e20vf

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F


o		REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934


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

For the fiscal year ended December 31, 2007


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

For the transition period from to

Commission file number 0-29946


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

Date of event requiring this shell company report

If this is an annual report , indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No o

QIAO XING UNIVERSAL TELEPHONE, INC.

(Exact name of Registrant as specified in its charter)

QIAO XING UNIVERSAL TELEPHONE, INC.

(Translation of Registrant’s name into English)

British Virgin Islands

(Jurisdiction of incorporation or organization)

Qiao Xing Science Industrial Park
Tang Quan
Huizhou City, Guangdong,
People’s Republic of China 516023

(Address of principal executive offices)

Albert Leung, CFO
011-86-752-2820-268 (telephone)
albertleung@qiaoxing.com.hk (email)
011-86-752-2820-268 (facsimile)

Qiao Xing Science Industrial Park
Tang Quan
Huizhou City, Guangdong,
People’s Republic of China 516023
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.


Title of each class		Name of each exchange on which registered

$.001 Par Value Common Stock (“Common Stock”)		NASDAQ

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

(Title of Class)

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

30,948,836 Shares of Common Stock as of December 31, 2007

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No þ

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

þ		U.S. GAAP

o		International Financial Reporting Standards as issued by the International Accounting Standards Board

o		Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o		Item 17

o		Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Not Applicable.

TABLE OF CONTENTS


PART I
	ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
	ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
	ITEM 3. KEY INFORMATION
	ITEM 4. INFORMATION ON THE COMPANY
	ITEM 4A. UNRESOLVED STAFF COMMENTS
	ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
	ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
	ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
	ITEM 8. FINANCIAL INFORMATION
	ITEM 9.THE OFFER AND LISTING
	ITEM 10. ADDITIONAL INFORMATION
	ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
	ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
PART II
	ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
	ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
	ITEM 15. CONTROLS AND PROCEDURES
	ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
	ITEM 16B. CODE OF ETHICS
	ITEM 16C.PRINCIPAL ACCOUNTANT FEES AND SERVICES
	ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
	ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
PART III
	ITEM 17. FINANCIAL STATEMENTS
	ITEM 18. FINANCIAL STATEMENTS
	ITEM 19. EXHIBITS
SIGNATURES
INDEX TO EXHIBITS
List of Significant Subsidiaries of the Company
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) and 18.U.S.C. Section 1350
Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) and 18.U.S.C. Section 1350

SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. These include statements about our expectations, plans, objectives, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plans,” “potential,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend” and similar expressions. These statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed for the reasons described in this annual report. You should not place undue reliance on these forward-looking statements.

You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including but not limited to:

	•		dependence upon certain customers

	•		dependence on key personnel

	•		control by principal shareholder

	•		competitive factors

	•		the operation of our business

	•		general economic conditions

You should also consider carefully the statements under “Risk Factors” and other sections of this annual report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.

The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

We may use data and industry forecasts in this annual report which we have obtained from internal surveys, market research, publicly available information and industry publications. Industry publications generally state that the information they provide has been obtained from sources believed to be reliable but that the accuracy and completeness of such information is not guaranteed. Similarly, we believe that the surveys and market research we or others have performed are reliable, but we have not independently verified this information.

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PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

A. SELECTED FINANCIAL DATA.

We prepare our consolidated financial statements in accordance with United States Generally Accepted Accounting Principles (“US GAAP”). The following summary consolidated statements of operations data for the years ended December 31, 2005, 2006 and 2007 and the consolidated balance sheet data as of December 31, 2006 and 2007 were derived from our audited financial statements included elsewhere in this annual report and should be read in conjunction with such financial statements. The following summary consolidated statements of operations data for the year ended December 31, 2003 and 2004 and the consolidated balance sheet data as of December 31, 2003, 2004 and 2005 were derived from our audited financial statements not included elsewhere in this annual report and have been prepared in accordance with US GAAP and have been derived from audited financial statements. The following summary financial data should be read in conjunction with Item 5. Operating and Financial Review and Prospects and the consolidated financial statements and the notes thereto included elsewhere in this annual report.


	2003			2004			2005			2006			2007
	Rmb’000			Rmb’000			Rmb’000			Rmb’000			Rmb’000			US$’000
Net sales		1,783,760			1,720,389			2,635,184			3,221,212			3,874,107			531,092
Cost of goods sold		(1,543,796	)		(1,497,177	)		(2,156,798	)		(2,651,392	)		(2,898,964	)		(397,412	)
Gross profit		239,963			223,212			478,386			569,820			975,143			133,680

Operating expenses:
Selling expenses		(75,843	)		(29,065	)		(24,726	)		(28,401	)		(59,820	)		(8,200	)
General and administrative expenses
Including stock-based compensation		(75,115	)		(90,554	)		(55,341	)		(126,076	)		(131,074	)		(17,969	)
Research and development		(6,649	)		(18,378	)		(20,694	)		(30,747	)		(34,452	)		(4,723	)
In process research and development		(35,263	)		—			—			(41,739	)		—			—

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	2003			2004			2005			2006			2007
	Rmb’000			Rmb’000			Rmb’000			Rmb’000			Rmb’000			US$’000
Amortization of acquired intangible assets		(31,361	)		(11,880	)		(11,880	)		(15,178	)		(32,280	)		(4,425	)

Income from operations		15,732			73,335			365,745			327,679			717,517			98,363
Interest income		3,045			492			7,130			8,108			42,127			5,775
Exchange gain (loss), net		—			—			(2,659	)		3,225			28,255			3,874
Interest expense		(17,022	)		(27,060	)		(41,752	)		(100,432	)		(248,014	)		(34,000	)
Loss on re-measurement of embedded derivatives		—			—			—			(134,439	)		(129,084	)		(17,696	)
Loss on extinguishment of convertible debt		—			—			—			—			(142,090	)		(19,479	)
Gain on disposal of interests in subsidiaries		—			—			10,307			—			482,614			66,160
Gain on sale of equity investee		—			11,397			—			—			—			—
Gain on sale of stocks by subsidiary		—			—			—			—			383,965			52,637
Provision for litigation settlement		—			—			—			—			(15,319	)		(2,100	)
Impairment of investment at cost		—			—			(7,348	)		—			—			—
Other income, net		2,088			1,597			640			4,453			59,055			8,096
Income before income tax		3,843			59,761			332,063			108,594			1,179,026			161,630
Provision for income tax		(5,862	)		(7,397	)		(25,486	)		(58,192	)		(124,120	)		(17,015	)
Income before minority interests		(2,019	)		52,364			306,577			50,402			1,054,906			144,615
Minority interests		(28,800	)		(51,903	)		(99,270	)		(84,473	)		(168,554	)		(23,107	)
Equity in earnings of equity investees		6,802			955			—			—			—			—
Net income (loss) before extraordinary gain		(24,017	)		1,416			207,307			(34,071	)		886,352			121,508
Extraordinary gain on acquisition of minority interests		—			—			37,592			14,237			17,596			2,412

Net Income (Loss)		(24,017	)		1,416			244,899			(19,834	)		903,948			123,920

Other comprehensive (loss) income

Translation adjustments		(746	)		70			1,821			7,203			(50,106	)		(6,869	)

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	2003			2004		2005		2006			2007
	Rmb’000			Rmb’000		Rmb’000		Rmb’000			Rmb’000		US$’000
Comprehensive income (loss)		(24,763	)		1,486		246,720		(12,631	)		853,842		117,051
Basic earnings (loss) per common share
Before extraordinary gain		(1.56	)		0.09		11.32		(1.44	)		24.46		3.35
Extraordinary gain		—			—		2.05		0.60			0.49		0.07

After extraordinary gain		(1.56	)		0.09		13.37		(0.84	)		24.95		3.42
Diluted earnings (loss) per common share
Before extraordinary gain		(1.56	)		0.09		11.32		(2.03	)		24.20		3.31
Extraordinary gain		—			—		2.05		0.59			0.48		0.07

After extraordinary gain		(1.56	)		0.09		13.37		(1.44	)		24.68		3.38

Weighted average number of shares outstanding
- Basic (2)		15,420,000			16,443,000		18,319,000		23,712,000			29,836,000		29,836,000
- Diluted (2)		15,420,000			16,560,000		18,320,000		24,016,000			30,201,000		30,201,000


