accounts. After all attempts to collect a receivable have failed, the receivable
is written off against the allowance. The Company believes that its allowance
for doubtful accounts was adequate as of December 31, 2003 and 2004. However,
actual write-offs might exceed the recorded allowance.
As of December 31, 2004, accounts receivable resulting from pre-charged fees
amounted to $2,125,777, which was collected in March 2005.
The following table presents activities in the allowance for doubtful accounts.
December 31
------------------------
2003 2004
------------------------
Beginning balance $ 30,143 $ 28,158
Additions charged to expense -- 19,764
Recovered (4,492) --
Actual write off -- --
---------- ----------
Ending balance $ 25,651 $ 47,922
========== ==========
Inventories
Inventories consist principally of mobile phones manufactured by name brand
manufacturers with various features and are stated at the lower of cost
(weighted-average) or market.
Rebates and Credits Receivable
In 2004 the Company's major vendor began providing rebates and credits if the
Company meets certain sales volume levels prescribed by the vendor. As a result,
the Company is entitled to receive certain rebates and credits for the inventory
held and sold by the Company within the specified period of time as defined by
its vendor through submitting the necessary application forms. In general, once
the vendor approves these applications the amounts of these rebates and credits
will be deducted from the Company's accounts payable to its vendor and decrease
the cost of goods sold or inventory held correspondingly.
Capitalization of Software Costs
The Company's software is developed by an independent third party to enable
pager users to accept certain recoded information which is transmitted, 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.
F-11
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Property and equipment
Property and equipment are recorded at cost and are stated net of accumulated
depreciation. Depreciation expense is determined using the straight-line method
over the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
Maintenance and repairs are charged directly to expense as incurred, whereas
betterment and renewals are generally capitalized in their respective property
accounts. When an item is retired or otherwise disposed of, the cost and
applicable accumulated depreciation are removed and the resulting gain or loss
is recognized and reflected as an item before operating income (loss).
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 years ended December 31, 2003 and 2004.
Fair Value of Financial Instruments
The carrying amount of cash, notes receivable, accounts receivable, other
receivables, advances to vendor, accounts payable and accrued liabilities are
reasonable estimates of their fair value because of the short maturity of these
items.
Advertising Expenses:
Advertising expenses are expensed in the period incurred. Advertising expenses
for the years ended December 31, 2004 and 2003 were $ 60,092 and $ 18,909,
respectively.
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%, in general, depending on the types
of products purchased and sold. The input VAT can be offset against the output
VAT.
F-12
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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. Deferred tax assets and liabilities are recognized for the future tax
consequence attributable to the difference between the tax bases of assets and
liabilities and their reported amounts in the financial statements. Deferred tax
assets and liabilities are measured using the enacted tax rate expected to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the
enactment date. The Company establishes a valuation when it is more likely than
not that 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 area and has been treated by the Shanghai
Municipal Administration of Labor as an enterprise that provides unemployed and
handicapped people with jobs. Accordingly, Sifang Information is entitled to 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 year ended December
31, 2003. The income tax provision presented for the year ended December 31,
2004 is based on 7.5% for the months of January to June and 15% for the months
of July to December. The 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 Income (Loss)
The Company 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.
F-13
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Earnings (Loss) 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, similar to fully diluted earnings (loss) per share. The Company did not
have any potentially dilutive common share equivalents as of December 31, 2003
or 2004.
Reclassifications
Certain amounts included in the prior year's consolidated financial statements
have been reclassified to conform to the current year presentation. Such
reclassifications did not have any effect on reported net income and are
immaterial to the financial statements as a whole.
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
F-14
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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 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.
NOTE 3 - Equity Transactions
On June 23, 2004, the Company issued 167,895 shares of its common stock to a
consultant for services relating to the reverse merger that was completed in
fiscal 2004. The trading price of the Company's common stock on June 23, 2004
was $3.60 per share, accordingly, the fair value of 167,895 shares was $604,422.
On June 23, 2004, the Company issued 166,667 shares of its common stock in
exchange for services performed by an existing major shareholder of Boulder
Acquisitions for his consulting services involved with the reverse merger . The
common stock was issued at a price of $1.14 per share in exchange for gross
proceeds of $190,000 based on a stock purchase agreement. The $1.14 per share
price was pre-negotiated between the Company and the shareholder before the
reverse merger had been completed. Pursuant to the stock purchase agreement, the
Company granted the existing shareholder an option which required the Company to
purchase up to the aforementioned 166,667 shares of common stock at a price of
$1.14 per share, such option being exercisable at any time after the date that
is 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 a
small business issuers. On February 8, 2005, the SEC approved the registration
filing and accordingly, the Company has recorded these shares in shareholders'
equity as the contingency surrounding these shares expired as of February 8,
2005. On June 23, 2004, the trading price of the Company's stock at the end of
the day was $3.60 per share. Due to the relationship between the parties, the
difference between the price of $1.14 per share and the price of $3.60 per share
was recorded as compensation by presenting $410,001 in additional paid-in
capital and in general and administrative expenses.
