10-K 1 v070269_10k.htm
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
______________
 
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______.
 
Commission file number: 000-117718
 
ORSUS XELENT TECHNOLOGIES, INC. 
(Exact name of registrant as specified in its charter)
 
Delaware
(State of incorporation)
 
 
20-11998142 
(I.R.S. Employer Identification No.)
 
12th Floor, Tower B, Chaowai MEN Office Building
26 Chaowai Street, Chaoyang Disc.
Beijing, People’s Republic Of China 100020
(Address of principal executive offices, including zip code)
 
86-10-85653777
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, par value $0.001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o No x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 

 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. 

Large accelerated filer o  Accelerated filer o  Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of June 30, 2006, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $30,692,480 based on the closing price as reported on the OTC Bulletin Board. 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding at March 17, 2007
Common Stock, $.001 par value per share
 
29,756,000 shares


 

PART I

Item 1. Business.
 
Except as otherwise indicated by the context, references in this Annual Report to “we,” “us,” “our,” or the “Company” are to the combined business of Orsus Xelent Technologies, Inc. and its indirect wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited (“Xelent”).

Introduction

On March 31, 2005, we completed a stock exchange transaction (the “Exchange Transaction”) with the stockholders of United First International Limited, a company incorporated under the laws of Hong Kong (“UFIL”). The Exchange Transaction was consummated under Delaware law and pursuant to the terms of that certain Securities Exchange Agreement dated effective as of March 31, 2005 (the “Exchange Agreement”).
 
Pursuant to the Exchange Agreement, we issued shares of our common stock to the stockholders of UFIL, in exchange for 100% of the outstanding capital stock of UFIL. Pursuant to the Exchange Transaction, UFIL became our wholly owned subsidiary. We carry on our business through UFIL’s wholly owned subsidiary, Xelent.
 
Description of Business

We, through the operations of Xelent, have been engaged since May 2003 in the business of designing for retail and wholesale distribution economically priced cellular phones. In February of 2004, Xelent registered "ORSUS" with the State Administration for Industry and Commerce in the People’s Republic of China (the “PRC”) as its product trademark, also known as “Orsus Cellular” within the industry. Xelent has sold approximately 500,000 cellular phones in the PRC in 2006.

The market in the PRC for cellular phones has continued to expand and we have taken advantage of that expansion by gradually introducing more mature 2.5G wireless products to the public in the PRC. As the 3G standards become more mature, we anticipate that we will seek to produce our own 3G products based on both our own research and development efforts and cooperation with our strategic partners in the industry.

Organizational Structure

The organizational structure of the company is linear in nature and is comprised of ten separate departments developed to ensure proper project management and control. These departments are as follows:
 
·  
Project Management Department, which is responsible for coordinating the management of cellular phone projects, exchanging concepts and ideas with our research and development team, providing weekly project reports and supervising the project schedules.
 
1

 
·  
Technology Support and Quality Control Department, which is responsible for technical support for software and hardware design and testing and industrial design and mechanical design (“ID/IM”) checking and auditing, as well as tooling engineering and quality control during mass production;
 
·  
Business Management Department, which is responsible for materials purchase, supply chain management, business coordination and to sign the business agreements, contracts and other kinds of documents for the business partners;
 
·  
Planning and Finance Department, which is responsible for overall accounting matters, including accounting methods and processes, auditing, compiling financial plans and monthly/quarterly/yearly financial statements and financial budgets, and control of expenses;
 
·  
Human Resources Department, which is responsible for our employment issues, including hiring and termination of staff;
 
·  
Financing and Investment Department, which is responsible for overall accounting matters, financing and investment research and analysis.
 
·  
Customer Service Department, which is responsible for maintenance, spare parts ordering, authorized network management, refurbishing, after-sale data analysis and service charge fees return, , as well as a hotline service center and customer service training center, technical support and after-sale service quality assurance systems of the Company; and
 
·  
R&D Department that is responsible for researching new models of mobile phones and developing new technologies;
 
·  
Marketing Development Department, which is responsible for help the Company to find new business partners, which will act as the countryside distributors, provincial dealers and some overseas wholesalers. The department also helps the long-term partners and new incomers to set up the marketing concepts and business models of Orsus Cellular.
 
·  
Logistics Department, collect phones from each maintenance station nationwide and send the repaired phones to customers
 
Our headquarters in Beijing have seven regional management centers and a technical support center. We also have an unaffiliated network of service providers, including 179 cellular phone service centers located throughout the PRC. Of these providers, 42 are provincial replacement and refurbishment centers and 137 are maintenance and repair centers.


Market Overview and Strategic Partners
 
According to a research conducted by the PRC Ministry of Information Industry, new cellular phone users in the PRC increased by 68 million in 2006, with total consumers reaching 460 million during that year. Currently, the PRC has the largest number of cellular phone users in the world. The penetration rate for cellular phones in the PRC was approximately 35% in 2006. The number of cellular phone users is expected to reach 500 million by the year-end 2007. The cellular phone market in the PRC is expected to reach $120 billion by the year end of 2006 according to the PRC Ministry of Information Industry.

On February 26, 2006, the TD-SCDMA technology standard was officially announced as the 3G (Third Generation) technology standard in the PRC. However, sales of products incorporating the 3G has not developed as rapidly as generally anticipated (it was that 3G network construction and issuance of 3G licenses would be approved by the end of 2006). Although the granting of 3G licenses has been delayed until the middle of 2007, once introduction to the market of products utilizing the 3G technology is commenced, Xelent should be in a good position to take advantage of this business opportunity. We have commenced the development of our owned 3G cellular phone products, including 3G PCBA (3G technologies platform) and cellular phones with 3G PCBA, based on our existing 2G and 2.5G cellular technologies and cooperation with our 3G solution and chips providers. Additionally, we are planning to join into the TD-SCDMA Industry League, and we are working toward the granting of 3G cellular phones manufacturing licenses from the PRC government in 2007.

Our cellular products are customarily equipped with leading features including 1.8-inch to 2.2-inch CSTN or TFT dual-color displays, one to 120 minutes video recording, 300K to 3 million pixels photography, MP3, MPEG4 and U disk support, dual stereo speakers, e-mail messaging multimedia messaging, 40 to 64 polyphonic ring tones, slim bar-phone and flip-phone technology, ultra thin innovative lightweight design with handwriting and PDA functions, all at low to moderate price points.

Our relationships with our strategic partners, CEC Cellular Limited (“CECM”), Beijing Xingwang Shidai Tech & Trading Co., Ltd. (“XWSD”) and CECT-Chinacomm Communications Co., Ltd. (“ZDHT”) have help us to increase our market penetration. CECM, which is controlled by China Electronics Corporation Group, is a manufacturer of cellular phones with annual production of approximately one million units. CECM serves as a manufacturer for our cellular phone products. In addition, CECM has its own sales network, and we sell some of our products to CECM, who in turn sells those products to its own provincial and national sales distributors and dealers, thus increasing the distribution capabilities for our products. XWSD is also one of our major agents, selling our cellular phones to provincial distributors, city distributors and dealers. XWSD employ several market promotion services companies to enhance the sales networks of our products throughout the PRC. ZDHT is a new customer which began to cooperate with us from the fourth quarter of 2006 and is a provider and operator of telecommunication devices and services.


Description of Products & Services

Since inception, Xelent has developed, and where indicated launched, the following cellular phone products:

Project Initiation Date
 
Launch Date
 
Model/Project Code
 
Network
 January, 2006 
 
 March, 2006 
 
 C 109 
 
 CDMA
 January, 2006 
 
 March, 2006 
 
 D9000 
 
 GSM/GPRS 
 January, 2006 
 
 March, 2006 
 
 D8600 
 
 GSM/GPRS 
 January, 2006 
 
 March, 2006 
 
 X718 
 
 GSM/GPRS 
 January, 2006 
 
 March, 2006 
 
 TDA 6028 
 
 CDMA 
 January, 2006 
 
 April, 2006 
 
 X188 
 
 GSM 
 January, 2006 
 
 June, 2006 
 
 X5 
 
 GSM/GPRS 
 March, 2006 
 
 September, 2006 
 
 C300 
 
 CDMA 
 June, 2006 
 
 September, 2006 
 
 D8120 
 
 GSM/GPRS 
 March, 2006 
 
 September, 2006 
 
 C200 
 
 CDMA 
 June, 2006 
 
 September, 2006 
 
 C8000 
 
 CDMA/GSM 
 June, 2006 
 
 September, 2006 
 
 D8110 
 
 GSM/GPRS 

We outsource the manufacturer of our products to unaffiliated third parties. Once our products have been manufactured, they are delivered to a network of unaffiliated national sales distributors (see “Description of Current Business - Market Overview and Strategic Partners”) and dealers that, in turn, distribute the products to provincial sales distributors and dealers and these provincial sales distributors and dealers distribute our products to retailers throughout the PRC.


Research & Development

We do business with many kinds of research and development enterprises. We cooperate with professional design houses such as Shanghai Huntel Technology Limited (“Huntel”) and Tranzda wireless(“Tranzda”), who are mainly involved with us in MMI (U2) (“Man Machine Interface”) designing, software and hardware testing, CTA (“China Type Approval”) certification, acquisition and phone main board updating and software adaptability testing. In addition, we work with cooperative partners, such as Dalian Daxian Telecom Co., Ltd. (“Daxian”) and some companies in developing ID/MD and the layout of cellular phone main boards. Based on this research and development, our strategic business partners and we are then able to design and develop new products.
 
We mainly cooperate with other professional design houses and work together on research and development projects. Whenever possible, we use and lease their instruments and equipment, rather than purchasing it ourselves. In the area of software compiling, testing & updating, we utilize data cables and computers installed with professional software in a testing environment. All the computers and data cables are owned by Xelent.
 
As 3G continues to develop in the PRC in 2006, we anticipate that we will be able to develop our own 3G mobile phones based on both our own research and development efforts and cooperation with the strategic industry partners. We are now being negotiated with several parties including foreign 3G technology providers such as Spreadtrum Communication (Shanghai) Inc. (“SCI”), several 3G chipset and solution providers in order to get us well prepare the launch of 3 G services in coming future. We will put our efforts to focus on the development of the products in TD-SCDMA and WCDMA standard. Our strategic partners, such as SCI developed 2.5 G and 3G integrated circuit and provides 2.5G GPRS and 3G TD-SCDMA chipset and software development platforms and solutions, are the successful corporations in the PRC telecommunication industry. We believe the cooperation with 3G technology providers in working on future research and development projects will help facilitate our entry into the 3G wireless market.
 
We have established a team for technology development. The members of our team are our product planning division, project management division and industrial design center. Our product planning division is responsible for constructing the medium term strategic plans and research and development scheduling. Our project management division administers our research and development efforts, overseas manufacturing and quality control of our products and monitors costs, including human resource costs. Our industrial design center is responsible for evaluating design plans provided by third party industrial design companies and confirming model structural design and tracing the issues on module production and quality.

·  
Introduced the first watch-style cellular based on CDMA2000IX with joint efforts of Telson Electronics Co., Ltd, a South Korea company, in May of 2003.

