S-1 1 v101835_s-1.htm
 
As Filed with the Securities and Exchange Commission on February 5, 2008
Registration No. 333-____________


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
________________
 
FORM S-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
 
________________
 
ORSUS XELENT TECHNOLOGIES, INC.
(Name of Registrant As Specified in its Charter)

Delaware
7389
20-1198142
(State or Other Jurisdiction of
(Primary Standard Industrial
(I.R.S. Employer Identification No.)
Incorporation
Classification Code Number)
 
or Organization)
 
 
 
12th Floor, Tower B, Chaowai MEN Office Building
26 Chaowai Street, Chaoyang Disc.
Beijing, People’s Republic Of China 100020
86-10-85653777
(Address and Telephone Number of Principal Executive Offices)
 
________________
 
Liu Yu
12th Floor, Tower B, Chaowai MEN Office Building
26 Chaowai Street, Chaoyang Disc.
Beijing, People’s Republic Of China 100020
86-10-85653777
(Name, Address and Telephone Number of Agent for Service)
 
________________
 
Copy to

Robert S. Matlin, Esq.
Joel D. Mayersohn, Esq.
Aaron W. Menzi, Esq.
Arnstein & Lehr LLP
Kirkpatrick & Lockhart Preston Gates Ellis LLP
200 East Las Olas Boulevard
599 Lexington Avenue
Suite 1700
New York, New York 10022
Fort Lauderdale, Florida 33301-2299
Telephone (212) 536-4066
Tel: (954) 713-7614
Facsimile (212) 536-3901
Fax: (954) 713-7714
________________
 
Approximate Date of Proposed Sale to the Public: As promptly as practicable after this registration statement becomes effective and the satisfaction or waiver of certain other conditions described herein.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. £

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. £

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. £

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement the same offering. £
 

 

CALCULATION OF REGISTRATION FEE
 

   
Proposed
Proposed
 
   
Maximum
Maximum
Amount of
Title of Each Class of
Amount To Be
Offering Price
Aggregate
Registration
Securities To Be Registered
Registered
Per Share (2)
Offering Price (2)
Fee (3)
Common Stock, $.001 par value per share (1)
[____]
[____]
$18,400,000.00
$723.12
Underwriter’s Warrants to Purchase Common Stock Expiring [2012]
[____]
[____]
 
-- (4)
Common Stock, $.001 par value per share issuable upon conversion of Underwriter’s Warrants Expiring [2012](5)
[____]
[____]
$2,208,000.00
$86.71
 Total Registration Fee
     
$809.89(6)


 
(1)
Includes __________ shares that may be issued upon exercise of a 45 day option granted to the underwriters to cover over-allotments.

 
(2)
Estimated pursuant to Rule 457(c) of the Securities Act of 1933 solely for the purpose of computing the amount of the registration fee based on the average of the high and low sales prices reported on the American Stock Exchange on [______], 2008.

 
(3)
Calculated by multiplying the proposed maximum aggregate offering price by 0.0000393.

 
(4)
No fee pursuant to Rule 457(g).

 
(5)
We have agreed to sell to the Underwriter warrants to purchase up to 10% of the total number of shares sold to the public in this offering. The exercise price of the Underwriter's warrants is equal to 120% of the public offering price.

 
(6)
This amount is being paid herewith.
________________

The Registrant amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall hereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the registration statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.
 


 
 
The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission becomes effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted. 

PRELIMINARY PROSPECTUS

Subject to Completion, Dated __________, 2008

[__________] SHARES OF COMMON STOCK

ORSUS

We are offering [__________] shares of our common stock. We have granted to the underwriters a 45-day option to purchase up to [__________] additional shares of common stock solely to cover over-allotments, if any (over and above the [_________] shares of common stock referred to above). Our shares of common stock are listed for trading on the American Stock Exchange (“AMEX”) under the ticker symbol “ORS”. On February 1, 2008, the closing sales price for our common stock on AMEX was $2.10 per share.
 
 
 
Price Per share
 
Total
 
                        shares of Common stock (1)
  $       
Underwriting discounts and commissions(2)
  $       
 
           
Proceeds to us, before expenses
  $              

(1)
Excludes __________ shares of our common stock that may be issued upon exercise of a 45 day option granted to the underwriters to cover over-allotments.

(2)
Excludes the non-accountable expense allowance payable to the underwriters equal to 2% of the gross proceeds of the offering, or $__________. The non-accountable expense allowance is not payable with respect to the shares sold upon exercise of the underwriters’ over-allotment option.
________________
 
The purchase of the securities involves a high degree of risk. See section entitled “Risk Factors” beginning on page 9.
 
________________

Neither the U.S. Securities and Exchange Commission nor any state securities commission has approved or disapproved of anyone’s investment in these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
________________

The underwriters expect to deliver the shares of common stock to purchasers on or about _________, 2008.

NEWBRIDGE SECURITIES CORPORATION
 
_______________, 200_
 

 
 
Orsus Mobile Models

Orsus Mobile Models


 


   
1
 
   
6
 
   
7
 
   
7
 
   
19
 
   
20
 
   
21
 
   
21
 
   
44
 
   
59
 
   
63
 
   
64
 
   
65
 
   
68
 
   
71
 
   
71
 
   
71
 
   
F-1
 
   
II-1
 
   
II-4
 
________________
 
Please read this prospectus carefully. It describes our business, our financial condition and results of operations. We have prepared this prospectus so that you will have the information necessary to make an informed investment decision.

In this prospectus, Orsus Xelent Technologies, Inc. is referred to as “Orsus” and, together with its subsidiaries as “we,” “our,” “us” and the “Company.” The principal operating subsidiary of Orsus is its indirect wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited (“Xelent”).
 
You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with information different from that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of the common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
 

 


Because this is only a summary, it does not contain all of the information that may be important to you. You should carefully read the more detailed information contained in this prospectus, including our financial statements and related notes. Our business involves significant risks. You should carefully consider the information under the heading “Risk Factors” beginning on page 7.

OVERVIEW

Orsus Xelent Technologies Inc. (AMEX: ORS), incorporated in the State of Delaware and headquartered in Beijing, China, is an emerging designer and manufacturer of popular mobile phones principally in the People's Republic of China (the “PRC”). Our business encompasses the design, manufacture and distribution of mobile phones, related digital circuits, and hardware and software development such as Man to Machine Interface (“MMI”), through which we have become an ambitious pioneer in mobile phone integration technology. We introduced the PRC's first wristwatch-style cellular phone, and we continue to break new ground with state-of-the-art phones that include advanced features and functions, including Mobile TV, Mobile Stock, Bar-code scanning, finger-print recognition, touch panel, 3 mega pixel cameras with macro, and video recording capabilities of up to four hours. Since our launch in 2004, we have established "ORSUS" as a popular brand in the PRC and we have achieved a significant share of the domestic handset market. Increasingly, we are focused on developing and marketing special application mobile phones for functional users in a wide variety of business and government professions under our “PROXLINK” trademark.

We have been engaged in retail and wholesale distribution in the telecommunications industry since May 2003, principally in the PRC market, primarily through our wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited (“Xelent”), which is also commonly called “Orsus Cellular” within the cellular phone industry. Xelent sells its handsets and total solutions, including economically priced and fully-loaded cell phones for both Global System for Mobile communications (“GSM”) and Code Division Multiple Access (“CDMA”) platforms, to a diverse base of customers and dealers. At present, GSM mobile devices constitute a significant percentage of the sales and profit of the Company. Xelent has emphasized the development of specialized application mobile terminals in accordance with market changes and popular features.

We have an industrial design center for the sole purpose of developing proprietary mobile phones reflecting features and designs that are favored by our customers in the PRC. Most of our mobile phone models are either designed by us for both our exclusive distribution and joint sales under established co-brands, or developed in conjunction with outside design firms. The long-term partners and manufacturers we employ to produce our cell-phones and accessories are the same experienced OEM plants utilized by global brands such as Motorola, Nokia and Ericsson. Our current operations include the purchase of raw materials and spare parts, outsourcing of manufacturing and customization, oversight of production and quality control at our OEM factories, and coordination of the distribution of the products to retailers and customers. In an effort to reduce our reliance on third-party manufacturers, we are currently in negotiations to acquire a factory that will enable us to produce our own phones and accessories.

Our corporate structure consists of ten integrated departments created to ensure proper project management and control. These departments include Project Management, Technology Support and Quality Control, Business Management, Planning and Finance, Human Resources, Financing and Investment, Customer Service, R&D, Marketing Development, and Logistics. Our headquarters in Beijing oversees 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 with additional offices in Hong Kong, Shenzhen, and Tianjin.

PRC CELL PHONE MARKET

The cellular phone industry is rapidly evolving and a highly competitive market. The PRC has been one of the most robust mobile markets worldwide with the largest number of cellular phone users in the world. According to the PRC Ministry of Information Industry, from January to June of 2007, approximately 71.47 million domestically produced handsets were sold in the PRC, an increase of 25.5% as compared to the same period last year, which were valued at 84.6 billion RMB (approximately $11.4 billion). Telecommunications operators forecast that the domestic PRC market will continue to gain approximately 60 million new mobile phone users per year while the PRC’s implementation of the next generation ("Third-Generation" or "3G") mobile telecommunication technology and its applications will promote the industry's development.

1

 
 
The production and sales of mobile phones steadily increased throughout 2007 and we believe the trend will continue based on four primary reasons:

Increase in global mobile phone sales: Global mobile phone sales in 2007 will jump by 16% over the previous year with total sales surpassing 1.1 billion phones according to International Data Corporation ("IDC"), a corporation that specializes in the collection and analysis of market information;

Increase in mobile phone replacements: The Ministry of Information Industry of the PRC has estimated that with the improving living standard in large and medium cities, the mobile phone replacement rate in cities may increase to 70-75% for 2007 from 40-50% for the previous year (data source: China Electronics News);

Delivery of next generation products: As reflected in the PRC government’s issuance of the “Integration of 3 Networks” in the 11th Five Five-Year Plan (the PRC Central Government’s Plan for the implementation of 3G technology for 2006-2010), the PRC will see an accelerated development between the next generation of telecommunication and 3C (Computer, Communication, Consumer Electronics) from 2006 to 2010;

Increase in the number of new customers arising from mobile products launched by telecommunication operators: Gartner Inc. (NYSE: IT), the world’s leading information technology research and advisory company, estimated that global mobile phone sales in Q1 of 2007 were 257.4 million, up 14% from the same period of the previous year, with Asia and Pacific Area increasing over 40% while Western Europe and North America only increased 4% and 2%, respectively.

