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 September 30, 2004
0-12536
(Commission File Number)
CHINA DIGITAL WIRELESS, INC.
(Exact name of registrant as specified in its charter)
Nevada 90-0093373
(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation)
429 Guangdong Road
Shanghai, People's Republic of China 200001
(Address of principal executive offices) (Zip Code)
Issuer telephone number, including area code: (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
As of December 15, 2004, 17,018,692 of the Issuer's $.001 par value common stock
were 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 September 30, 2004 (Unaudited) F-1
Consolidated Statement of Operations and Comprehensive Income
For the Three Months and Nine Months
Ended September 30, 2004 and 2003 (Unaudited) F-2
Consolidated Statement of Stockholders' Equity (Unaudited) F-3
Consolidated Cash Flow Statements for the Nine Months
Ended September 30, 2004 and 2003 (Unaudited) F-4
Notes to Consolidated Financial Statements F-5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION 3
ITEM 3. CONTROLS AND PROCEDURES 13
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS 13
SIGNATURES 14
2
CHINA DIGITAL WIRELESS, INC AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In U.S. Dollars)
December 31, September 30,
------------- -------------
2003 2004
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,713,748 $ 127,066
Note (trade) and accounts receivable, net of allowance for
doubtful accounts by $30,143, $25,651, and $28,157 2,363,327 2,075,228
Trade receivable from a related party -- 2,177,459
Advances to employees, net of allowance for doubtful accounts
by $659, and $356 12,525 6,769
Advances to vendors 76,891 540,139
VAT recoverable 83,414 78,640
Inventories 1,591,223 1,069,408
Deposits and prepaids 248,288 332,867
Deferred tax assets 4,955 9,024
------------- -------------
Total current assets 6,094,371 6,416,600
------------- -------------
Loan receivable from a related party -- 2,140,607
Escrow receivable -- 1,500,000
Property and equipment, net 1,354,238 1,234,549
------------- -------------
Total assets $ 7,448,609 $ 11,291,756
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 111,569 $ 6,526
Deferred revenue 537,046 579,996
Employee welfare payable 67,240 79,707
VAT payable -- 6,671
Other taxes payable 26,171 106,916
Accrued liabilities 22,919 53,295
------------- -------------
Total current liabilities 764,945 833,111
------------- -------------
Total liabilities 764,945 833,111
------------- -------------
Redeemable common stock, 0.001 par value; 1,482,456 shares
issued and outstanding, with a redemption price of $1.14
per share -- 1,690,000
Commitments
Stockholders' equity:
Common stock - $0.001 par value, 100,000 000 shares
authorized, 13,782,636 shares and 15,536,236 shares
issued and outstanding and additional paid-in capital 13,783 15,537
Additional paid-in capital 1,436,217 2,541,456
Retained earnings 5,233,652 6,211,485
Accumulated other comprehensive income (loss) - translation
adjustments 12 167
------------- -------------
Total stockholder's equity 6,683,664 8,768,645
------------- -------------
Total liabilities and stockholders' equity $ 7,448,609 $ 11,291,756
============= =============
See accompanying notes to consolidated financial statements.
F-1
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In U.S. Dollars)
Three Months Ended Sep. 30, Nine Months Ended Sep. 30,
---------------------------- ----------------------------
2003 2004 2003 2004
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenues:
Mobile phones distribution $ 3,183,577 $ -- $ 10,968,075 $ 4,914,465
Mobile phone sales to a related party -- 6,239,802 -- 10,512,821
Service revenue, net 659,440 779,719 2,351,449 2,467,990
------------ ------------ ------------ ------------
Total revenues 3,843,017 7,019,521 13,319,524 17,895,276
Cost of goods sold 2,961,937 -- 9,988,095 4,526,396
Cost of goods sold to a related party -- 6,126,537 -- 10,132,267
Cost of service 256,721 196,882 708,475 660,791
------------ ------------ ------------ ------------
Gross profit 624,359 696,102 2,622,954 2,575,822
Operating expenses:
Selling 40,770 42,748 116,241 127,833
General and administrative 88,733 177,675 292,784 1,462,504
Loss on disposal of fixed assets -- -- -- --
------------ ------------ ------------ ------------
Total operating expenses 129,503 220,423 409,025 1,590,337
------------ ------------ ------------ ------------
Income from operations 494,856 475,679 2,213,929 985,485
Agency income from a related party -- 130,060 -- 130,060
Interest expense (1,208) 18,339 (10,873) 31,931
------------ ------------ ------------ ------------
Income before income taxes 493,648 624,078 2,203,056 1,147,476
Income tax provision (benefit) 37,024 54,306 165,229 169,643
------------ ------------ ------------ ------------
Net income $ 456,624 $ 569,772 $ 2,037,827 $ 977,833
============ ============ ============ ============
Other comprehensive income (loss):
Translation adjustments $ (17) $ 3 $ (119) $ 155
------------ ------------ ------------ ------------
Comprehensive income $ 456,605 $ 569,775 $ 2,037,706 $ 977,988
============ ============ ============ ============
Basic and diluted earning per share $ 0.03 $ 0.03 $ 0.15 $ 0.07
Weighted average common shares outstanding 13,782,636 17,018,692 13,782,636 14,927,857
See accompanying notes to consolidated financial statements.
F-2
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Years Ended December 31, 2002 and 2003 and Nine Months Ended Sep. 30, 2004)
(In U.S. Dollars)
Common Accumulated
----------------------------- Additional Other Total
Stock Stock Paid-in Retained Comprehensive Stockholders'
Shares Amount Capital Earnings Income (Loss) Equity
------------- ------------- ------------- ------------- ------------- -------------
Balance, January 1, 2002 13,782,636 $ 13,783 $ 1,436,217 336,674 $ (117) $ 1,786,557
Net income -- -- 2,008,998 -- 2,008,998
Translation adjustments -- -- -- (252) (252)
------------- ------------- ------------- ------------- ------------- -------------
Balance, 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 adjustments -- -- -- 381 381
------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 2003 13,782,636 13,783 1,436,217 5,233,652 12 6,683,664
Recapitalization and
reorganization (unaudited) 1,585,705 1,586 308,465 -- -- 310,051
Shares issued for consulting
expense (unaudited) 167,895 168 604,254 -- -- 604,422
Shares issued for proceeds
of $190,000 (unaudited) 166,667 -- 410,001 -- -- 410,001
Shares issued for proceeds
of $1.5 million (unaudited)
(See Note 3) 1,315,789 -- -- -- -- --
Offset by issuing cost
(unaudited) -- -- (217,481) -- -- (217,481)
Net income (unaudited) -- -- -- 977,833 -- 977,833
Translation adjustments -- -- -- -- 155 155
------------- ------------- ------------- ------------- ------------- -------------
Balance, Sep.30 2004 17,018,692 $ 15,537 $ 2,541,456 6,211,485 $ 167 $ 8,768,645
============= ============= ============= ============= ============= =============
See accompanying notes to consolidated financial statements.