·  
Based on GPRS CLASS 10 module, developed the first GPRS cellular collaborating system, with South Korea's TELSON, which is based on WISMO PAC P5186D, the GPRS module of WAVECOM company, in May of 2003, which was introduced on October of 2003.
 
5

 
·  
Formed a production line of 1 to 3-million Charge Coupled Device (“CCD”) pixel camera by configuring high-resolution CMOS (“Complementary Metal Oxide Semiconductor”)

Competition 
 
The Company faces substantial competition from other wireless phone manufacturers such as: Nokia, Motorola, which controlled above 50% totally, of the cellular market in the PRC in the first three quarters of 2006. In addition we face competition from Ningbo Bird Corporation Ltd and Lenovo Group Limited, both of which are domestic PRC producers and controlled between 4% and 10%, respectively of the cellular market in the PRC in 2005.
 
Government Regulation 

There is no government regulation banning or making material effect on Xelent, including but not limited, any law, rule or regulation or any order, writ, judgment, injunction, decree, determination or award binding on or applicable to Xelent. In the PRC cellular market, cellular manufacturers are responsible for repair, replacement and return of cellular phone to customers within the warranty period in accordance with certain rules and regulation in the PRC.

Intellectual Property and Proprietary Rights 

Xelent has applied for “orus”as the registered trademark and the China Trademark Agency has distributed “Notification of Acceptance” is serial number ZC3878232SL.

We utilize other intellectual property legally with partners that we cooperate with through contracts or agreements.

Employees 

We have approximately 60 employees. Of the 60 employees, 7 persons serve in management related capacities. The remaining employees are in 10 departments, namely the Project Management Department which employs 2 persons; the Technology Support and Quality Control Department which employs 4 persons; the Business Management Department which employs 2 persons; the Planning and Finance Department which employs 5 persons; the Human Resources Department which employs 8 persons; the Financing and Investment Department which employs 1 person, the Customer Service Department which employs 19 persons; the R&D Department which employs 6 persons; the Marketing Development Department which employs 3 persons and the Logistics Department employs 3 persons.

We believe that our relationship with our employees is good, and there are no collective bargaining arrangements in place. 
 
6

 
Item 1A. Risk Factors.

 You should carefully consider the following risks and the other information set forth elsewhere in this Current Report. If any of these risks occur, our business, financial condition and results of operations could be adversely affected. As a result, the trading price of our common stock could decline, perhaps significantly.
 
Risks Related to Our Business 
 
Loss of significant customers, or other major customers, could casually hurt our business by reducing our revenues and profitability.
 
Our success depends substantially upon retaining our significant clients. We cannot guarantee that we will be able to retain long-term relationships or secure renewals of short-term relationships with our significant clients in the future.
 
We face intense competition.
 
The market we serve is intensely competitive in the PRC. There are other providers that we compete with for business. There are low barriers to entry for new competitors in this market and we may experience negative impacts as a result of increased competition. In addition, our existing or potential competitors may in the future achieve greater market acceptance and gain additional market share, which in turn could reduce our revenues.
 
We depend on key personnel for the success of our business. Our business may be severely disrupted if we lose the services of our key executives and employees or fail to add new senior and middle managers to our management.
 
Our future success is heavily dependent upon the continued service of our key executives. Our future success is also dependent upon our ability to attract and retain qualified senior and middle managers to our management team. If one or more of our current or future key executives and employees are unable or unwilling to continue in their present positions, we may not be able to easily replace them, and our business may be severely disrupted. In addition, if any of these key executives or employees joins a competitor or forms a competing company, we could lose customers and suppliers and incur additional expenses to recruit and train personnel. Each of our executive officers has entered into an employment agreement with us.
 
We also rely on a number of key technology staff for the operation of our company. Given the competitive nature of our industry, the risk of key technology staff leaving our company is fairly high and could disrupt our operations.
 
We rely on a third party production center.
 
We utilize a third party production center for the manufacture of the products we sell to our customers. Should we be required to utilize a different source for our manufactured products our costs could be negatively affected.
 
7

 
Rapid growth and a rapidly changing operating environment strain our limited resources.
 
We will need to increase our investment in our technology infrastructure, facilities and other areas of operations, in particular our product development. If we are unable to manage our growth and expansion effectively, the quality of our products and services and in turn our customer support could deteriorate and our business may suffer. Our future success will depend on, among other things, our ability to:
 
·  
Continue to develop through our research and development facilities new technologies acceptable to the PRC market,
 
·  
continue training, motivating and retaining our existing employees and attract and integrate new employees, including our senior management, most of whom have been with our company for less than one year,
 
·  
develop and improve our operational, financial, accounting and other internal systems and controls, and
 
·  
maintain adequate controls and procedures to ensure that our periodic public disclosure under applicable laws, including U.S. securities laws, is complete and accurate.
 
We may not be able to adequately protect our intellectual property, and we may be exposed to infringement claims by third parties.
 
We rely on contractual restrictions on disclosure to protect our intellectual property rights. Monitoring unauthorized use of our information services is difficult and costly, and we cannot be certain that the steps we take will effectively prevent misappropriation of our technology and content. Our management may determine in the future to make application for copyright, trademark or trade secret protection if management determines that such protection would be beneficial and cost-effective.
 
From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources. In addition, third parties may initiate litigation against us for alleged infringement of their proprietary rights. In the event of a successful claim of infringement and our failure or inability to develop non-infringing technology or content or license the infringed or similar technology or content on a timely basis, our business could suffer. Moreover, even if we are able to license the infringed or similar technology or content, license fees that we pay to licensors could be substantial or uneconomical.
 
We have limited business insurance coverage.
 
The insurance industry in the PRC is still at an early stage of development. Insurance companies in the PRC offer limited business insurance products, and do not, to our knowledge, offer business liability insurance. As a result, we do not have any business liability insurance coverage for our operations. Any business disruption, litigation or natural disaster might result in substantial costs and diversion of resources.
 
8

 
Our ability to generate revenues could suffer if the Chinese market for cellular phones does not develop as anticipated.
 
The cellular phones market in the PRC has evolved rapidly over the last four years, with the introduction of new products, development of consumer preferences, market entry by new competitors and adaptation of strategies by existing competitors. We expect each of these trends to continue, and we must continue to adapt our strategy to successfully compete in our market. It is extremely difficult to accurately predict consumer acceptance and demand for various existing and potential new offerings and services, and the future size, composition and growth of this market.
 
Risks Related to Doing Business in the PRC
 
A downturn in the Chinese economy may slow down our growth and profitability.
 
The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business. Our profitability will decrease if expenditures for wireless services decrease due to a downturn in the Chinese economy. More specifically, increased penetration of wireless services in the less economically developed central and western provinces of China will depend on those provinces achieving certain income levels so that cellular phones and related services become affordable to a significant portion of the population.
 
Government regulation of the telecommunications industry may become more complex.
 
Government regulation of the telecommunications industry is highly complex. New regulations could increase our costs of doing business and prevent us from efficiently delivering our services. These regulations may stop or slow down the expansion of our user base and limit the access to our services.
 
The uncertain legal environment in China could limit the legal protections available to you.
 
The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In the late 1970s, the Chinese government began to promulgate a comprehensive system of laws and regulations governing economic matters. The overall effect of legislation enacted over the past 20 years has significantly enhanced the protections afforded to foreign invested enterprises in China. However, these laws, regulations and legal requirements are relatively recent and are evolving rapidly, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to foreign investors, such as the right of foreign invested enterprises to hold licenses and permits such as requisite business licenses.
 
Any recurrence of severe acute respiratory syndrome, or SARS, or another widespread public health problem, could adversely affect our business and results of operations.
 
A renewed outbreak of SARS or another widespread public health problem in China, where all of our revenue is derived, and in Beijing where our operations are headquartered, could have a negative effect on our operations. Our operations may be impacted by a number of health-related factors, including the following:
 
9

 
·  
quarantines or closures of some of our offices which would severely disrupt our operations,
 
·  
the sickness or death of our key officers and employees, and
 
·  
a general slowdown in the Chinese economy.
 
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations.
 
Changes in China’s political and economic policies could harm our business.
 
The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the Chinese government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD. These differences include:
 
·  
economic structure;
 
·  
level of government involvement in the economy;
 
·  
level of development;
 
·  
level of capital reinvestment;
 
·  
control of foreign exchange;
 
·  
methods of allocating resources; and
 
·  
balance of payments position.
 
As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.
 
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
 
Because almost all of our future revenues may be in the form of Renminbi, any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign invested enterprises may only buy, sell or remit foreign currencies, after providing valid commercial documents, at those banks authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi, especially with respect to foreign exchange transactions.
 
10

 
The value of our securities will be affected by the foreign exchange rate between U.S. dollars and Renminbi.
 
The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position and the price of our common stock may be adversely affected. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our ordinary shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.
 
Risks Related to our Common Stock
 
The market price for our common stock may be volatile.
 
The market price for our common stock is likely to be highly volatile and subject to wide fluctuations in response to factors including the following:
 
·  
actual or anticipated fluctuations in our quarterly operating results,
 
·  
announcements of new products and services by us or our competitors,
 
·  
changes in financial estimates by securities analysts,
 
·  
changes in the economic performance or market valuations of other companies providing similar products and services,
 
·  
announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments,
 
·  
additions or departures of key personnel,
 
·  
potential litigation, or
 
·  
conditions in the cellular phone market.
 
In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.
 
Stockholders could experience substantial dilution.
 
We may issue additional shares of our capital stock to raise additional cash for working capital. If we issue additional shares of our capital stock, our stockholders will experience dilution in their respective percentage ownership in the company.
 
11

 
We have no present intention to pay dividends.
 
We have never paid dividends or made other cash distributions on our common stock, and do not expect to declare or pay any dividends in the foreseeable future. We intend to retain future earnings, if any, for working capital and to finance current operations and expansion of our business.
 
A large portion of our common stock is controlled by a small number of stockholders.
 
A large portion of our common stock is held by a small number of stockholders. As a result, these stockholders are able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions including business combinations. In addition, the occurrence of sales of a large number of shares of our common stock, or the perception that these sales could occur, may affect our stock price and could impair our ability to obtain capital through an offering of equity securities. Furthermore, the current ratios of ownership of our common stock reduce the public float and liquidity of our common stock which can in turn affect the market price of our common stock.
 
We may be subject to “penny stock” regulations.
 
The U. S. Securities and Exchange Commission has adopted rules that regulate broker-dealer practices in connection with transactions in “penny stocks.” Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system). Penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from those rules, to deliver a standardized risk disclosure document prepared by the SEC, which specifies information about penny stocks and the nature and significance of risks of the penny stock market. A broker-dealer must also provide the customer with bid and offer quotations for the penny stock, the compensation of the broker-dealer, and our sales person in the transaction, and monthly account statements indicating the market value of each penny stock held in the customer’s account. In addition, the penny stock rules require that, prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the trading activity in the secondary market for stock that becomes subject to those penny stock rules. Whenever any of our securities become subject to the penny stock rules, holders of those securities may have difficulty in selling those securities.
 
Our securities are quoted on the OTC Bulletin Board, which limits the liquidity and price of our securities more than if our securities were quoted or listed on The Nasdaq Stock Market or a national exchange.
 