	2003		2004		2005		2006		2007
	Rmb’000		Rmb’000		Rmb’000		Rmb’000		Rmb’000		US$’000
Balance Sheet Data
Cash and bank deposits		122,466		140,890		391,660		1,096,477		3,033,010		415,788
Working capital		302,027		429,253		856,839		1,498,715		3,946,468		541,012
Property, machinery and equipment, net		98,305		107,162		52,664		209,542		192,601		26,403
Construction in progress		1,184		50,934		59,105		60,295		—		—
Lease prepayments, net		182,985		178,577		173,161		207,206		36,106		4,950
Debt issuance cost, net		—		—		—		31,845		—		—
Total assets		1,523,303		2,042,048		2,534,547		4,177,986		6,378,841		874,461
Short-term-debts		439,472		700,186		754,212		1,155,290		1,471,454		201,718
Long-term-debts		11,939		10,428		7,959		229,784		196,854		26,986
Total liabilities		771,189		1,157,693		1,316,418		2,192,713		2,260,956		309,949
Minority interests (1)		190,980		242,883		220,832		115,224		1,095,917		150,237
Shareholders’ equity		561,134		641,471		997,297		1,870,049		3,021,968		414,275
Cash flows data

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	2003			2004			2005			2006			2007
	Rmb’000			Rmb’000			Rmb’000			Rmb’000			Rmb’000			US$’000
Cash flows from operating activities		(307,404	)		(204,036	)		116,682			(156,840	)		954,654			130,872
Cash flows from investing activities		159,323			(82,451	)		(3,822	)		(603,009	)		(650,317	)		(89,151	)
Cash flows from financing activities		260,345			304,841			136,505			1,465,657			1,675,920			229,748


(1)		Mr. Rui Lin Wu and Mr. Zhi Yang Wu own minority equity interests in certain subsidiaries of our company.

(2)		Earnings per share is computed by dividing net income for 2003 by 15,420,000 shares, for 2004 by 16,443,000 shares, for 2005 by 18,319,000 shares, for 2006 by 23,712,000 shares and for 2007 by 29,836,000 shares. Diluted earnings per common share is computed by using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of outstanding stock options, warrants and convertible debentures, to the extent such instruments were dilutive during the period.

(3)		Translation of amounts from Renminbi (“Rmb”) into United States dollars (“US$”) is for the convenience of readers and has been made at the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2007 of US$1.00 = Rmb 7.2946. No representation is made that the Renminbi amounts could have been, or could be, converted into United States dollars at that rate or at any other rate.

Exchange Rate Information

We have prepared our consolidated financial statements in accordance with United States Generally Accepted Accounting Principles consistently applied and publish such statements in Renminbi, the functional currency of our subsidiaries and the legal tender currency of China. All references to “Renminbi” or “Rmb” are to Renminbi. All references to “U.S. Dollars,” “dollars,” “US$” or “$” are to United States dollars.

The following table sets forth certain information concerning exchange rates between Renminbi and U.S. dollars for the periods indicated:


	Noon Buying Rate(1)
Calendar Year	Average(2)
	(Rmb per US$)
2003		8.2771
2004		8.2768
2005		8.1826
2006		7.9579
2007		7.5806

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(1)		The noon buying rate in New York for cable transfers payable in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York. Since April 1994, the noon buying rate has been based on the PBOC Rate. As a result, since April 1994, the noon buying rate and the PBOC Rate have been substantially similar.

(2)		Annual averages are calculated from the month-end rates.


Calendar Month	High		Low		Average
January 2008		7.2946		7.1818		7.2405
February 2008		7.1973		7.1100		7.1644
March 2008		7.1110		7.0105		7.0722
April 2008		7.0185		6.9840		6.9997
May 2008		7.0000		6.9377		6.9725
June 2008		6.9633		6.8591		6.8993
July 2008 (through July 8)		6.8608		6.8510

As of July 8, 2008, being the latest practicable date, the exchange rate was US$1.00 = Rmb 6.8510.

This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars were made at the noon buying rate in the City of New York for cable transfers in Renminbi per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York as of December 31, 2007, which was Rmb 7.2946 to $1.00. No representation is made that the Renminbi amounts referred to in this annual report could have been or could be converted into U.S. dollars at any particular rate or at all.

The People’s Bank of China, or PBOC, issued a public notice on July 21, 2005 increasing the exchange rate of the Renminbi against the U.S. dollar by approximately 2% to Rmb 8.11 per US$1.00. Further to this notice, the PRC government has reformed its exchange rate regime by adopting a managed floating exchange rate regime based on market supply and demand with reference to a portfolio of currencies. Under this new regime, the Renminbi will no longer be pegged to the U.S. dollar. This change in policy has resulted in a more than 7.4% appreciation of the Renminbi against the U.S. dollar. The PRC government may decide to adopt an even more flexible currency policy in the future, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.

B. CAPITALIZATION AND INDEBTEDNESS.

Not applicable.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS.

Not applicable.

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D. RISK FACTORS

Our future revenues and operating results are inherently unpredictable, and as a result, we may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline.

Our revenues and operating results have fluctuated significantly from quarter-to-quarter in the past, and may continue to fluctuate significantly in the future. Factors that are likely to cause these fluctuations, some of which are outside of our control, include, without limitation, the following:

	•		the current economic environment and other developments in the telecommunications industry;

	•		the mix of our products sold, including inventory items with low product costs;

	•		our ability to control expenses;

	•		fluctuations in demand for and sales of our products, the acceptance of our products in the marketplace, and the general level of spending in the telecommunications industry;

	•		our ability to maintain appropriate manufacturing capacity, and particularly to limit excess capacity commensurate with the volatile demand levels for our products;

	•		our ability to successfully complete a transition to an outsourced manufacturing model;

	•		the ability of our outsourced manufacturers to timely produce and deliver subcomponents, and possibly complete products in the quantity and of the quality we require;

	•		competitive factors, including the introduction of new products and product enhancements by competitors and potential competitors, pricing pressures, and the competitive environment in the markets into which we sell our products, including competitors with substantially greater resources than we have;

	•		our ability to effectively develop, introduce, manufacture, and ship new and enhanced products in a timely manner without defects;

	•		the availability and cost of components for our products;

	•		new product introductions that may result in increased research and development expenses and sales and marketing expenses that are incurred in one quarter, with revenues, if any, that are not recognized until a subsequent or later quarter; and

	•		the unpredictability of consumer demand and difficulties in meeting such demand.

A high percentage of our expenses, including those related to manufacturing, engineering, sales and marketing, research and development, and general and administrative functions, is fixed in the short term. As a result, if we experience delays in generating and recognizing revenue, our quarterly operating results are likely to be seriously harmed.

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Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. Our results for one quarter should not be relied upon as any indication of our future performance. It is possible that in future quarters our operating results may be below the expectations of public market analysts or investors. If this occurs, the price of our common stock would likely decrease.

Our stock price is highly volatile.

The trading price of our common stock has fluctuated significantly since our initial public offering in February 1999, and is likely to remain volatile in the future. The trading price of our common stock could be subject to wide fluctuations in response to many events or factors, including the following:

	•		quarterly variations in our operating results;

	•		significant developments in the businesses of other telecommunications companies;

	•		changes in financial estimates by securities analysts;

	•		changes in market valuations or financial results of telecommunications-related companies;

	•		announcements by us or our competitors of technology innovations, new products, or significant acquisitions, strategic partnerships or joint ventures;

	•		any deviation from projected growth rates in revenues;

	•		any loss of a major customer or a major customer order;

	•		additions or departures of key management or engineering personnel;

	•		any deviations in our net revenue or in losses from levels expected by securities analysts;

	•		activities of short sellers and risk arbitrageurs;

	•		future sales of our common stock; and

	•		volume fluctuations, which are particularly common among highly volatile securities of telecommunications-related companies.

In addition, the stock market has experienced volatility that has particularly affected the market prices of equity securities of many high technology companies, which often has been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock.

We experience intense competition with respect to our products.

Some of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, some of these competitors are able to devote greater resources to the development, promotion, sale, and support of their products. In addition, our competitors that have larger market capitalization or cash reserves are better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines.

-9-

We are subject to a concentration of credit risk.

We perform ongoing credit evaluations of each customer’s financial condition. We maintain reserves for potential credit losses and such losses in the aggregate have not exceeded management’s projections. As of December 31, 2006 and 2007, our five largest accounts receivable accounted for approximately 43% and 38% of our total accounts receivable.

The economy of China differs from the economies of most countries and creates significant risks.

Although the majority of productive assets in China are still owned by the government, economic reform policies since 1978 have emphasized decentralization and the utilization of market mechanisms in the development of the Chinese economy. We have significantly benefited from such reforms, as the Ministry of Post and Telecommunications since 1994 has opened the telecommunications equipment market of China to all kinds of manufacturers. Our management believes that the basic principles underlying the reforms will continue to provide an acceptable framework of the PRC’s political and economic systems. In addition, we currently see no evidence that this refinement and readjustment process may adversely affect, directly or indirectly, the Company’s operations in the future.

