UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
0-12536
(Commission File Number)
CHINA DIGITAL WIRELESS, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 90-0093373
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
429 Guangdong Road
Shanghai, People's Republic of China 200001
(Address of principal executive offices)
Issuer's telephone number: (86 21) 6336-8686
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to the filing requirements for at least the past 90 days. [X]Yes [ ]No
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ]Yes [X]No
As of August 4, 2006, there were 17,147,268 shares of $.001 par value common
stock outstanding.
Transitional Small Business Disclosure Format: [ ]Yes [X] No
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 2005 and June 30, 2006
(Unaudited) 3
Consolidated Statements of Income and Comprehensive Income (Unaudited)
For the Three Months and Six Months Ended June 30, 2005 and 2006 4
Consolidated Statements of Cash Flows (Unaudited) for the Six Months
Ended June 30, 2005 and 2006 5
Notes to Consolidated Financial Statements (Unaudited) 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION 17
ITEM 3. CONTROLS AND PROCEDURES 27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 28
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 28
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 28
ITEM 5. OTHER INFORMATION 28
ITEM 6. EXHIBITS 28
SIGNATURES 29
2
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, June 30,
2005 2006
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,578,367 $ 1,793,179
Accounts receivable, net of allowance for doubtful
accounts of $44,472 and $4,387 844,977 83,345
Inventories 62,386 43,121
Deferred tax assets 12,846 2,533
Due from related parties 3,094,969 5,022,917
Advances and deposits to suppliers 19,970 36,659
------------ ------------
Total current assets 7,613,515 6,981,754
Property and equipment, net 1,105,756 1,017,486
Deposit for business acquisition 6,257,590 6,257,590
------------ ------------
Total assets $ 14,976,861 $ 14,256,830
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 881,218 $ 285,342
Advance from customer 6,399 6,454
Deferred revenue 31,598 18,750
VAT payable 92,649 2,695
Income tax payable 193,586 70,797
Due to related parties 223,399 149,548
Other current liabilities 375,960 458,788
------------ ------------
Total current liabilities 1,804,809 992,374
------------ ------------
Shareholders' equity:
Common stock - $0.001 par value, 100,000,000 shares
authorized, 17,147,268 shares issued and outstanding at
December 31, 2005 and June 30, 2006 17,148 17,148
Additional paid-in capital 4,229,845 4,229,845
Retained earnings 8,084,922 8,126,528
Restricted reserves 554,466 554,466
Accumulated other comprehensive income 285,671 336,469
------------ ------------
Total shareholders' equity 13,172,052 13,264,456
------------ ------------
Total liabilities and shareholders' equity $ 14,976,861 $ 14,256,830
============ ============
See accompanying notes to consolidated financial statements.
3
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
Three Months ended June 30 Six Months ended June 30
---------------------------- ----------------------------
2005 2006 2005 2006
------------ ------------ ------------ ------------
Revenues:
Product sales $ 803,693 $ 60,155 $ 1,472,884 $ 410,152
Product sales to related parties 3,748,031 -- 7,808,545 890,744
Information service revenue, net 350,474 310,125 959,689 571,910
Advertising service revenue, net 713,829 95,122 1,172,960 272,281
------------ ------------ ------------ ------------
Total revenues 5,616,027 465,402 11,414,078 2,145,087
Cost of goods sold 815,660 23,067 1,421,548 356,801
Cost of goods sold to related parties 3,613,279 -- 7,577,184 777,884
Cost of information service 158,511 302,144 329,189 491,463
Cost of advertising service 25,399 33,727 48,218 73,783
------------ ------------ ------------ ------------
4,612,849 358,938 9,376,139 1,699,931
Gross profit 1,003,178 106,464 2,037,939 445,156
Operating expenses:
Sales and marketing 51,736 67,610 95,025 94,577
General and administrative 210,328 67,306 402,367 274,920
------------ ------------ ------------ ------------
Total operating expenses 262,064 134,916 497,392 369,497
------------ ------------ ------------ ------------
Income (loss) from operations 741,114 (28,452) 1,540,547 75,659
Other revenue 127 -- 127 204
Interest income (expense) (4,130) 871 (3,665) 986
------------ ------------ ------------ ------------
Income (loss) before income taxes 737,111 (27,581) 1,537,009 76,849
Income tax provision (benefit) 135,570 (1,053) 269,060 35,243
------------ ------------ ------------ ------------
Net income (loss) $ 601,541 $ (26,528) $ 1,267,949 $ 41,606
============ ============ ============ ============
Other comprehensive income :
Foreign currency translation adjustment $ (2) $ 12,803 $ (4) $ 50,798
Comprehensive income (loss) $ 601,539 $ (13,275) $ 1,267,945 $ 92,404
============ ============ ============ ============
Basic and diluted earnings per share $ 0.04 $ (0.00) $ 0.07 $ 0.00
Weighted average common shares outstanding 17,018,692 17,147,268 17,018,692 17,147,268
See accompanying notes to consolidated financial statements.
4
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months ended June 30,
--------------------------
2005 2006
----------- -----------
Cash flows from operating activities:
Net income $ 1,267,949 $ 41,606
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 121,692 96,230
Bad debt recoveries (25,217) (40,085)
Loss on disposal of property and equipment -- 475
Deferred tax assets 18,117 10,313
Changes in assets and liabilities:
Accounts receivable 1,475,139 801,717
Inventories (481,146) 19,265
Due from related parties (1,234,218) (50,531)
Advances and deposits to suppliers (3,050,882) (16,689)
Accounts payable 640,916 (595,876)
Advance from customer -- 55
Deferred revenue (599,570) (12,848)
VAT payable (217,640) (89,954)
Income tax payable (3,784) (122,789)
Due to related parties (100,260) (73,851)
Other current liabilities (15,395) 82,828
----------- -----------
Net cash flows provided by (used in) operating activities (2,204,299) 49,866
Cash flows from investing activities:
Purchase of property and equipment (231,902) --
Proceeds on disposal of property and equipment -- 953
Repayment from (Loan to) related parties 2,580,104 (1,877,417)
----------- -----------
Net cash flows provided by (used in) investing activities 2,348,202 (1,876,464)
----------- -----------
Cash flows from financing activities:
Escrow receivable 1,500,000 --
----------- -----------
Net cash flows provided by financing activities 1,500,000 --
----------- -----------
Foreign currency translation adjustment (4) 41,410
----------- -----------
Net increase (decrease) in cash and cash equivalents 1,643,899 (1,785,188)
Cash and cash equivalents, beginning of the period 75,511 3,578,367
----------- -----------
Cash and cash equivalents, end of the period $ 1,719,410 $ 1,793,179
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ -- $ --
Income taxes $ 254,728 $ 156,911
See accompanying notes to consolidated financial statements.
5
CHINA DIGITAL WIRELESS INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - ORGANIZATION AND BUSINESS BACKGROUND
China Digital Wireless, Inc. ("CDW") through its subsidiary sells mobile phones
to retailers, distributors, and related parties, provides advertising services
and provides information services to users of mobile phones and pagers.
Substantially all operations are conducted in Shanghai, People's Republic of
China ("PRC").
In order to meet ownership requirements under Chinese law that restrict a
foreign company from operating in certain industries such as value-added
telecommunication, advertising service and internet services, CDW's subsidiary
has entered into information service and cooperation agreements with two of
CDW's affiliates that are incorporated in China: Shanghai Sifang Information
Technology Co. ("Sifang Information") and Shanghai Tianci Industry Co. Ltd
("Tianci Industry"). CDW holds no ownership interest in Sifang Information or
Tianci Industry. Sifang Information and Tianci Industry contract with China
Mobile Communications Corporation ("China Mobile"), and China United
Telecommunications Corporation ("China Unicom"), to provide wireless value-added
information services to wireless receiver customers in China via China Mobile
and China Unicom. Sifang Information transmits those services to customers of
China Mobile and China Unicom on behalf of itself and Tianci Industry pursuant
to a signed agreement between Sifang Information and Tianci Industry.