Our securities are traded in the over-the-counter market and quoted on the OTC Bulletin Board, an inter-dealer automated quotation system for equity securities sponsored and operated by the National Association of Securities Dealers, Inc., or NASD, but not included in The Nasdaq Stock Market. Quotation of our securities on the OTC Bulletin Board limits the liquidity and price of our securities more than if our securities were quoted or listed on The Nasdaq Stock Market or a national exchange. Lack of liquidity will limit the price at which you may be able to sell our securities or your ability to sell our securities at all.
 
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Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

We have offices in Beijing, Shenzhen, Shanghai, Tianjin and Hong Kong. Our Beijing office serves as our corporate headquarters. Our Shenzhen Office serves as the base for cellular component sourcing and coordination with suppliers and manufacturers. Our Shanghai Office is mainly responsible for sourcing and coordination with cellular component suppliers, coordination with our research and development partners and following up the hardware and software testing aspects before the mass production. Our Tianjin Office is mainly responsible for the production management. Its functions include coordination with our principal manufacturer to adjust the produciton plan in accordance with our sales plan, raw material supply and cellular phone delivery management and supervision of the production processing of our principal manufacturer, as well as the quality control. The office in Hong Kong is a representive office for coordination with customers.

The following is relevant information on our offices:

Address
 
Office / Production
 
Process / Lease
 
Monthly Rental (rmb)
 
Monthly Rental (usd)
 
Lease period
26T, Xinbaohui Plaza, Nanyou Avunue, Nanshan Dist., Shenzhen
 
Office
 
Lease
 
5,000.0
 
640
 
08/06 to 08/07
                     
12th Floor, Tower B, Chaowai MEN Office Building, 26 Chaowai Street, Chaoyang Disc., Beijing
 
Office
 
(1)
 
 
 
05/06 to 12/06
                     
No. 3, Lane 600, Tianshan Rd., Changning Dist., Shanghai
 
Office
 
Lease
 
9,960
 
1,274
 
05/06 to 04/07
                     
No.185, Xinda Road, Hebei District, Tianjin
 
Office
 
— (2)
 
 
 
                     
No. 1, Fuyou Street, Airport Huoyun Road, Shunyi Dist., Beijing
 
Office
 
—(3)
 
 
 
                     
Room 1502, Jubilee Centre, 18 Fenwick Street, 46 Gloucester Road, Wanchai, Hong Kong
 
Office
 
Lease
 
16,300(HKD)
 
2,095
 
9/5/05 to 9/4/07
 

(1)
From May 1, 2006 to December 31, 2006, there is a rent-free period for our headquarter in Beijing, the rental charge is still under the negotiation with landlord.
 
(2)
Our Tianjin office is located in the CECM factory. The office is provided by CECM and is cost-free to us.
 
(3)
These two offices are provided by Beijing Xin Ganxian Logistic Company and is cost-free to us.
 
13


Item 3. Legal Proceedings
 
We are not party to any litigation, and we are not aware of any threatened litigation that would have a material adverse effect on us or our business.
 
Item 4. Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of securityholders during the fourth quarter of the fiscal period ended December 31, 2006.

PART II
 
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and  Issuer Purchases of Equity Securities.
 
Shares of our common stock are traded on the OTC Bulletin Board under the symbol “ORXT.OB” Our common stock has been traded on the OTC Bulletin Board since March 2005.

Holders.

  As of March 17, 2006, we had approximately 24 stockholders of our common stock of record, and our common stock had a closing bid price of $2.05 per share and a closing ask price of $1.85 per share.

The following table sets forth the quarterly average high and low bid prices per share for our common stock for the period commencing with the Exchange Transaction and ending on December 31, 2006:

Fiscal Year Ended
 
Common Stock
 
December 31, 2005
 
High
 
Low
 
First Quarter
   
NA
   
NA
 
Second Quarter
 
$
3.10
 
$
1.90
 
Third Quarter
 
$
2.00
 
$
1.10
 
Fourth Quarter
 
$
2.25
 
$
1.29
 
 
         
December 31, 2006
         
First Quarter
 
$
2.40
 
$
1.85
 
Second Quarter
 
$
2.60
 
$
1.90
 
Third Quarter
 
$
2.06
 
$
1.10
 
Fourth Quarter
 
$
3.00
 
$
1.60
 
 
The source for the high and low closing bids quotations is the Yahoo Finance website and does not reflect inter-dealer prices. Such quotations are without retail mark-ups, mark-downs or commissions, and may not represent actual transactions and have not been adjusted for stock dividends or splits.
 
14


Outstanding Options, Conversions, and Planned Issuance of Common Stock.

There are no warrants or options outstanding to acquire any shares of our common stock

Preferred Stock.

Our corporate charter permits us to issue up to 100 million shares of preferred stock from time to time, as are determined by resolution of our Board of Directors. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of our Company without further action by stockholders and could adversely affect the rights and powers, including voting rights, of holders of common stock, with us acting in accordance with our corporate charter and bylaws. In certain circumstances, the issuance of preferred stock could depress the market price of the common stock.

There are no shares of preferred stock outstanding.

Dividends.

We have never declared or paid any cash dividends or distributions on our common stock. We currently intend to retain our future earnings to support operations and to finance future growth and expansion and, therefore, do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Transfer Agent and Registrar.

Our transfer agent is Corporate Stock Transfer, located at 3200 Cherry Creek Drive South, Suite 430, Denver, Colorado 80209. Their telephone number is (303) 282-4800.

Securities Authorized for Issuance Under Equity Compensation Plans.

As of the fiscal year ended December 31, 2006, we have no shares of our common stock or preferred stock that are issuable under compensation plans approved by our security holders.

Recent Sales of Unregistered Securities.

Each issuance set forth below was made in reliance upon the exemptions from registration requirements of the Securities Act of 1933, as amended, contained in Section 4(2) on the basis that such transactions did not involve a public offering. When appropriate, we determined that the purchasers of securities described below were sophisticated investors who had the financial ability to assume the risk of their investment in our securities and acquired such securities for their own account and not with a view to any distribution thereof to the public. Where required by applicable law, the certificates evidencing the securities bear legends stating that the securities are not to be offered, sold or transferred other than pursuant to an effective registration statement under the Securities Act or an exemption from such registration requirements.
 
15


Each of the following individuals received their shares pursuant to the Exchange Agreement on March 31, 2005:
 
Name
 
Shares
 
         
Wang Xin
   
3,000,000
 
Liu Yu
   
6,000,000
 
Wang Zhibin
   
6,000,000
 
 
Item 6. Selected Financial Data.

The following selected financial data has been extracted from our financial statements for the year ended December 31, 2006. This selected financial data should be read in conjunction with our financial statements and the related notes included in Item 8 of this Annual Report.

Statement of Operations Data
 
For year ended December 31, 2006
 
For year ended December 31, 2005
 
 
 
 
 
 
 
Operating Expenses
 
$
60,102,000
   
25,711,000
 
 
         
Other Income - Interest, net
 
$
75,000
   
544,000
 
 
         
Net Income
 
$
6,718,000
   
3,492,000
 
 
         
Weighted Average Common Shares Outstanding
   
29,756,000
   
29,756,000
 
 
         
Net Income Per Common Share - Basic and Diluted
 
$
0.23
   
0.12
 
 
 
Balance Sheet Data
 
As of December 31, 2006
 
As of December 31, 2005
 
 
 
 
 
 
 
Working Capital
 
$
21,963,000
   
14,158,000
 
 
         
Total Assets
 
$
45,887,000
   
31,011,000
 
 
         
Stockholders’ Equity
 
$
22,283,000
   
14,939,000
 


Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion should be read in conjunction with our financial statements and footnotes thereto contained in this report.

Overview

The Company was organized under the laws of State of Delaware in May 2004, under the name “Universal Flirts Corp”. On June 1, 2004, the Company acquired all the issued and outstanding shares of Universal Flirts Inc., a New York corporation, from Darrel Lerner, the sole shareholder, in consideration for the issuance of 8,500,000 shares of the Company’s common stock to Mr. Lerner pursuant to a stock exchange agreement between Universal Flirts Inc. and the Company. Pursuant to the purchase and share exchange transaction, Universal Flirts Inc. became the wholly-owned subsidiary of the Company.

Pursuant to Stock Transfer Agreement dated March 29, 2005, the Company transferred all of the common stock of Universal Flirts Inc. to Mr. Darrell Lerner in exchange for the cancellation of 28,200,000 shares of the Company’s common stock. The Company then had 14,756,000 shares of its common stock outstanding.

On March 31, 2005, Universal Flirts Corp. completed a stock exchange transaction with the stockholders of United First International Limited, a company incorporated under the laws of Hong Kong (“UFIL”). The exchange was consummated under the laws of State of Delaware and pursuant to the terms of the Exchange Agreement. In connection with its acquisition of UFIL, the Company also authorized a 4-1 forward split of its common stock.

Pursuant to the Exchange Agreement, Universal Flirts Corp. issued 15,000,000 shares of its common stock, $0.001 par value, to the stockholders of UFIL, representing approximately 50.41% of the Company’s issued and outstanding common stock, in exchange for 20,000,000 outstanding shares of UFIL and cash payment of $50,000 from UFIL. Immediately after giving effect to the exchange, the Company had 29,756,000 shares of its common stock outstanding. Pursuant to the exchange, UFIL became a wholly-owned subsidiary of the Company and most of the Company’s business operations are now conducted through UFIL’s wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited (“Xelent”).

On April 19, 2005, the Company, formerly known as Universal Flirts Corp., changed its list name to Orsus Xelent Technologies, Inc. The Company's OTC Bulletin Board symbol is ORXT and its CUSIP Number is 68749U106.

In July, 2005 a wholly owned subsidiary, Orsus Xelent Trading (HK) Company Limited, was incorporated in Hong Kong. Orsus Xelent Trading (HK) Company Limited is engaged in the trading of cellular phones and accessories with overseas customers.

Business Review

The respective market shares of domestic PRC cellular phone manufacturers decreased in the first quarter of 2006. The primary cause of this decrease was increased competition among domestic and overseas manufacturers. Advancements in technology prompted foreign cellular phone manufacturers to speed up the rollout of new products. Also, foreign cellular phone manufacturers offered price reductions to promote and clear their inventories of older products. This increase in competition was compounded by the continuing proliferation of counterfeit and “black market” cell phones in the PRC, which impacted sales of cellular phone products by legitimate manufacturers such as Xelent.
 
17


By the second quarter of 2006, most of the domestic PRC cellular phone manufacturers had adjusted their strategy to increase the competitiveness by price cutting, improving the quality of the products and accelerating the pace of new product rollouts. These manufacturers are creating better efficiency by introducing products designed for the local market and better using their supply chain. As a result, they have adapted to the rapidly changing market in the PRC and regained in the second quarter of 2006 some of the market share they lost in the first quarter. Additionally, they are beginning to make a stronger move into the overseas market to broaden their sales and increase their revenues.