As substantially all of our operations are conducted in Mainland China, we are subject to special considerations and significant risks not typically associated with companies operating in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. Our results may be adversely affected by changes in the political and social conditions in Mainland China, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

In addition, substantially all of our revenue is denominated in Renminbi (“Rmb”) which must be converted into other currencies before remittance outside Mainland China. Both the conversion of Renminbi into foreign currencies and the remittance of foreign currencies abroad require the approval of the Mainland Chinese government.

Our currency is not freely convertible.

The State Administration for Exchange Control (“SAEC”), under the authority of the People’s Bank of China (the “PBOC”), controls the conversion of Renminbi into foreign currency. The value of the Renminbi is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China Foreign Exchange Trading System (“CFETS”) market. Since substantially all of our raw materials are provided by local suppliers using Renminbi and the majority of our expenses are denominated in Renminbi, restrictions on currency conversions did not materially affect our operations. Also, since we do not

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expect to require any raw material that are not permitted or are limited to purchase using foreign currencies, our management believes that such restriction will not materially affect our operations in the future. However, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and our other holdings and investments, and our operating subsidiaries located in China may be subject to restrictions on the conversion of Renminbi to U.S. dollars and, as a result, may be restricted to make distributions to us.

We may not maintain adequate insurance coverage for damage to our Chinese factories.

We have no direct business operation, other than our ownership of our subsidiaries located in China, and our results of operations and financial condition are currently solely dependent on our subsidiaries’ factories in China. We currently maintain fire, casualty and theft insurance covering various of our stock in trade, goods and merchandise, furniture and equipment, and factory buildings in China. The proceeds of this insurance may not sufficiently cover material damage to, or the loss of, any of our factories due to fire, severe weather, flooding or other cause, and such damage or loss would have a material adverse effect on our financial condition, business and prospects. However, we have not materially suffered from such damage or loss to date.

The discontinuation of the preferential tax treatment currently available to our PRC subsidiary, CEC Telecom Co., Ltd., could materially adversely affect our results of operations.

Our PRC operating subsidiary, CEC Telecom Co., Ltd. (“CECT”), was subject to the PRC Enterprise Income Tax Law Concerning Foreign-Invested Enterprises and Foreign Enterprises. CECT, as a foreign-invested enterprise, was generally subject to enterprise income tax at a statutory rate of 33% (30% national income tax plus 3% local income tax) through 2007 under this law and its related regulations, and 25% from January 1, 2008 under the new tax law described below. However, as a “high-tech enterprise” formed in the Zhongguancun Science Park high technology zone in Beijing, CECT enjoyed preferential tax treatment through 2007. In particular, CECT was exempted from enterprise income tax from May 22, 2000 to December 31, 2002 and was entitled to preferential enterprise income tax rates of 7.5% from January 1, 2003 to December 31, 2005 and 15% from January 1, 2006 to December 31, 2007.

On March 16, 2007, the National People’s Congress of the PRC passed the PRC Enterprise Income Tax Law, which law took effect as of January 1, 2008. In accordance with the new tax law, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises such as CECT. However, certain qualifying high-technology enterprises may still benefit from a preferential tax rate of 15% under the new tax law if they meet the definition of “qualifying high-technology enterprise” to be set forth in the more detailed implementing rules when they are adopted. As a result, if CECT qualifies as a “qualifying high-technology enterprise”, it will continue to benefit from a preferential tax rate of 15%. Before being qualified as a “qualifying high-technology enterprise” under the new tax law, CECT’s applicable tax rate increased from its then existing tax rate of 15% to the unified tax rate of 25% effective January 1, 2008. Regarding the implementation of the preferential treatment for “qualifying high-technology enterprise” under the new tax law, the

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Chinese government has taken the first step in creating a mechanism to review the qualifications of “high-technology enterprise” with the issuance of “Circular 172” on April 14, 2008. This guidance, however, is not detailed enough and specifies that additional detailed guidelines will be issued. Such additional guidelines are expected to be issued within the next several months, with the actual detailed procedures being set up sometime thereafter. As a result, we expect that qualified enterprises will only receive their “High-technology Enterprise Certificate” in the second half of 2008 or sometime next year.

We cannot assure you that CECT will qualify as a “qualifying high-technology enterprise” under the new tax law, and even if CECT successfully obtains this high-tech enterprise status, its preferential tax treatment may be discontinued by the tax authorities at their discretion or pursuant to any future changes in PRC tax laws, rules or regulations. Before being qualified as a “qualifying high-technology enterprise” under the new tax law, CECT is subject to a 25% rate from January 1, 2008 under the new tax law described above, which significantly increases our effective tax rate and materially adversely affects our operating results.

The dividends that our BVI-incorporated investment holding subsidiaries receive from their subsidiaries in the PRC and our global income may be subject to PRC tax under the new PRC Enterprise Income Tax Law, which would have a material adverse effect on our results of operations. In addition, our foreign corporate holders of ordinary shares may be subject to a PRC withholding tax upon the dividends payable by us and upon gains realized on the sale of our ordinary shares, if we are classified as a PRC “resident enterprise.”

Under the new PRC Enterprise Income Tax Law, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in the PRC to its foreign investor who is a non-resident enterprise will be subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a reduced rate of withholding tax. The British Virgin Islands, where our investment holding subsidiaries are incorporated, does not have such a tax treaty with the PRC. If these BVI-incorporated investment holding subsidiaries are considered non-resident enterprises, this new 10% withholding tax imposed on their dividend income received from their PRC subsidiaries would reduce our net income and have an adverse effect on our operating results.

Under the new tax law, an enterprise established outside the PRC with its “de facto management body” within the PRC is considered a resident enterprise and will be subject to the enterprise income tax at the rate of 25% on its worldwide income. The “de facto management body” is defined as the organizational body that effectively exercises overall management and control over production and business operations, personnel, finance and accounting, and properties of the enterprise. It remains unclear how the PRC tax authorities will interpret such a broad definition. Substantially all of our management members are based in the PRC. If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our worldwide income will be subject to income tax at a uniform rate of 25%, which may have a material adverse effect on our financial condition and results of operations. Notwithstanding the foregoing provision, the new tax law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. Therefore, if our

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BVI-incorporated investment holding subsidiaries are classified as resident enterprises, the dividends they receive from their PRC subsidiaries may be exempted from income tax. In addition, under the new tax law, foreign corporate holders of our ordinary shares may be subject to a 10% withholding tax upon dividends payable by us and gains realized on the sale or other disposition of ordinary shares, if such income is sourced from within the PRC. Although we are incorporated in the British Virgin Islands, it remains unclear whether the dividends payable by us or the gains our foreign corporate holders may realize will be regarded as income from sources within the PRC if we are classified as a PRC resident enterprise. Any such tax may reduce the return on an investment in our ordinary shares by a foreign corporation.

Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to acquire PRC companies or to inject capital into our PRC subsidiary, limit our PRC subsidiary’s ability to distribute profits to us, or otherwise materially and adversely affect us.

The State Administration of Foreign Exchange (“SAFE”) issued a public notice in October 2005, or the SAFE notice, requiring PRC residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside of China, referred to as an “offshore special purpose company,” for the purpose of acquiring any assets of or equity interest in PRC companies and raising fund from overseas. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch, with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. If any PRC shareholder of any offshore special purpose company fails to make the required SAFE registration and amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore special purpose company. Moreover, failure to comply with the SAFE registration and amendment requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

Due to lack of official interpretation, some of the terms and provisions in the SAFE notice remain unclear and implementation by central SAFE and local SAFE branches of the SAFE notice has been inconsistent since its adoption. Based on the advice of our PRC counsel and after consultation with relevant SAFE officials, we believe that our PRC resident shareholders were required to complete their respective SAFE registrations pursuant to the SAFE notice. Since our PRC resident shareholders did not complete their SAFE registrations before March 31, 2006, the local SAFE branch will not accept their applications for SAFE registration until the detailed rules concerning the penalties for those who failed to make their SAFE registrations before March 31, 2006 are implemented. However, we believe the likely penalties for failure to complete the SAFE registration will be nominal and there should be no other legal obstacles for our PRC resident shareholders to complete or amend their respective SAFE registrations with respect to the Company. Moreover, because of uncertainty over how the SAFE notice will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect

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our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with the SAFE notice by our PRC resident beneficial holders. In addition, such PRC residents may not always be able to complete the necessary registration procedures required by the SAFE notice. We also have little control over either our present or prospective direct or indirect shareholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident shareholders to comply with the SAFE notice, if SAFE requires it, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiary’s ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

In addition, the National Development and Reform Commission (the “NDRC”) promulgated a rule in October 2004, or the NDRC Rule, which requires NDRC approvals for overseas investment projects made by PRC entities. The NDRC Rule also provides that approval procedures for overseas investment projects of PRC individuals shall be implemented with reference to this rule. However, there exist extensive uncertainties in terms of interpretation of the NDRC Rule with respect to its application to a PRC individual’s overseas investment, and in practice, we are not aware of any precedents that a PRC individual’s overseas investment has been approved by the NDRC or challenged by the NDRC based on the absence of NDRC approval. Our current beneficial owners who are PRC individuals did not apply for NDRC approval for investment in a subsidiary. We cannot predict how and to what extent this will affect our business operations or future strategy. For example, the failure of our shareholders who are PRC individuals to comply with the NDRC Rule may subject these persons or our PRC subsidiary to certain liabilities under PRC laws, which could adversely affect our business.