OUR STRATEGIES

Continuing our focus on mid level and high end products. Beginning in 2007, we shifted our operations strategy to increase profitability and avoid the mass distribution of low priced products. This strategy included a renewed focus on the importance of our mid-level and high-end products. We predict that the industry in general will focus on the application of multimedia features (“Mobile TV”, “Mobile Video”, and “Walkman” phones), intelligent handsets (“Smart Phones”), and specialized occupation or industry handheld devices and software (“PDA”, “Mobile Stock”, and “Mobile Dictionary”). We believe that the primary competitive factors in the cell phone industry are targeted marketing and sales (including niche marketing and segmentation), brand recognition, product quality, product layout and value propositions.

Maximizing strategic relationships. In order to continue our successful growth and further expand our business, we are committed to enlarging our customer base and maintaining our after-sale service. We are continuing to optimize our operations to achieve an appropriate balance of material supplies and finished products in our inventory while maintaining a healthy turnover rate. Since 2006, we have formed strategic relationships with telecommunication operators and suppliers (such as Unicom Huasheng Telecommunications Technology Co. Ltd. and Beijing Enxiang Networking Engineering Company) to increase our sales and orders, and in 2007 we entered into cooperative agreements with several software designers and developers (such as Shanghai Yuede Computer Networking Engineering Co., Ltd.). We will continue to maximize our relationships with other strategic partners (including CEC Cellular Limited (“CECM”), Beijing Xingwang Shidai Tech & Trading Co., Ltd. (“XWSD”) and CECT-Chinacom Communications Co., Ltd. (“CECT-Chinacom”) to increase our market penetration.
 
Acquisition of Manufacturing Facility. On August 27, 2007 we signed a Letter of Intent to acquire 60% of the shares of Hebei Lemon Times Communications Equipment Manufacturing Co. Ltd (“Lemon Times”) in the Hebei Province for cash and stock of the Company. Lemon Times is a private limited liability company incorporated under PRC laws. Lemon Times has a 5,000 square meters electronics factory on approximately 64,000 square meters of land that includes one complete SMT (Surface Mount Technology) product line which can produce feature-rich mobile units and other electronic products, as well as four EOL (End Of Life) product lines available for assembly, testing and packaging. Lemon Times also currently employs more than 100 skilled technical staff and has achieved electronic information industry ISO 9000 Quality Management System Certification. Lemon Times also expects to achieve OHSAS18000 and ISO14001 certification in the coming months. Currently, the auditors are continuing their audit of Lemon Times, and the acquisition agreement will be finalized and the transaction consummated following the completion of the audit.

2

 
 
Supplying the Beijing Olympic Games. Beijing will host the Olympic Games in August 2008. Hosting the Olympic Games in Beijing will require the development and implementation of new telecommunication technologies and products that will benefit the mobile market as a whole. In order to take advantage of this opportunity, we are in negotiations with the digital operation platform provider for the Beijing Olympics Authority to become one of the suppliers of digital mobile terminals for the Olympic Games. We also anticipate providing products associated with specific competitions in the Olympic Games.
 
Doing it All with 3G
 
3

 
 
We took advantage of cell phone market expansion by introducing more enhanced 2.5G wireless products to the public in the PRC during 2007. We believe Xelent is positioned to take advantage of the business opportunities presented by the 3G platform because:

 
·
We have already commenced the development of our own 3G cellular phone products;

 
·
We are planning to join the Time Division Synchronous Code Division Multiple Access Industry League ("TD-SCDMA") which will enable us to obtain our 3G license more easily; and

 
·
We have already taken steps toward obtaining 3G cellular phone manufacturing licenses from the PRC government. To obtain 3G licenses, qualified companies must own a production facility other than OEM. This requirement is the primary reason we intend to use a significant portion of the proceeds of this offering to acquire a production facility. Owing our own manufacturing facility will also reduce our reliance on third-party manufacturers and suppliers for the ORSUS branded mobile phones and may permit us to provide OEM production for other companies.  

RISK FACTORS

We face risks in operating our business, including risks that may prevent us from achieving the objectives of our growth strategies. You should carefully consider these risks before investing in our common stock. For a description of the risks affecting our business or an investment in our common stock, please see the section entitled “Risk Factors.”

4

 

THE OFFERING

Securities offered
[__________] shares
   
Common stock outstanding immediately before this offering
 
29,756,000 shares
Common stock outstanding immediately after this offering:
 
 
without over-allotment option(1)
 
[__________] shares
 
with over-allotment option(1)(2)
 
[__________] shares
 
Use of proceeds
 
We intend to use the net proceeds from this offering to continue new product development, to integrate 3G technologies into our existing products, to acquire a manufacturing facility, and for general corporate purposes, capital expenditures and working capital.
 
Dividend Policy
 
We have never paid dividends to our stockholders. We will consider future dividends on a discretionary basis, based on continuing profitability and our strategic and operating needs. There can be no guarantee that future dividends will be paid.
 
American Stock Exchange symbol for our common stock
“ORS”
________

(1)
Excludes ________ shares of our common stock issuable upon exercise of underwriter’s warrants.

(2)  These shares may be issued upon exercise of a 45 day option granted to the underwriters to cover over-allotments.
 
5

 
 

The following summary financial information contains the consolidated statement of operations data for the nine months ended September 30, 2007 and 2006 (unaudited) and each of the periods ended December 31 (audited) for the three-year period from incorporation of the Company (May 2004) to December 31, 2006, and the consolidated balance sheet data as of September 30, 2007 (unaudited) and year-end for each of the years in the three-year period ended December 31, 2006. Such financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements starting on page F-1 and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Consolidated Statements of Operations
 
Nine Months Ended
September 30,
 
Year Ended December 31,
 
   
2007
 
2006
 
2006
 
2005
 
2004
 
 
 
(unaudited)
 
(unaudited)
 
 
 
 
 
 
 
 
 
(in thousands, except share and per share amounts)
 
Revenues
 
$
58,411
 
$
45,901
 
$
68,108
 
$
28,705
 
$
70,822
 
 
                               
Costs of Sales
   
47,586
   
37,879
   
55,226
   
22,272
   
56,231
 
 
                               
Sales & Marketing Expenses
   
389
   
926
   
1,045
   
1,554
   
3,314
 
                                 
General & Admin Expenses
   
763
   
519
   
1,560
   
1,064
   
1,435
 
                                 
R&D Expenses
   
319
   
187
   
255
   
413
   
586
 
                                 
Depreciation & Amortization
   
113
   
149
   
175
   
310
   
598
 
                                 
Allowance for Obsolete Inventory
   
700
   
- 
   
1,387
   
98
   
-
 
                                 
Allowance for Trade Deposit Receivable
   
1,487
   
1,364
   
-
   
-
   
-
 
                                 
Loss on Disposal of property, Plant and Equipment
   
-
   
-
   
454
   
-
   
-
 
                                 
Interest Expenses
   
747
   
70
   
116
   
25
   
143
 
                                 
Other Income, net
   
21
   
1
   
75
   
544
   
64
 
 
                               
Income Before Taxes and Minority Interest
   
6,328
   
4,808
   
7,965
   
3,513
   
8,579
 
                                 
Minority Interest
   
-
   
-
   
-
   
-
   
120
 
                                 
Income Tax
   
1,062
   
160
   
1,247
   
21
   
-
 
                                 
Net Income
   
5,266
   
4,648
   
6,718
   
3,492
   
8,699
 
                                 
Weighted Average Common Shares Outstanding (Basic and diluted)
   
29,756
   
29,756
   
29,756
   
29,756
   
29,756
 
 
                               
Net Income Per Common Share - Basic and Diluted
   
0.18
   
0.16
   
0.23
   
0.12
   
0.29
 

   
As of September 30,
 
As of December  31,
 
Consolidated Balance Sheets
 
2007(unaudited)
 
2006
 
2005
 
2004
 
 
 
(in thousands)
 
Current Assets
   
60,019
   
45,567
   
30,230
   
28,243
 
                           
Total Assets
   
60,412
   
45,887
   
31,011
   
29,021
 
                           
Current Liabilities
   
32,863
   
23,604
   
16,072
   
17,923
 
                           
Total Liabilities
   
32,863
   
23,604
   
16,072
   
17,923
 
                         
Total Stockholders’ Equity
   
27,549
   
22,283
   
14,939
   
11,098
 
 
6

 


The information contained in this prospectus, including in the documents incorporated by reference into this prospectus, includes some statements that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding our management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including our financial condition, results of operations, and the expected impact of the proposed facility acquisition on the parties’ individual and combined financial performance. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

The forward-looking statements contained in this prospectus are based on current expectations and beliefs concerning future developments and the potential effects on the parties and the transaction. There can be no assurance that future developments actually affecting us will be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond the parties’ control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements, including the following:

Our dependence on government contracts;
 
Fluctuation and unpredictability of costs related to our products and services;
 
Changes in the laws of the PRC that affect our operations;
 
Our failure to meet or timely meet contractual performance standards and schedules;
 
Any recurrence of severe acute respiratory syndrome (SARS) or Avian Flu;
 
Reduction or reversal of our recorded revenue or profits due to “percentage of completion” method of accounting;
 
Our dependence on aluminum markets;
 
Exposure to product liability and defect claims;
 
Our ability to obtain all necessary government certifications and/or licenses to conduct our business;
 
Development of a public trading market for our securities;
 
The cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations; and
 
The other factors referenced in this prospectus, including, without limitation, under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Description of Business.”
 