Business History
CDW's business is primarily conducted through its wholly-owned subsidiary Sifang
Holdings and Sifang Holdings' wholly-owned subsidiary TCH Data Technology Co.,
Ltd. ("TCH"), that collectively with CDW are referred to as the "Company".
Sifang Holdings was established under the laws of the Cayman Islands on February
9, 2004 for the purpose of holding a 100% equity interest in TCH. TCH was
established as a foreign investment enterprise in Shanghai under the laws of the
PRC on May 25, 2004, with registered capital of $7.2 million.
CDW's current operations were originally a business division of Sifang
Information. Sifang Information is a Shanghai-based privately owned enterprise
established under the laws of the PRC on August 14, 1998. Sifang Information is
engaged in the business of pager and mobile phone distribution and provides
value added information services to the customers in the Shanghai metropolitan
area. In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information services business to
TCH. As the acquiring entity under common control, TCH initially recognized all
the assets and liabilities transferred at their carrying amounts in the accounts
of Sifang Information at the date of transfer under the guidance of Statements
of Financial Accounting Standards ("SFAS") No. 141, Appendix D.
On May 26, 2004, Sifang Information exchanged 100% of its equity interest in TCH
for a 100% equity interest in Sifang Holdings. Since the ultimate owners of the
three entities were the same owners and the three entities remained under common
control, the ownership exchange transaction was accounted for at historical
costs under the guidance of SFAS No. 141, Appendix D. Prior to May 26, 2004,
Sifang Holdings conducted no business activities. As a result of the exchange of
ownership between TCH and Sifang Holdings, TCH's historical financial statements
became the historical financial statements of Sifang Holdings.
As a result of the spin-off, the Company now engages in the business of mobile
phone distribution and provides pager and mobile phone users with access to
certain value-added information reformatted by TCH. TCH purchases mobile phones
from first tier distributors and sells them to retailers and distributors with a
mark-up. In the process of providing value-added information services through
entering into monthly subscription agreements with various users, TCH purchases
trading activity information from stock exchanges, comments and analysis on PRC
stock markets provided by certain reputable security and investment companies,
lottery information, weather forecast, and other value-added products and
reformats the aforementioned information through decoding and recoding and then
has the reformatted information transmitted by Sifang Information, via service
contracts, to pager users. The value-added information is constantly saved on
TCH's server in order for mobile phone users to dial in via China Mobile or
China Unicom. By signing a monthly subscription agreement, wireless receiver
users agree to make advance payments for its services for either three or
six-month subscription periods.
6
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("U.S. GAAP") for interim financial information and the instructions to
Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include
all of the information and footnotes required by U.S. GAAP for a complete
presentation of financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the Company's financial condition and results of operations
for the interim periods presented in this Form 10-QSB have been included.
Operating results for the interim periods are not necessarily indicative of
financial results for the full year. These unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of CDW, its
wholly-owned subsidiary, Sifang Holdings, and its wholly-owned subsidiary, TCH.
Substantially all of CDW's revenues are derived from the operations of TCH,
which represents substantially all of CDW's consolidated assets and liabilities
as of June 30, 2006. All significant intercompany accounts and transactions have
been eliminated.
Foreign Currency Translations and Transactions
The Renminbi ("RMB"), the national currency of the PRC, is the primary currency
of the economic environment in which the operations of the Company are
conducted. The Company uses the United States dollar ("U.S. dollars") for
financial reporting purposes.
The Company translates its financial statements into U.S. dollars in accordance
with SFAS No. 52, "Foreign Currency Translation." All asset and liability
accounts have been translated using the exchange rate prevailing at the balance
sheet date (at June 30, 2006, the prevailing exchange rate of the U.S. dollar
against the RMB was 8.0001), and the statement of income is translated at the
average rate during the reporting period (the average rate of the U.S. dollar
against the RMB during the quarter ended June 30, 2006 was 8.0123). Equity items
are translated at historical rates. Adjustments resulting from the translation
of the Company's financial statements from RMB into U.S. dollars are recorded in
shareholders' equity as part of accumulated other comprehensive income. Gains or
losses resulting from transactions in currencies other than RMB are reflected in
the statement of income for the reporting periods.
Revenue Recognition
The Company derives revenues from the sale of mobile phones, advertisement
designing service and the provision of wireless information services that are
used on mobile phones, pagers and prepaid phone cards. The Company additionally
earns commission income ("Agency Income") from the sale of CDMA mobile phones on
the behalf of a related party. The Company recognizes its revenues net of
related business taxes and value-added taxes.
Mobile Phone Sales:
Revenues generated from the sale of mobile phones are recognized when the
products are shipped to the distributor or retailer and when persuasive evidence
of an arrangement exists, delivery of the products has occurred, customer
acceptance has been obtained, which means the significant risks and rewards of
ownership have been transferred to the customer, the price is fixed or
determinable and collectibility is reasonably assured.
Advertising Servicing Revenue, Net:
Advertising revenues are derived from advertisement designing, masterminding and
producing services. The Company recognizes service revenues over the term of the
noted agreement at the time of completion of the services. The Company records
the revenue from Shanghai Sifang Media Co., Ltd. ("Sifang Media") on a net basis
7
in compliance with EITF 99-19, "Reporting Revenue Gross as a Principle versus
Net as an Agent" because the Company is not the primary obligor in the
arrangement and they receive a fixed fee from Shanghai Sifang Media Co., Ltd.
and they have no latitude in determining prices.
Information Services:
The Company recognizes service revenues over the term of the noted agreement
and/or when the services have been provided to the end user.
i) Information Services - TCH:
By signing a subscription agreement, wireless receiver users agree to make
payments for three to six-month subscriptions in advance. TCH records the
proceeds as deferred revenue and amortizes the deferred revenue over the
subscription period. When customers buy a pre-charged service card, the Company
records the proceeds as deferred revenue. When a customer starts to use this
card to access the Company's server and starts to use a pager to access the
aforementioned information, the Company identifies the subscription period and
amortizes the deferred revenue over the subscription period.
ii) Information Services - Installing Agent:
In response to a retailer's request, the Company has an installing agent who
installs the Company's software on mobile phones, which are owned by the
retailer. The retailer sells these phones for a premium covering a fee to be
paid to the installing agent and pre-charged six-month subscription fees to be
paid to the Company. After a customer using such a phone dials into the server
to access the desired information, the server records a unique identification
number installed on the mobile phone, which indicates that a specific phone user
starts his or her subscription period. After the Company receives a detailed
list from the installing agent regarding the number of phones that have been
installed with the Company's software, the Company matches this information with
a detailed list from the retailer setting forth how many such phones have been
sold. Based on the number of such phones sold, the Company records accounts
receivable and deferred revenue correspondingly. At the date on which a customer
starts to dial into the server, the six-month subscription period begins and the
Company amortizes deferred revenue accordingly.
iii) Information Services - China Mobile and/or Unicom:
The Company's affiliates, Sifang Information and Shanghai Tianci Industrial
Group Co., Ltd. ("Tianci Group"), contract with China Mobile and/or China Unicom
(collectively, "Mobile Operators") for the transmission of the Company's
value-added information services. The Mobile Operators bill and collect from
customers and then pass those fees (net of billing and collection service fees
charged by the Mobile Operators) to Sifang Information and Tianci Group who in
turn pass those fees to the Company. The Company recognizes net revenues based
on the total amount paid by its customers, for which the Mobile Operators bill
and collect on behalf of the Company. There is a time lag ranging from 10 days
to 45 days between the end of the service period and the date the Mobile
Operators send out their billing statements due to the segregated billing
systems of each of the provincial subsidiaries of the Mobile Operators. The
Company has not recognized service revenue based on the records provided by its
own server but has performed a reconciliation on a monthly basis of the revenues
recognized by the Company's server to the Mobile Operator's billing statement.