We depend upon certain key personnel to manage our company.

Our ability to successfully carry out our business plans continues to be largely dependent upon the efforts of our senior management and executive officers, particularly our chairman, Rui Lin Wu. We have not entered into an employment agreement with Mr. Wu and the loss of his services would have a material adverse effect on our ability to achieve our business objectives. Further, we do not maintain any key-person life insurance policy on his life.

We are controlled by one of our shareholders, whose interests may differ from other shareholders.

Rui Lin Wu, our chief executive officer and chairman, and members of his family beneficially own or control approximately 22.0% of our outstanding shares as of July 8, 2008. Accordingly, he has significant influence in determining the outcome of any corporate transaction or other matter submitted to the shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. He also may have the power to prevent or cause a change in control. In addition, without his consent, we could be prevented from entering into transactions that could be beneficial to us. The interests of this shareholder may differ from the interests of the other shareholders.

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Our holding company structure creates restrictions on the payment of dividends.

We have no direct business operations, other than our ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions. If future dividends are paid in Renminbi, fluctuations in the exchange rate for the conversion of Renminbi into U.S. dollars may adversely affect the amount received by U.S. shareholders upon conversion of the dividend payment into U.S. dollars.

As a “foreign private issuer”, we are not subject to certain rules promulgated by Nasdaq that other Nasdaq-listed issuers are required to comply with.

Our common shares are currently listed on the Nasdaq Global Market and, for so long as our securities continue to be listed, we will remain subject to the rules and regulations established by Nasdaq applicable to listed companies. As permitted under Nasdaq rules applicable to foreign private issuers, we have determined not to comply with the following Nasdaq rules:

	•		our independent directors do not hold regularly scheduled meetings in executive session;

	•		the compensation of our executive officers is not determined by an independent committee of the board or by the independent members of the board of directors, and our CEO may be present and participate in the deliberations concerning his compensation;

	•		related party transactions are not required to be reviewed or approved by our audit committee or other independent body of the board of directors; and

	•		we are not required to solicit shareholder approval of stock plans, including those in which our officers or directors may participate; stock issuances that will result in a change in control; the issuance of our stock in related party transactions or other transactions in which we may issue 20% or more of our outstanding shares; or, below market issuances of 20% or more of our outstanding shares to any person.

We may in the future determine to voluntarily comply with one or more of the foregoing provisions.

It may be difficult to serve us with legal process or enforce judgments against us or our management.

We are a British Virgin Islands holding company, and all or a substantial portion of our assets are located in China. In addition, all of our directors and officers are non-residents of the United States, and all or a substantial portion of the assets of such non-residents are located outside the United States. As a result, it may not be possible to effect service of process within the United States upon them. Moreover, there is doubt as to whether the courts of the British Virgin Islands or China would enforce:

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	•		judgments of United States courts against us, our directors or our officers based on the civil liability provisions of the securities laws of the United States or any state; or

	•		in original actions brought in the British Virgin Islands or China, liabilities against us or non-residents based upon the securities laws of the United States or any state.

Some information about us may be unavailable due to exemptions under the Exchange Act for a foreign private issuer.

We are a foreign private issuer within the meaning of the rules under the Exchange Act. As such, we are exempt from certain provisions applicable to United States domestic public companies, including:

	•		the rules under the Exchange Act requiring the filing with the Securities and Exchange Commission of quarterly reports on Form 10-Q or current reports on Form 8-K;

	•		the provisions of Regulation FD aimed at preventing issuers from making selective disclosures of material information;

	•		the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; and

	•		the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction.

Because of these exemptions, investors are not provided with the same information which is generally available about domestic public companies organized in the United States.

Since we are a British Virgin Islands company, the rights of our shareholders may be more limited than those of shareholders of a company organized in the United States.

Under the laws of most jurisdictions in the United States, majority and controlling shareholders generally have certain fiduciary responsibilities to the minority shareholders. Shareholder action must be taken in good faith, and actions by controlling shareholders which are obviously unreasonable may be declared null and void. British Virgin Island law protecting the interests of minority shareholders may not be as protective in all circumstances as the law protecting minority shareholders in U.S. jurisdictions. In addition, the circumstances in which a shareholder of a BVI company may sue the company derivatively, and the procedures and defenses that may be available to the company, may result in the rights of shareholders of a BVI company being more limited than those of shareholders of a company organized in the U.S.

Furthermore, our directors have the power to take certain actions without shareholder approval which would require shareholder approval under the laws of most U.S. jurisdictions. The directors of a BVI corporation, subject in certain cases to court approval but without shareholder approval, may implement a reorganization, merger or consolidation, the sale of any assets, property, part of the business, or securities of the corporation. Our ability to amend our Memorandum of Association and Articles of Association without shareholder approval could have the effect of delaying, deterring or preventing a change in our control without any further action by the shareholders, including a tender offer to purchase our common stock at a premium over then current market prices.

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ITEM 4. INFORMATION ON THE COMPANY

A. HISTORY AND DEVELOPMENT OF THE COMPANY.

From our inception through December 31, 2002, Qiao Xing Universal Telephone, Inc. (“Qiao Xing” or “we”) was principally engaged in the manufacturing and sales of telecommunication terminals and equipment, including corded and cordless telephone sets, in China. Our history dates back to April 1992 when Mr. Rui Lin Wu, our founder and chief executive officer, established Qiao Xing Telecommunication Industry Co. Ltd. in Huizhou, People’s Republic of China (“PRC” or “China”). We initially were engaged in the original design and manufacturing of corded telephones, whereby products are designed and manufactured to the customer’s requirements and instructions and are marketed under the customer’s designated brand name or without a designated brand name. When we commenced our operations in August 1992, we had only 100 employees and two production lines producing telephones.

In August 1995, we were awarded the ISO9001 certificate, which reflected our reputation as a high quality telephone manufacturer.

Our company, formerly known as Pastiche Investments Limited, was incorporated as an international business company under the International Business Companies Act of the British Virgin Islands on December 6, 1994. As of July 8, 2008, we owned 69.9% of Qiao Xing Mobile Communication Co. Ltd. (“QX Mobile”), an international business company incorporated in the British Virgin Islands on January 31, 2002. QX Mobile owns 96.55% of CEC Telecom Co., Ltd., a limited liability company established in China (“CECT”). We also own 100% of Qiao Xing Communication Holdings, Ltd., an international business company incorporated in the British Virgin Islands on May 21, 2002 (“QX Communication Holdings”), which owns 90% of Hui Zhou Qiao Xing Property, Ltd. (“QX Property”), a PRC joint venture, and 90% of Hui Zhou Qiao Xing Communication Industry, Ltd. (“HZQXCI”), a PRC joint venture.

The remaining ownership of each of QX Property and HZQXCI is owned by Qiao Xing Group Limited, a PRC company owned by Rui Lin Wu and his eldest son Zhi Yang Wu. Messrs. Wu and Wu are two of our executive officers and directors.

Refer to Item 4.B. Business Overview for a description of the important events in the development of our business for the period from the beginning of 2002 up to the date of filing of this report.

For 2005, our total capital expenditure was about Rmb20.9 million, which primarily included: 1) Rmb 12.7 million for acquisition of property, machinery and equipment; and 2) Rmb 8.2 million for construction in progress.

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For 2006, our total capital expenditure was about Rmb 208.7 million, which primarily included: 1) Rmb 168.5 million for property, machinery and equipment; and 2) Rmb 39.0 million for land use rights.

For 2007, our total capital expenditure was about Rmb 7.0 million, which primarily included: 1)Rmb 6.5 million for acquisition of property, machinery and equipment; and 2)Rmb 0.5 million for construction in progress.

Our principal place of business and our executive office is the Qiao Xing Science Industrial Park, Tang Quan, Huizhou City, Guangdong, People’s Republic of China, 516023, telephone: (011) 86-752-2820-268. We have designated Andrew N. Bernstein, 5445 DTC Parkway, Suite 520, Greenwood Village, Colorado 80111 as our agent for service of process in the United States.