F-3
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
CONSOLIDATED CASH FLOW STATEMENTS
(In U.S. Dollars)
Nine Months Ended Sep. 30,
--------------------------
2003 2004
----------- -----------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net income $ 2,037,827 $ 977,833
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 172,271 138,851
Bad debt expenses 3,499 4,257
Stock compensation -- 1,014,423
Deferred tax assets 5,556 (4,069)
Changes in assets and liabilities:
Accounts receivables (251,770) (1,891,866)
Prepaids, deposit and advances to employees 34,218 (80,574)
Advance to vendors (1,153,961) (463,248)
Inventories (1,403,365) 521,815
Accounts payable 474,889 (105,043)
Deferred revenue 235,579 42,950
Employee welfare payable 15,609 12,467
VAT recoverable 201,194 4,774
VAT payable -- 6,671
Other taxes payable 49,309 80,745
Accrued liabilities 9,223 30,376
----------- -----------
Net cash provided by operating activities 429,957 290,362
----------- -----------
Cash flows from investing activities:
Purchase of property, equipment, and software (141,898) (19,162)
Decease (Increase) in due from a related party (604,062) (2,140,607)
----------- -----------
Net cash provided by (used in) investing activities (745,960) (2,159,769)
----------- -----------
Cash flows from financing activities:
Reorganization and recapitalization -- 310,051
Proceeds from issuing redeemable common stock -- 1,690,000
Escrow receivables -- (1,500,000)
Issuing cost -- (217,481)
----------- -----------
Net cash provided by (used in) financing activities 282,570
----------- -----------
Foreign currency translation (119) 155
----------- -----------
Net increase in cash and cash equivalents (316,003) (1,586,682)
Cash and cash equivalents, beginning of the period 1,193,690 1,713,748
----------- -----------
Cash and cash equivalents, end of the period $ 877,687 $ 127,066
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ -- $ --
Income taxes -- --
=========== ===========
See accompanying notes to consolidated financial statements.
F-4
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
NOTE 1 - Summary of Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation have
been included. Operating results for the six-month period ended September 30,
2004 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2004.
Foreign Currency Translations and Transactions
The Renminbi ("RMB"), the national currency of PRC, is the primary currency of
the economic environment in which the operations of THC Data Technology Co.,
Ltd., or THC are conducted. The Company uses the United States dollar ("U.S.
dollars") for financial reporting purposes.
The Company translates TCH's assets and liabilities into U.S. dollars using the
rate of exchange prevailing at the balance sheet date, and the statement of
income is translated at average rates during the reporting period. Adjustments
resulting from the translation of TCH's financial statements from RMB into U.S.
dollars are recorded in stockholders' equity as part of accumulated
comprehensive loss - translation adjustments. Gains or losses resulting from
transactions in currencies other than RMB are reflected in the statement of
income for the reporting periods.
Revenue Recognition
Revenues generated from sales of mobile phones are recognized 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 the ownership have been transferred to the customer, the price is
fixed or determinable and collectability is reasonably assured.
The Company, through TCH, provides wireless receiver users with access to
certain financial information provided by stock exchanges, comments and analysis
on PRC based stock market activity provided by certain reputable security
investment companies in China, lottery information, weather forecast, and other
value added services through the execution of a monthly subscription agreement
or through the purchase of a pre-charged service card. TCH purchases the
aforementioned information from respected vendors, reformats it through decoding
and recoding and transmits the reformatted information via Shanghai Sifang
Information Technology Co., or Sifang Information to pager users. The
information is constantly stored in the Company'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 need to make payments for a
three- to six-month subscription 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 or 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.
In response to a retailer's request, the Company has an installing agent install
the Company's software on mobile phones, which are owned by the retailer. The
retailer sells these phones for a premium covering a fee to be paid to the
installing agent and pre-charged six-month subscription fee to be paid to the
Company. After a customer using such a phone dials into the server to access the
desired information, the server records a unique identification number installed
on the mobile phone which indicates that a specific phone user starts his or her
subscription period. After the Company receives a detailed list from the
installing agent regarding the number of phones that have been installed with
the Company's software, the Company matches this information with a detailed
list from the retailer setting forth how many 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.
F-5
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
Since April 2004, the revenue generated from selling pre-charged cards has
gradually decreased while the revenue generated through monthly subscription
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
Group Co., Ltd., or Tianci, contract with the Mobile Operators for the
transmission of the Company's value-added information service. The Mobile
Operators bill and collect from customers and then pass those fees (net of
billing and collection service fees charged by the Mobile Operators) to Sifang
Information and Tianci who in turn pass those fees to the Company. The Company
recognizes net revenues based on the total amount paid by its customers, for
which the Mobile Operators bill and collect on behalf of the Company. There is a
time lag of a few months between the end of a particular service period and the
date the Mobile Operators send out their billing statements due to the
segregated billing systems of each provincial subsidiary of the Mobile
Operators. For the nine months ended September 30, 2004, approximately 13% of
the Company's service revenue from mobile phone users is recognized based on
monthly billing statements prepared by the provincial subsidiaries of the Mobile
Operators. The Company has not recognized service revenue based on the records
provided by its own server. 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 service is not covered by a monthly
service subscription and the Company has no control over whether it will incur.
These network usage fees charged by the Mobile Operators are reflected as a part
of cost of services in the financial statements. 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 currently records the mobile phone service revenue based on the
amounts paid by its customers net of the Mobile Operators' service charge for
billing and collection on behalf of the Company. According to EITF Issue No.
99-19, recognizing revenue on a net basis in this situation is appropriate if
the Company does not act as a principal, in connection with the provision of its
services. Factors which support a conclusion that the Company is not acting as a
principal include:
o limited ability to adjust the cost of services by adjusting the design
or marketing of the service,
o limited ability to determine prices, the Company must follow the price
policy within ranges prescribed by Mobile Operators, and
o limited ability to assume risk of non-payment by customers.
The Company has very limited ability to adjust the ratio of our revenues to cost
of services (which include the Mobile Operators' network usage fee, and other
fees, if any). In addition, the majority of service revenue derived from mobile
phone users is subject to the floor price for monthly service set by the Mobile
Operators and the Company does no have an ability to negotiate with its
customers. The Mobile Operators will normally make payments within several
months after the Company receives the billing statement because it takes time
for the Mobile Operators to collect payments from the Company's customers.
Consequently, the Company actually bears less risk of non-payment by customers
as Mobile Operators need to take care of their collections first. Only about 13%
of the total service revenue derived from mobile phone users in the nine months
ended September 30, 2004 was billed through the Mobile Operators' billing
systems. Whereas, there are three items of mobile phone services over which the
Company does have an ability to determine prices. The portion of this type of
revenue was immaterial in the nine months ended September 30, 2004. Therefore,
the Company has concluded that reporting net revenue billed through the Mobile
Operators' billing systems is appropriate.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturity of three
months or less to be cash equivalents.