In addition, the Mobile Operators charge a network usage fee based on a fixed
per message fee multiplied by the excess of messages sent over messages
received. (This type of service is not covered by a monthly service subscription
and the Company has no control over whether it will occur or not.) Network usage
fees charged by the Mobile Operators are reduced for messages received by the
Company because the Mobile Operators separately charge the sender a fee for
these transmissions.
The Company records the revenue from the Mobile Operators on a net basis in
compliance with EITF 99-19, "Reporting Revenues Gross as a Principle versus Net
as an Agent" because the Company:
o Is not the primary obligor in the arrangement, as it relies on
Sifang Information to transmit the information services to the
end user,
o Has limited ability to adjust the cost of services by
adjusting the design or marketing of the service,
8
o Has limited ability to determine prices, the Company must
follow the price policy within ranges prescribed by Mobile
Operators, and
o Has limited ability to assume risk of non-payment by
customers.
The Company's dependence on the substance and timing of the billing systems of
the mobile telecommunications operators may require the Company to estimate
portions of its reported revenue for information services from time to time. As
a result, subsequent adjustments may be made to the information service revenue
in the Company's consolidated financial statements. As the Company does not bill
its information services users directly, the Company depends on the billing
systems and records of the mobile telecommunications operators to record the
volume of its information services provided, to charge its users through mobile
telephone bills, to collect payments from its users, and to pay the Company.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less to be cash equivalents. The Company maintains its cash accounts
at credit worthy financial institutions.
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to
retailers and distributors who are mainly located in the Shanghai metropolitan
area. Typically, for mobile phone distributors, credit terms require payment to
be made within 30 days of the sale. The Company does not require collateral from
its customers. The Company's policy is to provide for an allowance for doubtful
accounts that is based on 5% of total trade accounts receivable less amounts due
from related parties and from the installing agent. Total trade accounts
receivable due from related parties was nil as of December 31, 2005 and June 30,
2006.
The Company regularly evaluates and monitors the creditworthiness of each
customer on a case-by-case basis. The Company includes any account balances that
are determined to be uncollectible in the overall allowance for doubtful
accounts. After all attempts to collect a receivable have failed, the receivable
is written off against the allowance. The Company believes that its allowance
for doubtful accounts was adequate as of June 30, 2005 and 2006. However, actual
write-offs may exceed the recorded allowance.
The following table presents activities in the allowance for doubtful accounts:
December 31, June 30,
2005 2006
------------ ------------
(Unaudited)
Beginning balance $ 47,922 $ 44,472
Additions charged to expense -- --
Recovered (3,450) (40,085)
Actual write off -- --
------------ ------------
Ending balance $ 44,472 $ 4,387
============ ============
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 by submitting the necessary application forms. In general, once the
vendor approves the applications, the amounts of these rebates and credits will
be deducted from the Company's accounts payable to its vendor and decrease the
cost of goods sold or inventory held correspondingly.
9
Capitalization of Software Costs
The Company's software is developed by an independent third party to enable
pager users to accept certain recoded information which is transmitted by the
Company, through affiliates, and enables mobile phone users to dial into the
Company's server. The software is developed for internal use and gives the
Company the ability to provide value added information services. In accordance
with SOP 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," the Company capitalizes the external cost incurred
to develop this internal-use software by an engineering company at the
application development stage and amortizes that cost over the estimated
economic life of the software (two or three years) which is consistent with the
expected life of a particular type of mobile phone.
Property and equipment
Property and equipment are recorded at cost and are stated net of accumulated
depreciation. Depreciation expense is determined using the straight-line method
over the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
Maintenance and repairs are charged directly to expense as incurred, whereas
betterment and renewals are generally capitalized in their respective property
accounts. When an item is retired or otherwise disposed of, the cost and
applicable accumulated depreciation are removed and the resulting gain or loss
is recognized and reflected as an item before operating income.
Impairment of Long-Lived Assets
The Company applies the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", issued by the Financial Accounting
Standards Board ("FASB"). SFAS No. 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets. Whenever any such impairment exists, an impairment
loss will be recognized for the amount by which the carrying value exceeds the
fair value. There was no impairment of long-lived assets during the year ended
December 31, 2005 and six months ended June 30, 2006.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, advances
and deposits to supplier, accounts payable and other current liabilities are
reasonable estimates of their fair value because of the short maturity of these
items.
Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payment". SFAS No. 123R requires companies to estimate the fair
value of share-based payment awards on the date of grant using an option-pricing
model. The value of the portion of the award that is ultimately expected to vest
is recognized as expense ratably over the requisite service periods. Currently,
the Company does not have a stock option plan.
Value Added Tax
TCH is subject to value added tax ("VAT") imposed by the PRC on TCH's domestic
product sales. The output VAT is charged to customers who purchase mobile phones
from TCH and the input VAT is paid when TCH purchases mobile phones from its
vendors. The VAT rate applied for TCH is 17%. The input VAT can be offset
against the output VAT.
10
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires an entity to recognize
deferred tax liabilities and assets. Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the difference between
the tax bases of assets and liabilities and their reported amounts in the
financial statements. Deferred tax assets and liabilities are measured using the
enacted tax rate expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The Company establishes a
valuation when it is more likely than not that that the assets will not be
recovered.
The Company's Chinese subsidiary, TCH, is registered at Pudong District in
Shanghai and subject to a favorable income tax rate of 15% compared to a normal
income tax rate of 33% (30% for the central government and 3% for the local
government) under current PRC tax laws. Sifang Information is registered in the
Shanghai downtown and the area has been treated by the Shanghai Municipal
Administration of Labor as an enterprise that provides unemployed and
handicapped people with jobs. Accordingly, Sifang Information is entitled to a
favorable income tax rate of 15% and qualified for an income tax exemption for
three years from January 1, 2000 to December 31, 2002, and a 50% income tax
reduction for three years from January 1, 2003 to December 31, 2005. The income
tax provisions presented in the Company's consolidated financial statements for
the six months ended June 30, 2005 and 2006 are based on 15%. The deferred tax
assets are determined based on the historical income tax rates applicable at the
TCH level.
There is no income tax for companies domiciled in the Cayman Islands.
Accordingly, the Company's consolidated financial statements do not present any
income tax provisions related to Cayman Islands tax jurisdiction.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S.
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ materially from those estimates.
Comprehensive Income
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", issued by
the FASB. SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company has chosen to report comprehensive income in
the statements of income and comprehensive income. Comprehensive income is
comprised of net income and all changes to shareholders' equity except those due
to investments by shareholders and distributions to shareholders.
Earnings Per Share
The Company computes earnings per share in accordance with the SFAS No. 128,
"Earnings per Share". Basic earnings per share includes no dilution and is
computed by dividing net income available to common shareholders by the weighted
average number of shares outstanding during the period. Diluted earnings per
share reflect the potential dilution of securities that could share in the
earnings of an entity if they were converted. The Company did not have any
potentially dilutive common share equivalents as of June 30, 2005 or 2006.
Reclassifications
Certain amounts included in the prior period's consolidated financial statements
have been reclassified to conform to the current period presentation. Such
reclassifications did not have any effect on reported net income and are
immaterial to the consolidated financial statements as a whole.
11
NOTE 3 - EQUITY TRANSACTIONS
On August 9, 2005, the Company announced its intent to apply for listing on the
American Stock Exchange ("AMEX"). In connection with the AMEX application,
certain persons who held more than 200,000 shares of the Company's common stock
entered into lockup agreements with the Company, agreeing to not offer, sell,
assign or otherwise transfer a portion of their shares or other equity
securities of the Company without prior written consent of the Company until the
earlier of (i) 180 days after the date of the lockup agreements or (ii) the date
that AMEX has approved the Company's listing application. The lockup agreements
became effective on September 21, 2005, and were executed by ten of the
Company's officers and directors and three additional shareholders. Under the
lockup agreements with the non-officer/director shareholders, the Company issued
an aggregate of 128,576 shares of common stock in consideration thereof.