Sale of $25,000,000 Senior Convertible Notes

Background

On August 17, 2007, we entered into a Securities Purchase Agreement (the “August ’07 Agreement”) with two accredited investors pursuant to which we agreed to issue and the investors agreed to purchase an aggregate amount of $25,000,000 of our 5.5% senior convertible notes, as well as 490,677 common stock purchase warrants. In addition, our placement agent received 245,339 common stock purchase warrants with identical terms to those issued to the investors.

The Transaction

Set forth below is a summary of the material terms of the transaction which is qualified in its entirety by the August ’07 Agreement and the exhibits thereto.

The material terms and conditions of the senior convertible notes are summarized as follows:

	•		the interest rate on the notes is 5.5% per annum, payable in cash in arrears on a calendar semi-annual basis beginning December 31, 2007

	•		the date of maturity of the notes is February 17, 2010, 30 months from the closing date

	•		the notes are convertible at the investors’ option into our common stock, $0.001 per share par value

	•		the initial conversion price for our common stock is $10.19 per share (which represents a 10% premium to the five day volume weighted average price (“VWAP”) of our common stock as of the date of closing this transaction), subject to adjustment as provided in the notes

	•		the investors cannot convert the notes to the extent that after giving effect to such conversion, the investors (together with their affiliates) would beneficially own in excess of 9.99% of our common stock outstanding immediately after giving effect to the conversion without prior written notice to us

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	•		the conversion price for our common stock is subject to reset if the average of the daily VWAP of our common stock for the five trading days ending on each two-month anniversary of the closing until maturity (each a “Reset Date”) is less than $9.26 (or such lower reset price as previously adjusted pursuant hereto). In that event, the conversion price is reset to a price equal to 90% of the VWAP of our common stock for the five trading days ending on the applicable Reset Date. In no event will the conversion price be reset to a price less than $5.56 per share.

	•		the notes require an automatic repricing of the conversion price if we make certain sales of our common stock or common stock equivalents in a capital-raising transaction at a price below the conversion price. (This “ratchet adjustment” provision does not apply in the case of certain exempt issuances.)

	•		the notes are unsecured

	•		the investors can require us to redeem the notes on the first anniversary of the issuance of the notes in an amount equal to the sum of (a) the outstanding principal of the notes, and (b) the accrued and unpaid interest thereon

	•		we have the right to require the investors to convert the notes into shares of our common stock if the VWAP of our common stock exceeds for thirty (30) consecutive trading days $15.285 (150% of the conversion price), subject to certain additional terms and conditions

	•		we may be required to prepay the notes if certain transactions or events of default occur at the greater of:

	•		the conversion amount to be redeemed multiplied by a redemption premium of 125%, or

	•		the product of the conversion rate at the time of default and the closing bid price on the date immediately preceding such event of default

•

we are subject to certain cash penalties if we are unable to deliver to the investors the common stock receivable upon conversion of the notes and exercise of the warrants in a timely manner

The material terms and conditions of the common stock purchase warrants are summarized as follows:

	•		each warrant is exercisable to purchase one share of our common stock

	•		the initial exercise price of each warrant is $10.19 per share, subject to adjustment as provided in the warrant

	•		the warrants are exercisable for a period of five (5) years from their date of issuance on August 17, 2007

	•		the warrants contain a “cashless exercise” feature if the registration statement covering the shares underlying the warrants is not available for the resale of the shares upon exercise of the warrants

	•		the warrants contain certain limitations on the exercise thereof in the event that the holder would beneficially own in excess of 9.99% of our common stock outstanding immediately after giving effect to such exercise

	•		the warrants require an automatic repricing of the exercise price if we make certain sales of our common stock or common stock equivalents in a capital-raising transaction at a price below the warrant exercise price. (This “ratchet adjustment” provision does not apply in the case of certain exempt issuances.)

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Recent Development – Initial Public Offering of QX Mobile Shares And Non-Competition Arrangement

QX Mobile conducted an initial public offering of 12,500,000 of its ordinary shares (the “QXM IPO”). The initial offering price of the QX Mobile Shares was US$12.00 per share and the shares were listed for trading on the New York Stock Exchange under the symbol “QXM” on May 2, 2007.

In connection with the QXM IPO, we entered into a non-competition agreement with QX Mobile, HZQXCI and Mr. Rui Lin Wu, which became effective upon the completion of the QXM IPO and will remain valid until we or Mr. Rui Lin Wu or any family member of Mr. Rui Lin Wu does not directly or indirectly own any QX Mobile shares, or until termination of such agreement through the written consent of the parties. The agreement provides that we, HZQXCI and Mr. Rui Lin Wu will not, and will procure their subsidiaries and Mr. Wu’s family members to not, solely or jointly, or through any person, company, enterprise or unit other than QX Mobile and its subsidiaries, develop, carry on, participate in, engage in, or be involved in any business or activities that result in or may result in direct or indirect competition with QX Mobile’s business, including but not limited to:

(i)

making investments in businesses that result in or may result in direct or indirect competition with QX Mobile’s business;

(ii)

soliciting any business, for itself or for other persons, from any person that has business relationships with QX Mobile;

(iii)

soliciting the employment of, or hiring, any officer, directors or employee of QX Mobile; and

(iv)

interfering with QX Mobile’s business or encouraging other persons to interfere with QX Mobile’s business.

This arrangement also prohibits us and Mr. Rui Lin Wu from using knowledge of QX Mobile’s business and strategy to QX Mobile’s detriment and provides QX Mobile with the right of first refusal over new business opportunities that come to the attention of us, HZQXCI or Mr. Rui Lin Wu and his family members, which are reasonably likely to result in direct or indirect competition with QX Mobile’s business or are reasonably associated with QX Mobile’s business. This non-competition arrangement does not affect HZQXCI’s ability to conduct its current business, which includes the manufacture and sale of COSUN-branded economy mobile handsets for the PRC market.

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B. BUSINESS OVERVIEW.

Through the fiscal year ended December 31, 2002, we were principally engaged in the design, manufacture and sale of telecommunication terminals and equipment in the PRC, including primarily in-house corded and cordless telephone sets under the trademark of “Qiao Xing”. According to the National Statistic Bureau of the China Technology Progress Information Centre, we were the largest in house telephone manufacturer by number of sales units in the PRC in 1999. For 2000, 2001 and 2002, we ranked as the second largest in house telephone manufacturer in the PRC by number of sales units. We believe that we are a leading player in the in-house telephone market.

In May and June 2002, our then wholly-owned subsidiary QX Mobile entered into two sale and purchase agreements for acquisition of an aggregate equity interest of 65% in CECT for an aggregate consideration of Rmb 312,750,000 (the “Acquisitions”). CECT is a limited liability company established in China and is principally engaged in production and sales of mobile phones and accessories in China. In February 2003, the Acquisitions were approved by all the appropriate governmental authorities, including the Ministry of Information Industry, the State Development Planning Commission, the Ministry of Foreign Trade and Economic Cooperation and the State Administration for Industry and Commerce. The process of obtaining new business licenses was finally completed and a new business license for the new entity was granted.

Pursuant to one agreement dated May 23, 2002, QX Mobile acquired a 25% equity interest in CECT from Tianjin Taida Company Limited (Tianjin) for cash consideration of Rmb 108,750,000.

Pursuant to a second agreement dated May 23, 2002 and a supplementary agreement dated May 23, 2002, QX Mobile acquired a 40% equity interest in CECT from China Electronics Corporation (CEC) and other group companies of CEC for cash consideration of Rmb 204,000,000.

In August 2004, we announced that our subsidiary HZQXCI was purchasing a 25% equity interest in CECT from CEC. As of June 2005, the acquisition had been approved by Beijing Commercial Bureau of PRC. Subsequently, HZQXCI assigned and transferred to QX Mobile the 25% shareholding in CECT and the transfer was approved by Beijing Commercial Bureau in September 2005.

In July 2006, QX Mobile further increased its ownership stake in CECT to 93.4% through a cash capital injection into CECT in which the other CECT shareholder did not participate.

Qiao Xing Group Limited acquired the remaining 6.6% equity interest in CECT in December 2006 from the last of the original CECT shareholders.

In May 2007, QX Mobile reached an agreement with CECT and Qiao Xing Group Limited to increase the paid-up capital of CECT by US$50 million. According to the terms of the agreement, the US$50 million will be contributed in full by QX Mobile and will be used to fund the expansion of CECT in China. The capital injection was completed in June 2007 and QX Mobile’s equity interest in CECT increased from 93.41% to 96.55%, and the equity interest held by Qiao Xing Group Limited was reduced from 6.59% to 3.45%.