These risks and uncertainties, along with others, are also described under the heading “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of the parties’ assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.


Any investment in our common stock involves a high degree of risk. Investors should carefully consider the risks described below and all of the information contained in this prospectus before deciding whether to purchase our common stock. The risks described below are not the only ones facing our Company and you should pay particular attention to the fact that we conduct our operations in China and are governed by a legal and regulatory environment that in some respects differs significantly from the environment that may prevail in other countries.. Additional risks not presently known to us or that we currently deem immaterial may also impair our operations.
 
7

 
 
This prospectus also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face as described below and elsewhere in this prospectus. With respect to this discussion, the terms, “we,” “us,” or “our” refer to the combined business of Orsus Xelent Technologies, Inc. and our wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited (“Xelent”).
 
RISKS RELATED TO OUR BUSINESS 

Loss of significant customers, or other major customers, could occasionally 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. For the nine months ended September 30, 2007, we had two major customers: Beijing Xingwang Shidai Tech & Trading Co., Ltd., which was responsible for over 93% of our revenues, and China Electronic Appliance Corporation, who became our customer in the second quarter in 2007. We have developed and enhanced our relationship with and positioned ourselves for long-term cooperation with them by taking the following steps:
 
·
we assisted them in coordinating their sales channels and carriers;
 
·
we ensured they received high performance products at the specified prices; and

·
we worked with their feedback regarding consumer demands regarding our products and responded by adjusting our product lines and providing them our most favorable products.
 
Competition from providers of similar products and services could materially adversely affect our revenues and financial condition.

The industry in which we compete is a rapidly evolving, highly competitive and fragmented market driven by consumer preferences and quickly evolving technology. Our competitors are comprised of overseas brands, such as Nokia, Motorola and Samsung, and domestic brands, such as Lenovo, Bird, Amoi, Changhong and Gionee, among others. We believe that the main competitive factors in the cell phone industry are effective marketing and sales, brand recognition, product quality, product placement and availability, niche marketing and segmentation. We expect competition to intensify in the future due to the increased number of competitors and the factors discussed below. Other companies, both foreign companies and Chinese enterprises, may also enter the PRC market with better products or services, greater financial and human resources and/or greater brand recognition. Competitors will also continue to improve or expand current products and introduce new products. There can be no assurance that we will be able to compete effectively or that we will have the significant resources in technical innovation, business development, advertising and marketing necessary to compete effectively and build our brand awareness. Remaining competitive will require substantial human and capital resources of us and further developing brand awareness of our products and services, features and functionality, and cost. We may also have to continue to rely on strategic partnerships for critical branding and relationship leverage, which partnerships may or may not be sufficient. We cannot assure that it will have sufficient resources to make these investments or that we will be able to make the advances necessary to be competitive. Increased competition may result in price reductions, reduced gross margin and loss of market share. Failure to compete successfully against current or future competitors could have a material adverse effect on the Company’s business, operating results and financial condition.
 
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.
 
8

 
 
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.
 
The acquisition of a manufacturing facility is costly and such acquisition may not enhance our financial condition.

The process of identifying and consummating an acquisition could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities and exposure to undisclosed or potential liabilities of acquired companies. In addition, even if we are successful in acquiring a manufacturing facility, there are no assurances that the operations of these business will enhance our future financial conditions, including to the extent that the business acquired does not remain competitive, some or all of the goodwill related to that acquisition could be charged against our future earnings, if any.

Any acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value, and harm our operating results.

We plan to review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets and sales channels, enhance our technical capabilities, or otherwise offer growth opportunities. If we make any future acquisitions, we could issue stock that would dilute existing stockholders’ percentage ownership, incur substantial debt, or assume contingent liabilities.

Our experience in acquiring other businesses and technologies is limited. Potential acquisitions also involve numerous risks, including the following:

 
· 
 
problems integrating the purchased operations, technologies, products, or services with our own;
 
     
 
· 
 
unanticipated costs associated with the acquisition;
 
     
 
· 
 
diversion of management’s attention from our core businesses;
 
     
 
· 
 
adverse effects on existing business relationships with suppliers and customers;
 
     
 
· 
 
risks associated with entering markets in which we have no or limited prior experience;
 
     
 
· 
 
potential loss of key employees and customers of purchased organizations;
 
     
 
· 
 
increased costs and efforts in connection with compliance with Section 404 of the Sarbanes-Oxley Act; and
 
     
 
·
 
risk of impairment charges related to potential write-downs of acquired assets in future acquisitions.
 
Our acquisition strategy entails reviewing and potentially reorganizing acquired business operations, corporate infrastructure and systems, and financial controls. Unforeseen expenses, difficulties, and delays frequently encountered in connection with rapid expansion through acquisitions could inhibit our growth and negatively impact our profitability. We may be unable to identify suitable acquisition candidates or to complete the acquisitions of candidates that we identify. In addition, we may encounter difficulties in integrating the operations of acquired businesses with our own operations or managing acquired businesses profitably without substantial costs, delays, or other operational or financial problems.

9

 
 
Rapid growth and a rapidly changing operating environment may 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.
 
Unless we are able to take advantage of technological developments on a timely basis, we may experience a decline in a demand for our services or may be unable to implement our business strategy.
 
Our industry is experiencing rapid change as new technologies are developed that offer consumers an array of choices for their communications needs. In order to grow and remain competitive, we will need to adapt to future changes in technology, to enhance our existing offerings and introduce new offerings to address our customers’ changing demands. If we are unable to meet future advances in competing technologies on a timely basis or at an acceptable cost, we could lose customers to our competitors. Technological advances, the introduction of new products, new designs and new manufacturing techniques could render our inventory obsolete, or it could shift demand into areas where we are not currently engaged. If we fail to adapt to those changing conditions in a timely and efficient manner, our revenues and profits would likely decline. To remain competitive, we must continue to incur significant costs in product development, equipment and facilities and to make capital investment. These costs may increase, resulting in greater fixed costs and operating expenses. As a result, we could be required to expend substantial funds for and commit significant resources to the following: research and development activities on existing and potential products; additional engineering and other technical personnel; advanced design, production and test equipment; manufacturing services that meet changing customer needs; and technological changes in manufacturing processes. Our future operating results will depend to a significant extent on our ability to continue to provide new products that compare favorably on the basis of time to market, cost and performance with the design and manufacturing capabilities and competing third-party suppliers and technologies. Our failure to increase our net sales sufficiently to offset these increased costs would reduce our profitability.
 
Our research and development efforts may not lead to successful development of commercially viable or acceptable products, which could cause a decline in customer use of our products.

The markets in which we compete are characterized by:

 
· 
rapidly changing technology;
 
   
 
· 
evolving industry standards and transmission protocols;
 
   
 
· 
frequent improvements in products and services; and
 
   
 
· 
fierce competition from well-funded and technologically advanced companies.
 
10

 
 
To succeed, we must continually improve our current products and develop and introduce new or enhanced products that adequately address the requirements of our customers and are competitive in terms of functionality, performance, quality and price. We are currently developing new 3G products, however, our research and development efforts may not lead to any new or enhanced products or generate sufficient market share to justify commercialization. For example, 3G is a new and evolving technology, and we may not be able to recoup our research and development costs and expenses, we may not be able to serve our customers’ 3G needs, and customers may refuse to purchase our products.

Changes in industry standards, technology, customer requirements and government regulation could limit our ability to sell our products.

The mobile phone market is characterized by changing end-user preferences and demand for new and advanced functions and applications on wireless handsets, rapid product obsolescence and price erosion, intense competition, evolving industry standards and wide fluctuations in product supply and demand. This requires us to continuously develop new products and enhance our existing products to keep pace with evolving industry standards and rapidly changing customer requirements. In order to encourage widespread market adoption of 2G, 2.5G and 3G technologies, efforts have been made to develop industry standards, and we have designed our products to comply with these standards. Changes in industry standards, or the development of new industry standards, may make our products obsolete or negate the cost advantages we believe we have in our products.

Our business, operating results, financial condition and cash flows could be adversely affected by any decline in demand for our existing products, the introduction of products and technologies by our competitors that serve as a replacement or substitute for, or represent an improvement over, our existing products, technological innovations or new standards that our existing products do not address, or our inability to release enhanced versions of our existing products on a timely basis. We have begun to offer products based on the 3G standard promoted by the PRC government, and are focusing a significant portion of our product design and sales and marketing efforts on products that comply with such standard. We also are devoting significant resources to the development of solutions that will support certain 2.5G wireless standards and 3G wireless standards. If the wireless standards for which we are developing products are not widely adopted by the market, we may not be able to sell these 2.5G and 3G solutions and our revenue could decline. Because it is not practicable to develop products that comply with all current standards and standards that may be adopted in the future, our ability to compete effectively will depend on our ability to accurately select industry standards that will be widely adopted by the market and to design our products to support those relevant industry standards. We may be required to invest significant effort and to incur significant expense to redesign our products to address relevant standards. We may not have the financial resources to fund future innovations. If our products do not meet relevant industry standards that are widely adopted for a significant period of time, our revenue would decline, adversely affecting our operating results, business and prospects.

If the wireless communication sector in China does not maintain its current pace of growth, or the PRC government does not issue the Company a 3G license in the near future, the profitability and future prospects of our business and our liquidity could be materially and adversely affected. 

Our future success depends on the continued growth of the PRC wireless communication industry. Any slowdown in the development of the wireless communication industry in China or reduction in our customers’ expenditures on mobile phone products and services may reduce market demand for our products and services. Alternatively, if the PRC government or other relevant regulatory authorities fail to allow construction of new wireless communication networks, or decide to terminate, delay or suspend construction or extension of new or existing wireless communication networks, the profitability and future prospects for our business could be materially and adversely affected.

 
The third generation wireless communication, or 3G, network deployment will require significant capital investment by PRC telecommunication operators, including investments in wireless coverage products and services, RF parts and components and wireless communication systems. Therefore, we believe that issuance of 3G licenses will in general have a positive impact on the growth of our business. Until we receive our 3G license from the PRC government, the expected return on our investments in 3G technology is uncertain. Continued delay in the issuance of 3G licenses will negatively impact our business growth and liquidity.