NOTE 4 - RELATED PARTY TRANSACTIONS
Related Party Relationships
The following related parties are related through common ownership with the
major shareholders of the Company:
Shanghai Sifang Information Technology Co. ("Sifang Information")
Shanghai Tianci Industry Co. Ltd. ("Tianci Industry")
Shanghai Tianci Industry Group Co. Ltd. ("Tianci Group")
Shanghai Shantian Telecommunication Co. Ltd. ("Shantian")
Shanghai Sifang Telecommunication Co. Ltd. ("Sifang Telecom")
Shanghai Tianci Real Estate Co. Ltd. ("Tianci Real Estate")
Shanghai Sifang Media Co., Ltd. ("Sifang Media")
Shanghai Kena Energy Saving Co., Ltd. ("Kena")
Merchandise Sold to Related Parties
Three months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Shantian $ 3,748,031 $ --
============ ============
During the three months ended June 30, 2006, TCH did not sell any Samsung GSM
mobile phones to Shantian, compared to the sales of $3,748,031 at a gross profit
margin of 3.6% or $134,752 for the same period of the prior year.
Six months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Shantian $ 7,808,545 $ 890,744
============ ============
During the six months ended June 30, 2006, TCH sold Samsung GSM mobile phones
valued at $890,744 at a gross profit margin of 12.7% or $112,860 to Shantian,
compared to $7,808,545 at a gross profit margin of 3.0% or $231,361 for the same
period of the prior year. Accounts receivable includes nil and nil due from
Shantian, as of December 31, 2005 and June 30, 2006, respectively.
Advertising Services Rendered to Related Party
Three months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Tianci Real Estate $ 713,559 $ 95,122
============ ============
12
Six months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Tianci Real Estate $ 1,172,960 $ 272,281
============ ============
In January 2005, Sifang Media and TCH entered into the "Bank Digital TV's
Cooperation Agreement", where TCH will assist in the promotion of TV ads for
various customers, including Tianci Real Estate. TCH received a fee of $272,281
for providing the service during the six months ended June 30, 2006, compared to
$1,172,960 for the same period of the prior year. TCH received a fee of $95,122
for providing the service during the three months ended June 30, 2006, compared
to $713,559 for the same period of the prior year. There was an "Advertisement
Agency Contract" between Tianci Real Estate and Sifang Media, which terminated
in November 2005.
Service Provided by Related Party
Three months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Sifang Information $ 108,052 $ 126,435
============ ============
In accordance with terms contained in signed service agreements between TCH and
Sifang Information giving TCH the right to use Sifang Information's facility
(which may not be owned by foreign investors at the present time) to transmit
the reformatted information, the Company paid service fees of $90,618 and
$93,679 for the three months ended June 30, 2005 and 2006, respectively. The
service agreements are in effect for ten years and became effective on June 1,
2004.
During the three months ended June 30, 2006, Sifang Information also provided
other management support and marketing services to TCH for $32,756, compared to
$17,434 for the three months ended June 30, 2005.
Six months Ended June 30,
2005 2006
------------ ------------
(Unaudited) (Unaudited)
Sifang Information $ 229,608 $ 233,745
============ ============
In accordance with terms contained in signed service agreements between TCH and
Sifang Information giving TCH the right to use Sifang Information's facility
(which may not be owned by foreign investors at the present time) to transmit
the reformatted information, the Company paid service fees of $181,236 and
$186,921 for the six months ended June 30, 2005 and 2006, respectively. During
the six months ended June 30, 2006, Sifang Information also provided other
management support and marketing services to TCH for $46,824, compared to
$48,372 for the six months ended June 30, 2005.
Due from Related Parties
December 31, 2005 June 30, 2006
----------------- -----------------
(unaudited)
Sifang Information $ 2,165,624 $ 4,026,930
Sifang Media 929,345 958,488
Kena -- 37,499
----------------- -----------------
$ 3,094,969 $ 5,022,917
================= =================
In order to develop the Company's mobile phone distribution business, the
Company applied to become a distributor of Nokia mobile phones (on the
provincial level). On March 20, 2005, TCH signed an agreement with Sifang
13
Information with respect to the distribution of Nokia mobile phones and under
which TCH will act as an agent to sell Nokia phones on Sifang Information's
behalf. In May 2005, Sifang Information obtained the final approval from Nokia.
In order to develop the Company's advertising service business, in January 2006,
the Company entered into an agreement with Sifang Information for the
establishment of a new joint cooperation entity with a third party. The joint
cooperation entity will act as the sole advertising agent of TCH. On January 10,
2006, the Company advanced RMB 20,000,000 (equivalent to $2,499,969) to Sifang
Information to contribute to the joint cooperation entity. The remaining
outstanding advances of $1,526,961 to Sifang Information were for the mobile
phone and information services businesses. These advances will be repaid by
December 31, 2006 through Sifang Information's source of income.
As of June 30, 2006, Sifang Media has collected $1,027,162 from TCH's
advertising customers on its behalf and paid $68,674 to TCH. The amount of
$37,499 is owed to the Company by Kena because of certain operating expenses
paid by the Company on behalf of Kena.
Deposit for Business Acquisition
In December 2005, TCH entered into a series of agreements to purchase (i) 95% of
the equity interests of Shanghai Kena Energy Saving Electric Co Ltd ("Kena") for
an aggregate purchase price of RMB 28,500,000 (approximately $3,532,000); (ii) a
related patent from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000); and (iii) related rights to make a patent
application from one of the shareholders of Kena for RMB 11,000,000
(approximately $1,363,000). The purchase price for both the equity interests in
Kena and the consideration for purchase of the patent and the right to apply for
registration of the patent shall be paid by Sifang Information on behalf of TCH.
On February 10, 2006, these agreements were amended to impose an additional
condition on Mr. Zhang Naiyao, the transferor of the patent and holder of the
right to make the patent application, that if he fails to provide the necessary
technical assistance services to enable TCH to use the patented technology in
producing products on a large scale that meet the standards set by the Company
within one year, TCH shall have the right to demand the return of the relevant
payment received by him in full and to terminate the agreement for the
assignment of the patent and the right to apply for registration of the patent.
The amendments also set forth the arrangement for payment of the purchase price
between TCH and Sifang Information. The purchase price for both the equity
interests in Kena and the consideration for purchase of the patent and the right
to apply for registration of the patent shall be paid by Sifang Information on
behalf of TCH. According to the amended agreements, the amount of the purchase
consideration paid by Sifang Information on behalf of TCH will be applied to
offset the trade and other receivables owed to TCH by Sifang Information.
Kena was established on April 26, 2005 and it specializes in the research,
development and manufacture of energy-saving products, as well as illumination
projects in China. The patent and patent application mentioned above relate to a
"three phase transformer" which is used in connection with a power supply system
and utilizes technology that allows manufacturers to produce transformers with
high energy transfer efficiency at a low costs. This technology is expected to
be available for mass production within one year.
The transactions are subject to regulatory approval by the PRC.
Due to Related Parties
December 31, 2005 June 30, 2006
----------------- -----------------
(unaudited)
Tianci Real Estate $ 123,467 $ 149,548
Shantian 99,932 --
----------------- -----------------
$ 223,399 $ 149,548
================= =================
The balance owed to Tianci Real Estate represented rental payments since 2004
and the expenses paid by Tianci Real Estate on behalf of the Company during the
six months ended June 30, 2006 and the year ended December 31, 2005,
14
respectively. The balance owed to Shantian represents the advances received from
Shantian for mobile phone sales. All of the above amounts due to related parties
are unsecured, non-interest bearing and due on demand.