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On August 20, 2002, QX Mobile entered into a subscription agreement for its sale of 200,000 shares representing 20% of the total outstanding equity of QX Mobile to Galbo Enterprises Limited, a non-affiliated BVI corporation (“Galbo”), for Rmb 67,000,000. The subscription price was fully paid before December 31, 2002. The subscription price was applied by QX Mobile toward the acquisition of its 65% interest in CECT. Upon completion of the subscription, our controlling interest in QX Mobile was reduced to 80%.

By a stock purchase agreement dated as of September 30, 2006 between us and Galbo, we repurchased the foregoing 200,000 shares of QX Mobile from Galbo for a total purchase price of Rmb 340,685,800 (US$43,654,720), which represented 20% of seven times the net income of QX Mobile for the fiscal year ended December 31, 2005. The purchase price was paid as follows:

(i) Rmb 170,342,900 (US$21,827,360) was paid in cash; and

(ii) an aggregate of 1,562,348 newly issued restricted shares of our common stock were issued, based on a per share price of US$13.794, equal to the volume weighted average price of our common stock for the seven trading days prior to September 30, 2006.

Upon completion of this transaction in November 2006, our controlling interest in QX Mobile was restored to 100%.

Our two major operating subsidiaries include CECT and HZQXCI. Through our HZQXCI subsidiary, we conduct the business of the research and development and distribution of mobile phones and the design and distribution of fixed line telephones, wireless telephones and fax machines. CECT manufactures and sells mobile handsets based primarily on Global System for Mobile Communications, or GSM, global cellular technologies.

We classify our products into two core business segments, namely mobile phones and indoor phones. In view of the fact that we operate principally in Mainland China, no geographical segment information is presented. Sales in the PRC market accounted for approximately 97% and 97% of our total revenues for the fiscal years ended December 31, 2006 and 2007, respectively.


	2005		2006		2007
	Rmb’000		Rmb’000		Rmb’000
Net sales:

Mobile phones		2,380,531		2,985,432		3,636,431
Indoor phones		254,653		235,780		237,676

		2,635,184		3,221,212		3,874,107

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QX Mobile and Its Subsidiary CECT’s Business Overview

QX Mobile is one of the leading domestic manufacturers of mobile handsets in China in terms of unit sales volume. It manufactures and sells mobile handsets based primarily on Global System for Mobile Communications, or GSM, global cellular technologies. It operates its business primarily through CEC Telecom Co., Ltd., or CECT, its 96.6%-owned subsidiary in China. Currently, its products have been primarily sold under the “CECT” brand name and it recently launched the “VEVA” brand name in May 2008.

QX Mobile develops, produces, and markets a wide range of mobile handsets, with increasing focus on differentiated products that generally generate higher profit margins. QX Mobile sold approximately 2.26 million and 3.82 million handset products in 2006 and 2007, respectively. The average selling price of its handsets was Rmb 1,094 in 2006 and Rmb 816 (US$112) in 2007.

QX Mobile’s in-house handset development teams are based in its two research and development centers in Beijing and Huizhou. The Beijing research center focuses on developing higher-end and differentiated products, while the Huizhou research center concentrates on developing handsets targeted at the mid-range and economy markets based on existing technologies. QX Mobile’s in-house research and development teams developed a number of handset designs and certain technologies used in producing its handsets, such as mobile phone application software, user-friendly product interfaces and printed circuit board designs, including baseband designs and radio frequency circuit designs, that contribute to its ability to produce differentiated handsets. QX Mobile also sources certain software and hardware designs used in producing its handsets from third-party designers to complement its in-house development capabilities.

QX Mobile currently has one main handset manufacturing facility in Huizhou City, Guangdong Province, China. This facility is equipped with three Surface Mount Technology, or SMT, lines and seven assembly and testing lines. QX Mobile historically outsourced and continues to outsource the manufacturing of a substantial portion of its products to electronics manufacturing service providers, or EMS providers. QX Mobile produced approximately 0.61 million units in its Huizhou facility in 2006 and 0.56 million units in 2007. It outsourced approximately 1.60 million units in 2006 and 3.33 million units in 2007 through EMS providers. To reduce its reliance on third-party suppliers, in January 2008, it completed the construction of a new manufacturing facility in Huizhou to produce molds, cast components and other handset parts.

Substantially all of QX Mobile’s products are sold in China. It sells its products primarily to its national and provincial distributors, TV direct sales distributors and internet distributors, which resell its products to end customers either directly or through their own distribution networks, which are typically composed of local distributors and retail outlets. QX Mobile’s distribution network currently includes five national distributors, 77 provincial distributors, three TV direct sales distributors and two internet distributors. These distributors sell QX Mobile’s products to approximately 300 local distributors, over 4,000 retail outlets and directly to end users in China. In addition, certain of QX Mobile’s distributors and other third parties provide repairs and other after-sales services to QX Mobile’s customers through over 200 after-sales service centers located throughout China.

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HZQXCI’s Business Operations and Product Range

We have ceased the manufacturing of indoor telephones. Instead, we subcontract our telephone manufacturing orders to designated manufacturers.

We have produced corded telephones since our formation in 1992. In 1996, we successfully developed the manufacture of one-channel and ten-channel cordless telephones. However, since one-channel cordless phones can be easily interfered and create a lot of noises, we stopped producing them in June 1997 and now concentrate on ten-channel cordless phone manufacturing.

In October 1997, we introduced the smart card telephones, which is the first of many special function corded telephones that we expected to develop and introduce to the market. In the first quarter of 1998, we developed and introduced caller ID display telephones and coin operated telephones. We developed the digital cordless phone in 1999 and introduced digitally enhanced cordless telephones (“DECT”) in 2000. In 2002, we commenced production of GSM phones.

During 2002, we developed the wuxiangtong telephone. It is a cordless and wireless phone that employs the GSM core technology with the look, functions and dimensions of an ordinary press-key phone. With its wireless connection to the GSM network, the service fee for using the wuxiangtong telephone is the same as using a fixed line telephone, since only the caller and not the receiving party pays for the call. Such phones are most suitable for those corporate, government and residential users in the remote parts of the rural areas, where communication via fixed optical fiber lines would be very costly. It can also be used as mobile public phones, for outdoor users and land commuters.

During 2002, we developed the short message telephone, a corded fixed line telephone that can send and receive short messages like mobile phones. In addition to its function as an ordinary caller ID display telephone, its other functions include the ability to send and receive short messages, an alarm clock function, games and calendar memo options.

During 2002, we developed the web telephone model. In addition to its ordinary telephone functions, our web phone can browse the internet, send and receive e-mail and send mobile phone short messages.

HZQXCI started its business in 2003 and it currently specializes in:

	(i)		the design and manufacture through sub-contractors of COSUN-branded GSM mobile phones for its own account;

	(ii)		the development and marketing of wired and wireless telephones (indoor phones), including telephones with special functions; and

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(iii)

the development and sale of internet-related products and other consumer electronics products.

HZQXCI launched the sale of the wuxiangtong and short message telephones in 2003. The wuxiangtong and short message telephones are special telephones with much higher margins than ordinary wire and wireless telephones. HZQXCI has also developed and launched such wuxiangtong telephones that run on the CDMA network.

During 2003, HZQXCI launched the new Little Smart phone, referred to in Chinese as “XiaoLingTong.” It is a China Personal Handyphone System (PHS) service that supplements and extends China Telecom’s and China Netcom’s fixed line network service in China. With Little Smart phones, users can communicate freely within the areas covered by fixed line networks via wireless connectivity. Because China Netcom and China Telecom subscribers could enjoy XiaoLingTong services for the cost of a fixed line call, it was a much welcomed communication service for the average income group within the cities and suburban areas of China. The functionalities of Little Smart phones have been significantly enhanced due to technological innovations.

In November 2004, HZQXCI launched its new generation of VOIP phones (voice over internet protocol phones) in partnership with SOYO Group, Inc. (OTCBB: SOYO). Juniper Research has forecasted the global VOIP markets to exceed US$32 billion by 2009. HZQXCI believes that the China market for VOIP phones should follow this trend of significant growth.

In May 2005, HZQXCI developed CDMA Cityphone handsets for supply to China Telecom Shenzhen Branch. Like the PHS phone, the CDMA Wireless Cityphone is a mobile wireless communication terminal product based on the landline network mainly operated by China Telecom and China Netcom in China. However, it uses the more advanced CDMA technology instead of the PHS technology. The advantages of CDMA technology include better communication qualities and ease in transition to 3G. Based on the one-way charge system, the airtime charge for using Cityphone is the same as that for the indoor telephone. In Shenzhen alone, it is estimated that there will be two million users.

During 2007, HZQXCI developed and launched a number of higher-end wired or wireless phones and internet-related products, including:

	(i)		Little Smart phones with removable cards;

	(ii)		ADSL2. Compared to the first generation of ADSL, its upstream channel rate and downstream channel rate are much faster; and

	(iii)		Home Gateway (residential gateway). The Home Gateway is a device that acts as a hub between the home environment and the broadband network. Under the control of the service provider, it simplifies the user experience when utilizing broadband services.