11

 
 
Our ability to generate revenues could suffer if the PRC 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.
 
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.
 
Our products may be subject to counterfeiting and/or imitation, which could harm our business and competitive position.

We cannot guarantee that counterfeiting or imitation of our products will not occur in the future or that we will be able to detect it and deal with it effectively. Any occurrence of counterfeiting or imitation could impact negatively upon our corporate and brand image. In addition, counterfeit or imitation products could result in a reduction in our market share, a loss of revenues or an increase in our administrative expenses in respect of detection or prosecution.

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.
 
Product defects or the failure of our products to meet specifications could cause us to lose customers and revenue or to incur unexpected expenses.

If our products do not meet our customers’ performance requirements, our customer relationships may suffer. Also, our products may contain defects or fail to meet product specifications. Any failure or poor performance of our products could result in:

 
· 
delayed market acceptance of our products;
 
   
 
· 
delayed product shipments;
 
   
 
· 
unexpected expenses and diversion of resources to replace defective products or identify and correct the source of errors;
 
12

 
 
 
· 
damage to our reputation and our customer relationships;
 
   
 
· 
delayed recognition of sales or reduced sales; and
 
   
 
· 
product liability claims or other claims for damages that may be caused by any product defects or performance failures.
 
If the limited warranty provisions in our contracts are unenforceable in a particular jurisdiction or if we are exposed to product liability claims that are not covered by insurance, a claim could harm our business.
 
We may have difficulty collecting our accounts receivable.

During the normal course of business, we extend unsecured credit to our customers. Typical credit terms require payment to be made within 90 days of the invoice date. We do not require collateral from our customers.

We regularly evaluate and monitor the creditworthiness of each customer on a case-by-case basis. We include any account balances that are determined to be uncollectible in the allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to management, the Company believes that its allowance for doubtful accounts as of September 30, 2007 and December 31, 2006 was adequate, respectively. However, actual write-off may exceed the recorded allowance.

We currently offer and intend to offer open account terms to certain of our customers, which may subject us to credit risks, particularly in the event that any receivables represent sales to a limited number of customers or are concentrated in particular geographic markets. The collection of our accounts receivable and our ability to accelerate our collection cycle through the sale of accounts receivable is affected by several factors, including, but not limited to:
 
 
 
our credit granting policies,
 
     
 
 
contractual provisions,
 
     
 
 
our customers’ and our overall credit rating as determined by various credit rating agencies,
 
     
 
 
industry and economic conditions, and
 
     
 
 
the customer’s and our recent operating results, financial position and cash flows.
 
Adverse changes in any of these factors, certain of which may not be wholly in our control, could create delays in collecting or an inability to collect our accounts receivable which could impair our cash flows and our financial position and cause a reduction in our results of operations.

Our financial results may be affected by mandated changes in accounting and financial reporting.

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. These principles are subject to interpretation by the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies may have a significant effect on our reported results and may even retroactively affect previously reported transactions.

The cyclical nature of the aluminum industry causes variability in our production costs and cash flows.
 

Our costs of production depend on the market for primary aluminum, which is a highly cyclical commodity with prices that are affected by global demand and supply factors and other conditions. Historically, aluminum prices have been volatile and we expect such volatility to continue. These prices are driven, in part, by global demand for aluminum arising from favorable global economic conditions and strong demand in China.

13

 

RISKS RELATED TO DOING BUSINESS IN THE PRC

There are substantial risks associated with doing business in greater China, as set forth in the following risk factors.

A downturn in the PRC economy may slow down our growth and profitability.

The growth of the PRC economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the PRC 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 PRC economy. More specifically, increased penetration of wireless services in the less economically developed central and western provinces of the PRC 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.
 
Because we depend on governmental agencies for a portion of our revenue, our inability to win or renew government contracts could harm our operations and reduce our profits.

Our inability to win or renew Chinese government contracts could harm our operations and reduce our profits. Chinese government contracts are typically awarded through a regulated procurement process. Some Chinese government contracts are awarded to multiple competitors, causing increases in overall competition and pricing pressure. The competition and pricing pressure, in turn may require us to make sustained post-award efforts to reduce costs in order to realize revenues under these contracts. If we are not successful in reducing the amount of costs we anticipate, our profitability on these contracts will be negatively impacted. Finally, Chinese government clients can generally terminate or modify their contracts with us at their convenience.

We rely on sales to the Chinese government and a significant decline in overall government expenditures or a delay in the payment of our invoices by the government could have a negative impact on our future operating results.

We believe that some of the success and growth of our business will continue to depend on our ability to win government contracts. Many of our government customers are subject to budgetary constraints and our continued performance under these contracts, or award of additional contracts from these agencies, could be jeopardized by spending reductions or budget cutbacks at these agencies. Our operating results may also be negatively impacted by other developments that affect these government programs generally, including the following:

· 
adoption of new laws or regulations relating to government contracting or changes to existing laws or regulations;
 
· 
delays or changes in the government appropriations process; and

· 
delays in the payment of our invoices by government payment offices.
 
The uncertain legal environment in the PRC could limit the legal protections available to you.
 
The PRC 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 value as precedent in the PRC. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy or criminal proceedings. In the late 1970s, the PRC 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 the PRC. However, these laws, regulations and legal requirements are relatively recent are evolving rapidly, and their interpretation and enforcement involve uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. 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.
 
14

 
 
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 the PRC, 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:
 
·
quarantines or closures of some of our offices that would severely disrupt our operations,
   
·
the sickness or death of our key officers and employees, and
   
·
a general slowdown in the PRC 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 the PRC’s political and economic policies could harm our business.
 
The economy of PRC 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 PRC government have had a positive effect on the economic development of the PRC, 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 PRC 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 PRC economy were similar to those of the OECD member countries. As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources by controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways. While these measures may benefit the overall PRC economy, they may also have a negative effect on us, especially if such measures create an unfriendly environment for businesses in the technology sector of the economy.
 
15

 
 
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 (the “RMB”), any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside the PRC or to make dividend or other payments in U.S. dollars. Although the PRC government introduced regulations in 1996 to allow greater convertibility of the RMB 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 RMB for capital account items, including direct investment and loans, is subject to governmental approval in the PRC, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the PRC regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB, especially with respect to foreign exchange transactions.
 
Because our revenues are generated in RMB and our results are reported in U.S. dollars, devaluation of the RMB could negatively impact our results of operations.
 
The value of RMB is subject to changes in the PRC’s governmental policies and to international economic and political developments. In January, 1994, the PRC government implemented a unitary managed floating rate system. Under this system, the People’s Bank of China, or PBOC, began publishing a daily base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for RMB within a specified band around the central bank’s daily exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined. This modification has resulted in an approximate 7.3% appreciation of the RMB against the U.S. dollar from July 21, 2005 to May 2, 2007. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further fluctuations of the exchange rate of RMB against the U.S. dollar, including possible devaluations. As all of our net revenues are recorded in RMB, any future devaluation of RMB against the U.S. dollar could negatively impact our results of operations.
 
The value of our securities will be affected by the foreign exchange rate between U.S. dollars and RMB.
 
The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and RMB. For example, to the extent that we need to convert U.S. dollars into RMB for our operational needs and should the RMB 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 RMB 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 RMB, the U.S. dollar equivalent of our earnings from our subsidiaries in the PRC would be reduced.
 
Inflation in the PRC could negatively affect our profitability and growth.

While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. During the past decade, the rate of inflation in the PRC has been as high as approximately 20% and the PRC has experienced deflation as low as approximately minus 2%. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect on our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the PRC economy. In April 2006, the People’s Bank of China raised the interest rate again. Repeated rises in interest rates by the central bank would likely slow economic activity in the PRC which could, in turn, materially increase our costs and also reduce demand for our products and services.

16

 
 
We are subject to the United States Foreign Corrupt Practices Act.

We are required to comply with the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC, particularly in our industry since it deals with contracts from the Chinese Government, and our executive officers and employees have not been subject to the United States Foreign Corrupt Practices Act prior to the completion of the Exchange Agreement (defined herein). If our competitors engage in these practices they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. We can make no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

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.
 
17

 
 
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.
 
50.41% or 15,00,000 shares of our common stock are held by three stockholders, including 30.25% held by our executive officers and directors as a group. As a result, these stockholders are able to control 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.
 
18

 


We estimate that the net proceeds of this offering will be as follows:

Assuming an offering price of $_____ per share, the mid-point of the range shown on the cover of this prospectus, we estimate that the net proceeds from this offering will be approximately $________, or $____________if the underwriters' over-allotment option is exercised in full, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase in the public offering price per share would increase the expected net proceeds by approximately $___________. A $1.00 decrease in the public offering price per share would decrease the expected net proceeds by approximately $___________. We do not expect that a change in the offering price or the number of shares by these amounts would have a material effect on our uses of the proceeds from this offering.

We foresee two critical events that will occur in the PRC in the next year: the Olympic Games in Beijing and the official granting of 3G mobile production licenses by the PRC government. In order to take advantage of the opportunities presented by these two events, we plan to acquire a factory to internalize and better control our production process, focus on new product research and development and the integration of 3G technology into our existing products, continue our development of advanced mobile technologies, strengthen our brand recognition, and build upon our cooperative relationships with telecommunications operators in the PRC. We intend to use the proceeds of this offering as follows:

Use of Net Proceeds of Offering
 
Without
Over-Allotment
Option
 
Over-Allotment
Option Exercised
 
   
$ of Net
Proceeds
 
% of New
Proceeds
 
$ of Net
Proceeds
 
% of New
Proceeds
 
Acquisition of manufacturing facility
         
50%
 
$
 
   
                           
Research and development expenses for new 3G products and new digital platform terminals
         
20%
 
           
                           
Production costs for launching 3 mobile models of new technologies, with each model consisting of over 20,000 production units
         
30%
 
           

Pending the consummation of the acquisition described above, proceeds will be used for general corporate purposes, capital expenditures, and working capital. We may need to build additional facilities and purchase new equipment for the acquired factory. We will reorganize the established facilities in accordance with our products and manufacturing needs as well as recruit and train additional employees to supplement the those employees and managers who remain. We also intend to increase the production scale for our products which may result in an increase in our purchases of raw materials.