On June 28, 2004, the Company issued, in aggregate, 1,315,789 shares of its
common stock to three investors at a price of $1.14 per share in exchange for
gross proceeds of $1,500,000 based on a stock purchase agreement. The $1.14 per
share price was pre-negotiated between the Company and the investors before the
reverse merger had been completed. Pursuant to the signed stock purchase
agreement, the Company granted to each of the three investors an option which
requires the Company to purchase up to the aforementioned 1,315,789 shares, in
aggregate, of common stock at a price of $1.14 per share, such option being
exercisable at any time after the date that is 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
F-15
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
were held in an escrow account with an agent who is related to a shareholder. As
of December 31, 2004, the Company has treated the proceeds held in escrow as a
current asset as the entire amount was released from escrow in March 2005 and
paid to the Company. According to Topic D-98 from SEC, "Classification and
Measurement of Redeemable Securities," these shares should be presented outside
the permanent equity section. However, on November 12, 2004, the Company filed a
Registration Statement on Form SB-2 with the SEC, for registration of these
securities to be sold to the public by small business issuers. On February 8,
2005, the SEC declared the registration statement effective. Accordingly, the
Company has recorded these shares in shareholders' equity as the contingency
surrounding these shares expired as of February 8, 2005.
In connection with the June 28, 2004, issuance of common stock, the Company
incurred share issue costs of $217,481 and accounted for it as a reduction of
additional paid-in capital.
NOTE 4 - PROPERTY AND EQUIPMENT
A summary of property and equipment at cost is as follows:
December 31,
--------------------------
2003 2004
--------------------------
Buildings $ 943,368 $ 943,391
Software 391,660 489,103
Vehicles 65,484 65,485
Other equipment 424,891 455,453
----------- -----------
1,825,403 1,953,432
Accumulated depreciation (471,165) (754,923)
----------- -----------
$ 1,354,238 $ 1,198,509
=========== ===========
Depreciation expense for the years ended December 31, 2003 and 2004 was $234,055
and $287,232, respectively.
As of December 31, 2004, in accordance with the "Business and Related Assets
Transfer Agreement" signed by TCH and Sifang Information, the ownership of the
building suite and two motor vehicles, (collectively known as "Assets") are
recorded on TCH's books of record. The net book value of the pledged assets was
$853,743. The property is pledged as security for a $2.5 million line of credit
held under the credit facility agreement between Sifang Information and the
bank. The line of credit is recorded on Sifang Information's books and has a
balance of $2,416,334 as of December 31, 2004. However, the two parties have
declared that the ownership of the "Assets" should be TCH's as of the balance
sheet date and have signed a legal agreement, as noted above. Sifang Information
is expected to pay off the line of credit balance in May 2005 and at that point
they will transfer the legal title of the property and the motor vehicles within
one week after the pledge is to be released by the bank.
F-16
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - RELATED PARTY TRANSACTIONS
Related Party Relationships
The following related parties are related through common ownership with the
major shareholder of the Company:
================================================================================
Shanghai SFT Co., Ltd. ("Sifang Information")
Shanghai Tianci Industry Co. Ltd. ("Tianci Industry")
Shanghai Tianci Industry Group Co. Ltd. ("Tianci Group")
Shanghai Shantian Telecommunication Co. Ltd. ("Shantian")
Shanghai Sifang Telecommunication Co. Ltd. ("Sifang Telecom")
Shanghai Tianci Real Estate Co. Ltd. ("Tianci Real Estate")
Merchandise Sold to Related Parties
Years Ended December 31,
------------------------
2003 2004
------------------------
Shanghai Shantian Telecommunication Co. Ltd. $ -- $9,178,674
Shanghai Tianci Industry Group Co. Ltd. -- 136,310
Shanghai Tianci Industry Co. Ltd. -- 576,707
---------- ----------
$ -- $9,891,691
========== ==========
During the year ended December 31, 2004, TCH sold Samsung GSM mobile phones
valued at $ 9,178,674 at a 4% gross profit margin to Shantian. Accounts
receivable include $1,583,512 due from Shantian. During the year ended December
31, 2004 TCH also sold mobile phones to other related parties, which included
Tianci Industy and Tianci Group for $136,310 and $576,707 at gross profit
margins of 17% and 16% respectively.