According to our market research, the market of cellular phones equipped with specialized applications for specific industry users has been developed rapidly in the PRC. These products are custom designed and equipped with specialized applications and software to meet the special requirements of users in various specialized industries (such as bank, State Administration for Industry & Commerce (“SAIC”), logistic and securities companies). In the fourth quarter of this year, we entered into an Intent of Cooperation Agreement with a software development provider, Hua Yuan Run Tong (Beijing) Technology CO., Ltd. (“HYRT”), to assist us in meeting the need for these customized cellular phones. HYRT developed specialized software to support an application platform called the Industry & Commerce Law-Enforcement Platform (“ICEP”). The ICEP platform uses the CDMA 1X wireless data networks of the PRC to integrate commercial and government information resources. This includes a customized digital administration system for SAIC of the PRC in the Hebei Province that provides easy access by SAIC's professional law-enforcement teams. It provides technical support for SAIC officials to conduct mobile law-enforcement and food-safety monitoring. The public can also access business information through the ICEP. We anticipate that 20,000 specialized application devices will be provided to SAIC of Hebei Province in 2007. The business relating to our specialized application cellular phone devices will grow rapidly as a consequence of our cooperation with the software development company, HYRT and SAIC, and this could provide us a considerable advantage as we look to broaden our presence in the larger commercial markets.

In the fourth quarter of 2006, the device, model X180, which is provided by Xelent, has passed the test by HYRT, and got the NO. 001 qualified test report. We become the first terminal product provider of HYRT. Our product X180 becomes the only one model for the exhibition and illustration during the business promotion by HYRT to SAIC and China Unicom. Through the promotion conducting by HYRT, our product X180 is widely affirmed and recognized by SAIC and China Unicom. The recognition by China Unicom could help us to further develop our specialized application device in other industries. We believe the product line of specialized application device could have a significant growth in the year of 2007.

Demand for our cellular phone products has increased as a result of the correct positioning of our products to meet the needs of the mid-level and low-end markets in the PRC. Our mid-level and low-end products are all equipped with a number of attractive features, such as MP3, MEPG4, camera and support outer card storage card. Also, the overall reduction in the GSM charges of PRC telecommunication providers, which caused an increase in the number of new cellular phone subscribers, also enhanced the demand of new cellular phones. After reduction of inventories by price cutting from domestic manufacturers in the second quarter, the profit margin of domestic cellular phones manufacturers, including Xelent, in the third quarter was comparable to profit margins in the first quarter of 2006. We expect this trend to continue and we are, therefore, optimistic with respect to our profits for the fourth quarter.
 
18


The following table summarizes our operation result for the year 2006 and 2005:

 
 
Year ended
December 31, 2006
 
Year ended
December 31, 2005
 
Comparison
 
 
 
$’000
 
% of revenue
 
$’000
 
% of revenue
 
$’000
 
% 
 
Revenues
   
68,108
       
28,705
       
39,403
   
137.27
%
Cost of sales
   
55,226
   
81.09
%
 
22,272
   
77.59
%
 
32,954
   
147.96
%
Sales & Marketing expenses
   
1,045
   
1.53
%
 
1,554
   
5.41
%
 
(509
)
 
- 32.75
%
General & Admin expenses
   
1,560
   
2.29
%
 
1,064
   
3.71
%
 
496
   
46.62
%
R&D expenses
   
255
   
0.37
%
 
413
   
1.44
%
 
(158
)
 
- 38.26
%
Depreciation & Amortization
   
175
   
0.26
%
 
310
   
1.08
%
 
(135
)
 
- 43.55
%
Allowance for Obsolete Inventory
   
1,387
   
2.04
%
 
98
   
0.34
%
 
1,289
   
1,315.31
%
Loss on Disposal of property, Plant and Equipment
   
454
   
0.67
%
 
0
   
0.00
%
 
454
   
0.00
%
Interest expenses
   
116
   
0.17
%
 
25
   
0.09
%
 
91
   
364.00
%
Other income, net
   
75
   
0.11
%
 
544
   
1.90
%
 
(469
)
 
- 86.21
%
Income before tax
   
7,965
   
11.69
%
 
3,513
   
12.24
%
 
4,452
   
126.73
%
Income taxes
   
1,247
   
1.83
%
 
21
   
0.07
%
 
1,226
   
5,838.10
%
Net income
   
6,718
   
9.86
%
 
3,492
   
12.17
%
 
3,226
   
92.38
%
 

The following table summarizes our operating result for the three months ended December 31, 2006 and 2005, respectively:

 
 
Three months ended December 31, 2006
 
Three months ended December 31, 2005
 
Comparison
 
 
 
$’000
 
% of revenue
 
$’000
 
% of revenue
 
$’000
 
% 
 
Revenues
   
22,207
   
100.00
%
 
12,101
   
100.00
%
 
10,106
   
83.51
%
Cost of sales
   
17,973
   
80.93
%
 
8,891
   
73.47
%
 
9,082
   
102.15
%
Sales & Marketing expenses
   
119
   
0.54
%
 
423
   
3.50
%
 
-304
   
-71.87
%
General & Admin expenses
   
-323
   
-1.45
%
 
295
   
2.44
%
 
-618
   
-209.49
%
R&D expenses
   
68
   
0.31
%
 
76
   
0.63
%
 
-8
   
-10.53
%
Depreciation & Amortization
   
26
   
0.12
%
 
146
   
1.21
%
 
-120
   
-82.19
%
Allowance for Obsolete Inventory
   
761
   
3.43
%
 
222
   
1.83
%
 
539
   
242.79
%
Loss on Disposal of property, Plant and Equipment
   
454
   
2.04
%
 
0
   
0.00
%
 
454
   
0.00
%
Interest expenses
   
46
   
0.21
%
 
0
   
0.00
%
 
46
   
0.00
%
Other income, net
   
74
   
0.33
%
 
3
   
0.02
%
 
71
   
2,366.67
%
Income before tax
   
3,157
   
14.22
%
 
2,051
   
16.95
%
 
1,106
   
53.92
%
Income taxes
   
1,087
   
4.89
%
 
-2
   
-0.02
%
 
1,089
   
54,450.00
%
Net income
   
2,070
   
9.32
%
 
2,053
   
16.97
%
 
17
   
0.83
%
 
Application of critical accounting policies and estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities, including those related to revenue recognition, inventories, adequacy of allowances for doubtful accounts, valuation of long-lived assets, income taxes, and warranties. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The policies discussed below are considered by management to be critical to an understanding of our financial statements.

Revenue recognition

Net sales represent the invoiced value of goods, net of value-added tax (“VAT”) and returns. We generally recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. We have a policy of including handling costs incurred for finished goods, which are not significant, in sales and marketing expenses.
 
20


Warranties

We offer warranties on the products we manufacture. Terms generally are for one year from the date of sale. Provision for warranty expense is established for costs that are expected to be incurred after the sales and delivery of products under warranty. The balance of warranty provision was $53,000 by the year ended December 31, 2006. The warranty provision is determined based on known product failures, historical experience of the level of repairs and replacements, and other currently available evidence.

Income taxes

Provision for income and other related taxes have been provided in accordance with the tax rates and laws in effect in the PRC. 

Income tax expense is computed based on pre-tax income included in the consolidated statements of operations. Deferred income taxes are provided, using the liability method, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities and their reported amounts. The tax consequences of those differences are classified as current or non-current based upon the classification of the related assets or liabilities in the consolidated financial statements. 

Trade receivables and allowance for doubtful accounts

Trade receivables are recorded at original invoice amount, less an estimated allowance for uncollectible accounts. Trade credit is generally extended on a short-term basis, thus trade receivables do not bear interest. Trade receivables are periodically evaluated for collectibility based on past credit history with customers and their current financial condition. Changes in the estimated collectibility of trade receivables are recorded in the results of operations for the year in which the estimate is revised. Trade receivables are presented net of an allowance for doubtful accounts of $230,000 and $149,000 as of December 31, 2006 and of 2005 respectively.

Inventories

Inventories are stated at the lower of cost or market. Potential losses from obsolete and slow-moving inventories are provided for when identified. Cost, which comprises all costs of purchase and, where applicable, other costs that have been incurred in bringing the inventories to their present location and condition, is calculated using the weighted average method. Market represents the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. 

Impairment of long-lived assets

The long-lived assets we hold and use are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
 
21


Results of operation

Revenues

Our revenues were $68,108,000 for the twelve months ended December 31, 2006, representing an increase of 137.27% as compared to 28,705,000 in the Fiscal Year 2005. After going through an environment of reformation in the cellular phone market in 2005, we adjusted our business model, our market position and our strategy and improved our technology and the quality of our products, in terms of both function and appearance. We believe that we are now in a much better position to deal with the rapidly changing and competitive market for cellular phone products in the PRC. Also, we are better prepared to take advantage of the rejuvenated cellular phone market that has resulted from the reduction in the monthly fee charged by telecommunication provides in the second quarter of 2006.
 
We continue the cooperation with telecommunication operator and expanded the sales of our CDMA products, which accounted for 37% of our total revenues for the year ended December 31, 2006, representing an increase of 398%, compared to 2005. Meanwhile, the sales of GSM products have remained relatively stable. Our business strategy emerged in the second quarter and took effect in the third and fourth quarter.
 
Our mid-level and low-end products contain a number of attractive features, such as MP3, MPEG4, video recording and outer card storage. Our high-end products contain those same features as well as PDA, GPRS and office software function, special industry applications and other attractive features and functions. The appearance of all our products are in line with the latest trends, including being ultra slim and containing a wide use of metal casing, and they have been well received by our customers. We introduced a middle-grade dual mode cellular phone with both GSM & CDMA applications in the third quarter to meet the demand in the market for this type of product.
 
Products Segment

For the year ended December 31, 2006, products attributed over 3% of our revenues are shown as follows: 
 
     
Twelve months ended December 31, 2006 
 
     
$’000 
   
% of revenue 
 
D8120
   
10,805
   
15.86
%
C8000
   
10,442
   
15.33
%
D8110
   
10,124
   
14.86
%
Daxian X5
   
8,395
   
12.33
%
C300
   
4,572
   
6.71
%
C200
   
3,373
   
4.95
%
C109
   
2,474
   
3.63
%
Others
   
17,923
   
26.32
%
 
22

 
In 2006, we kept on our self-developed handsets business and jointly cooperation with our R&D partners, which took 53% of the total revenue, representing a decrease of 5%, as compared to 58% in 2005; we also developed the trade sales activities in order to widen our revenue streams, which took 47% of the total revenue in 2006, representing an increase of 5%, as compared to 42% in 2005. The increase in the portion of the trading mobile phones activities subsequently provides a risk-control on R&D investments and materials-ordering in facing the competition from the ‘black market’ (counterfeit) cellular phones in the PRC, because the business cycle of trade sales is shorter than R&D models, which made us forestall the ‘black market’ cellular phones in the market.

The total revenue for the twelve months ended December 31,2006 amounted to $68,108,000, of which the sale of GSM products in this period accounted for $43,064,000, or 63.23%, of our total revenue. The GSM products mainly included, D8120 ($10,805,000), D8110 ($10,124,000), Daxian X5 ($8,395,000), and others ($13,740,000). The sales of CDMA was $25,044,000, representing 36.77% of our total revenue, which included C8000 ($10,442,000), C300 ($4,572,000), C200 ($3,373,000), C109 ($2,474,000), and others ($4,183,000). The CDMA sale has sharply increased by $20,012,000, or 397.69%, as compared to $5,032,000 in fiscal year 2005.