Accounts Receivable, Employees Receivable, and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to
its retail customers who are mainly located in Shanghai metropolitan area.
Typically credit terms require payment to be made within 30 days of the sale.
The Company does not require collateral from its customers. The Company
maintains its cash accounts at credit worthy financial institutions.
F-6
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
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, along with a general reserve, in the overall
allowance for doubtful accounts. After all attempts to collect a receivable have
failed, the receivable is written off against the allowance. Based on the
information available to management, the Company believes that its allowance for
doubtful accounts was adequate as of September 30, 2003 and 2004. However,
actual write-offs might exceed the recorded allowance.
The Company advances cash to sales people for their travel and business activity
needs. Under certain circumstances, the advances to employees might not be fully
recovered by the Company. Accordingly, the Company also provides allowances
against any doubtful accounts. The following table presents combined allowance
activities in accounts receivable and advances to employees.
September 30
-----------------------
2003 2004
-----------------------
Beginning balance $ 30,143 $ 26,310
Additions charged to expense 8,507 2,203
Recovered -- --
Actual write off -- --
---------- ----------
Ending balance $ 38,650 $ 28,513
========== ==========
Inventories
Inventories consist principally of mobile phones manufactured by name brand
manufactures with various features and are stated at the lower of cost
(first-in, first-out) or market.
Rebates and Credits Receivable
In 2004, the Company's major vendor began providing sales rebates and credits if
the Company can fulfill certain sales volumes prescribed by the vendor in order
to attract its distributors to sell more of its products. As a result, the
Company is entitled to receive certain rebates and credits for the inventory
held and sold by the Company within the specified period of time as defined by
its vendor through submitting the necessary application forms. In general, once
the vendor approves these applications the amounts of these rebates and credits
will be deducted from the Company's accounts payable to its vendor and decrease
the cost of goods sold or inventory held, correspondingly.
Capitalization of Software Costs
The Company's software is developed by an independent third party to enable
pager users to accept certain recoded information which is transmitted by the
Company and enable 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, 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
Properties and equipment are recorded at cost and are stated net of accumulated
depreciation. Depreciation expense is determined using the straight-line method
over the shorter of the estimated useful lives of the assets as follows:
Buildings 20 years
Software 2-3 years
Vehicles and other equipment 2-5 years
F-7
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
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 nine months ended September 30, 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. Loan receivable from a related party bear interest at 5% per annum which
is similar to the market interest rate in China as of September 30, 3004.
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. The VAT payable or receivable balance presented on the Company's balance
sheets represents the input VAT either less than or larger than the output VAT.
The debit balance represents a credit against future collection of output VAT
instead of a real receivable.
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 State Administration of Labor
Affairs. 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 $25,766, and $19,951 to these
funds as part of selling, general and administrative expenses for the nine
months ended September 30, 2003 and 2004, respectively.
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
F-8
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
assets and liabilities are measured using the enacted tax rate expected to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that included the
enactment date.
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 registered
in the Shanghai downtown and 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 be
subject to a favorable income tax rate of 15% and qualifies for income tax
exemption for three years from January 1, 2000 to December 31, 2002, and 50% of
income tax reduction for three years from January 1, 2003 to December 31, 2005.
The income tax provisions presented on the Company's financial statements are
based on the historical actual income tax rates of Sifang Information at 7.5%
for the nine months ended September 30, 2003 and 2004. The deferred tax assets
are determined based on the historical income tax rates applicable at the Sifang
Information 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.
Stock-based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), establishes a fair value method of accounting
for stock-based compensation plans and for transactions in which a company
acquires goods or services from employees and non-employees in exchange for
equity instruments. SFAS No. 123 also gives the option, for employees only, to
account for stock-based compensation, utilizing the intrinsic value method, in
accordance with Accounting Principles Board Opinion No. 25 ("APB No. 25"),
"Accounting for Stock issued to Employees." The Company has chosen to account
for stock-based compensation for employees utilizing the intrinsic value method
prescribed in APB No. 25 and to provide the pro forma disclosures required by
SFAS No. 123. As of September 30, 2004, the Company has not granted any stock
options to employees.
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.
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").
The statement replaces the calculation of primary and fully diluted earnings
(loss) per share with basic and diluted earnings (loss) per share. 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 does not
have any potential common share equivalents as of September 30, 2004.
F-9
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
NOTE 2 - Recapitalization and Reorganization
On June 23, 2004, Boulder Acquisitions, Inc. (Boulder Acquisitions) entered into
a stock exchange agreement with Sifang Holdings Co. Ltd. Pursuant to the stock
exchange agreement, Boulder Acquisitions issued 13,782,636 shares of its common
stock in exchange of 100% equity interest in Sifang Holdings Co. Ltd., 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 (generally defined as a brewery which
produces less than 15,000 barrels per year) in Boulder, Colorado. During 1990,
as a result of various debt defaults, Boulder Brewing's assets were foreclosed
upon and the Company ceased all business operations. 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,
Inc., 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.
Sifang Holdings Co. Ltd. (Sifang Holdings) was incorporated under the laws of
the Cayman Islands on March 8, 2004 for the purpose of holding a 100% equity
interest in TCH Data Technology Co. Ltd. ("TCH"). TCH was established as a
foreign investment enterprise in Shanghai under the laws of People's Republic of
China ("PRC") on May 25, 2004 with a registered capital of $7.2 million.
The above stock exchange transaction resulted in those shareholders of Sifang
Holdings obtaining a majority voting interest in Boulder Acquisitions. Generally
accepted accounting principles 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 has
acquired 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 are 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 stockholders' equity of
$310,051 with 1,585,705 shares of common stock outstanding, all of which were
included in the consolidated financial statements of Sifang Holdings. Please see
the unaudited stockholders' equity statement for the period from January 1, 2004
to September 30, 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. On August 6th,
2004, Boulder Acquisitions, Inc. changed its name to China Digital Wireless,
Inc.
NOTE 3 - Equity Transactions
On June 23, 2004 the Company issued 167,895 share of its common stock to a
consultant in lieu of cash payment. The trading price on June 23, 2004 was $3.60
per share, accordingly, the fair value of the 167,895 shares was $604,422.
On June 23, 2004, the Company issued 166,667 shares of its common stock to an
existing stockholder at a price of $1.14 per share in exchange for gross
proceeds of $190,000 based on a stock purchase agreement. Pursuant to the signed
stock purchase agreement, the Company granted to the existing stockholder an
option which requires the Company to purchase 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
F-10
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
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 stockholder's shares are eligible for resale under Rule 144 under the
Securities Act of 1933. According to Topic D-98 from SEC, "Classification and
Measurement of Redeemable Securities," the Company believes that these shares
should be presented outside the permanent equity section, however, these shares
should be considered to be included in determining basic earnings per share as
there was no contingency surrounding these underlying shares. The above
transaction occurred on June 23, 2004, the trading price on that day was $3.60
per share. Due to the nature of this insider transaction, the difference between
the price of $1.14 per share and the price of $3.60 per share was recorded as
deemed compensation to an existing stockholder by presenting the increase of
$410,001 in additional paid-in capital and the increase of $410,001 in general
and administrative expenses.