NOTE 5 - SEGMENT REPORTING
The Company currently operates in four principal business segments. Management
believes that the following table presents all relevant information to the chief
operation decision makers for measuring business performance and financing needs
and preparing the corporate budget, etc. As most of the Company's customers are
located in the Shanghai metropolitan area and the Company's revenues are
generated in Shanghai, the PRC, no geographical segment information is
presented.
Advertising
Service Mobile Phone Beep Pagers
Revenue Phone Sales Service Service Corporate Total
------------ ------------ ------------ ------------ ------------ ------------
Three months ended
June 30, 2005
Revenues $ 713,829 $ 4,551,724 $ 218,996 $ 131,478 $ -- $ 5,616,027
Gross profit 688,430 122,785 107,057 84,906 -- 1,003,178
Depreciation -- -- 39,694 -- 14,314 54,008
Interest income, net -- -- -- -- (4,130) (4,130)
Net income (loss) 525,859 68,654 54,548 58,731 (106,251) 601,541
Expenditures for long-lived
assets 157,264 -- 24,186 -- -- 181,450
Three months ended
June 30, 2006
Revenues $ 95,122 $ 60,155 $ 126,493 $ 183,632 $ -- $ 465,402
Gross profit (loss) 61,395 37,088 (108,445) 116,426 -- 106,464
Depreciation -- -- 38,347 -- 9,587 47,934
Interest income, net -- -- -- -- 871 871
Net income (loss) 5,204 (7,069) (72,616) 43,268 4,685 (26,528)
Expenditures for long-lived
assets -- -- -- -- -- --
Six months ended
June 30, 2005
Revenue $ 1,172,960 $ 9,281,429 $ 620,606 $ 339,083 $ -- $ 11,414,078
Gross profit 1,124,742 282,697 405,470 225,030 -- 2,037,939
Depreciation -- -- 93,065 -- 28,627 121,692
Interest income -- -- -- -- (3,665) (3,665)
Net income (loss) 889,357 144,423 267,725 147,319 (180,875) 1,267,949
Expenditures for long-lived
assets 157,264 -- 74,638 -- -- 231,902
Total Assets, as of
June 30, 2005 157,264 6,665,011 297,021 -- 6,519,686 13,638,982
15
Six months ended
June 30, 2006
Revenue $ 272,281 $ 1,300,896 $ 259,050 $ 312,860 $ -- $ 2,145,087
Gross profit (loss) 198,498 166,211 (98,603) 179,050 -- 445,156
Depreciation -- -- 76,984 -- 19,246 96,230
Interest (expense) -- -- -- -- 986 986
Net income (loss) 78,606 61,126 (82,244) 68,077 (83,959) 41,606
Expenditures for long-lived
assets -- -- -- -- -- --
Total Assets, as of
June 30, 2006 -- 149,631 140,274 -- 13,966,925 14,256,830
NOTE 6 - EMPLOYEE WELFARE AND RETIREMENT BENEFITS
The PRC has been undergoing significant reforms with regard to its employee
welfare and fringe benefits administration. Any enterprise operating in the PRC
is subject to government-mandated employee welfare and retirement benefit
contribution. In accordance with PRC laws and regulations, TCH participates in a
multi-employer defined contribution plan pursuant to which TCH is required to
provide employees with certain retirement, medical and other fringe benefits.
PRC regulations require TCH to pay the local labor administration bureau a
monthly contribution at a stated contribution rate based on the monthly basic
compensation of qualified employees. The local labor administration bureau,
which manages various investment funds, will take care of employee retirement,
medical and other fringe benefits. TCH has no further commitments beyond its
monthly contribution. TCH contributed a total of $26,259 and $26,664 to these
funds as part of selling, general and administrative expenses for the six months
ended June 30, 2005 and 2006, respectively.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments--an amendment of FASB Statements No. 133 and 140," to
permit fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation in
accordance with the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 155 is effective for all financial
instruments acquired, issued, or subject to a remeasurement event occurring
after the beginning of an entity's fiscal year that begins after September 15,
2006. We will adopt SFAS No. 155 in fiscal year beginning January 1, 2007. The
adoption of this Statement is not expected to have a material effect on our
consolidated financial statements.
In March 2006, FASB issued SFAS No. 156, "Accounting for Servicing of Financial
Assets--an amendment of FASB Statement No. 140," that provides guidance on
accounting for separately recognized servicing assets and servicing liabilities.
In accordance with the provisions of SFAS No. 156, separately recognized
servicing assets and servicing liabilities must be initially measured at fair
value, if applicable. Subsequent to initial recognition, the company may use
either the amortization method or the fair value measurement method to account
for servicing assets and servicing liabilities within the scope of this
Statement. SFAS No. 156 is effective as of the beginning of an entity's fiscal
year that begins after September 15, 2006. The Company will adopt SFAS No. 156
in fiscal year beginning January 1, 2007. The adoption of this Statement is not
expected to have a material effect on our consolidated financial statements.
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)", that will become effective beginning July 2006. FSP FIN No. 46(R)-6
clarifies that the variability to be considered in applying Interpretation 46(R)
shall be based on an analysis of the design of the variable interest entity. The
adoption of this FSP is not expected to have a material effect on our
consolidated financial statements.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This report contains certain forward-looking statements that involve
risks and uncertainties. These statements relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "could," "expect," "plan,"
"intend," "anticipate," "believe," "estimate," "predict," "potential," or
"continue," or the negative of such terms or other comparable terminology. These
statements are only predictions and are subject to certain risks, 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.
The following discussion should be read in conjunction with our
consolidated financial statements and the notes thereto and the other financial
information appearing elsewhere in this document. 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 of this report.
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.
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.
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 the PRC.
TCH engages in the business of mobile phone distribution and provides
access to certain information reformatted by TCH to pager and mobile phone
(collectively "wireless receiver") users. TCH purchases mobile phones from the
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.
In 2005, we launched a digital media project to move into the media
market in China in 2005. In conjunction with charitable organizations, we have
installed donation boxes with digital TV incorporated on top of them in the main
lobbies of commercial banks, hotels, malls and other public locations to call
the public's attention to the charity and to broadcast commercial
advertisements.
17
Discussion and Analysis of Operating Results
Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005
Revenue
Total Revenues
Total sales revenues consist of product sales, product sales to related
parties, and net information and advertising service revenue. Total sales
revenues for the six months ended June 30, 2006 decreased by $9,268,991,
representing a 81.2% decrease, to $2,145,087 as compared to $11,414,078 for the
same period of the prior year. The decrease was mainly due to the significant
decline of the advertising service revenue and mobile phone sales. The demand
for mobile phones in the Chinese telecommunication market is decreasing as the
market gradually becomes saturated.
In the six months ended June 30, 2006, Samsung and Nokia's mobile
phones accounted for about 76.5% and 23.5% of our total product sales,
respectively, compared to the same period of the prior year, in which Samsung's
mobile phones accounted for 97% of our total product sales and other brands
accounted for the balance. During 2006, market competition for mobile phone
sales continued to intensify, causing us to reposition ourselves in the
marketplace and move away from the low-margin sales. The increase of our overall
mark-up ratio to 12.8%, in comparison with a mark-up ratio of 3.0% for the same
period of the prior year, primarily resulted from the exceptionally high mark-up
for the sales of mobile phone to customers, including a related party during the
period
Product Sales
Revenue for product sales in the six months ended June 30, 2006
decreased by $1,062,732, representing a 72.2% decrease, to $410,152 as compared
to $1,472,884 for the same period of the prior year. The decrease was mainly due
to the market factors described above. We reduced the effort and cost of
generating sales from such business throughout the period.