In the event the proceeds of this offering cannot be generated in time, we will still implement the projects and will temporarily reserve cash in-flow to acquire the factory. After the acquisition is completed, we may use the factory as collateral to obtain a bank loan to maintain operations. This may require us to adjust the development and launch schedules of the new products due to reallocation of financial resources, such as producing and releasing them in sequence in stead of all at the same time. The finalization of the acquisition will be subject to the completion of the proper audit and due diligence of the target company, which will determine when the proceeds of the offering will be needed to finance the acquisition.

19

 
 
 
Shares of our common stock have been listed for trading on AMEX under the ticker symbol “ORS” since May 10, 2007. 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 Agreement (as defined in the Overview portion of the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) and ending on September 30, 2007:

 
 
Common Stock
 
Fiscal Year Ended 
 
High
 
Low
 
December 31, 2005
             
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
 
               
December 31, 2007
             
First Quarter
   
4.04
   
2.55
 
Second Quarter
   
5.60
   
3.05
 
Third Quarter
   
4.05
   
2.00
 
Fourth Quarter
   
7.90
   
2.25
 
 
The source for the high and low closing bids quotations is the Google 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.

Holders.

As of December 31, 2007, we had approximately 2,500 stockholders of our common stock of record, and our common stock had a closing bid price of $2.55 per share.

Dividends and Related Policy.

We do not expect to declare or pay any cash dividends on our common stock in the foreseeable future, and we currently intend to retain future earnings, if any, to finance the expansion of our business. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant.

Securities Authorized for Issuance Under Equity Compensation Plans.

As of the fiscal year ended December 31, 2007, we have no shares of our common stock or preferred stock that are issuable under compensation plans approved by our security holders.
 
20

 
 

The following selected consolidated statement of operations data contains the consolidated statements of operations data for the nine months ended September 30, 2007 and 2006 (unaudited) and each of the years in the three-year period from the incorporation of the Company (May 2004) to December 31, 2006 and the consolidated balance sheet data as of September 30, 2007 and 2006 (unaudited) and year-end for each of the years in the three-year period ended December 31, 2006. The consolidated statement of operations data and balance sheet data were derived from the audited consolidated financial statements, except for data for the periods ended and as of September 30, 2007 and 2006. Such financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements starting on page F-1 and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Consolidated Statements of Operations
 
Nine Months Ended
September 30,
 
Year Ended December 31,
 
   
2007
 
2006
 
2006
 
2005
 
2004
 
     (unaudited)                  
 
 
(in thousands, except share and per share amounts)
 
                       
Revenues
 
$
58,411
 
$
45,901
 
$
68,108
 
$
28,705
 
$
70,822
 
 
                               
Operating Expenses
   
51,327
   
41,024
   
60,102
   
25,711
   
62,164
 
 
                               
Other Income - Interest, net
   
21
   
1
   
75
   
544
   
64
 
 
                               
Net Income
   
5,266
   
4,648
   
6,718
   
3,492
   
8,699
 
                                 
Weighted Average Common Shares Outstanding (Basic and diluted)
   
29,756
   
29,756
   
29,756
   
29,756
   
29,756
 
 
                               
Net Income Per Common Share Basic and Diluted
   
0.18
   
0.16
   
0.23
   
0.12
   
0.29
 

Consolidated Balance Sheets
 
As of September 30,
 
As of December 31,
 
   
2007(unaudited)
 
2006
 
2005
 
2004
 
 
 
(in thousands)
 
       
Current Assets
 
$
60,019
 
$
45,567
 
$
30,230
 
$
28,243
 
                           
Total Assets
   
60,412
   
45,887
   
31,011
   
29,021
 
                           
Current Liabilities
   
32,863
   
23,604
   
16,072
   
17,923
 
                           
Total Liabilities
   
32,863
   
23,604
   
16,072
   
17,923
 
                         
Total Stockholders’ Equity
   
27,549
   
22,283
   
14,939
   
11,098
 
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus.

FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, general economic and business conditions, changes in foreign, political, social, and economic conditions, regulatory initiatives and compliance with governmental regulations, the ability to achieve further market penetration and additional customers, and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this prospectus are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

21

 
 
OVERVIEW

The Company was organized under the laws of State of Delaware in May 2004, under the name of “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 stock exchange transaction, Universal Flirts Inc. became a wholly-owned subsidiary of the Company. Pursuant to a 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. Immediately following such cancellation, the Company 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 (“UFIL”), a company incorporated under the laws of Hong Kong. The exchange was consummated under the laws of State of Delaware and pursuant to the terms of the Securities Exchange Agreement dated as of March 31, 2005 (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 this 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, a limited liability company established in Beijing under the laws of the PRC in May of 2003.

On April 19, 2005, the Company, changed its list name to Orsus Xelent Technologies, Inc.

In April 2007, the Company’s common shares were approved for listing on the American Stock Exchange (“AMEX”), and began trading on AMEX on May 10, 2007 under the ticker symbol “ORS”. The Company’s CUSIP Number is 68749U106.

Subsidiaries

Beijing Orsus Xelent Technology & Trading Company Limited - The business operations of UFIL are conducted through its wholly-owned subsidiary, Beijing Orsus Xelent Technology & Trading Company Limited ("Xelent"), which is also commonly called “Orsus Cellular” within the cellular phone industry. Incorporated in May 2003 under the laws of the PRC, Xelent has been engaged in the business of designing economically priced cellular phones for retail and wholesale distribution. In February 2004, Xelent registered “ORSUS” with the PRC State Administration for Industry and Commerce as its product trademark. The cellular phone products produced by Xelent are customarily equipped with industry leading features, including 1.8-inch to 2.8-inch CSTN (Color Super Twisted Nematic), TFT (Thin Film Transistor) or QVGA (Quarter Video Graphic Array) dual-color display, 1 minute to 4 hours video recording, 300K to 3 million pixel photography, MP3 (Moving Picture Experts Group Audio Layer III), MPEG 4 (Moving Picture Experts Group Audio Layer IV) and Universal disk (U disk) support, dual stereo speakers, e-mail messaging, multimedia messaging, 40 to 64 ring tone storage, slim bar-phone & flip-phone technology and ultra-thin innovative lightweight design. Xelent has sold approximately 1,615,500 cellular phones since its first product launched in 2004.

In the GSM mobile market, Xelent provided its handsets to various customers and dealers and continues to maintain a good relationship with them. At present, GSM mobile devices constitute a significant percentage of the sales and profit of the Company. Further, Xelent has emphasized the development of specialized application mobile terminals in accordance with market changes and popular features. The Company has established itself in the specialized application field and made significant marketing efforts since entering the field in September 2006. Based on its evaluation of the market and the engagement proposals received from its major customers, the Company began to produce X180 in mass volumes since April 2007 and took advantage of the great opportunity to win the specialized application mobile terminal market. In June 2007, the Company received an order for 15,000 units from China Unicom under an initial intent agreement for 50,000 units. This is the first agreement and order signed with China Unicom, the second largest telecom operator in the PRC, since the establishment of the Company.

22

 
 
We have shipped 10,000 units to Unicom Huasheng and will continue with new deliveries. However, as of June 2007, Unicom Huasheng notified us that the contract would be postponed because of decreased market demand and the government delay of their funding. We have initiated negotiations with Unicom Huasheng with the expectation of resuming the remaining deliveries. Additionally, the Company is about to sign a contract on a new model (Orsus-X688) and is expecting to enter an arrangement for shipments to begin in the first quarter of 2008.

In the first quarter 2007, the Company confirmed its business relationship with China Unicom and started a cooperative relationship based on the specialized application mobile terminal. With the operational expansion during the first two fiscal quarters of 2007, the third quarter witnessed another increase in revenues and net income. The revenues marked a record high for the current year and the net profit exceeds the sum of last two fiscal quarters. It is anticipated that both revenues and profit for this year will reach or surpass that of each year since the establishment of the Company.

Orsus Xelent Trading (HK) Company Limited - In July 2005, we formed Orsus Xelent Trading (HK) Company Limited ("OXHK") under the laws of Hong Kong. This wholly owned subsidiary is engaged in the trading of cellular phones and accessories with overseas customers. In September 2005, OXHK commenced its Hong Kong operations to sell and distribute our cellular phone products and technical support services to customers outside the PRC.
 
Business Review

In the beginning of 2006, the Company implemented a strategy to set up cooperative relationships with telecom operators and suppliers to increase sales and orders for the Company. Now the benefits of this policy are being realized. The Company has focused on the implementation of 3G mobile technologies in the PRC. The Company has negotiated with many 3G design companies and expects to provide samples to China Mobile for testing. Currently, we are planning to join the TD-SCDMA Industry League, and are working toward obtaining 3G cellular phones manufacturing licenses for the Company (or its holding company) from the PRC government in 2008. The Company has positioned itself well to take advantage of this opportunity. Furthermore, to become less reliant on third-party manufacturers, the Company has worked on preparations to acquire the proposed factory and expects to complete the acquisition by the end of this year. This means the company will change from OEM production to independent production of its own-brand mobile phones.

The Company’s management team has become more experienced and has a clearer focus on sales targets and its distribution market. Furthermore, the Company optimized the organization of its operations during the last year. The newly setup business center has begun to strengthen the ties between the Company, the market and its customers. Meanwhile, the Company continued to work diligently to expand its customer base, including a continued push into the field of specialized applications. Even with these initiatives, the Company continued to grow its traditional markets, as evidenced by the great contribution it made to the fiscal year’s highlights; in the third quarter, traditional handsets contributed prominently to the increase of sales and revenues. For the most recent fiscal quarter ended September 30, 2007, we achieved a 27.25% increase in operational revenues and a 13.30% increase in net profit as compared to the same period last year.