On June 28, 2004, the Company issued, in the aggregate, 1,315,789 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 respective stock purchase agreements. Pursuant
to the signed stock purchase agreements, the Company granted to each of three
investors an option which requires the Company to purchase the aforementioned
1,315,789 shares, in aggregate, 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 stockholders, up to and including the earlier of the
date that such registration statement is declared effective by the SEC or the
existing stockholders' shares are eligible for resale under Rule 144 under the
Securities Act of 1933. As of September 30, 2004, the proceeds of $1.5 million
were kept in an escrow. Due to the uncertainty of when a Form SB-2 will be
declared effective, the Company treated this escrow receivable a long-term asset
instead of a current asset. According to Topic D-98 from SEC, "Classification
and Measurement of Redeemable Securities," the Company believes that these
shares should be presented outside the permanent equity section; however, these
shares should be considered to be included in determining basic earnings per
share as there was no contingency surrounding these underlying shares.
The Company incurred issuing expense of $217,481 (mainly audit and legal
expense) and accounted for it as a reduction to additional paid-in capital.
NOTE 4 - Related Party Transactions
During the nine months ended September 30, 2004, the Company paid to Sifang
Information the amount of $425,879 for transmitting value-added information to
pager users pursuant to an information service and cooperation agreement between
the Company and Sifang Information.
On June 30, 2004, TCH signed an agreement with Sifang Information Co. Ltd. for
developing a smart card information system related to citizen health and
exercise. This project is approved by the Shanghai Municipal Government.
Pursuant to the signed agreement, Sifang Information will develop smart card
information system in terms of the specifications contained the design
blueprint. This card can be used for accessing gym facilities and other
approved, related health facilities under the program. In accordance with the
financial terms of the signed agreement, Sifang Information will take care of
expenses related to the smart card marketing and related customer after-market
services. TCH will take care of expenses related to the detailed smart card
information system design and development, hardware and software maintenance,
and related information service. In return, TCH is entitled to share a major
portion of the future revenue generated by this smart card information system.
In order to initiate this project, TCH gave Sifang Information a line of credit
of up to RMB20,000,000 (equivalent approximately $2,418,000) for financing its
market promotion and penetration and deployment, with an interest rate based on
the market interest rate (at September 30, 2004 the interest rate was 5%),
interest payable monthly and principal to be repaid by Sifang Information no
later than June 30, 2006 resulting in an estimated total expense of
approximately RMB22,800,000 (equivalent of $2.7 million). The aforementioned
$2.4 million includes the outstanding balance of amounts due from Sifang of
$2,140,607 as of September 30, 2004. The interest income incurred on the
outstanding balance due from Sifang Information for the nine months ended
September 30, 2004 was $ 30,205, based on 5% as the annual interest rate.
Currently, TCH is engaging in the process of designing the sophisticated
software for the card information system and preparing for the operating of the
related hardware.
F-11
CHINA DIGITAL WIRELESS, INC. AND SUBSIDIARY
notes to consolidated financial statements
(In U.S. Dollars)
In the beginning of the third quarter of 2004, TCH had not obtained all
necessary government issued VAT invoices. As such, TCH was prohibited from
selling cellular phones to third parties. In lieu, TCH sold Samsung and other
brand GSM and CDMA mobile phones to Shantian and Sifang Information , two
related parties. As of September 30, 2004 the accounts receivable (trade)
balance due from Shantian and Sifang Information was $2,177,459.
F-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Management's Discussion and Analysis of Plan of Operation
The following discussion should be read in conjunction with our financial
statements and the notes thereto and the other financial information appearing
elsewhere in this document. 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
-------------------------------
Our business is primarily conducted through our wholly-owned subsidiary Sifang
Holdings Co., Ltd., or Sifang Holdings and its wholly-owned subsidiary TCH Data
Technology Co., Ltd., or TCH Sifang Holdings was formed under the laws of the
Cayman Islands on February 9, 2004 for the purpose of holding 100% of the equity
interests in TCH. TCH was established as a foreign investment enterprise in
Shanghai under the laws of People's Republic of china, or PRC on May 25, 2004,
with a registered capital of $7.2 million.
Our current operations were originally a business division of Shanghai Sifang
Information Technology Co., or 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 pager and mobile phone distribution business and the majority of
its value added information services business to TCH 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. Being a receiving entity
under the 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 the exchanging of
ownership between TCH and Sifang Holdings, TCH's historical financial statements
become the historical financial statements of Sifang Holdings.
As a result of the spin-off, TCH engages in the business of mobile phone
distribution and the provision of 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 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 are asked to make advance payments for either three or six-month
subscription periods.
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires the use of estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
3
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period.
Management periodically evaluates the estimates and judgments made. Management
bases its estimates and judgments on historical experience and on various
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates as a result of different assumptions or
conditions.
The following critical accounting policies affect the more significant judgments
and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Revenues generated from sales of mobile phones are recognized 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 the ownership have been transferred to the customer, the price is
fixed or determinable and collectibility is reasonably assured.
We provide wireless receiver users with access to certain financial information
provided by stock exchanges, comments and analysis on stock market activity
provided by certain reputable security investment companies in China, lottery
information, weather forecasts, and other value-added products through the
execution of a monthly subscription agreement or through the purchase of a
pre-charged service card. We purchase the aforementioned information from
respected vendors and reformat it through decoding and recoding and transmit the
reformatted information via Sifang Information to pager users. We constantly
store the reformatted information in our 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 need to make payments for three to six-month
subscriptions in advance. We record the proceeds as deferred revenue and
amortize the deferred revenue over the subscription period. When customers buy a
pre-charged service card, we record the proceeds as deferred revenue. When a
customer commences using this card to access our server or begins using a pager
to access the aforementioned information, we identify the subscription period
and amortize the deferred revenue over the subscription period.
In response to a retailer's request, we have an installing agent install our
software on mobile phones, which are owned by the retailer. The retailer sells
these phones for a premium covering a fee to be paid to the installing agent
with the pre-charged six-month subscription fee being paid to us. After a
customer using such a phone dials the server to access the desired information,
the server records a unique identification number installed on the mobile phone
which indicates that a specific phone user starts his or her subscription
period. After we receive a detailed list from the installing agent regarding the
number of phones that have been installed with our software, we match this
information with a detailed list from the retailer setting forth how many such
phones have been sold. Based on the number of such phones sold, we record
accounts receivable and deferred revenue, correspondingly. At the date on which
a customer starts to dial into the server, the subscription period begins and we
amortize deferred revenue accordingly.