We entered an agreement to distribute selected Nokia mobile phones
exclusively in the Shanghai region of China in May 2005 and now have obtained
the right to distribute two popular models of Nokia's mobile phones. Initially,
management believed that this agreement would enhance both our market share and
profitability. The initial margin of Nokia was as high as 8% in mid 2005;
however, as a result of the sudden change in the market factors during the
latter half of 2005, the sales mark-up of the Nokia mobile phones to our
customers dropped significantly to 1% during the 4th quarter of 2005. Although
the mark-up for Nokia phones reached the exceptional level of 29.9% during the
1st half of 2006, the quantity of mobile phones sold dropped significantly due
to the loss of market share and the Company's management has decided to
discontinue its mobile phone distribution business in the second half of 2006 as
the market situation has remained soft.
Product sales to a related party
We distributed Samsung mobile phones to our related party, Shantian,
(in which Sifang Information holds a 51% equity interest) for its retail market
channel and facility. During the six months ended June 30, 2006, we sold
$890,744 worth of mobile phones to Shantian, with an average mark-up of
approximately 12.7%, (compared to $7,808,545 at a gross profit margin of 3.0% in
2005), which represents a $6,917,801 or 88.6% decrease compared to the same
period of the prior year. The decrease in sales was attributable to the market
factors mentioned above. However, due to the urgent demand of a specific model
of Samsung mobile phones from Shantian in first quarter of 2006, we were able to
charge an exceptionally high mark-up during the period, which mark-up did not
continue in the second quarter.
18
Information service revenue, net
Total information service revenue net of related business tax and
service fee for the six months ended June 30, 2006 decreased by $387,779,
representing a decrease of approximately 40.4%, to $571,910 compared to $959,689
for the same period of the prior year.
Value-added service revenue from mobile phone users for the six months
ended June 30, 2006 decreased by $361,556 to $259,050 compared to $620,606 for
the same period of the prior year, representing a 58.3% decrease. During the six
months ended June 30, 2006, there was no service revenue from mobile phone users
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 $585,235 decrease
compared to the same period of the prior year. The entire $259,050 of service
revenue in 2006 was generated by our SMS service via China Mobile's network,
representing a material increase of $223,679 compared to $35,371 generated in
the same period of the prior year. The increase was mainly due to the recent
growth of our financial value-added service. The recently reactivated Chinese
stock market along with active stock exchanges assisted our growth in this
segment of business.
In addition, service revenue from pager users for the six months ended
June 30, 2006 decreased by $26,223 to $312,860 compared to $339,083 for the same
period of the prior year, representing a decrease of approximately 7.7%. We
believe that service revenue from pager users will continue to decrease given
the increased popularity of mobile phones over beepers and pagers. We anticipate
that the decrease in service revenue from pager users will likely plateau at a
certain level as most lower income pager users still like to use pagers to
access our information services.
Advertising service revenue, net
We launched a digital media project to enter into the media market in
China in 2005. In conjunction with charitable organizations, we have installed
donation boxes with digital TV incorporated on top of them in the main lobbies
of commercial banks, hotels, malls and other public locations to call the
public's attention to the charity and broadcast commercial advertisements.
We entered into an agreement with China Charity Foundation ("CCF"), a
national non-profit charitable organization, which enables the Company to
install donation boxes for CCF in banks and other commercial locations
throughout China that will also have the Company's out-of-home digital
television advertising media platform attached. The completion of this agreement
enables us to accelerate the placement of out-of-home digital television
platforms, particularly in banks across China. The Company negotiates placement
of the donation boxes and digital television media platform with banks and other
commercial entities that wish to support the national charity. The China Banking
Regulatory Commission ("CBRC") has previously agreed, pending completion of the
agreement with CCF, to support and coordinate this effort with respect to
approvals of donation box placements in banks throughout China.
This agreement facilitates the continued placement of platforms with
little or no direct costs. We believe that such costs may constitute as much as
30% of the direct costs of our competitors based upon an analysis of publicly
available information.
We have placed more than 850 multimedia donation boxes in the inbound
area of Shanghai and other arranged spots will be rolled out in the public
places with high traffic flow. Based on our experience in Shanghai, our strategy
is to expand our network to penetrate other large and mid-sized developed cities
throughout China. We believe the earnings potential from the advertising service
will be a new source of profit in view of the upcoming Special Olympic World
Summer Games in 2007 and World Exposition in 2010 to be held in Shanghai.
In addition, during the six months ended June 30, 2006, TCH generated
$272,281 of service income from advertisement designing and producing services,
which represents a decrease of $900,679 or 76.8%, compared to the service
revenue of $1,172,960 rendered from the advertisement designing and producing
services to Tianci Real Estate, a related party, for publicity and promoting the
use of its apartment for office use during the six months ended June 30, 2005.
19
Cost of goods sold
The cost of goods sold for the six months ended June 30, 2006 decreased
by $7,864,047 to $1,134,685 compared to $8,998,732 for the same period of the
prior year, representing a 87.4% decrease. The decrease was consistent with the
decrease of revenue from product sales.
Cost of service
The cost of service for the six months ended June 30, 2006 increased by
$187,839 to $565,246 compared to $377,407 for the same period of the prior year,
representing a 49.8% increase. The increase was mainly due to the increase of
information fees paid to content providers for the value-added pager service.
The breakdown of our service business has changed and the proportion of pager
services that are related to financial information has increased, resulting in
an increase in associated costs pertaining to the securities information fee
paid. During the six months ended June 30, 2006, we continued to maintain
current fee structures and establish collaborative relationships or partnerships
with Chinese mobile operators and certain information content providers. Most of
the cost of service is fixed costs, and cannot be reduced in response to the
decrease in information service revenue.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for the six months ended June 30, 2006 decreased by
approximately $1,592,783 to $445,156, representing a 78.2% decrease, compared to
gross profit of $2,037,939 for the same period of the prior year. The decrease
in gross profit was primarily attributable to the drop of proceeds generated
from advertising services and phone sales during the six months ended June 30,
2006.
The following table summarizes certain information related to the
various components of revenue.
Information
Advertising Service - Information
Service Mobile Service -
Revenue Phone Sales Phone Pager Total
Six months ended June 30, 2006
Revenue $ 272,281 $ 1,300,896 $ 259,050 $ 312,860 $ 2,145,087
Cost 73,783 1,134,685 357,653 133,810 1,699,931
Gross profit (loss) 198,498 166,211 (98,603) 179,050 445,156
Gross profit (loss) ratio 72.9% 12.8% (38.1)% 57.2% 20.8%
Six months ended June 30, 2005
Revenue $ 1,172,960 $ 9,281,429 $ 620,606 $ 339,083 $11,414,078
Cost 48,218 8,998,732 195,369 133,820 9,376,139
Gross profit 1,124,742 282,697 425,237 205,263 2,037,939
Gross profit ratio 95.9% 3.0% 68.5% 60.5% 17.9%
Sales and marketing expenses
Sales and marketing expenses for the six months ended June 30, 2006
decreased by $448 to $94,577 compared to $95,025 for the same period of the
prior year. The decrease was primarily due to the drop of the management fee
paid for Sifang Information as a result of the declining revenue generated from
information services.
20
General and administrative expenses
General and administrative expenses for the six months ended June 30,
2006 decreased by $127,447 to $274,920 compared to $402,367 for the same period
of the prior year, representing a 31.7% decrease. The decrease was mainly due to
the tightened control of expense incurred in TCH.
General and administrative expenses incurred at the TCH level for the
six months ended June 30, 2006 decreased from $186,648 to $116,699, representing
a 37.5% decrease. The decrease was primarily attributable to the collection of
accounts receivable from our clients, resulting in the recovery of provisions
for bad debts, and enhanced cost control, which led to the decline of office
expenses and professional fees. At the parent level, we incurred an aggregate of
$158,221 of audit fees and other general expenses in the six months ended June
30, 2006, compared to audit fees and service fees for Investor Relations and
Public Relations of $215,719 incurred in the prior year.
Interest income (expense)
During the six months ended June 30, 2006, interest income derived from
bank deposits increased by $1,203 to $2,439, compared to $1,236 for the same
period of the prior year.