Beginning in 2007, we shifted our operation strategy to increase our profitability and avoid the mass distribution of low price products. Our focus is on the importance of mid-level and high-end products, which will allow us to reduce our operating costs and expenses as compared to revenues.

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. On an on-going basis, we evaluate our estimates based on historical experience and 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.

23

 
 
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.

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 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.

24

 
 
RESULTS OF OPERATIONS

The following table sets forth our statements of operations for the nine months ended September 30, 2007 and 2006, and the fiscal years ended December 31, 2006, 2005 and 2004, respectively:

Results of Operations
 
Nine Months Ended
September 30,
 
Year Ended December 31,
 
   
2007
 
2006
 
2006
 
2005
 
2004
 
 
 
(unaudited)
     
 
 
 
 
 
 
 
 
(in thousands, except share and per share amounts)
 
                       
Revenues
 
$
58,411
 
$
45,901
 
$
68,108
 
$
28,705
 
$
70,822
 
Costs of Sales
   
47,586
   
37,879
   
55,226
   
22,272
   
56,231
 
Sales & Marketing Expenses
   
389
   
926
   
1,045
   
1,554
   
3,314
 
General & Admin Expenses
   
763
   
519
   
1,560
   
1,064
   
1,435
 
R&D Expenses
   
319
   
187
   
255
   
413
   
586
 
Depreciation & Amortization
   
113
   
149
   
175
   
310
   
598
 
Allowance for Obsolete Inventory
   
700
   
- 
   
1,387
   
98
   
-
 
Allowance for Trading Deposit Receivable
   
1,487
   
1,364
   
-
   
-
   
-
 
Loss on Disposal of property, Plant and Equipment
   
-
   
-
   
454
   
-
   
-
 
Interest Expenses
   
747
   
70
   
116
   
25
   
143
 
Other Income, net
   
21
   
1
   
75
   
544
   
64
 
Income Before Taxes and Minority Interest
   
6,328
   
4,808
   
7,965
   
3,513
   
8,699
 
Minority Interest
   
-
   
-
   
-
   
-
   
120
 
Income Tax
   
1,062
   
160
   
1,247
   
21
   
-
 
Net Income
   
5,266
   
4,648
   
6,718
   
3,492
   
8,699
 
Weighted Average Common Shares Outstanding
   
29,756
   
29,756
   
29,756
   
29,756
   
29,756
 
                                 
Net Income Per Common Share Basic and Diluted
   
0.18
   
0.16
   
0.23
   
0.12
   
0.29
 

Nine Months Ended September 30, 2007 and 2006

The following table summarizes our operating results for the nine months ended September 30, 2007 and September 30, 2006, respectively:

 
 
 
Nine months ended
September 30, 2007
 
Nine months ended
September 30, 2006
 
Comparison
 
   
$’000
 
% of
Revenue
 
$’000
 
% of
Revenue
 
$’000
 
%
 
Revenue
 
$
58,411
   
100.00
%
$
45,901
   
100.00
%
$
12,510
   
27.25
%
Cost of sales
   
47,586
   
81.47
%
 
37,879
   
82.52
%
 
9,707
   
25.63
%
Sales & marketing expenses
   
389
   
0.67
%
 
926
   
2.02
%
 
-537
   
-57.99
%
General & admin. expenses
   
763
   
1.31
%
 
519
   
1.13
%
 
244
   
47.01
%
R&D expenses
   
319
   
0.55
%
 
187
   
0.41
%
 
132
   
70.59
%
Depreciation
   
113
   
0.19
%
 
149
   
0.32
%
 
-36
   
-24.16
%
Allowance for obsolete inventories
   
700
   
1.20
%
 
- 
   
-
   
700
   
100.00
%
Allowance for trading deposit receivable
   
1,487
   
2.55
%
 
1,364
   
2.97
%
 
123
   
9.02
%
Interest expenses
   
747
   
1.28
%
 
70
   
0.15
%
 
677
   
967.14
%
Other net income
   
21
   
0.04
%
 
1
   
0.00
%
 
20
   
2000.00
%
Pre-tax profit
   
6,328
   
10.83
%
 
4,808
   
10.47
%
 
1,520
   
31.61
%
Income tax
   
1,062
   
1.82
%
 
160
   
0.35
%
 
902
   
563.75
%
Profit (Loss)
   
5,266
   
9.02
%
 
4,648
   
10.13
%
 
618
   
13.30
%
 
25

 
 
Revenues

Our revenues were $58,411,000 for nine months ended September 30, 2007, representing an increase of 27.25% as compared to $45,901,000 in the corresponding period in 2006. The increase of our operation revenues as compared to the same period last year was mainly due to two factors: we experienced a slow business period in 2006 because of the reformation of the cellular industry and products which affected our operation revenues for that period; However, in the third quarter of 2007, product sales achieved a record high, with our GSM products continuing to meet the market’s demand for mid-level and high-end handsets, resulting in a higher sales volume and triggering the increased revenue growth over the same period last year.

At present, we divide our products into three categories according to distribution channel:
(1)     tailor-made products for operators;
(2)     specialized application mobile terminals; and
(3)     traditional products for common customers in the market.
For the nine months ended September 30, 2007, our sales reached $34,576,000 or 59.19% of the revenues from our operator-tailored products, $3,914,000 or 6.7% from specialized application mobile terminals, and $19,921,000 or 34.11% from our traditional products.  

In addition, we created three series of product lines based on the nature of the products, such as functions, appearances, prices and target market. Our mid-level and low-end products contain a number of attractive features, such as MP3, MPEG4, video recording and outer card storage, while our high-end products contain the above-mentioned features as well as PDA, GPS and office software functions, Mobile TV, special industry applications and others.  

Category by Sales Channel
 
Nine months ended September 30, 2007
 
Future
 
Sample Model
 
Tailor-made products for operators
   
59%
 
 
40% (±5)%
 
 
No. 1 and No.2
 
Specialized application mobile terminals
   
7%
 
 
30% (±5)%
 
 
No. 3 and No.4
 
Traditional products for common customers in the market
   
34%
 
 
30% (±5)%
 
 
No. 5 and No.6
 
 
26

 

Sample Model No. 1

Sample Model No. 1
C8000, Dual Networks Simultaneous Standby, business mobile
Network type: CDMA800M / GSM900M/1800M
Body size: 102mm*52mm*19mm
Inner screen: 2.4’ TFT 320*240, 260,000 colors
Ring: embedded MP3 player, MPEG4 video play
Camera: 1.3M pixels
Voice talk time: 180 minutes
Standby time: 70 hours
Remarks: support manual input, outside-connected T-Flash card, flash memory, USB interface to realize rapid storage, PowerWord, MP3, MP4 and Kara OK.
Pricing: high (retailing price at the beginning: RMB 3,500 Yuan)

Sample Model No. 2

Sample Model No. 2
Proxlink
X180 Specialized Application Mobile Terminal; High-end product tailor-made for operators
2.8’ super large color manual input screen
Speedy independent CPU 400MHz
GGPS ONE network/satellite positioning
Electronic compass
Bluetooth voice data transmission
Super mass memory and outside memory card (2GB)
Embedded micro-distance bar code scanner
Outside RFID, bar code scanner, mini printer
Linux operating system
Secret mode for call and short message
HTML website browse, WAP browse, email
Powerful MP3 and MP4 multi-media
Mobile office support PDF and OFFICE
Pricing: high (market price: RMB 3,800 Yuan)
 
Sample Model No. 3  
   
Sample Model No. 3
OS70, TFT, HD camera mobile; middle-level products for traditional market; honor and noble
Network type: GSM900/DCS1800
Body size: 98.5×43.5×21 mm
Inner screen: 1.8” CSTN 128*160 pixels, 65000 colors
Outer screen: 1.1”, 96×64, white and black
Digital camera: embedded camera, 300,000 pixels, support shoot of short movie for 3-5 seconds
Ring: 40 PCM, pleasant ring
Voice talk time: 80-120 minutes
Standby time: 60-120 hours
Memory: 128M
State indicator: 7 color lamp for calls
Support MMS
Launch date: July 2004
Pricing: medium (retailing price at the beginning: RMB 2280 Yuan)
 
Sample Model No. 4

Sample Model No. 4
X5, super thin music mobile; middle-level product for traditional market
Network type: GSM, 900/1800MHz
Body size: 109.5*46.5*11.5mm
Inner screen: 2.0”TFTô176*220ô65,000 colors
Ring: embedded MP3 player, MPEG4 video play
Camera: 1.3M pixels
Voice talk time: 120-180 minutes
Standby time: 76-100 hours
Remarks: T-Flash card, maximum of 512M
Pricing: Media and low (retailing price at the beginning: RMB 1060 Yuan)
 
27

 
 

Sample Model No. 5

Sample Model No. 5
C100 low-end CDMA mobile, tailored-made for operators
Network type: CDMA, 1 X 800 MHz
Body size: 82.2*42.6*22.1mm
Inner screen: 1.5”CSTN 128ö160 pixels, 65,000 colors
Ring: 32 PCM pleasant rings
Voice talk time: 80-120 minutes
Standby time: 48-150 hours
State indicator: 7 color lamp for calls
Pricing: low (retailing price at the beginning: RMB 780 Yuan)

Sample Model No. 6


Sample Model No. 6
X188, low-end music mobile for traditional market
Network type: GSM, 900/1800MHz
Body size: 101*41*17mm
Inner screen: 1.5”CSTN 128ö160 pixels, 65,000 colors
Ring: embedded MP3 player, MPEG4 (3g format) video
Voice talk time: 120-180 minutes
Standby time: 76-100 hours
Remarks: Mini SD card
Pricing: Low (retailing price at the beginning: RMB 625 Yuan)
 
Products Segment

In 2007, in order to carry out the business in three major channels, we achieved great improvement in our operator-tailored products. At the same time, we put effort into distributing our traditional products, maintained our joint cooperation projects with our R&D partners and increased our trading activities in order to widen our revenue streams. We increased the number of mobile phone models we sold in the market as compared to the same period last year, most of which were newly created in the current year. Through the first three quarters of 2007, our mid-level and high-end GSM products performed extraordinarily well with accumulated sales of $12,135,000.
 