Since April 2004, the revenue generated from selling pre-charged cards has
gradually decreased while the revenue generated through monthly subscription
with China Mobile and/or China Unicom (collectively "Mobile Operators") has
gradually increased as the Mobile Operators' billing systems have been enhanced.
Our affiliates, Sifang Information and Shanghai Tianci Industrial Group Co.,
Ltd., or Tianci, contract with the Mobile Operators for the transmission of our
value-added information service. The Mobile Operators bill and collect from
customers and then pass those fees (net of billing and collection service fees
charged by the Mobile Operators) to Sifang Information and Tianci who in turn
pass those fees to us. We recognize net revenues based on the total amount paid
by our customers, for which the Mobile Operators bill and collect on our behalf
. There is a time lag ranging from 10 days to 45 days between the service period
cut-off date and the date the Mobile Operators send out their billing statements
due to the segregated billing systems of each provincial subsidiary of the
Mobile Operators. For the nine months ended September 30, 2004, about 10% of our
service revenue from mobile phone users is recognized based on monthly billing
statements prepared by the provincial subsidiaries of the Mobile Operators.
However, as of September 30, 2004 none of such revenue can be attributed to the
relationship between Tianci and China Unicom, as billing delays have prevented
us from recognizing any revenue from this relationship. We have also not
recognized service revenue based on the records provided by our own server. 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 service is not covered by a monthly service subscription and we have
no control over whether or not it will occur.). These network usage fees charged
by the Mobile Operators are reflected as a part of cost of services in the
financial statements. Network usage fees charged by the Mobile Operators are
reduced for messages received by us because the Mobile Operators separately
charge the sender a fee for these transmissions.
We currently record the mobile phone service revenue based on the amounts paid
by our customers net of the Mobile Operators' service charge for billing and
collection on our behalf. According to EITF Issue No. 99-19, recognizing revenue
on a net basis in this situation is appropriate if we do not act as a principal
in connection with the provision of our services. Factors which support a
conclusion that we are not acting as a principal include:
4
o limited ability to adjust the cost of services by adjusting the design
or marketing of the service;
o limited ability to determine prices, we must follow the price policy
within ranges prescribed by Mobile Operators; and
o limited ability to assume risk of non-payment by customers.
We have very limited ability to adjust the ratio of our revenues to cost of
services (which include the Mobile Operators' network usage fee and other fees,
if any). In addition, the majority of service revenue derived from mobile phone
users is subject to the floor price for monthly service set by the Mobile
Operators as we do no have an ability to negotiate with our customers. The
Mobile Operators will normally make payments within the 30 days after we receive
the billing statement because it takes time for the Mobile Operators to collect
payments from our customers. Consequently, we actually bear less risk of
non-payment by customers as Mobile Operators must take care of their collections
first. Only about 10% of the total service revenue derived from mobile phone
users in the nine months ended September 30, 2004 was billed through the Mobile
Operators' billing systems. Whereas, there are three items of mobile phone
services over which we do have an ability to determine price, however, the
portion of this type of revenue was immaterial in the nine months ended
September 30, 2004. Therefore, we have concluded that reporting net revenue
billed through the Mobile Operators' billing systems is appropriate.
Accounts Receivable, Employees Receivable, and Allowance for Doubtful Accounts
During the normal course of business, we extend unsecured credit to our retail
customers who are mainly located in the Shanghai metropolitan area. Typically,
the credit terms require payment to be made within 30 days of the sale. We do
not require collateral from our customers. We maintain our cash accounts at
credit worthy financial institutions.
We regularly evaluate and monitor the creditworthiness of each customer on a
case-by-case basis. We include any account balances that are determined to be
uncollectable, along with a general reserve, in the overall allowance for
doubtful accounts. After all attempts to collect a receivable have failed, the
receivable is written off against the allowance. Based on the information
available to management, we believe that our allowance for doubtful accounts was
adequate as of September 30, 2004. However, actual write-offs might exceed the
recorded allowance.
We advance cash to sales people for their travel and business activity needs.
Under certain circumstances, the advances to employees might not be fully
recovered by us. Accordingly, we also provide allowances against any doubtful
accounts.
Inventories
Inventories consist principally of mobile phones manufactured by name brand
manufactures with various features and are stated at the lower of cost
(first-in, first-out) or market.
Rebates and Credits Receivable
In 2004 our major vendor began providing sales rebates and credits if we
fulfilled certain sales volumes prescribed by the vendor in order to induce our
distributors to sell more of our products. As a result, we are entitled to
receive certain rebates and credits for the inventory held and sold by us within
the specified period of time as defined by our vendor through submitting the
necessary application forms. In general, once the vendor approves these
applications the amounts of these rebates and credits will be deducted from our
accounts payable to our vendor and decrease the cost of goods sold or inventory
held, correspondingly.
Impairment of Long-Lived Assets
We apply the provisions of Statement of Financial Accounting Standard No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("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 nine months ended September 30, 2003 and 2004, respectively.
Income Taxes
We account 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
5
tax assets and liabilities are recognized for the future tax consequence
attributable to the difference between the tax bases of assets and liabilities
and their reported amounts in the financial statements. Deferred tax assets and
liabilities are measured using the enacted tax rate expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that included the
enactment date.
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, registered in the Shanghai downtown 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 be subject to a favorable income tax rate of 15% and
qualifies for income tax exemption for three years from January 1, 2000 to
December 31, 2002, and 50% of income tax reduction for three years from January
1, 2003 to December 31, 2005. The income tax provisions presented on our
financial statements are based on the historical actual income tax rates of
Sifang Information at 7.5% for the nine months ended September 30, 2003 and
2004, respectively. The deferred tax assets are determined based on the
historical income tax rates applicable at the Sifang Information level.
There is no income tax for companies domiciled in the Cayman Islands.
Accordingly, Sifang Holdings financial statements do not present any income tax
provisions related to Cayman Islands tax jurisdiction.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ materially from those
estimates.
Discussion and Analysis of Operating Results
Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30,
2003
Revenue
Mobile phone distribution
Our mobile phone distribution in the nine months ended September 30, 2004
increased by approximately $4,459,211, representing an approximately 41%
increase, to $ 15,427,286 (including product sales to three related parties
(Shanghai Shantian Telecommunication Technology Inc., Tianci Group Co., Ltd., or
Tianci Group, and Sifang Information) as compared to $ 10,968,075 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. For the nine months
ended September 30, 2004, Samsung's mobile phones accounted for about 97% of
total product sales and other name brands mobile phones accounted for the
remaining 3%. Compared to the nine months ended September 30, 2003, Samsung's
mobile phones accounted for 99% of total product sales and other brands
accounted for the balance. Market competition for mobile phone sales is so
fierce that we decreased our overall mark-up ratio to 5.0% in order to maintain
our market position, compared to the mark-up ratio of 8.9% for the same period
the prior year.