During the six months ended June 30, 2006, finance expense incurred in
discounting bank drafts net of interest income from bank deposits decreased by
$3,892 to $1,573, compared to $5,465 for the same period of the prior year.
Income tax
The Company's Chinese subsidiary, TCH, is registered at Pudong District
in Shanghai and is subject to a favorable income tax rate of 15% compared to a
normal income tax rate of 33% (30% for the central government and 3% for the
local government) under current PRC tax laws. The income tax provisions
presented in the Company's consolidated financial statements are based on the
historical actual income tax rates of TCH at 15% for the year ended December 31,
2005. In the six months ended June 30, 2005 and 2006, income tax expense was
$269,060 and $35,243, respectively, based on pretax income of $1,537,009 and
$76,849, respectively.
Comprehensive income
We recorded comprehensive income of $92,404 for the six months ended
June 30, 2006, a $1,175,541 decrease in comprehensive income compared to
comprehensive income of $1,267,945 for the same period of the prior year,
representing a decrease of approximately 92.7%. The decrease in comprehensive
income was attributable to (i) the decrease of revenue contribution from our
advertising business that was initiated in the 2005 fiscal year, and (ii) the
significant declines in revenue from sales of mobile phones and information
services during the period. These factors offset the appreciation of Chinese RMB
to US dollars.
Earnings per share
The earnings per share for the six months ended June 30, 2006 was $0.00
compared to $0.07 for the same period of the prior year. The decrease was due to
the decrease in the net income.
Three Months ended June 30, 2006 Compared to Three Months Ended June 30, 2005
Revenues
Total Revenues
Total sales revenues consist of product sales, product sales to related
parties, and net information and advertising service revenue. Total sales
revenues for the three months ended June 30, 2006 decreased by $5,150,625,
21
representing a 91.7% decrease, to $465,402 as compared to $5,616,027 for the
same period of the prior year. The decrease was mainly due to the significant
decline of the advertising service revenue and mobile phone sales. The demand
for mobile phones in the Chinese telecommunication market is decreasing as the
market gradually becomes saturated.
In the three months ended June 30, 2006, Samsung and Nokia's mobile
phones accounted for about 14.5% and 85.5% of our total product sales,
respectively, compared to the same period of the prior year, in which Samsung's
mobile phones accounted for 98% of our total product sales and other brands
accounted for the balance. During 2006, market competition for mobile phone
sales continued to intensify, causing us to reposition ourselves in the
marketplace and move away from the low-margin sales. The increase of our overall
mark-up ratio to 38.3%, in comparison with a mark-up ratio of 2.7% for the same
period of the prior year, primarily resulted from the exceptionally high mark-up
for the small sales of Nokia mobile phone during the period.
Product Sales
Revenue for product sales in the three months ended June 30, 2006
decreased by $743,538, representing a 92.5% decrease, to $60,155 as compared to
$803,693 for the same period of the prior year. The decrease was mainly due to
the market factors described above. We reduced the effort and cost of generating
sales from such business throughout the period.
We entered an agreement to distribute selected Nokia mobile phones
exclusively in the Shanghai region of China in May 2005 and have obtained the
right to distribute two popular models of Nokia's mobile phones. Initially, we
believed that this agreement would enhance both our market share and
profitability. The initial margin of Nokia was as high as 8% in mid 2005;
however, as a result of the sudden change in the market factors during the
latter half of 2005, the sales mark-up of the Nokia mobile phones to our
customers dropped to 1% during the 4th quarter of 2005. Although the mark-up for
Nokia phones reached the exceptional level of 24.3% during the quarter ended
June 30, 2006, the quantity of mobile phones sold is dropped significantly due
to the loss of market share and the Company's management has decided to
discontinue its mobile phone distribution business in second half of 2006, as
the market situation has remained soft.
Product sales to a related party
We distributed Samsung mobile phones to our related party, Shantian, in
which Sifang Information holds a 51% equity interest, for its retail market
channel and facility. During the three months ended June 30, 2006, we did not
sell any mobile phones to Shantian (compared to $3,748,031 at a gross profit
margin of 3.6% in 2005), which represents a $3,748,031 or 100% decrease compared
to the same period of the prior year. The decrease in sales is also attributable
to the market factors mentioned above.
Information service revenue, net
Total information service revenue net of related business tax and
service fee for the three months ended June 30, 2006 decreased by $40,349,
representing a decrease of approximately 11.5%, to $310,125 compared to $350,474
for the same period of the prior year.
Value-added service revenue from mobile phone users for the three
months ended June 30, 2006 decreased by $92,503 to $126,493 compared to $218,996
for the same period of the prior year, representing a 42.2% decrease. During the
six months ended June 30, 2006, there was no service revenue from mobile phone
users 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 $148,110
decrease compared to the same period of the prior year. The entire $259,050 of
service revenue in 2006 was generated by our SMS service via China Mobile's
network, representing a material increase of $223,679 compared to $35,371
generated in the same period of the prior year. The increase was mainly due to
the recent growth of our financial value-added service. The increase was mainly
due to the recently reactivated Chinese stock market along with active stock
exchanges assisted our growth in this segment of business during this quarter.
22
In addition, service revenue from pager users for the three months
ended June 30, 2006 increased by $52,154 to $183,632 compared to $131,478 for
the same period of the prior year, representing an increase of approximately
39.7%. We believe that the increase of the service revenue from pagers is a
short-term rebound due to the recently reactivated Chinese stock market during
the second quarter of 2006.
Advertising service revenue, net
We launched a digital media project to enter into the media market in
China in 2005 as mentioned above in "Six Months Ended June 30, 2006 Compared to
Six Months Ended June 30, 2005". During the three months ended June 30, 2006,
TCH generated $95,122 of service income from advertisement, designing and
producing services, which represents a decrease of $618,437 or 86.7%, compared
to service revenue of $713,559 from the advertisement designing and producing
services to Tianci Real Estate, a related party, for publicity and promoting its
apartment during the three months ended June 30, 2005.
Cost of goods sold
The cost of goods sold for the three months ended June 30, 2006
decreased by $4,405,872 to $23,067 compared to $4,428,939 for the same period of
the prior year, representing a 99.5% decrease. The decrease was consistent with
the decrease in revenue from product sales.
Cost of service
The cost of service for the three months ended June 30, 2006 increased
by $151,970 to $335,880 compared to $183,910 for the same period of the prior
year, representing a 82.6% increase. The increase was mainly due to the increase
of personnel costs for the value-added mobile phone and pager services. The
breakdown of our service business has changed and the proportion of pager
services that are related to financial information has increased, resulting in
an increase in associated costs pertaining to the securities information fee
paid. During the three months ended June 30, 2006, we continued to maintain
current fee structures and establish collaborative relationships or partnerships
with Chinese mobile operators and certain information content providers. Most of
the cost of service is fixed costs, and cannot be reduced in response to the
decrease in information service revenue.
Gross profit
After taking into account the cost of goods sold and cost of service,
our gross profit for the three months ended June 30, 2006 decreased by $896,714
to $106,464, representing a 89.4% decrease, compared to gross profit of
$1,003,178 for the same period of the prior year. The decrease in gross profit
was primarily attributable to the drop of proceeds generated from advertising
service and phone sales during the three months ended June 30, 2006.
The following table summarizes certain information related to the
various components of revenue.
Information
Advertising Service - Information
Service Mobile Service -
Revenue Phone Sales Phone Pager Total
Three months ended June 30, 2006
Revenue $ 95,122 60,155 $ 126,493 $ 183,632 $ 465,402
Cost 33,727 23,067 234,938 67,206 358,938
Gross profit (loss) 61,395 37,088 (108,445) 116,426 106,464
Gross profit (loss) ratio 64.5% 61.7% (85.7)% 63.4% 22.9%
23
Three months ended June 30, 2005
Revenue $ 713,829 $ 4,551,724 $ 218,996 $ 131,478 $ 5,616,027
Cost 25,399 4,428,939 111,939 46,572 4,612,849
Gross profit 688,430 122,785 107,057 84,906 1,003,178
Gross profit ratio 96.4% 2.7% 48.9% 64.6% 17.9%
Sales and marketing expenses
Sales and marketing expenses for the three months ended June 30, 2006
increased by $15,874 to $67,610 compared to $51,736 for the same period of the
prior year. The increase was primarily due to the increase of the management fee
paid for Sifang Information and salary costs.