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	(iv)		EasyPay Terminal is a type of payment terminal with common phone functions. Wherever you are, at home, office or variety marketplace, it can act like a DTMF/FSK caller ID phone, as well as an advanced electronic payment tool, applied to pay your bills, query your account, transfer funds between credit or debit cards, etc.

			EasyPay Terminal is particularly designed for individual users. It could be used as soon as you connect it to PSTN through a single telephone cable without spending time on setup or installation. Secondly, it is easy for new users to operate with a user-friendly interface. Therefore, almost everyone can learn how to use it rapidly. Thirdly, EasyPay Terminal has high security through binding telephone numbers, PSAM (Purchase Secure Access Module) with serial numbers of both card and terminal. Lastly, it is affordable for most people in China and is becoming more and more popular among individual users.

As of December 31, 2007, HZQXCI developed and sold more than 413 corded models and 46 cordless models, 12 models of fax machines, 60 models of wireless fixed phones, 16 models of ADSL, five models of Little Smart phones and five models of VOIP phones. The mobile phone division of HZQXCI has introduced 72 models of COSUN-branded GSM mobile phones which range from lower-end to middle-end and high-end.

Since the second half of 2004, HZQXCI launched the COSUN-branded GSM mobile handset and has continued its transformation from a sub-contractor of CECT to a designer and distributor of its own brand of mobile handsets. In June 2006, HZQXCI received a license from the National Development and Reform Commission (NDRC) to manufacture GSM mobile phones.

In the first five months of 2008, HZQXCI has launched nine models of COSUN-branded mobile phones, including COSUN 2122, which is extremely slim and has a flashlight function, and COSUN 9566, which has a telescope/binocular function.

Production Management

HZQXCI currently designs indoor telephones, internet-related products and GSM mobile phones. Its indoor telephones and internet-related products are manufactured by unaffiliated third parties, while its mobile phones are subcontracted to CECT and other third parties.

Quality Assurance System

HZQXCI places significant emphasis on preventive measures in the quality control process and employs quality control procedures at every critical manufacturing stage, with the aim of identifying, analyzing and solving problems at the earliest possible stage of the production process. Its subcontractors are equipped with the necessary testing facilities to handle the quality control tests and provide in-house training for their quality control staff.

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Quality control tests on the production process include:

	•		sampling test method is used to inspect all incoming materials on a sample basis;

	•		at each stage of production process, quality control inspectors monitor the production flow and check the quality of the products; and

	•		finished products are checked by quality control staff on a sample basis.

HZQXCI has not received any material claims for defective products from customers for the three years ended December 31, 2007.

Sales and Marketing

HZQXCI’s Indoor Telephone Division

HZQXCI has established long-term strategic partnership relationships with many of China’s telecommunications operators, including China Telecom, China Netcom, China Railcom, China Mobile and China Unicom. By participating in public bids invited by these operators at provincial and municipal levels, HZQXCI directly supplies them (direct sale) with conventional indoor phones and high-end products of a value-added nature such as wireless fixed phones, CDMA Cityphones, CDMA inter-village phones, Little Smarts, ADSL, Residential Gateways, and VOIP phones. HZQXCI has become a major supplier to these operators to provide them with numerous categories of value added service products across China. HZQXCI has now established representative offices in Beijing and other 30 provinces as liaisons with the headquarters and branch companies of the five largest telecommunications operators. HZQXCI is the dominant supplier for more than 20 provinces in China. Its direct sales have now become the major domestic distribution channel.

HZQXCI currently has maintained 31 provincial agents who serve its local distributors in different provinces in the PRC. There is at least one representative assigned to each agent to make frequent visits in order to understand the business operation and assist management. These agents distribute HZQXCI’s telecommunication products to a network of over 3,500 retail outlets. The purchase orders for telephones from these retail outlets are collected by the 31 provincial agents, who would then place consolidated purchase orders with HZQXCI on their own accounts. The provincial agents are each responsible for the credit risk and settlement of their own customers. HZQXCI gives a settlement period of 30 days to 270 days to the distributors. The long credit period granted is comparable to the common business practice for household telephones.

HZQXCI has established strategic relationships with leading telecommunications operators and distributors of telecommunications terminal products in North America, Latin America, Southeast Asia, South Asia, Europe, the Middle East and Russia. These include Telefonica, the world’s no. 3 telecommunications operator, Binatone, the British leader in this field, and Unisonic, a major supplier to Bell South.

HZQXCI periodically holds distributor fairs in order to attract and select potential distributors for its products at home and abroad.

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HZQXCI’s sales and marketing strategy focuses on satisfying customers with high quality product, consistent timely delivery, competitive product pricing and efficient after-sales service. HZQXCI’s staff communicates regularly with the regional distributors and their customers to obtain market information and to ascertain their needs. HZQXCI also conducts regular reviews to analyze customers’ potential demands and to plan for new products.

Our management believes that the provision of efficient after-sale service is an important factor in influencing consumers’ choices. HZQXCI offers a one-year warranty on its telephones. During the warranty period, all repair and maintenance services are provided free of charge. After the warranty period, customers assume the cost of repair and the components used. HZQXCI has selected some of its distributors as after-sale service centers across China. HZQXCI experiences no significant warranty expenses due to low labor costs in China.

HZQXCI advertises through various media, including national and regional television networks, radio, newspapers, magazines, posters, billboards and advertising pamphlets. In addition, the “Qiao Xing” and “COSUN” brand names are also promoted through sponsorship of sports events and sports celebrities, including the number 8 ranked worldwide snooker champion.

Since 2003, HZQXCI shifted its focus to selling short message phones, wireless fixed phones, CDMA Cityphones, PHS Little Smart Phones, ADSL and VOIP phones, which generate much higher margins than ordinary telephones. In addition to the established distribution network, HZQXCI sells its products to China Telecom, China Netcom and mobile network operators or their subcontractors to promote its new products jointly. Backed up by all levels of government, these operators have dominant influence over consumers, which is very favorable for HZQXCI to introduce new products into the market and capture market share swiftly.

HZQXCI spent approximately Rmb 383,000 and Rmb 902,000 (US$124,000) in 2006 and 2007, respectively, for advertising in its Indoor Telephone Division.

HZQXCI’s Mobile Phone Division

For sales of its COSUN-branded mobile phone handsets, HZQXCI now has 700 agents at the national level, provincial level and municipal level in 31 provinces in China and 184 after-sales service centers. Those 700 agents distribute mobile phones to approximately 6% of all local distributors and 12% of all retail stores in China.

As the market potential in tier 3 and 4 cities and towns in China has been growing significantly, HZQXCI has adjusted its distribution strategy to directly sell its products not only to agents at the provincial level, but also to some agents at the municipal level in some provinces. Those municipal agents are better able than the provincial agents to extend their distribution networks more deeply into tier 3 and tier 4 markets.

HZQXCI has commenced the export of its mobile phones to overseas markets by setting up business relationships with some overseas telecommunications operators. Recently, HZQXCI has established representative offices in India, Russia and Vietnam to promote sales of mobile phones in those countries.

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HZQXCI is also actively participating in bids held by China Mobile and China Unicom in order to directly sell a large volume of mobile phones to them.

HZQXCI is also exploring other emerging distribution channels, such as TV direct sales and other e-commerce methods.

HZQXCI believes that after-sales service, as well as quality and competitive price, are the three most important competitive factors. In that regard, HZQXCI has an after-sales repair workshop at its headquarters with more than 90 workers in order to guarantee timely and complete after-sales service. In the past, its after-sales service was conducted primarily by some of its distributors. Currently, HZQXCI has also selected many third parties rather than its distributors to serve as its after-sales centers to specialize in offering repair services.

HZQXCI conducts at least two agents fairs each year to promote its products on a larger scale, both of which occur one month prior to the two Golden Week holidays.

The COSUN brand name has improved much among mobile phone consumers as a result of a series of promotional activities and advertisements conducted in 2006 and 2007. HZQXCI continues to implement its plan to set up 2,000 image stores for its COSUN-branded mobile phones in cooperation with its agents and distributors.

HZQXCI spent approximately Rmb 3,121,000 and Rmb 13,969,000 (US$1,915,000) in 2006 and 2007, respectively, for advertising in its Mobile Phone Division.

Materials and Components

HZQXCI holds annual suppliers’ meetings at which more than 100 mobile phone components suppliers bid for supplying materials and components for its GSM phones. HZQXCI’s management believes it is a good way to select better suppliers and would contribute to the reduction of its manufacturing cost in the future.

HZQXCI also seeks out local suppliers who can supply chipset bundled with software platforms needed for further research and development, as well as application software at more competitive prices than foreign suppliers.