Mobile phone sales to a related party
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. During the nine months ended September 30, 2004, we sold
$10,512,821 of mobile phones with a reasonable mark-up of approximately 3.6% in
order to support start-up stage of Shantian's business as compared to the
aggregate mark-up ratio of 5.0% for the products sold to all other customers.
Compared to the mark-up ratio of 7.9% in the first half year of 2004, the
decrease in mark-up ratio was due mainly to the significant decline of mark-up
to 1.8% for the three months ended September 30, 2004 compared to 7.0% for the
same period of the prior year. Because TCH had not obtained all the government
issued VAT invoices for the mobile phones distribution, the sales of mobile
phones went through the related parties during the third quarter.
6
Service revenue, net
Total service revenue net of the related business tax and surcharge for the nine
months ended September 30, 2004 increased by approximately $116,541,
representing approximately a 5.0% increase, to $2,467,990 compared to $2,351,449
for the same period of the prior year. Moreover, the components of service
revenue changed significantly. Service revenue from mobile phone users for the
nine months ended September 30, 2004 increased by $1,433,076 to $1,828,041
compared to $394,965 for the same period of the prior year, representing an
increase of approximately 363%, which resulted in the overall increase in
service revenue. Service revenue from pager users for the nine months ended
September 30, 2004 decreased by $1,316,535 to $ 639,949 compared to $1,956,484
for the same period of the prior year, representing approximately a 67%
decrease. We believe that service revenue from pager users will continue to
decrease given the increased popularity of mobile phones over beepers and
pagers. 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.
Cost of goods sold
The cost of goods sold for the nine months ended September 30, 2004 increased by
$4,670,568 to $14,658,663 compared to $9,988,095 for the same period of the
prior year, representing an approximately 47 % increase. The increase was
consistent with the increases in revenue from product sales.
Cost of service
The cost of service for the nine months ended September 30, 2004 decreased by
$47,684 to $660,791 compared to $708,475 for the same period of the prior year,
representing an approximately 6.7% decrease. This decrease was the result of a
decrease in the content fee charged by the content providers from $66,901 to
$25,538 in the comparison of the nine months ended September 30, 2004 and the
same period last year. According to the contracts signed between TCH and other
content providers who offered us information content related to securities,
lottery entertainment and so on, we recorded all accrued expenses in the third
quarter of year 2004. We expect that the final determined fee due to the
providers will be confirmed in the fourth quarter of 2004. Meanwhile, we are
striving to expand the contents included in our value-added services within the
current fee-charge level and trying to establish collaborative relationships or
partnerships with certain information content providers.
Gross profit
After considering the cost of goods sold and cost of service, our gross profit
for the nine months ended September 30, 2004 decreased by approximately $47,132
to approximately $2,575,822, representing an approximately 1.8 % decrease,
compared to the gross profit of $2,622,954 for the same period of the prior
year. The decrease of gross profit was primarily attributable to the fact: (i)
service revenue from pager users generated in the nine months ended September
30, 2004 decreased from $1,956,484 to $639,949, representing an approximately
67.3% decrease, compared to the same period in fiscal 2003; and (ii) the gross
profit ratio of the mobile phone distribution for the first three quarters in
fiscal 2004 decreased from 8.9% to 5.0% resulting in the decline of the total
gross profit.
7
The following table presents in summary certain information related to the
various components of revenue in a manner similar to segment reporting
information.
Information Information
Mobile Phone Service - Service -
Distribution Mobile Phone Pager Total
------------ ------------ ------------ ------------
For nine months ended September 30, 2004
Revenue $ 15,427,286 $ 1,828,041 $ 639,949 $ 17,895,276
Cost 14,658,663 150,900 509,891 15,319,454
Gross profit 768,623 1,677,141 130,058 2,575,822
Gross profit ratio 5.0% 91.7% 20.3% 14.4%
For nine months ended September 30, 2003
Revenue $ 10,968,075 $ 394,965 $ 1,956,484 $ 13,319,524
Cost 9,988,095 163,827 544,648 10,696,570
Gross profit 979,980 231,138 1,411,836 2,622,954
Gross profit ratio 8.9% 58.5% 72.2% 19.7%
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 relevant monthly
service for China Unicom. According to the signed agreement, should Tianci Group
sell varieties of CDMA mobile phones owned by China Unicom to customers who
would like to subscribe for monthly service for a period of two years with a
monthly service fee of $3.38, Tianci Group would be entitled to receive an sales
commission from China Unicom of $15.70 per unit, sales commission of $3.62 per
SIM card, and $12.08 for monthly service subscription. Tianci Group feels that
TCH has been in a better position to sell these CDMA mobile phones, SIM cards
and monthly service subscriptions. Therefore, Tianci Group entered into an agent
agreement with TCH and asked TCH to conduct these businesses on behalf of Tianci
Group. Consequently, TCH would be entitled to receive the sales commission from
Tianci Group based on the terms between Tainci Group and China Unicom. This
agent business started in August 2004 along with the promotion initiated by
China Unicom. As this business activity is more uncertain in nature, we reported
this sales commission as other income instead of regular revenue. We recognized
agent income of $130,060 in the nine months ended September 30, 2004 at TCH
level. The recurrance of this type of transaction depends on the promotion
initiated by China Unicom. Therefore, we recognize the agent income as other
income.
Selling expenses
Selling expenses for the nine months ended September 30, 2004 increased by
$11,592 to $127,833 compared to $116,241 for the same period of the prior year,
representing an approximately 10% increase. The increase was due to promotion
expenses for value-added information service related to mobile phone users.
Advertising fees increased from $889 to $29,707.
General and administrative expenses
General and administrative expenses for the nine months ended September 30, 2004
increased by $1,169,720 to $1,462,504 compared to $292,784 for the same period
of the prior year, representing a material increase. The increase was due mainly
to the stock-based compensation expenses of approximately $1,014,000 and an
increase of $19,737 in software amortization expenses from $75,293 to $95,030.
In addition, office rental expense increased by approximately $20,556 and audit
and consultant fees incurred in the first three quarters of fiscal 2004
accounted for a $10,656 increase for the reorganization and recapitalization
transaction. Other miscellaneous items accounted for the remaining increase of
$4,355 for the nine months ended September 31, 2004.
Of the aforementioned stock-based compensation of $1,014,000 for the nine months
ended September 30, 2004, $604,000 was the fair value of the 167,895 shares
issued to a consultant in lieu of cash payment, and other $410,000 was total
premium difference between the trading price ($3.60 per share) and the stock
purchase price ($1.14 per share) per a stock purchase agreement resulting in the
issuance of 166,667 redeemable shares.
8
Interest income (expense)
For the nine months ended September 30, 2004, interest income was $31,931, which
was mainly derived from the amount due from Sifang Information. For the nine
months ended September 30, 2003, there were two borrowing and lending
transactions between TCH and Sifang Information resulting in the interest
expense $10,873.