Our GSM products are mainly purchased from China Electronic Apparatus Company and Beijing Dong Fang Long Yu Trading Company, which include D8120 (ultra thin, slide PDA with MP3, MEPG4, Camera, T-Flash Card, handwriting touch screen), D8110 (ultra thin, slide PDA with MP3, MEPG4, Camera, T-Flash Card), X5 (ultra thin with MP3, MEPG4, Camera, T-Flash Card). Our CDMA products are mainly purchased from Tian Feng Ju Yuan Technology Company Limited, Beijing Tian Hong Bo Communication Apparatus Company Limited and Dalian Daxian Telecom Co., Ltd, which include C8000 (a high-end PDA with MP3, MEPG4, Camera, T-Flash Card, GSM & CDMA Simultaneous Standby Dual Mode handset), C300 (a high-end cell phone with colorful screen, MP3, Camera and IM System), C200 (a low-end shell phone with colorful screen, MP3, Camera), C109 (a low-end bar phone with colorful screen).

For the three months ended December 31, 2006, products attributed over 3% of our revenues are shown as follows:
 
     
Three months ended December 31, 2006 
 
     
$’000 
   
% of revenue 
 
D8110
   
8,698
   
39.17
%
C8000
   
6,737
   
30.34
%
D8120
   
5,893
   
26.54
%
Others
   
879
   
3.96
%
 
23

 
In the fourth quarter of 2006, sales reached $22,207,000, as compared with $12,101,000 in the same period in 2005, which represents a growth in sales of 83.51%. Revenue derived from GSM cellular phones in the fourth quarter of 2006 was $15,053,000 and accounted for 67.79% of the sales in this quarter. Meanwhile, sales of our CDMA products in the fourth quarter of 2006 generated revenue of $7,154,000 and accounted for 32.21% of sales in this quarter, which accounts for a $5,092,000 increase as compared to the same period of 2005.

The revenue in the fourth quarter of 2006 had increased by 8.19%, as compared to $20,525,000 in the third quarter of 2006. The increase of the revenue is primarily attributable to the launch of our ultra-thin, slim bar modes which are currently in demand by the market; and our cooperation with telecommunication operators with respect to our CDMA products in various grades.

Customers Segment
 
     
Twelve months ended
December 31, 2006 
 
     
$’000 
   
% of revenue 
 
Beijing Xingwang Shidai Tech & Trading Co., Ltd.
   
36,406
   
53.45
%
CEC Cellular Limited
   
12,902
   
18.94
%
CECT-Chinacomm Communications co.,ltd
   
10,485
   
15.39
%
Others
   
208
   
0.31
%
Subtotal (Domestic)
   
60,001
   
88.10
%
Singapore ST
   
6,112
   
8.97
%
Singapore CEO
   
1,996
   
2.93
%
Subtotal (Overseas)
   
8,107
   
11.90
%

Our revenues were primarily derived from three major domestic customers. For the twelve months ended December 31, 2006, our revenues generated from Beijing Xingwang Shidai Tech & Trading Co., Ltd. (“XWSD”), CEC Cellular Limited (“CECM”) and CECT-Chinacomm Communications Co.,Ltd (“ZDHT”) were $36,406,000, $12,902,000, and $10,485,000 respectively. XWSD is one of the most important customers of Xelent for a long period of time, the sales to XWSD was accounting for 53.45% of the total revenues in 2006. The other two major domestic customers accounted for 18.94% (CECM) and 15.39% (ZDHT) respectively. Both XWSD and CECM are distributors and dealers in Mainland China, and their sales networks cover most of the major cities in the PRC. ZDHT is a new customer which began to cooperate with us from the fourth quarter of 2006. ZDHT is a telecommunication devices and services operator. In the overseas market, we distribute our products to two Singapore customers, which are namely ST Electronics (Info-Software Systems) Pte Ltd. and Chartered Electro-Optics Pte Ltd. The revenues generated from these two companies were $8,107,000, or 11.90% of the total revenue.

 
     
Three months ended
December 31, 2006 
 
     
$’000 
 
 
% of revenue 
 
Beijing Xingwang Shidai Tech & Trading Co., Ltd.
   
11,590
   
52.19
%
CECT-Chinacomm Communications co.,ltd
   
10,485
   
47.21
%
Others
   
132
   
0.60
%

In the fourth quarter, 52.19% of our revenue is generated from XWSD, and 47.21% from ZDHT. To reduce the risk of concentration, we developed a new customer of ZDHT in the fourth quarter, which could enlarge our customer base.

Other income, net

For the twelve months ended December 31, 2006, other net income was $75,000, or 0.11% of the total revenues. There was a significant decrease as compared with $544,000 of other net income in the same period of 2005. The decrease in other income, net in 2006 was primarily due to the once-off royalty fee rebate amounting to $309,000 in the second quarter of 2005.

Operating expenses

For the twelve months ended December 31, 2006, our operating expenses amounted to $60,102,000. The operating expenses mainly includes sales and marketing, general and administrative and R & D expenses and depreciation were shown and compared with the same period in 2005 as follows:
 
   
Twelve months ended December 31, 2006
 
Twelve months ended December 31, 2005
 
Comparison
 
 
 
$’000
 
% of revenue
 
$’000
 
% of revenue
 
$’000
 
% 
 
Cost of sales
   
55,226
   
81.09
%
 
22,272
   
77.59
%
 
32,954
   
147.96
%
Sales & marketing exp.
   
1,045
   
1.53
%
 
1,554
   
5.41
%
 
(509
)
 
-32.75
%
General & admin. exp.
   
1,560
   
2.29
%
 
1,064
   
3.71
%
 
496
   
46.62
%
R&D
   
255
   
0.37
%
 
413
   
1.44
%
 
(158
)
 
-38.26
%
Depreciation
   
175
   
0.26
%
 
310
   
1.08
%
 
(135
)
 
-43.55
%
Allowance for Obsolete Inventory
   
1,387
   
2.04
%
 
98
   
0.34
%
 
1,289
   
1315.31
%
Loss on Disposal of Property, Plant and Equipment
   
454
   
0.67
%
 
0
   
0.00
%
 
454
   
0.00
%
Total
   
60,102
   
88.25
%
 
25,711
   
89.57
%
 
34,391
   
133.76
%
 

For the three months ended December 31, 2006, our operating expenses was $19,078,000.

   
Three months ended December 31, 2006
 
Three months ended December 31, 2005
 
Comparison
 
 
 
$’000
 
% of revenue
 
$’000
 
% of revenue
 
$’000
 
% 
 
Cost of sales
   
17,973
   
80.93
%
 
8,891
   
73.47
%
 
9,082
   
102.15
%
Sales & marketing. exp.
   
119
   
0.54
%
 
423
   
3.50
%
 
(304
)
 
-71.87
%
General & admin. exp.
   
(323
)
 
-1.45
%
 
295
   
2.44
%
 
(618
)
 
-209.49
%
R&D
   
68
   
0.31
%
 
76
   
0.63
%
 
(8
)
 
-10.53
%
Depreciation
   
26
   
0.12
%
 
146
   
1.21
%
 
(120
)
 
-82.19
%
Allowance for Obsolete Inventory
   
761
   
3.43
%
 
222
   
1.83
%
 
539
   
242.79
%
Loss on Disposal of Property, Plant and Equipment
   
454
   
2.04
%
 
0
   
0.00
%
 
454
   
0.00
%
Total
   
19,078
   
85.92
%
 
10,053
   
83.08
%
 
9,025
   
89.77
%

Cost of Sales
 
For the twelve months ended December 31, 2006, our cost of sales was $55,226,000, or 81.09% of revenue. The cost of sales to revenues was 77.59% for the corresponding period in 2005, resulting in an increase of 3.50%. The principal reasons for this increase was the keen competition in the cellular phone industry in the PRC, the pressure on price cutting in our selling price was greater than the reduction in our purchase cost. Additioanlly $8,107,000 of the sales in the second quarter of 2006 were overseas trading, which have generally lower margins as compared to our domestic sales.
 
Sales and marketing expenses

Sales and marketing expenses mainly represent payments made to sales personnel, cost of provision for after-sales services, and marketing and transportation costs.

For the twelve months ended December 31, 2006, sales and marketing expenses were $1,045,000, or 1.53% of total revenue, as compared to $1,554,000, or 5.41% of total revenue for the corresponding period in 2005. This constituted a decrease of 32.75% as compared to the corresponding period in 2005. This decrease was due to the reduction in the number of personnel. In addition, the after-sales service expense was reduced resulting from the increase of the portion of trading of cellular phones, where no after-sales service is provided for the trading activities.
 
Because of the reasons above, for the three months ended December 31, 2006, sales and marketing expenses were $119,000, or 0.54% of total revenue, representing a 71.87% decrease, as compared to the same period of last year. It represents a decrease of 15%, as compared with $140,000 in the third quarter of 2005.
 
26

 
R&D expenses

Our R&D expenses were $255,000 or 0.37% of total revenue for the twelve months ended December 31, 2006, which represents 38.26% decrease, as compared with $413,000 or 1.44% of total revenues in the same period of 2005. This decrease R&D expenses was attributed to increase in our trading activities and the change of the business model to purchase mature projects instead of R&D independently. Moreover, the reduction of staff is another reason that decreased R&D expense.

General and administrative expenses

General and administrative expenses primarily consist of compensation for personnel, depreciation, travel expenses, rental, materials expenses related to ordinary administration and fees for professional services.

For the twelve months ended December 31, 2006, general and administrative expenses were $1,560,000, which represents 2.29% of total revenue. Included in general and administrative expenses was a allowance for doubtful accounts amounting to $767,000, due primarily to the uncertainty of long outstanding account receivables and trade deposits,. Except for the allowance factor, the general and administrative expenses were $793,000 or 1.16% of the total revenue and represented a decrease of $122,000 or 13.22%, as compared to $915,000 in 2005. The decrease in the expenses was mainly due to the fact that we laid off redundant personnel. Since the second half year of 2005, we have adjusted our business strategy, and this resulted in the redundant personnel, which made the ordinary staff costs, including the wages and insurance for personnel, decrease in relation to the decrease in the numbers of staff.

For the three months ended December 31, 2006, general and administrative expenses were $-323,000. The negative balance is due to that $605,000 bad debts which has been provided in third quarter was recovered in the fourth quarter. Except for this effect, the expenses were only $282,000 or 1.27% of the total revenue, which increased 46.23%, as compared to $146,000, for the corresponding period in 2005. General and administrative expenses increased $140,000 in the fourth quarter of 2006, as compared to 142,000 in the third quarter (expect for the provision of accounts receivables). The increases were mainly due to the seasonal fluctuation.

Allowance for obsolete inventories

For the twelve months ended December 31, 2006, allowance for obsolete inventories were $1,387,000, which was due to the provision on certain age materials for some products which have stopped.

Gross profit and gross profit margin

For the twelve months ended December 31, 2006, our gross profit was $12,882,000. Our gross profit margin for the reporting period was 18.91%, which represents 3.5% decrease, as compared to 22.41% of 2005. The gross profit margin in the fourth quarter had a slight increase, which reached 19.07%.

The changes in our gross profit margin are attributable to:

1.  
The keen competition from the domestic cellular manufactures and the overseas cellular providers by the strategy of price-cutting.
   