Agency Income from a Related Party
The Tianci Group entered into an agency agreement with TCH to sell CDMA mobile
phones owned by China Unicom. TCH obtains the same commission structure that
Tianci Group earns from China Unicom. For each phone sold, TCH receives $15.70
per unit, sales commission of $3.62 per SIM card. TCH recognized commission
income of $204,214 in the year ended December 31, 2004 from the Tianci Group,
which is recorded in service revenues, net on the income statement.
Purchase from Related Party
Years Ended December 31,
------------------------
2003 2004
------------------------
Shanghai Sifang Telecommunication Co. Ltd. $ -- $ 390,340
========== ==========
During the year ended December 31, 2004, TCH purchased local brand mobile phones
from Sifang Telecom valued at $390,340, and all these mobile phones were sold to
retailers in 2004.
F-17
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Service Provided by Related Party
Years Ended December 31,
------------------------
2003 2004
------------------------
Shanghai SFT Co., Ltd. $ 567,840 $ 604,314
========== ==========
In accordance with terms contained in signed service agreements between TCH and
Sifang Information giving TCH the right to use Sifang Information's factility
(which may not be owned by foreign investors at the present time) to transmit
the reformatted information the Company paid service fees of approximately $
567,000 in each of the years ended December 31, 2003 and 2004. The service
agreements are in effect for ten years and became effective on June 1, 2004. The
annual payments for the services should continue to approximate $567,000 per
year.
During the year ended December 31, 2004, Sifang Information also provided other
management support and marketing services to TCH for $36,462 and none for the
year ended December 31, 2003.
TCH earned information service revenues net of costs from China Mobile / China
Unicom that were passed through from Sifang Information and are recorded in
Service revenue, net on the income statement. For the year ended December 31,
2004, the total revenues generated were $846,416 and total cost of services were
$421,476 and none for the year ended December 31, 2003.
TCH earned paging service revenues net of costs that were passed through from
Sifang Information and are recorded in Service revenue, net on the income
statement. For the year ended December 31, 2004, the total revenues generated
were $964,869 and total cost of services were $533,199 and none for the year
ended December 31, 2003.
Leasing from Related Parties
Sifang signed a leasing agreement with the Tianci Real Estate for leasing its
apartment for office use, which was assumed by TCH as a part of the carve out
transaction. The original leasing term was from May 1, 2003 to April 30, 2008.
The lease agreement was terminated on September 30, 2004. The related rental
expense for the years ended December 31, 2003 and 2004 was $20,540 and $30,810,
respectively.
Amounts Due from a Related Party
As a result of the spin-off transaction, cash collections received and payments
made Sifang Information on behalf of TCH, resulted in a net receivable of
$2,910,956 due from Sifang Information at December 31, 2004. The amount due from
related party also consists of $501,000 relating to the value added information
services provided to Sifang Information and sold to China Unicom and another
$371,000 relating to the paging revenues that are collected by Sifang
Information on behalf of TCH. In the first quarter of 2005, TCH has collected
$3.2 million from Sifang Information subsequent to March 31, 2005 The Company's
management believes that the collection of the remaining balance of $582,956
from Sifang Information is reasonably assured and accordingly, no allowance has
been recorded as of December 31, 2004.
The Company also advanced US$1,205,000 to provide Sifang Information's needs for
working capital in order to complete spin-off procedures in the PRC. The
outstanding balance was fully collected in March 2005.
F-18
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Due to Related Parties
Years Ended December 31,
-------------------------
2003 2004
----------- -----------
Shanghai Tianci Real Estate Co. Ltd $ 20,540 $ 51,350
Shanghai Tianci Industry Group Co. Ltd. -- 48,910
----------- -----------
$ 20,540 $ 100,260
=========== ===========
The balance owed to Tianci Real Estate represents rental payments for fiscal
2003 and 2004. The rental agreement was cancelled as of September 30, 2004. The
balance owed to Tianci Group represents cash paid in advance for mobile phone
purchases. All of the above amounts due to related parties are unsecured,
non-interest bearing and due on demand.