Income tax
TCH is subject to taxation under the laws of the PRC, and the statutory income
tax rate for the nine months ended September 30, 2003 and 2004 was 7.5%. In the
nine months ended of September 30, 2003 and 2004, income tax expense was
$165,229 and $169,643, respectively, based on pretax income of $2,258,366 and
$1,247,476 (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, the income tax expense of $169,643 incurred
in China was based on the taxable income of approximately $2,261,899.
Net income
We recorded net income of $977,833 for the nine months ended September 30, 2004,
a $1,059,994 decrease in net income compared to a net income of $2,037,827 for
the same period of the prior year, representing an approximately 52% 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, and (ii) the decrease of the
gross profit generated from mobile phone distribution and the pager service
business.
Earnings per share
The earnings per share for the nine months ended September 30, 2004 decreased by
$0.08 to $0.07 compared to $0.15 for the same period of the prior year,
representing an approximately 53% decrease. The decrease was due mainly to the
decrease in our net income and the increase in the total outstanding shares of
common stock as the weighted average number of shares of common stock
outstanding for the nine months ended September 30, 2004 increased by
approximately 13%, compared the weighted average number of common stock
outstanding for the same period of the prior year.
Three Months Ended September 30, 2004 Comparing to Three Months Ended September
30, 2003
Revenue
Mobile phone distribution
Revenue from mobile phone distribution in the three months ended September 30,
2004 increased by approximately $3,056,225 to $6,239,802 (all revenues being
generated by sales to Shanghai Shantian, Tianci Group and Sifang Information,
three related parties), representing an approximately 96% increase, compared to
$3,183,577 for the same period of the prior year. Regarding mark-up ratios,
there was a significant decrease in the mark-up ratio from approximately 7.0% to
1.8% during the three months ended September 30, 2003 and 2004, respectively.
Because TCH has not obtained all the government issued VAT invoices for the
mobile phones distribution, the sales of mobile phones went through the related
parties during the third quarter.
Mobile phone sales to related parties
In March 2004, Sifang Information spun off its mobile phone distribution
business and the majority of its value added information service business by
presenting a set of cave-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 (as well
as the financial statements for the three months ended June 30, 2004). Although
TCH has been conducting its business as a stand-alone entity since May of 2004,
TCH was unable to invoice for sales until September 2004. As such, TCH was not
entitled to distribute mobile phones to customers directly other than through
the related parties. In order to prevent the depreciation of the existing
inventories, TCH sold $5,963,048 worth of Samsung mobile phones at a price near
actual cost to Sifang Information resulting in the significant decline of the
total mark-up in the third quarter of fiscal 2004. TCH was able to invoice for
sales and conduct its mobile phone distribution formally until after September
of 2004, and the rebates due from our major vendor who provided TCH the mobile
phones could be received and confirmed later in the period.
9
Service revenue, net
Total service revenue, net of related business tax and surcharges, for three
months ended September 30, 2004 increased by approximately $120,279 to $779,719,
as compared to $659,440 for the same period of the prior year, representing a
18.2% increase. The overall increase was the result of an increase of service
revenue from mobile phone users that was greater than the decrease of service
revenue for pager users. Service revenue for mobile phone users for three months
ended September 30, 2004 increased by approximately $721,689 to $745,926
compared to $24,237 for the same period of the prior year, resulting from the
expanding of our diversified services portfolio and the positive promotional
effect. Service revenue for pager users for three months ended June 30, 2004
decreased by $601,410 to $33,793 compared to $635,203 for the same period of the
prior year, representing an approximately 95% increase. We believe that service
revenue from pager users will continue to decrease along with the increased
popularity of mobile phones over pagers.
Cost of goods sold
Cost of goods sold for the three months ended September 30, 2004 increased by
approximately $3,164,600 to $6,126,537 as compared to $2,961,937 for the same
period of the prior year, representing an approximately 107% increase. The
increase was consistent with the increase in revenue resulting from selling
mobile phones.
Cost of service
The cost of service for the three months ended September 30, 2004 decreased by
approximately $59,839 to $196,882 compared to $256,721 for the same period of
the prior year, representing an approximately 23.3% decrease. The decrease was
primarily attributable to the variation of the depreciation incurred in the
third quarter of fiscal 2004, accounting for an approximately $18,986 decline in
comparison of the same period of the prior year. Additionally, the reduction of
the cost of purchasing information content from the content providers, from
$26,243 to $11,477, was responsible for the decrease in cost of services.
According to the contracts signed between TCH and other content providers who
offered us information content related to securities, lottery entertainment and
so on, we recorded all accrued expenses in the three months ended September 30,
2004. We expect that the fees due to the providers would be confirmed during the
fourth quarter of fiscal 2004. Meanwhile, we are striving to expand the contents
included in our value-added services within the current fee-charge level and
trying to establish collaborative relationships or partnerships with certain
information content providers.
Gross profit
After considering the cost of goods sold and cost of service, our gross profit
for the three months ended September 30, 2004 increased by approximately
$71,743, representing an approximately 11.5% increase, to approximately $696,102
as compared to $624,359 for the same period of the prior year. The increase was
due mainly to the significant growth of the value-added information service for
mobile phones users with a high gross profit, which increased from a negative
$12,022 to a positive 715,720, offsetting the bad performance in the value-added
information service for pager business and the decline of gross profit for our
mobile phone distribution business.
However, the percentage of gross profit over the total revenue for the three
months ended September 30, 2004 was approximately 9.9% compared to 16.2% for the
same period of the prior year, representing a 28% decrease. The decrease is the
result of: (i) the decline in mark-up ratio of mobile phone distribution for
some special reasons, which has been discussed in the item "mobile phone sales
to related parties" aforementioned; and (ii) given the decreased popularity of
beep pagers in China. In terms of the agreement signed between TCH and Sifang
Information, TCH is entitled to use Sifang Information's paging facility to
render value-added service for pagers, and has to repay Sifang Information
periodically for compensation, therefore, the fixed cost for pager service did
diminish even though the revenue derived from value-added information service
for pager users had declined significantly, which lead to the loss of
information services for pager users in the third quarter of fiscal 2004.
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The following table presents in summary certain information related to the
various components of revenue in a manner similar to segment reporting
information.