2.  
The gross profit of overseas trade being relatively low. We have continued to develop our overseas customers since the second quarter of 2006. At the beginning stage of the development of overseas customers, the price of our products was designed to be favorable and attractive to our customers, and the gross profit of overseas is approximately 15%
   
3.  
Increase in the sales of low-ended products, the demand of the low ended products was stimulated by the reduction of monthly charges by the telecommunication operators.

27


Net income

For the twelve months ended December 31, 2006, our net income was $6,718,000, or net profit margin 9.86%, representing an increase of 3,226,000 or 92.38%, as compared to $3,492,000, or net profit margin 12.17% in 2005. The improvement in our net profit is due primarily to the fact that we have been successful in changing the new business strategy, and positioning in the domestic market played an important part in the increase in our net income. Furthermore, the sharp decline of 30% in the labor costs resulting from our cost control efforts is another reason for the improvement in net income.

However, our net profit margin decreased by 2.30%, as compared to last year, which is mainly because:

1.  
In 2006, the allowance for obsolete inventories and doubtful accounts were amounted to $1,387,000 and $767,000 respectively and the loss on the disposal of old moulds amounted to $454,000.
   
2.  
The income tax of $1,247,000, which was provided in 2006.

Other than the two factors above, our net profit became $10,573, 000 and the net profit margin reached 15.52%, representing an increase of $6,833,000, as compared to the net income $3,740,000 of 2005(other than the provision). So our profitability has substantially increased in 2006.

Liquidity and Capital Resources

We generally finance our operations from cash flow generated internally.

As of December 31, 2006, we had current assets of $45,567,000. Current assets are mainly comprised of accounts receivable of $31,425,000, trade deposits of $8,989,000, restricted cash, cash and cash equivalents of $2,421,000, inventory of $1,230,000 and other accounts receivable of $1,502,000. Current liabilities of $23,604,000, included accounts payable of $10,964,000, short-term bank loan of $6,268,000, other accrued expenses and accrued liabilities of $4,444,000, tax payable of $1,294,000, amounts due to directors of $330,000 and other creditors of 304,000.

We offer two different trading terms to our customers, i.e. cash-on-delivery and on credit term within 45-90 days. As of December 31, 2006, our accounts receivable has increased $19,391,000, as compared to $12,034,000 on December 31, 2005. The increase in our account receivables was due primarily to trading with our two major customers, XWSD and CECM.
 
28


As of December 31, 2006, our trade deposits were $8,989,000, which represented a decrease of $1,591,000 or 15%, as compared to $10,580,000 on December 31, 2005. The trade deposit comprised the deposit of the produce of Specialized Application Devices and good-sale cellular phones.

As of December 31, 2006, our inventories were $1,230,000, which represented a decrease of $3,230,000 or 72.43%, as compared to $4,460,000 on December 31, 2005. This decrease was due in large part to our use of old materials during the production of our older models. In addition, our newly developed products do not require us to carry large level of inventories because the component parts are readily available. We have critically and regularly evaluated our inventory and an allowance for obsolete inventory was made. An aggregate of $1,804,000 was taken as an allowance for obsolete inventories as of December 31, 2006.

As of December 31, 2006, we provided an advance to third party of $288,000 to overseas partners, which are Hongkong Donor Development Company Limited ($248,000) and Millon Leader International Limited ($40,000).

As of December 31, 2006, our pledged deposit was $1,128,000. The deposit was pledged to a third party guarantor for providing guarantee service to us in respect of a bank borrowing of $6,268,000.

As of December 31, 2006, our accounts payables were $10,964,000, which represented an increase of $3,025,000 or 38.1%, as compared to $7,939,000 on December 31, 2005. The increase in accounts payable was attributable mainly to unpaid products from our vendor China Electronic Apparatus Company and Fusong Technology Development (Shenzhen) Ltd.

As of December 31, 2006, our accrued expenses and other accrued liabilities were $4,444,000, which represented a significant growth of $2,185,000 or 96.72%, as compared to $2,259,000 on December 31, 2005. The increase is mainly because of the aggregated VAT of $3,961,000.

As of December 31, 2006, our tax payable was $1,294,000, which was attributable mainly to the income tax that we mentioned in the net profit analysis.

As of December 31, 2006, our cash and bank balances were mainly denominated in Renminbi (“RMB”) and Hong Kong Dollar. Our revenue and expenses, assets and liabilities are mainly denominated in RMB. Our activities, assets and liabilities are mainly denominated in RMB, any further possible inflation of RMB would be beneficial to us. We consider that the exposure to exchange fluctuations is relatively low and therefore we have not engaged in any hedging activity.

Cash Flows

As of December 31, 2006, we have the cash and cash equivalents of $2,421,000, as compared to $2,974,000 on December 31, 2005. This represented a decrease of $553,000, or 18.59%. This decrease was mainly due to the increase in the accounts receivable, which was due to the convergent trade in the end of 2006 As a result; the cash coming to us was slower. However, these trading are in the credit term.
 
29


As of December 31, 2006, our short-term loan was $6,268,000, which is composed of $2,558,000 from Huaxia Bank and $3,710,000 from Beijing Rural Bank.

Our gearing ratio, calculated as total debts over total assets, was 51.44%, as of December 31, 2006, it was basically the same as compared to 51.83% as of December 31, 2005.
 
Contingent Liabilities

As of December 31, 2006, we had not entered into any guarantee contracts nor any non-disclosed contracts which will affect stockholders’ equity or share structure.

Off Balance Sheet Arrangements
  
As of December 31, 2006, we had no off balance sheet arrangements.
 
Contractual Commitments
  
The Company is obligated to make future under various contracts, including purchase and operating leases. The Company does not have any long-term debt or capital lease obligations. The following table summarized the Company’s contractual obligations at December 31, 2006, reported by maturity of obligation.

 
 
Payments due by period
 
Contractual Obligations
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
 
   
$’000
 
$’000
 
$’000
 
$’000
 
$’000
 
                       
Long-term Debt Obligations
   
6,268
   
6,268
   
-
   
-
   
-
 
Capital Lease Obligations
   
-
   
-
   
-
   
-
   
-
 
Operating Lease Obligations
   
27
   
27
   
-
   
-
   
-
 
Purchase Obligations
   
19,422
   
19,422
         
-
   
-
 
Other long-term liabilities reflected on the registrant’s balance sheet under GAAP
   
-
   
-
   
-
   
-
   
-
 
Total
   
25,717
   
25,717
   
-
   
-
   
-
 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
 
Market risk is the sensitivity of income to changes in interest rates, foreign exchanges, commodity prices, equity prices and other market-driven rates or prices. The Company, in the normal course of doing business, is exposed to market risk through changes in interest rates with respect to bank loans. Bank loans at December 31, 2006 were $6,268,000. The interest rate for twelve months ended December 31, 2006 was charged at 6.7% to 7.956% per annum.
 
30


The Company considers Renminbi as its functional currency as a substantial portion of the Company's business activities are based in Renminbi. However, the Company has chosen the United States dollar as its reporting currency.

Transactions in currencies other than the functional currency during the year are translated into the functional currency at the applicable rates of exchange prevailing at the time of the transactions. Monetary assets and liabilities denominated in currencies other than functional currency are translated into functional currency at the applicable rates of exchange in effect at the balance sheet date. Exchange gains and losses are recorded in the combined statements of operations.

For translation of financial statements into the reporting currency, assets and liabilities are translated at the exchange rate at the balance sheet date, equity accounts are translated at historical exchange rates, and revenues, expenses, gains and losses are translated at the weighted average rates of exchange prevailing during the period.

Translation adjustments resulting from this process are recorded, when material, in accumulated other comprehensive income (loss) within stockholders' equity.

 Item 8. Financial Statements and Supplementary Data.
 
Reference is made to pages F-1 through F-16 comprising a portion of this annual report on Form 10-K.
 
Item 9. Changes in and Disagreements with Accountants on Accounting and  Financial Disclosure.
 
None.
 
Item 9A. Controls and Procedures.
 
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and that such information is accumulated and communicated to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
The Company, under the supervision of our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures as of December 31, 2005. Based upon that evaluation, management, including our chief executive officer and chief financial officer, concluded that the Company’s disclosure controls and procedures were effective in alerting it in a timely manner to information relating to the Company required to be disclosed in this report.
 
During our fiscal year 2006, there were no significant changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
 
31


Item 9B. Other Information.
 
Not applicable.
 
PART III
 
Item 10. Directors, Executive Officers and Corporate Governance.

As of December 31, 2006, our current directors and executive officers were as follows:

Name
 
Age
 
Positions Held and Tenure
Wang Xin
 
38
 
Chief Executive Officer and a Director
Zhao Hongwei
 
41
 
Chief Financial Officer
Liu Yu
 
41
 
Director
Wang Zhibin
 
37
 
Director

Wang Xin has served as Chief Executive Officer and a member of our Board of Directors since March 31, 2005. From April 2003 to present, he has also served as Director and General Manager of Xelent. Prior to joining Xelent, he served as the as the General Manager of the Sales and Marketing Division of Shanghai Cellstar International Trading Co., Ltd. from January 2003 to April 2003, Director of Logistics & Customer Service of Shanghai Cellstar International Trading Co., Ltd. from November 1997 to January 2003, and Director and Vice President of Beijing VA Communication Equipment Co., Ltd. from May 1996 to October 1997.
 
Zhao Hongwei has served as our Chief Financial Officer since October 26, 2005. Mr. Zhao has over 15 years’ experience in accounting and financial management, mainly with listed companies in Hong Kong and Foreign Invested Enterprise in the PRC, most recently serving as the regional financial controller of XinAo Gas Holdings Limited, a listed company in Hong Kong.
 
Liu Yu has served as a member of our Board of Directors since March 31, 2005 and a member of the Board of Directors of Xelent since April 2003. From May 1998 to present he has also served as Chairman of the Board of Beijing Huanyitong Technology & Trading Co., Ltd. From May 1995 to April 1998, he served as General Manager of Beijing Lianwanjia Telecommunication Trading Center.
 
Wang Zhibin has served as a member of our Board of Directors since March 31, 2005, and a member of the Board of Directors of Xelent since August 2004. From May 1998 to present, he has also served as General Manager of Beijing Glory Real Estate Development Co., Ltd., and a director of Beijing Huanyitong Technology & Trading Co., Ltd. From May 1995 t o April 1998, he served as a Manager of Beijing Lianwanjia Telecommunication Trading Center.
 
Subsequent Events
 
On February 7, 2007, Naizhong Che, Peng Wang, Zhixiang Zhang, Nathaniel K. Hsieh, and Howard S. Barth were elected to our Board of Directors by unanimous written consent of our Board of Directors, effective immediately.
 
32

 
Mr. Naizhong Che earned his B.S. from Beijing University of Posts and Telecommunications. Now retired, he has broad experience in the communications industry including R&D, production, imports and exports. He served twelve years with the Ministry of Information Industry of China Posts and Telecommunications Industry Standardization Institute in various capacities.
 