NOTE 6 - INCOME TAXES
The income (loss) generated in the Cayman Islands and China before income taxes
in 2003 and 2004, respectively, was as follows:
Years Ended December 31,
-------------------------
2003 2004
----------- -----------
Loss in Cayman Islands before income taxes $ -- $(1,199,738)
Income in China before income taxes 3,134,674 3,164,338
----------- -----------
$ 3,134,674 $ 1,964,600
=========== ===========
The income tax provision was as follows:
Years Ended December 31,
-------------------------
2003 2004
----------- -----------
Current:
Cayman Islands $ -- $ --
China 246,093 389,102
----------- -----------
Deferred:
Cayman Islands -- --
China 601 (19,131)
----------- -----------
$ 246,694 $ 369,971
=========== ===========
F-19
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The difference between the effective income tax rate and the expected
federal statutory rate was as follows:
Year ended Year ended
December 31, December 31,
2003 2004
---------------------------------------------
Statutory rate 33.0% 33.0%
Income tax holiday (25.5) (21.9)
Permanent differences 0.4 7.7
Change in valuation allowance -- --
-------- --------
Effective income tax rate 7.9% 18.8%
--------------------------------------------------------------------------------
The primary components of temporary differences which give rise to the Company's
deferred tax assets are as follows:
Year Ended December 31,
-----------------------
2003 2004
---------- ----------
Allowance for receivables $ 1,973 $ 7,188
Accrued liabilities 2,982 21,584
---------- ----------
4,955 28,772
Valuation allowance -- --
---------- ----------
Net deferred tax assets $ 4,955 $ 28,772
========== ==========
NOTE 8 - SEGMENT REPORTING
The Company currently operates in three principal business segments. Management
believes that the following table presents the useful information to the chief
operation decision makers for measuring business performance and financing needs
and preparing the corporate budget, etc. As most of the Company's customers are
located in the Shanghai metropolitan area and the Company's revenues are
generated in Shanghai, no geographical segment information is presented.
Mobile Mobile
Agency Phone Phone Pagers
Income Distribution Service Service Corporate Total
------------ ------------ ------------ ------------ ------------ ------------
2003
Revenue -- $ 13,529,279 $ 1,297,323 $ 2,205,776 $ -- $ 17,032,378
Gross profit -- 1,104,825 1,009,859 1,476,922 -- 3,591,606
Depreciation -- -- 187,171 -- 46,884 234,055
Interest expense -- (12,082) -- -- -- 12,082
Net income -- 848,218 766,918 1,272,844 -- 2,887,980
Expenditures for long-lived -- -- 194,374 -- 65,484 259,858
assets
Total assets -- 2,039,505 2,196,789 286,376 2,925,939 7,448,609
F-20
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2004
Revenue $ 204,214 20,949,089 2,388,178 979,469 -- 24,520,950
Gross profit 204,214 1,340,257 1,889,984 431,670 -- 3,866,125
Depreciation -- -- 229,979 -- 57,253 287,232
Interest income -- -- -- -- 1,955 1,955
Net income 165,757 802,854 1,271,078 176,742 821,801 1,594,629
Total assets -- 2,721,741 2,443,657 -- 7,497,267 12,662,665
Expenditures for long-lived -- -- 132,155 -- -- 132,155
assets
NOTE 9 - CONCENTRATION OF CUSTOMERS AND VENDORS
Customers and vendors who account for 10% or more of revenues, accounts
receivable, purchases and accounts payable are presented as follows:
Customer Revenues Accounts Receivable
2003 2004 2003 2004
A - 37% - 34%
B 12% 11% 1% 7%
C 16% 5% 2% 3%
D 14% 6% 2% 4%
E 7% 8% 76% 46%
--- --- --- ---
49% 67% 81% 94%
Vendor Purchases Accounts Payable
2003 2004 2003 2004
A (Shantian, a related party) 36% 33% 0 96%
B 31% 0 0 0
C 23% 32% 0 4%
D 0 17% 0 0
90% 82% 0 100%
On December 31, 2004, the agreement between the installation agent and the
Company was terminated and not renewed. For the year ended December 31, 2004,
the Company earned $2,058,681 (2003 - $1,271,113) of information service
revenues from the installation agent.
NOTE 10 -EMPLOYEE WELFARE AND RETIREMENT BENEFITS
The PRC has been undergoing significant reforms with regard to its employee
welfare and fringe benefits administration. Any enterprise operating in the PRC
is subject to government-mandated employee welfare and retirement benefit
contribution as a part of operating expense to the State Administration of Labor
Affairs. In accordance with PRC laws and regulations, TCH participates in a
F-21
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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 $58,501 and $39,391 to these
funds as part of selling, general and administrative expenses for the years
ended December 31, 2003 and 2004, respectively.
F-22