Information Information
Mobile Phone Service - Service -
Distribution Mobile Phone Pager Total
------------ ------------ ------------ ------------
For three months ended September
30, 2004
Revenue $ 6,239,802 $ 745,926 $ 33,793 $ 7,019,521
Cost 6,126,537 30,205 166,677 6,323,419
Gross profit 113,265 715,721 -132,884 696,102
Gross profit ratio 1.8% 96.0% -393.2% 9.9%
For three months ended September
30, 2003
Revenue $ 3,183,577 $ 24,237 $ 635,203 $ 3,843,017
Cost 2,961,937 36,259 220,462 3,218,658
Gross profit 221,640 -12,022 414,741 624,359
Gross profit ratio 7.0% -49.6% 65.3% 16.2%
Other Income
On July 16, 2004, Tianci Group, a related party to TCH, entered into an
agreement with China Unicom to promote CDMA mobile phones and relevant monthly
service for China Unicom. According to the signed agreement, should Tianci Group
sell varieties of CDMA mobile phones owned by China Unicom to customers who
would like to subscribe for monthly service for a period of two years with a
monthly service fee of $3.38, Tianci Group would be entitled to receive an sales
commission of $15.70 per unit, sales commission of $3.62 per SIM card, and $
12.68 for monthly service subscription. Tianci Group felt that TCH was in a
better position to sell these CDMA mobile phones, SIM cards and monthly service
subscriptions. Therefore, Tianci Group entered into an agent agreement with TCH
and asked TCH to conduct these businesses on behalf of Tianci Group.
Consequently, TCH would be entitled to receive the sales commission from Tianci
Group based on the terms between Tainci Group and China Unicom. This agent
business started in August 2004 along with the promotion initiated by China
Unicom. As this business activity is more uncertain in nature, we reported this
sales commission as other income instead of regular revenue. We recognized agent
income of $130,060 in the three months ended September 30, 2004 at TCH level.
The recurrance of this type of transaction depends on the promotion initiated by
China Unicom. Therefore, we recognize the agent income as other income.
Selling expenses
Selling expenses for the three months ended September 30, 2004 increased by
approximately $1,978 to $42,748 compared to $40,770 for the same period of the
prior year, representing an approximately 5% increase. The slight fluctuation
was due to promotion expenses related to value-added information services for
mobile phone users.
General and administrative expenses
General and administrative expenses for the three months ended September 30,
2004 increased by approximately $88,942 to $177,675 compared to $88,733 for the
same period of the prior year, representing a 100% increase. The increase was
due mainly to the fact that the software amortization expenses increased from
$9,283 to $38,092, representing a material rise. In addition, audit fees and
consulting fees of $110,656 incurred in the third quarter of 2004, accounted for
62.3% of the total general and administrative expenses.
Interest income (expense)
For the three months ended September 30, 2004, there was $18,339 of income
generated at TCH level, which was deprived from the interest of funds on deposit
in the bank. (The accrued interest from amount due from Sifang Information was
11
not accounted for properly.) For the three months ended September 30, 2003, the
interest expense was approximately $1,208, which was paid to Sifang Information
for temporary money borrowing for mobile phone distribution business.
Income tax
The Company's Chinese subsidiary is subject to taxation under the laws of the
PRC, and the statutory income tax rate for the three months ended September 30,
2003 and 2004 was 7.5%. In the three months ended of September 30, 2003 and
2004, income tax expense was approximately $37,024 and $54,306, respectively,
based on pretax income of $493,648 and pretax income $724,078.
Net income
The Company recorded a net income of $569,772 for the three months ended
September 30, 2004, a $113,148 increase in net income compared to a net income
of $456,624 for the same period of the prior year, representing a 25% increase.
The increase in net income was mainly attributable to the significant growth of
the mobile phone information service and the new bundle sales of CDMA mobile
phones business.
Earnings (loss) per share
The earnings per share for the three months ended September 30, 2004 had no
change compared to the earning per share for the three months ended September
30, 2003. The reason is that the increase of net income for the three months
ended September 30, 2004 was offset by the increase in the weighted average
number of common shares outstanding.
Liquidity and Capital Resources
The Company's cash balance decreased by approximately $750,502 from
approximately $877,568 as of September 30, 2003 to approximately $127,066 as of
September 30, 2004. This decrease in cash was due primarily to the decrease in
net income and the increase of accounts receivable.
The cash flow provided by operating activities for the nine months ended
September 30, 2004 decreased by approximately $139,716 to $290,362 compared to
$430,078 cash provided in operating activities for the same period of the prior
year. We believe that the decrease was due mainly to the increase of $1,891,866
in accounts receivable offset by the non-cash expense of $1,014,423 and increase
of $68,166 in current liabilities for the nine months ended September 30, 2004.
First, net income of $977,833 for nine months ended September 30, 2004 compared
to net income of $2,037,827 in the same period of the prior year, represented a
change of $1,059,994. Second, the cash used in accounts receivable increased
$1,891,866 in the nine months ended September 30, 2004 compared to the net cash
used of $251,770 in the same period of the prior year, representing a change of
$1,640,096. Advances to vendors increased by $463,248 at September 30, 2004
compared to the increase of $1,153,961 for the same period of the prior year,
represented a positive change of $690,713. Inventory decreased by $521,815 at
September 30, 2004, compared to the increase in inventory by $1,403,365. VAT
recoverable in the nine months ended September 30, 2004 was a cash generator
representing a change of approximately $196,420 compared to that in the same
period of the prior year. However, the change in accounts payable was in a net
cash used position in the nine months September 30, 2004, representing a
negative change of approximately $579,932 compared to positive cash inflow of
$474,889 for the same period of the prior year. The change in deferred revenue
at September 30, 2004 was less than the change in deferred revenue for the same
period of the prior year.
The cash flow used in investing activities for the nine months ended September
30, 2004 increased by $1,413,809 to approximately $2,159,769 compared to
$745,960 for the same period of the prior year, representing a significant
increase. The increase in cash used in investing activities was due mainly to
the increase in loan receivables from Sifang Information, the parent company
before the reverse acquisition. See our Note 4, "Related Party Transactions".
The cash flow provided by financing activities for nine months ended September
30, 2004 increased by approximately $282,570 compared to the absent cash inflow
for the same period of the prior year. We believe that the increase was due
mainly to the proceeds from issuing its common stock in addition to the fact
that we did not have any payment for amount due to Sifang Information in the
nine month period ended September 30, 2004.
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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 January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46, as amended by FIN 46(R),
issued in January 2003, requires an investor with a majority of the variable
interests in a variable interest entity to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A variable interest entity is an entity in which the equity
investors do not have a controlling financial interest or the equity investment
at risk is insufficient to finance the entity's activities without receiving
additional subordinated financial support from other parties. The provisions of
FIN 46(R) are applicable for fiscal years ending after December 15, 2004. The
Company does not have any variable interest entities that must be consolidated.
Item 3. Controls and Procedures
Prior to the conclusion of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13(a)-14(c). Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings.
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the date
we carried out this evaluation.
PART II OTHER INFORMATION
Item 6. Exhibits
The following documents are filed as part of this report:
31.1 Chief Executive Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Chief Financial Officer Certification furnished pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Chief Executive Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Chief Financial Officer Certification furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CHINA DIGITAL WIRELESS, INC.
(Registrant)
Date: December 20, 2004 /s/ Tai Caihua
-----------------------------------
Tai Caihua, Chief Executive Officer
Date: December 20, 2004 /s/ Lu Qin
-----------------------------------
Lu Qin, Chief Financial Officer
14