General and administrative expenses
General and administrative expenses for the three months ended June 30,
2006 decreased by $143,022 to $67,306 compared to $210,328 for the same period
of the prior year, representing a 68.0% decrease. The decrease was mainly due to
the tightened control of expense incurred in TCH.
General and administrative expenses incurred at the TCH level for the
three months ended June 30, 2006 decreased from $84,647 to $46,750, representing
a 44.8% decrease. The decrease was primarily attributable to the collection of
accounts receivable from our clients, resulting in the recovery of provisions
for bad debts, and enhanced cost control, which led to the decline of office
expenses and professional fees. At the parent level, we incurred an aggregate of
$20,556 of bank charges and audit fees in the three months ended June 30, 2006,
compared to audit fees and service fees for Investor Relations and Public
Relations of $125,681 incurred in the prior year.
Interest income, net
During the three months ended June 30, 2006, the interest income
derived from bank deposits increased by $774 to $1,228, compared to $454 for the
same period of the prior year
During the three months ended June 30, 2006, finance expense incurred
in discounting bank drafts net of interest income from bank deposits increased
by $5,108 to $357, compared to $5,465 for the same period of the prior year.
Income taxes
The Company's Chinese subsidiary, TCH is registered at Pudong District
in Shanghai and is subject to a favorable income tax rate of 15% compared to a
normal income tax rate of 33% (30% for the central government and 3% for the
local government) under current PRC tax laws. The income tax provisions
presented in the Company's consolidated financial statements are based on the
historical actual income tax rates of TCH at 15% for the year ended December 31,
2005. In the three months ended June 30, 2005, income tax expense was $135,570,
based on pretax income of $737,111. In the three months ended June 30, 2006, the
income tax benefit was $1,053, whereas the loss before income taxes was $28,452.
Comprehensive income
We recorded comprehensive loss of $13,275 for the three months ended
June 30, 2006, a $614,814 decrease in comprehensive income compared to
comprehensive income of $601,539 for the same period of the prior year,
representing a decrease of approximately 102.2%. The decrease in comprehensive
income was attributable to (i) the decrease of revenue contribution from our
advertising business that was newly initiated in the 2005 fiscal year, and (ii)
significant declines in revenue from sales of mobile phones and advertising
services. These factors offset the appreciation of Chinese RMB to US dollars of
$12,803 in the quarter ended June 30, 2006.
24
Earnings per share
Earnings per share for the three months ended June 30, 2006 were $0.00
compared to $0.04 for the same period of the prior year. The decrease was due to
the decrease in the net income.
Liquidity and Capital Resources
Our net cash used during the six months ended June 30, 2006 was
$1,785,188 while we generated cash of $1,643,899 during the same period in 2005,
which represents a net change of $3,429,087.
Net cash flows provided by operating activities was $49,866 during the
six months ended June 30, 2006 compared to net cash flows used in operating
activities of $2,204,299 during the same period of the prior year. The net
change in cash provided was primarily due to the decrease in advances and
deposits to suppliers and inventories which was offset by the decrease in
collection of accounts receivable, accounts payable and net income.
Net cash flows used in investing activities was $1,876,464 for the six
months ended June 30, 2006 compared to net cash flows provided by investing
activities of $2,348,202 during the same period of the prior year. The change in
cash provided by investing activities was mainly due to the increase in loan to
related parties. As of June 30, 2006, the amounts due from Sifang Media, Sifang
Information and Kena represent $958,488, $37,499 and $4,026,930, respectively.
Net cash provided by financing activities for the six months ended June
30, 2006 was nil compared to $1,500,000 for the same period of the prior year.
The cash inflow of $1,500,000 during the six months ended June 30, 2005 related
to proceeds for shares that were issued in fiscal 2004 but were held in escrow
until we filed a Registration Statement on Form SB-2 with the SEC in 2005. We
treated the proceeds held in escrow as a current asset as the entire amount was
released from escrow in March 2005 and paid to us.
We believe that our current cash balance and cash flows from
operations, if any, will be sufficient to meet present growth strategies and
related working capital. In regards to the capital expenditures, we have
sufficient funds to expand our operations. We plan to utilize a combination of
internally generated funds from operations with potential debt and/or equity
financings to fund our longer-term growth over a period of two to five years.
The availability of future financings will depend on market conditions. There is
no assurance that the future funding will be available.
The forecast of the period of time through which our financial
resources will be adequate to support operations is a forward-looking statement
that involves risks and uncertainties.
Off-Balance Sheet Arrangements
We have never entered into any off-balance sheet financing arrangements
and have not formed any special purpose entities. We have not guaranteed any
debt or commitment of other entities or entered into any options or
non-financial assets.
Contractual Obligations and Commitments
The following table summarizes our contractual payment obligations and
commitments as of June 30, 2006:
Payment Obligations By Period
2006 (a) 2007 2008 2009 2010 Thereafter Total
-------- -------- -------- -------- -------- ---------- --------
Operating lease obligations $ 24,923 $ -- $ -- $ -- $ -- $ -- $ 24,923
Obligations for service agreement 22,804 45,609 45,609 45,609 45,609 155,829 361,069
----------------------------------------------------------------------------
Total $ 47,727 $ 45,609 $ 45,609 $ 45,609 $ 45,609 $ 155,829 $385,992
(a) Remaining 6 months in 2006.
25
Recent Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140,"
to permit fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation in
accordance with the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 155 is effective for all financial
instruments acquired, issued, or subject to a remeasurement event occurring
after the beginning of an entity's fiscal year that begins after September 15,
2006. We will adopt SFAS No. 155 in fiscal year beginning January 1, 2007. The
adoption of this statement is not expected to have a material effect on our
consolidated financial statements.
In March 2006, FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets-an amendment of FASB Statement No. 140," that provides guidance
on accounting for separately recognized servicing assets and servicing
liabilities. In accordance with the provisions of SFAS No. 156, separately
recognized servicing assets and servicing liabilities must be initially measured
at fair value, if applicable. Subsequent to initial recognition, the company may
use either the amortization method or the fair value measurement method to
account for servicing assets and servicing liabilities within the scope of this
statement. SFAS No. 156 is effective as of the beginning of an entity's fiscal
year that begins after September 15, 2006. The Company will adopt SFAS No. 156
in fiscal year beginning January 1, 2007. The adoption of this statement is not
expected to have a material effect on our consolidated financial statements.
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)", that will become effective beginning July 2006. FSP FIN No. 46(R)-6
clarifies that the variability to be considered in applying Interpretation 46(R)
shall be based on an analysis of the design of the variable interest entity. The
adoption of this FSP is not expected to have a material effect on our
consolidated financial statement.
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.
26
Item 3. CONTROLS AND PROCEDURES
Prior to the conclusion of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13(a)-14(c). Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings.
There were no changes in our internal controls over financial reporting that
materially affected or are reasonably likely to materially affect our internal
control over financial reporting during the quarter ended June 30, 2006.
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not currently involved in any pending legal proceedings other
than routine litigation incidental to the business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
The following documents are filed as part of this report:
31.1 Chief Executive Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Chief Financial Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Chief Executive Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Chief Financial Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
28
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
has caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
CHINA DIGITAL WIRELESS, INC.
(Registrant)
Date: August 17, 2006 /s/ Fu Sixing
----------------------------------
Fu Sixing, Chief Executive Officer
Date: August 17, 2006 /s/ Qian Fang
----------------------------------
Qian Fang, Chief Financial Officer
29