Mr. Peng Wang earned his bachelor’s degree at Central University of Finance and Economics and his master’s at Guanghua School of Management, Peking University. His expertise includes formulating, planning and implementing marketing strategies for technology companies. He is currently General Manager for Beijing Youlilianxu Technology Co., Ltd. where he is responsible for products in China, including ViewSonic projection, Samsung MP4 and LG projection.
 
Mr. Zhixiang Zhang earned bachelor and master’s degrees at Central University of Finance and Economics. He has extensive experience in corporate financial management, audits and financial strategy, and most recently was the Financial Controller for Cec-Chinacomm Communications Co., Ltd.
 
Mr. Nathaniel K. Hsieh is a member of the Illinois and Iowa Bar Associations. He earned his L.L.M. at Georgetown University and his J.D. at the University Of Iowa College Of Law. He is the Founder and President of Tritent International Corp. of Chicago, Illinois, which oversees tobacco import and manufacturing operations for one of the 60 independent tobacco manufacturers in U.S.
 
Mr. Howard S. Barth is a member of the Canadian Institute of Chartered Accountants and the Ontario Institute of Chartered Accountants. He earned his B.A. and M.B.A. at York University and has over 25 years of experience as a certified accountant. Until recently, he was chief executive officer and president with Yukon Gold Corporation, Inc., a public company which is dual-listed in the U.S. and Canadian markets. He is currently a director of Yukon Gold Corporation Inc. and has served on its audit committee. He is also a member of the Board of Directors and chairman of the audit committee for Nuinsco Resources Limited, a TSX-listed exploration company.

Committees of the Board of Directors

As of December 31, 2006, our Board of Directors did not have any standing committees.

On February 7, 2007, our Board of Directors approved and authorized the establishment of three new committees to facilitate and assist the Board of Directors in the execution of its responsibilities: the Audit Committee, the Compensation Committee and the Nominations/Corporate Governance Committee. In accordance with American Stock Exchange listing standards, all the committees are comprised solely of non-employee, independent Directors. Charters for each committee are available on the Company’s website at www.orsus-xelent.com. The charter of each committee is also available in print to any stockholder who requests it. The table below shows current membership for each of the standing committees of our Board of Directors.
 
33

 
Audit Committee
 
Nominating/Corporate Governance Committee
 
Compensation Committee
Nathaniel K. Hsieh (Chair)
 
Naizhong Che (Chair)
 
Naizhong Che (Chair)
Howard S. Barth
 
Nathaniel K. Hsieh
 
Zhixiang Zhang
Zhixiang Zhang
 
Peng Wang
 
Peng Wang

Audit Committee

The Audit Committee is comprised solely of non-employee Directors, all of whom our Board of Directors has determined are independent pursuant to the rules of the American Stock Exchange (the “AMEX Rules”). Our Board of Directors has determined that all the members of the Audit Committee are financially literate pursuant to the AMEX Rules. Our Board of Directors also has determined that Mr. Barth is an Audit Committee Financial Expert within the meaning stipulated by the Securities and Exchange Commission. As the Audit Committee was only recently established subsequent to the fiscal year end on December 31, 2006, the members of the Audit Committee were not involved in the review and approval of this annual report on Form 10-K.

Corporate Governance Committee

The Corporate Governance Committee is comprised solely of non-employee Directors, all of whom our Board of Directors has determined are independent pursuant to the AMEX Rules.

Compensation Committee

The Compensation Committee is comprised solely of non-employee Directors, all of whom our Board of Directors has determined are independent pursuant to the AMEX Rules.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee is comprised entirely of independent directors.

  Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities and Exchange Act of 1934, as amended, requires our directors, officers and persons owning more than 10% of our common stock to file reports of ownership and changes of ownership with the Securities and Exchange Commission. Based on its review of the copies of such reports furnished to us, or representations from certain reporting persons that no other reports were required, we believe that all applicable filing requirements were complied with during the fiscal year dated December 31, 2006.
 
34

 
Item 11. Executive Compensation.
 
Compensation Discussion and Analysis

General Philosophy
 
We compensate our senior management and key employees through a single way of base salary currently. However our compensation programs of a mix of base salary, bonus and equity compensation is under consideration and will be designed to impact all employees by setting general levels of compensation and helping to create an environment of goals, rewards and expectations. Because we believe the performance of every employee is important to our success, we are mindful of the effect of executive compensation and incentive programs on all of our employees.

At the senior-most levels, we will design the incentive compensation to reward company-wide performance through tying awards primarily to earnings growth and stock appreciation. At lower levels, we will design the incentive compensation to reward the achievement of specific operational goals within areas under the control of the relevant employees, although company-wide performance is also a factor.

Base Salaries

We want to provide our senior management with level of assured cash compensation in the form of base salary that facilitates an appropriate lifestyle given their professional status and accomplishments. For our chief executive officer, we concluded that a base salary of between $65,000 and $75,000 was appropriate in this regard for fiscal year ending December 31, 2006. Similarly, we concluded that a base salary of between $30,000 and $40,000 was appropriate for our chief financial officer for fiscal year ending December 31, 2006. These ranges were not objectively determined, but instead reflect levels that we concluded were appropriate based upon our general experience. We performed a similar analysis with respect to other senior management. At the senior vice president level we have a significant level of competition for them. We believe that this gives us the opportunity to attract and retain talented managerial employees both at the senior executive level and below.
 
35


Summary Compensation Table

SUMMARY COMPENSATION TABLE

Name & Principal Position
 
Year
 
Salary
($)
 
Bonus
($)
 
Stock
Awards
($)
 
Option
Awards
($)
 
Non-Equity Incentive Plan Compensation
($)
 
Change in Pension value and Nonqualified deferred compensation earnings
($)
 
All other Compensation
($)
 
Total
($)
 
Wang Xin, PEO
   
2006
   
66,309
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
66,309
 
Zhao Honwei, PFO
   
2006
   
30,110
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
30,110
 
Wang Xiaolong, Vice-President
   
2006
   
25,757
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
25,757
 
Zhou Liangyun Vice-president
   
2006
   
22,989
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
22,989
 
Wan Feng, CEO Assistant
   
2006
   
20,395
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
N/A
   
20,395
 

As of as of December 31, 2006, the Company did not have any “Grants of Plan-Based Awards”, “Outstanding Equity Awards at Fiscal Year-End”, “Option Exercises and Stock Vested”, “Pension Benefits”, or “Nonqualified Deferred Compensation”. Nor did the Company have any “Post-Employment Payments” to report.

There was no officer whose salary and bonus for the period exceeded $100,000. The amounts listed in the table above were paid by Xelent, the wholly owned subsidiary of our wholly owned subsidiary UFIL. While we do have employment agreements with our executive officers, the salary for our executive officers is at the discretion of our Board of Directors. We expect to pay substantially similar compensation to our executives in the future and anticipate continuing to pay them through Xelent.

We have no stock option, retirement, pension, or profit-sharing programs for the benefit of directors, officers or other employees, but our Board of Directors may recommend adoption of one or more such programs in the future.
 
Compensation of Directors
 
The Company does not has pay compensation to its directors. All directors are reimbursed for out-of-pocket expenses in connection with attendance at Board of Director’s and/or committee meetings. The Company may establish other compensation plans (e.g. options, cash for attending meetings, etc.) in the future.
 
36

 
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth information regarding the beneficial ownership of our common stock as of March 17, 2006 for each person known by us to be the beneficial owner of more than 5% of our outstanding shares of common stock. Unless otherwise indicated, we believe that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them.

       
Amount and Nature of Beneficial Ownership(2)
 
Title of Class
 
 
Name and Address of Beneficial Owner(1)
 
Number
of Shares (3)
 
Percent of
Voting Stock (4)
 
Common
   
Wang Xin, Chief Executive Officer and Director
   
3,000,000
   
10.09
%
Common
   
Liu Yu, Director
   
6,000,000
   
20.16
%
Common
   
Wang Zhibin
   
6,000,000
   
20.16
%
 

(1)
Unless otherwise noted, the address is that of the Company.

(2)
On March 17, 2006, there were 27,956,000 shares of our common stock outstanding. Each person named above has sole investment and voting power with respect to all shares of the common stock shown as beneficially owned by the person, except as otherwise indicated below.

(3)
Under applicable rules promulgated by the U. S. Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), a person is deemed the “beneficial owner” of a security with regard to which the person, directly or indirectly, has or shares (a) the voting power, which includes the power to vote or direct the voting of the security, or (b) the investment power, which includes the power to dispose or direct the disposition of the security, in each case irrespective of the person’s economic interest in the security. Under these SEC rules, a person is deemed to beneficially own securities which the person has the right to acquire within 60 days through (x) the exercise of any option or warrant or (y) the conversion of another security.
 
(4)
In determining the percent of our common stock owned by a person (a) the numerator is the number of shares of our common stock beneficially owned by the person, including shares the beneficial ownership of which may be acquired within 60 days upon the exercise of options or warrants or conversion of convertible securities, and (b) the denominator is the total of (i) the 29,756,000 shares of our common stock outstanding on March 17, 2006 and (ii) any shares of our common stock which the person has the right to acquire within 60 days upon the exercise of options or warrants or conversion of convertible securities. Neither the numerator nor the denominator include shares which may be issued upon the exercise of any other options or warrants or the conversion of any other convertible securities.
 
The following table sets forth information regarding the beneficial ownership of our common stock as of March 17, 2006 for each of our officers and directors and all our officers and directors as a group. Unless otherwise indicated, we believe that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them.
 
37

 
       
Amount and Nature of Beneficial Ownership(2)
 
Title of Class
 
 
Name and Address of Beneficial Owner(1)
 
Number
of Shares (3)
 
Percent of
Voting Stock (4)
 
Common
   
Wang Xin, Chief Executive Officer and Director
   
3,000,000
   
10.09
%
Common
   
Liu Yu, Director
   
6,000,000
   
20.16
%
Common
   
Zhao Hongwei, Chief Financial Officer
   
   
 
Common
   
Naizhong Che, Director
   
   
 
Common
   
Peng Wang, Director
   
   
 
Common
   
Zhixiang Zhang, Director
   
   
 
Common
   
Nathaniel K. Hsieh, Director
   
   
 
Common
   
Howard S. Barth, Director
   
   
 
Common
   
Directors and executive officers as a group (4 persons)
 
 
9,000,000
   
30.25
%
 

(1)
Unless otherwise noted, the address is that of the Company.

(2)
On March 17, 2006, there were 27,956,000 shares of our common stock outstanding. Each person named above has sole investment and voting power with respect to all shares of the common stock shown as beneficially owned by the person, except as otherwise indicated below.

(3)
Under applicable rules promulgated by the U. S. Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), a person is deemed the “beneficial owner” of a security with regard to which the person, directly or indirectly, has or shares (a) the voting power, which includes the power to vote or direct the voting of the security, or (b) the investment power, which includes the power to dispose or direct the disposition of the security, in each case irrespective of the person’s economic interest in the security. Under these SEC rules, a person is deemed to beneficially own securities which the person has the right to acquire within 60 days through (x) the exercise of any option or warrant or (y) the conversion of another security.
 