28

 
 
The revenues of product segments for the nine months ended September 30, 2007:

 
 
 
 
 
 
Nine months ended
September 30, 2007
 
Sales Channel
  Feature level  
Model
 
$’000
 
% of Revenue
 
Tailor-made products for operators
   
High-end
   
C8100
   
8,801
   
15.07
%
Traditional products for common
customers in market
   
Middle-level
   
CECTA2000
   
7,762
   
13.29
%
Tailor-made products for operators
   
High-end
   
C8000
   
6,735
   
11.53
%
Traditional products for common
customers in market
   
Low-end
   
D8110
   
6,287
   
10.76
%
Traditional products for common
customers in market
   
High-end
   
OBEE007
   
4,373
   
7.49
%
Tailor-made products for operators
   
High-end
   
D907
   
4,073
   
6.97
%
Specialized application mobile terminals
   
High-end
   
X180
   
3,914
   
6.70
%
Tailor-made products for operators
   
Low-end
   
M5
   
3,991
   
6.83
%
Tailor-made products for operators
   
High-end
   
H8801
   
3,389
   
5.80
%
Tailor-made products for operators
   
Low-end
   
M6
   
2,908
   
4.98
%
Tailor-made products for operators
   
High-end
   
M85
   
2,449
   
4.19
%
Tailor-made products for operators
   
Middle-level
   
N808
   
2,230
   
3.82
%
Traditional products for common
customers in market
   
Middle-level
   
N3201
   
672
   
1.15
%
Traditional products for common
customers in market
   
Middle-level
   
N3200
   
629
   
1.08
%
Other
               
198
   
0.34
%
Total
               
58,411
   
100
%
 
For the nine months ended September 30, 2007, total revenue was $58,411,000. The sales of CDMA products reached $38,490,000, representing 65.90% of our total revenue, as a result of the increase in sales of operator-tailored products since the beginning of the year. One factor in the growth was the expanded market for our specialized application mobile terminals Proxlink X180 and other intelligent mobile phones. The sale of GSM products in this period accounted for $19,921,000, or 34.10%, of our total revenue.

Our GSM products are purchased from Hebei Jvyuan Commerce and Trade Co., Ltd. and Beijing Dong Fang Long Yu Trading Company, which include CECTA2000 (Multimedia Player, Camera, Remote Control, Anti-stolen, U-disk), and D8110 (ultra thin, slide PDA with MP3, MP4, Camera, T-Flash Card, PC camera). Our CDMA products are provided by two major suppliers, China Electronic Appliance Corporation and Beijing Tian Hong Bo Communication Apparatus Company Limited, from whom the trading products included X180 of ORS’s brand Proxlink (high-end PDA, specialized application mobile terminal, barcode Scanning, and wireless handling of office work), C8100 (high-end PDA, MP3, MP4, Camera, T-flash Card, GSM & CDMA Simultaneous Standby Dual Mode handset), C8000 (high-end PDA, MP3, MP4, Camera, T-flash Card, GSM & CDMA Simultaneous Standby Dual Mode handset) and D907 (high-end CDMA cell phone of GSM & CDMA Simultaneous Standby Dual Mode, Mobile Stocks).

29

 
 
The increase in the Company’s revenues was attributable to:

·
the launch of specialized application mobile terminals to meet the specific application market;
   
·
the introduction of fashionable appearances and features to satisfy market demand; and
   
·
distribution through traditional channels.

Customer Segments

The revenues of customer segments for the nine month ended September 30, 2007:

 
 
Nine months ended September 30, 2007
 
   
$’000
 
% of Revenue
 
Beijing Xingwang Shidai Tech & Trading Co., Ltd.
   
54,497
   
93.30
%
China Electronic Appliance Corporation
   
3,914
   
6.70
%
Total
   
58,411
   
100.00
%

 For the nine months ended September 30, 2007, our revenues were mainly derived from two major domestic customers, Beijing Xingwang Shidai Tech & Trading Co., Ltd. (“XWSD”), and China Electronic Appliance Corporation (“CEAC”), in the amounts of $54,497,000 and $3,914,000, respectively, for a total amount of $58,411,000. In particular, Beijing Xingwang Shidai Tech & Trading Co., Ltd. has been our most important customer for a long period, and accounted for 93.30% of the total sales in this period. It is the largest distributor and dealer in Mainland PRC and has sales networks in major cities in the PRC. China Electronic Appliance Corporation, who became our customer in the second quarter, is a subsidiary of China Electronics Appliance Corporation Group (“CEC”), serving as one of the three largest trading enterprises in the electronic industry in the PRC.

Our accounts receivable were mainly derived from XWSD. However, we felt the risks we faced due to our reliance on XWSD were justified based on the following reasons:

1.
We placed a high level of importance on tailor-made products for operators during the restructuring of our product strategies, and the Company determined that XWSD was qualified to be our national distributor because it has over 170 sales branches in the PRC and it maintains close cooperation with provincial subsidiaries of China Unicom. We partnered with XWSD in order to utilize its distribution channels.

2.
Since our products go to end-users under the telecommunication platform operated by China Unicom, we chose XWSD to be our primary customer rather than utilize several small dealers. This helped to save time and control the sales and marketing expenses, even though we place a significant concentration of our sales with XWSD.

3.
At the beginning of 2007, we had a new products plan based on the TD-SCDMA platform. However, this plan had to be postponed because of governmental delays of network implementation. As a result, we had to slow down the supply of tailor-made products to China Mobile and rely on XWSD to increase our sales. Therefore, our accounts receivable were mainly generated by XWSD.

Other net income

For the nine months ended September 30, 2007, other net income accounted for $21,000, or 0.04% of the total revenue. It was mainly generated from selling obsolete raw materials in stock.

30

 
 
Operating expenses

For the nine months ended September 30, 2007, our operating expenses were $51,357,000. The operating expenses included sales and marketing, general and administrative, R & D expenses, and depreciation, which are set forth in the following table together with a comparison with the corresponding amounts from the same period in 2006:
 
 
 
Nine months ended
September 30, 2007
 
Nine months ended
September 30, 2006
 
Comparison
 
   
$’000
 
% of Revenue
 
$’000
 
% of Revenue
 
$’000
 
%
 
Cost of sales
   
47,586
   
81.47
%
 
37,879
   
82.52
%
 
9,707
   
25.63
%
Sales & marketing expenses
   
389
   
0.67
%
 
926
   
2.02
%
 
(537
)
 
(57.99
%)
General & Admin. expenses
   
763
   
1.31
%
 
519
   
1.13
%
 
244
   
47.01
%
R&D expenses
   
319
   
0.55
%
 
187
   
0.41
%
 
132
   
70.59
%
Depreciation
   
113
   
0.19
%
 
149
   
0.32
%
 
(36
)
 
(24.16
%)
Allowance for obsolete inventories
   
700
   
1.20
%
 
-
   
-
   
700
   
100.00
%
Allowance for trading deposit receivable
   
1,487
   
2.55
%
 
1,364
   
2.97
%
 
123
   
9.02
%
Total
   
51,357
   
87.92
%
 
41,024
   
89.37
%
 
10,333
   
25.19
%
 
Cost of sales

The cost of sales consists of material purchases made both by us and by our OEM factories, and any associated production charges or commissions. For the nine months ended September 30, 2007, our cost of sales was $47,586,000, or 81.47% of revenues. The cost of sales as a percentage of revenue decreased by 1.05%, as compared to 82.52% for the corresponding period in 2006. The principal reasons for the decrease were the decrease in sales of traditional mobiles over the period and the increase in sales of specialized application mobile terminal X180, which has a higher gross profit margin, resulting in the increased total gross operating income.

Sales and marketing expenses

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

For the nine months ended September 30, 2007, sales and marketing expenses were $389,000, or 0.67% of the revenues, which shows a decrease of 57.99% as compared to $926,000, or 2.02% of the revenues for the corresponding period in 2006. This sharp decrease was caused by a reduction in the number of personnel. The costs for salaries and social insurances were similarly reduced.

In 2006, the restructuring of the management framework and personnel reduction, which the Company started in the second quarter and finished in the third quarter, caused a decrease in sales and marketing expenses. In the fourth quarter, the after-sale maintenance services were shifted to materials suppliers, reducing the workload of our after-sale service department. After further negotiation, the costs of after-sale services, excluding the employees’ salaries, were borne by our cooperative partners. This resulted in a significant reduction of our sales and marketing expenses.
 
31

 

R&D expenses

Our R&D expenses were $319,000 or 0.55% of total revenue for the nine months ended September 30, 2007, which represents a 70.59% increase, as compared with $187,000 and 0.41%, of total revenue in the same period of 2006. The increase was attributed to the increased spending in research and development of promising and high-margin advanced smart mobile terminals.

General and Administrative expenses

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

For the nine months ended September 30, 2007, the total general and administrative expenses were $2,950,000, or 5.05% of the total revenue. After deducting the inefficient payment receivable of $1,487,000 and the allowance for obsolete inventories of $700,000, the actual general and administrative expenses were $763,000 or 1.31% of the total revenue, representing an increase of $244,000 or 47.01% as compared to $519,000 or 1.13% of the total revenues for the corresponding period in 2006.

Allowance for repairs and returns

For the nine months ended September 30, 2007, the allowance for repairs and returns was $60,199, representing a decrease of $41,188 or 40.62% as compared to $101,386 for the corresponding period in 2006.

Allowance for obsolete inventories

For the nine months ended September 30, 2007, allowance for obsolete inventories was $700,000, which was due to the fact that old models prior to 2006 were not produced any more and some related obsolete inventories were overstocked.

Allowance for trading deposits receivable

For the nine months ended September 30, 2007, allowance for trading deposits receivable was $1,487,000, representing a 9.02% increase as compared to $1,364,000. This increase occurred due to the following reasons:

1.
We organized our production process into many different categories and models. Often we paid in advance for the primary parts or materials, such as chips and boards. The amounts prepaid are relatively large and each cycle is long. As a result, we had a comparatively high balance for prepaid deposits.
   
2.
A portion of advance payments are fixed percentage of the total anticipated amount that will be required. In order to generate a larger volume of sales, some of our suppliers require their purchasers to pay deposits of 20% or more for raw materials and primary parts.
 
To change this unfavorable situation, we are in the process of acquiring a factory to set up our own production base and increase our financing capacity. Once we complete this process, we should be able to integrate our material purchases and reduce our required prepayments.

Gross Profit and Gross Profit Margin

For the nine months ended September 30, 2007, our gross profit was $10,825,000, reflecting a significant increase of $2,803,000, as compared to $8,022.000 for the same period of last year. In addition, our gross profit margin for the reporting period was 18.53%, which represents a 1.05% increase as compared to 17.48% for the same period of 2006.

The gross profit margin growth of our entire products lines is attributable to:

1.
the 27.25% increase of revenues for the nine months ended September 30,2007, as compared to the same period last year;
 
2.
the Company’s increased efforts to develop and distribute our more highly profitable products; and
 
32

 
 
3.
for the nine months ended September 30,2007, the products which yielded a profit margin of over 18% accounted for 56.89% of our sales revenues.

Net income

For the nine months ended September 30, 2007, our net income was $5,266,000 or a net profit margin of 9.02%, representing an increase of $618,000, or 13.30%, as compared to $4,648,000, or a net profit margin of 10.13% in the same period of 2006. The increase in our net profit is due to our new business strategy and cost controls.

However, our net profit margin does not show a significant change from last year, which is mainly because:

1.
In 2007, we paid income tax at the rate of 12% of aggregated profit.

2.
In 2007, the allowance for obsolete inventories and doubtful accounts amounted to $2,187,000 by the end of third quarter.
    
Due to comparatively higher profits on mid-level and high-end products, and the increased effectiveness of our control over trade deposits, we achieved net income of $2,570,000 in the third quarter, or 95.33% of the sum of the previous two quarters, which totaled $2,696,000.

Years Ended December 31, 2006 and 2005

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 providers in the second quarter of 2006.

We continued cooperating with telecommunication operators 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 quarters.

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 is in line with the latest trends, including being ultra slim and using 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 demand in the market for this type of product.

In 2006, we withdrew from the overseas market and restructured our product strategy to focus on the development of mobile phones for customers in the PRC. As an emerging enterprise, we believed it was very important to increase our market share in the large domestic market of the PRC.
 
Products Segment

For the year ended December 31, 2006, products that contributed over 10% of our revenues are shown as follows:
 
33

 

 
 
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
%
Others
   
17,923
   
26.32
%
 
In 2006, we continued our self-developed handsets business and jointly cooperated 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 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 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). CDMA sales have 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), and 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), and C109 (a low-end bar phone with colorful screen).

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
   
1,995
   
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 (“CECT-Chinacom”) were $36,406,000, $12,902,000, and $10,485,000 respectively. XWSD has been one of the most important customers of Xelent for a long period of time. The sales to XWSD accounted for 53.45% of the total revenues in 2006. The other two major domestic customers accounted for 18.94% (CECM) and 15.39% (CECT-Chinacom) respectively. Both XWSD and CECM are distributors and dealers in mainland PRC, and their sales networks cover most of the major cities in the PRC. CECT-Chinacom is a new customer which began to cooperate with us from the fourth quarter of 2006. CECT-Chinacom is a telecommunication devices and services operator. In the overseas market, we distribute our products to two Singapore customers, 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.

34

 
 
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 included sales and marketing, general and administrative and R & D expenses and depreciation 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
   
1,045
   
1.53
%
 
1,554
   
5.41
%
 
(509
)
 
-32.75
%
General & Admin
   
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
%
 
-
   
-
   
454
   
100.00
%
Depreciation
   
310
   
1.08
%
 
598
   
0.84
%
 
(288
)
 
(48.16
%)
Total
   
25,711
   
89.57
%
 
62,164
   
87.77
%
 
(36,453
)
 
(58.64
%)
 
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 reason 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. Additionally $8,107,000 of the sales in the second quarter of 2006 was 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 as a result of the increase of the portion of trading of cellular phones, where no after-sales service is provided for the trading activities.

35

 
 
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 a 38.26% decrease, as compared with $413,000 or 1.44% of total revenues in the same period of 2005. This decrease in R&D expenses was attributable to an increase in our trading activities and the change of the business model to purchase mature projects instead of R&D independently. The reduction of staff further decreased our R&D expenses.

General and administrative expenses

General and administrative expenses primarily consisted 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 represented 2.29% of total revenue. Included in general and administrative expenses was an allowance for doubtful accounts amounting to $767,000, due primarily to the uncertainty of long outstanding accounts receivable and trade deposits. Except for the allowance factor, 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. Since the second half of 2005, we adjusted our business strategy and eliminated some personnel, which made ordinary staff costs, including wages and insurance for personnel, decrease.

Allowance for repairs and returns

For the twelve months ended December 31, 2006, the allowance for repairs and returns was $146,203, representing a decrease of $294,244 or 66.81% as compared to $440,447 for the corresponding period in 2005.

 Allowance for obsolete inventories

For the twelve months ended December 31, 2006, allowance for obsolete inventories was $1,387,000, which was due to the provision for certain aged materials of mobile models whose production had been terminated.

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 represented a 3.5% decrease, as compared to 22.41% for 2005.

The changes in our gross profit margin are attributable to:

1.
Competition from domestic cellular manufacturers and overseas cellular providers through strategic price-cutting. We believe that the keys to strengthening our competitiveness in the market are our products strategy of providing tailor-made products to operators and supplying specialized application mobile terminals to end-users of special government and business sectors; diversification of our product lines to minimize competition from similar products in the market; and maintaining sufficient revenues streams and earning abilities.

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 was approximately 15%

3.
An increase in the sales of low-ended products. The demand for low-end products was stimulated by the reduction of monthly charges by telecommunications operators.

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 of 12.17% in 2005. The improvement in our net profit was due primarily to the fact that we were successful in changing the new business strategy, and positioning in the domestic market played an important part in the increase in our net income. The improvement in net income was also a result of a 30% decline in labor costs resulting from our cost control efforts.
 
36

 
 
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 amounted to $1,387,000 and $767,000, respectively, and the loss on the disposal of old models amounted to $454,000.
 
2.
Income tax totaled $1,247,000 in 2006.

Other than the two factors above, our net profit was $10,573,000 and net profit margin reached 15.52%, representing an increase of $6,833,000, as compared to net income of $3,740,000 for 2005 (other than the provision of $98,000 and $141,000 for obsolete inventories and for trade receivable doubtful accounts, respectively). Our profitability increased substantially in 2006.

Years Ended December 31, 2005 and 2004
 
Revenues
 
Our revenues for 2005 were $28,705,000, representing a decrease of 59.47% as compared to the same period in 2004. The decrease was primarily due to fierce competition in the PRC cellular phone market. The cellular phone manufacturer’s enlarging production capability during the past years and the rapid growth of the industry, together with the accelerating speed of new products launched, all contributed to a shorter products lifecycle and over supply of obsolete inventory. Additionally, competition from the counterfeit and “black market” cellular phones in the PRC market affected the operations and market environment of the PRC cellular phones industry. In order to meet changing market demands, we developed series of new products with innovative functions and extended our product lines by using our newly developed platform SpreadTrum and MTK in the second half of the year.
 
Our revenues increased from $3,440,000 in the first half of the year to $25,265,000 in the second half of the year, representing 88.02% of the revenues for the year ended December 31, 2005. The significant growth in revenues was primarily due to the introduction of a series of new products with innovative functions, such as 70A, 62+, 8205, 60+, M72 and M36. During 2005, multimedia cellular phones were the mainstream product in the market. We captured the latest demand trend of the domestic consumption market to launch new models with leading features including MP3, MPEG4, FM radio and large memory capacity. Such new products also generated a higher profit margin for us.
 
Additionally, in the second half of 2005, we changed our strategy to develop cellular phones for platforms other than the GSM system. We adopted a strategy to strengthen cooperation with telecommunications operators and other cellular phone manufacturers to provide solution consultation in the production of CDMA cellular phone model C100. The solution consultation included knowledge of the software application, field testing, mechanical and molding design and marketing. Through co-operation with telecommunications operators and other cellular phone manufacturers, we participated in the production of CDMA cellular phones and also built relationships with the telecommunications operators, providing us with opportunities to develop a potential CDMA market and generate additional orders from the telecommunications operators in the future. During this quarter, sales of C100 phones were $5,032,000, representing 17.53% of our revenues.
 
In addition, during this quarter, we commenced cellular phone trading activities with domestic and overseas customers. In the domestic market, we can earn profits by using our existing strategic partners’ sales networks, although the margin would be lower than the sales of self-produced cellular phones. In the overseas market, we sold over 10,000 units of M18+ to a customer in Hong Kong during the last quarter of 2005.
 
37

 
 
Product Segment
 
For the year ended December 31, 2005, products contributing over 5% of our revenues are shown as follows:
 
 
 
Twelve months ended December 31, 2005
 
   
$’000
 
% of revenue
 
C100
   
5,032
   
17.53
%
N108
   
2,326
   
8.10
%
8068
   
2,326
   
8.10
%
OS70+
   
1,959
   
6.82
%
K600
   
1,443
   
5.03
%
 
The sales of OS70+, represented 6.82% of our revenues and resulted from the new products launched in 2005. In the second half of 2005, total sales of new products were over $4,410,000, representing 15.36% of total revenues.
 
The sales of C100 amounted to $5,032,000, representing 17.53% of revenues, which was the result of cooperation with telecommunications operators. The trading activities generated from the sales of GSM cellular phones N108 and 8068 and CDMA cellular phone K600 were $2,326,000, $ 2,326,000 and $1,443,000, respectively, representing 8.10%, 8.10% and 5.03% of revenues, respectively. Through the introduction of new innovative features models and the development of new business streams, our revenues achieved stable growth since this quarter.

Customers Segment
 
 
 
Twelve months ended
December 31, 2005