(4)
In determining the percent of our common stock owned by a person (a) the numerator is the number of shares of our common stock beneficially owned by the person, including shares the beneficial ownership of which may be acquired within 60 days upon the exercise of options or warrants or conversion of convertible securities, and (b) the denominator is the total of (i) the 29,756,000 shares of our common stock outstanding on March 17, 2006 and (ii) any shares of our common stock which the person has the right to acquire within 60 days upon the exercise of options or warrants or conversion of convertible securities. Neither the numerator nor the denominator include shares which may be issued upon the exercise of any other options or warrants or the conversion of any other convertible securities.

Securities Authorized for Issuance Under Equity Compensation Plans.

As of the fiscal year ended December 31, 2006, we have no shares of our common stock or preferred stock that are issuable under compensation plans approved by our security holders.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

Messrs Wang Xin, Liu Yu and Wang Zhibin have outstanding loans to the company in the amount of $330,000, which loans are unsecured, interst-free and repayable by the Company on demand.
 
38


The Company has bank loans amounting of $6,268,000 which were guaranteed by the director, Messrs Liu Yu.

Director Independence

Messrs. Naizhong Che, Peng Wang, Zhixiang Zhang, Nathaniel K. Hsieh, and Howard S. Barth are all non-employee Directors, and all of whom our Board of Directors has determined are independent pursuant to the rules of the AMEX Rules and the Securities and Exchange Commission. All of the members of members of our Board of Directors Audit Committee, Nominating/Corporate Governance Committee and Compensation Committee are independent pursuant to the rules of the AMEX Rules and the Securities and Exchange Commission.

Item 14. Principal Accounting Fees and Services.
 
The firm of Moores Rowland Mazars acts as our principal accountant. The following is a summary of fees paid to our principal accountant for services rendered.

Audit Fees

During the fiscal year ended December 31, 2006, the fees for our principal accountant were $81,500, which was composed of $22,500 for quarters review and $59,000 for Form 10-K.

Audit Related Fees

During 2006, our principal accountant did not render assurance and related services reasonably related to the performance of the audit or review of financial statements.

Tax Fees

During 2006, our principal accountant did not render services to us for tax compliance, tax advice and tax planning.

All Other Fees

During 2006, there were no fees billed for products and services provided by the principal accountant other than those set forth above.

Audit Committee Approval 

As of December 31, 2006, our Board of Directors had not established an audit committee. The Audit Committee was established subsequent to the fiscal year end on December 31, 2006, but the Audit Committee has not held a meeting since its establishment and the members of the Audit Committee were not involved in the review and approval of this annual report on Form 10-K. Our equity securities are not currently listed on an exchange and automated quotation system that require its listed companies to appoint an audit committee. Our Board of Directors approved the engagement of Moores Rowland Mazars as our independent registered public accounting firm in a meeting held May 9, 2005.

39

 
PART IV  
 
Item 15. Exhibits and Financial Statement Schedules
 
(a)
Financial Statements.
 
Our financial statements as set forth in the Index to Financial Statements attached hereto commencing on page F-1 are hereby incorporated by reference.
 
(b)
Exhibits.
 
The following exhibits, which are numbered in accordance with Item 601 of Regulation S-K, are filed herewith or, as noted, incorporated by reference herein:

Exhibit
Number
 
Exhibit Description
3.1  
 
Certificate of Incorporation (1) 
     
3.2  
 
Bylaws (1) 
     
10.1  
 
Securities Exchange Agreement by and among Universal Flirts Corp, United First International Limited and the Shareholders of United First International Limited (2) 
     
10.2  
 
National Sales and Agency Contract by and among CEC Mobile Co. Ltd., Beijing Prosperous Times Commercial & Trading Co., Ltd. and Beijing Orsus Xelent Technology & Trading Company Limited dated May 26, 2004. (2) 
     
10.3  
 
National Sales and Agency Contract by and among CEC Mobile Co. Ltd., Beijing Prosperous Times Commercial & Trading Co., Ltd. and Beijing Orsus Xelent Technology & Trading Company Limited dated March 18, 2004. (2) 
     
10.4  
 
National Sales and Agency Contract by and among CEC Mobile Co. Ltd., Beijing Prosperous Times Commercial & Trading Co., Ltd. and Beijing Orsus Xelent Technology & Trading Company Limited dated April 29, 2004. (2) 
     
10.5  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Chengxin Electronic Technology Co., Ltd. dated May 28, 2004 (2) 
     
10.6  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Chengxin Electronic Technology Co., Ltd. dated May 28, 2004 (2) 
     
 
40

 
10.7  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Chengxin Electronic Technology Co., Ltd. dated May 28, 2004 (2) 
     
10.8  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Suncom Logidtics Limited dated April 14, 2004 (2) 
     
10.9  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Suncom Logistics Limited dated May 27, 2004 (2) 
     
10.10  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Suncom Logistics Limited dated May 27, 2004 (2) 
     
10.11  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Shanghai Suncom Logistics Limited dated May 27, 2004 (2) 
     
10.12  
 
Purchase Contract by and among Beijing Orsus Xelent Technology & Trading Company Limited and Truly Semiconductor Co., Ltd. dated May 21, 2004 (2) 
     
10.13  
 
National Sales and Agency Contract by and among CEC Mobile Co., Ltd., Beijing Prosperous Times Commercial & Trading Co., Ltd. and Beijing Orsus Xelent Technology & Trading Company Limited dated May 26, 2004 (2) 
     
10.14  
 
National Sales and Agency Contract by and among CEC Mobile Co., Ltd., Beijing Prosperous Times Commercial & Trading Co., Ltd. and Beijing Orsus Xelent Technology & Trading Company Limited dated May 26, 2004 (2) 
     
21.1  
 
Subsidiaries of the Company (3) 
     
24.1  
 
Power of Attorney (set forth on signature page) 
     
31.1  
 
Certification of Principal Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002 (3) 
     
31.2  
 
Certification of Principal Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002 (3) 
     
32.2  
 
Certification under Section 906 of the Sarbanes-Oxley Act of 2002 (3) 
 

(1)
Incorporation by reference to the Company's Registration Statement on Form S-1, as amended (Registration No. 333-125687).
   
(2)
Incorporated by reference to the Company's Current Report on Form 8-K dated May 4, 2005.
   
(3)
Filed herewith.
 
 
Orsus Xelent Technologies, Inc.

Index to Consolidated Financial Statements
Year ended December 31, 2006


   
Page
Report of Independent Registered Public Accounting Firm
 
F-1
Consolidated Statements of Operations
 
F-2
Consolidated Balance Sheets
 
F-3
Consolidated Statements of Changes in Stockholders’ Equity
 
F-4
Consolidated Statements of Cash Flows
 
F-5
Notes to Consolidated Financial Statements
 
F-6 - F-16
42

 
Report of Independent Registered Public Accounting Firm
 
To the Stockholders and Board of Directors
Orsus Xelent Technologies, Inc.
 
We have audited the accompanying consolidated balance sheets of Orsus Xelent Technologies, Inc. and its subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 
 
Moores Rowland Mazars
Chartered Accountants
Certified Public Accountants
Hong Kong

Date: March 30, 2007
 
F-1

 
Orsus Xelent Technologies, Inc.

Consolidated Statements of Operations
Years ended December 31, 2006 and 2005

 
     Note  
2006
 
2005
 
     
US$’000
 
US$’000
 
               
Operating revenues - Net sales
         
68,108
   
28,705
 
                     
Operating expenses:
                   
Cost of sales
         
55,226
   
22,272
 
Sales and marketing
         
1,045
   
1,554
 
General and administrative
         
1,560
   
1,064
 
Research and development
         
255
   
413
 
Depreciation
         
175
   
310
 
Allowance for obsolete inventories
         
1,387
   
98
 
Loss on disposal of property, plant and  equipment
         
454
   
-
 
                     
Total operating expenses
         
60,102
   
25,711
 
                     
Operating income
         
8,006
   
2,994
 
                     
Interest expense
         
(116
)
 
(25
)
Other income, net
         
75
   
544
 
                     
Income before income taxes
         
7,965
   
3,513
 
Income taxes 
   
4
   
(1,247
)
 
(21
)
                     
Net income
         
6,718
   
3,492
 
                     
Other comprehensive income
                   
Foreign currency translation adjustment
         
626
   
349
 
                     
Comprehensive Income
         
7,344
   
3,841
 
                     
Earnings per share
                   
Basic and diluted (US$)
   
5
   
0.23
   
0.12
 
                     
                     
Weighted average number of common shares outstanding
         
29,756,000
   
29,756,000
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
F-2


Orsus Xelent Technologies, Inc.

Consolidated Balance Sheets
As of December 31, 2006 and 2005 


 
   
Note 
 
2006
 
2005
 
     
US$’000
 
US$’000
 
ASSETS
         
 
 
Current assets
             
Cash and cash equivalents
         
2,421
   
2,974
 
Accounts receivable, net of allowance for doubtful accounts of $230,000 (2005: $149,000)
         
31,425
   
12,034
 
Inventories
   
6
   
1,230
   
4,460
 
Trade deposits paid
         
8,989
   
10,580
 
Advance to third party
         
288
   
-
 
Other current assets
         
86
   
182
 
Pledged deposit
   
7
   
1,128
   
-
 
                     
Total current assets
         
45,567
   
30,230
 
                     
Property, plant and equipment, net
   
8
   
320
   
781
 
                     
Total assets
         
45,887
   
31,011
 
                     
LIABILITIES AND STOCKHOLDERS’ EQUITY
                   
Current liabilities
                   
Short-term bank loan
   
9
   
6,268
   
-
 
Accounts payable - Trade
         
10,964
   
7,939
 
Accrued expenses and other accrued liabilities
         
4,444
   
2,238
 
Trade deposits received
         
251
   
5,432
 
Due to directors
   
12
   
330
   
320
 
Provision for warranty
         
53
   
122
 
Tax payables
         
1,294
   
21
 
                     
Total current liabilities
         
23,604
   
16,072
 
                     
Commitments and contingencies
   
13
             
                     
Stockholders’ equity
                   
Preferred stock, US$0.001 par value:  Authorized: 100,000,000 shares, no shares issued
         
-
   
-
 
Common stock and paid-in capital, US$0.001 par value: Authorized: 100,000,000 shares
                   
Issued and outstanding: 29,756,000 shares as of December 31, 2006 and as of December 31, 2005
         
30
   
30
 
Additional paid-in capital
         
2,484
   
2,484
 
Dedicated reserves
         
1,042
   
1,042
 
Other comprehensive income
         
975
   
349
 
Retained earnings
         
17,752
   
11,034
 
                     
Total stockholders’ equity
         
22,283
   
14,939
 
                     
Total liabilities and stockholders’ equity
         
45,887
   
31,011
 

The accompanying notes are an integral part of these consolidated financial statements.
 
F-3


Orsus Xelent Technologies, Inc.

Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2006 and 2005

 
   
Common stock issued
   
Additional
   
Dedicated
 
Other
compre-
         
   
No. of
shares
 
Amount
 
paid-in
capital
 
reserves
 
hensive
income
 
Retained
earnings
 
Total
 
       
US$’000
 
US$’000
 
US$’000
 
US$’000
 
US$’000
 
US$’000
 
                               
Balance as of January 1, 2005
   
29,756,000
   
30
   
2,484
   
1,042
   
-
   
7,542
   
11,098
 
                                             
Net income
   
-
   
-
   
-
   
-
   
-