Research and Development

We have 16 years of experience in research and development of telecommunications terminal products.

As the founder of the Guangdong Communication Engineering and Technology Center, HZQXCI has access to proven capabilities and can develop and design all types of telephones, video and audio products that meet international advanced standards. Its research and development division also performs work for third party clients.

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HZQXCI’s research and development (“R&D”) and engineering, technical and design functions are performed in the PRC through its own R&D, engineering, technical and design divisions and through appointed external technology development experts. As of December 31, 2007, HZQXCI employed 87 staff in its R&D division, who work closely with its sales and marketing executives to gauge the market demand in developing new products and new models of existing products.

HZQXCI has strategic relations with other renowned independent R&D firms such as Techfaith.

HZQXCI and its external R&D firms are also developing G+C mobile phones (mobile phones that can run on both GSM and CDMA networks), G+P mobile phones (mobile phones that can run on both GSM and land line networks) and 3G TV mobile phones.

HZQXCI’s R&D division is also developing additional indoor phones and mobile phones designed to be well suited for the overseas markets.

HZQXCI’s R&D division is participating in standard-making sessions organized by telecommunications operators for new terminal products pertaining to new telecommunications services to be launched, which it expects will enhance its competitive position in the bidding process.

The R&D, engineering, technical and design divisions are currently monitoring more than 393 particular models of corded telephones, 49 particular models of cordless telephones, 48 models of GSM cellular telephones, 67 models of wireless fixed phones (wuxiangtong), six models of PHS Little Smart phones, seven models of VOIP phones, 19 ADSL products, two models of its specialized cash registers and three models of Cityphone.

We spent Rmb 15.9 million (US$2.2 million), Rmb 14.5 million and Rmb 4.6 million in 2007, 2006 and 2005, respectively, on research and development activities in HZQXCI.

Competition

The market for telecommunications terminal products generally and corded and cordless indoor telephones, as well as facsimile machines, ADSL products and payment terminals with common telephone functions products, in particular in the PRC is intensely competitive. We believe that the principal competitive factors are:

	•		functions and designs;

	•		performance/cost ratio;

	•		brand name recognition;

	•		distribution capability;

	•		after-sale service;

	•		short lead time in product development;

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	•		product quality; and

	•		capability of mass production.

For indoor phones and internet-related products, HZQXCI considers that its products do not compete directly with imported products with similar features, which are sold in the higher price range. HZQXCI currently competes directly with domestic manufacturers in the PRC, namely TCL, Desai, BBK and CHNO in Guangdong, which include the second and third sellers of indoor telephones in the PRC, according to the statistical report released by the Trade and Foreign Economy Statistics Division of National Statistic Bureau. However, TCL and Desai are now diversifying into home electric appliance manufacture, including televisions, air conditioners, computers, DVD sets and Hi-Fi systems, which will likely divert some of their resources from the telephone manufacturing business. For BBK and CHNO, HZQXCI’s competitive advantages include its powerful R&D capacity and brand name recognition and its better relationship with various telecommunications operations.

For mobile phones, HZQXCI’s competitors include GIONEE and Tian Yu. HZQXCI believes that its competitive advantages include its greater experience in the telecommunications terminal area, its more extensive distribution network, its powerful in-house and external R&D capacity, and its greater brand name recognition.

In 2002, HZQXCI’s telephones were granted the label of “Chinese Renowned Brand Name Product” by the China Promotion Commission for Top Product Strategy. We believe that this recognition has created a favorable marketing environment for HZQXCI.

In June 2008, COSUN brand was appraised as “Leading Brand in Telephone Industry” by China Brand Research Institute. For each industry, there is only one leading brand.

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D. PROPERTY, PLANTS AND EQUIPMENT.

Our principal executive offices are located at Qiao Xing Science Industrial Park, Tang Quan, Huizhou City, Guangdong, PRC. Our main manufacturing facility is located on a leased property of approximately 3,700 square meters in Huizhou. In addition, we hold the land use rights for a property with an area of approximately 100,000 square meters in Huizhou City. We believe that our existing facilities are adequate and suitable to meet our present needs.

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and notes thereto and Item 3.A. Selected Financial Data. The amounts reflected in the following discussion are in Renminbi (“Rmb”). Translation of amounts for 2007 from Renminbi into United States dollars (“US$”) is for the convenience of readers and has been made at the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York of US$1.00 = Rmb 7.2946 on December 31, 2007.

A. OPERATING RESULTS.

Fiscal 2007 compared to Fiscal 2006

(i)

Net sales

Analysis of our sales revenue by business segment for fiscal year 2007 and 2006 is as follows:


			Year ended December 31
	2007				2006
	Rmb’000			%	Rmb’000		%
Mobile telephones		3,636,431		94		2,985,432	93
Indoor telephones		237,676		6		235,780	7

Total		3,874,107		100		3,221,212	100

Net sales revenue increased by Rmb 652.9 million from Rmb 3,221.2 million for fiscal year 2006 to Rmb 3,874.1 million (US$ 531.1 million) for fiscal year 2007, representing an increase of 20.3%.

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In 2006, the revenue from the mobile phone business segment was Rmb 2,985.4 million, while it amounted to Rmb 3,636.4 million (US$ 498.5 million) in 2007, representing an increase of Rmb 651.0 million. The increase was mainly attributable to the increase in revenue from the sale of CECT-branded handsets and accessories.

Revenue from the sale of CECT-branded handsets and accessories increased by 24.9% from RMB2,494.0 million in 2006 to RMB3,113.8 million ($426.9 million) in 2007, primarily due to increases in unit sales volume, which was offset to a certain extent by a decrease in the average selling price of our handsets. Sales volume of CECT-branded handsets increased by 68.7% from approximately 2,262,000 units in 2006 to approximately 3,816,000 units in 2007. The increase in the unit sales volume was primarily driven by the increase in the unit sales volume of the CECT-branded C1000 model handsets from 9,400 units in 2006 to 1,045,000 units in 2007, and the commercial launch of new models, such as C1000+, C2000, T100 and W100, which generated aggregate sales volume of approximately 2,026,000 units in 2007. The unit sales volume increase was also due to our increased sales and marketing efforts, including increased marketing expenses, increased use of TV direct sales programs and expansion of our sales and distribution network to include internet direct sales in 2007. Sales to our TV and internet direct sales distributors reached 1,090,000 units in 2007. The average selling price of the CECT-branded handsets decreased from RMB1,094 per unit in 2006 to RMB816 ($112) per unit in 2007, primarily reflecting the increased percentage of total sales of lower-cost but higher-margin differentiated products such as the C1000 series ultra-long standby handsets.

Net sales of the COSUN-branded mobile phone handsets for 2007 were Rmb 509.6 million (US$ 70.0 million), representing an increase of Rmb 18.6 million. The increase can to a certain extent be attributed to the popularity of the low-end models 2188 and 2189, which boast a battery with long-standby capabilities.

Net sales of indoor telephones for 2007 were Rmb 237.7 million (US$ 32.6 million), representing an increase of Rmb 1.9 million, or 0.8% from 2006.

(ii) Cost of Goods Sold

Analysis of our cost of goods sold by business segment for fiscal years 2007 and 2006 is as follows:


			Year ended December 31
	2007				2006
	Rmb’000			%	Rmb’000		%
Mobile telephones		2,692,678		93		2,457,129	93
Indoor telephones		206,286		7		194,263	7

Total		2,898,964		100		2,651,392	100

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Cost of goods sold increased by Rmb 247.6 million from Rmb 2,651.4 million for fiscal year 2006 to Rmb 2,899.0 million (US$ 397.4 million) for fiscal year 2007, representing an increase of 9.3%.

In 2006, the cost of goods sold for the mobile phones business segment was Rmb 2,457.1, while it amounted to Rmb 2,692.7 million (US$ 369.1 million) in 2007, representing an increase of Rmb 235.5 million. The increase was mainly attributable to the increase in the cost of goods sold relating to our CECT-branded mobile phone business.

Our cost of goods sold relating to our CECT-branded mobile phone business increased by 9.4% from RMB2,062.6 million in 2006 to RMB2,255.8 million ($309.2 million) in 2007, primarily driven by increased unit sales volume of our handset products, which resulted in, among others, a RMB124.1 million increase in raw materials and components cost. Our product design fees paid to third parties also increased by 49.7% from RMB49.7 million in 2006 to RMB74.4 million ($10.2 million) in 2007, primarily due to increased unit shipments. Depreciation of property, machinery and equipment increased from RMB3.9 million in 2006 to RMB9.0 million ($1.2 million) in 2007 due mainly to the depreciation of a factory premise which we acquired towards the end of 2006. The cost of goods sold as a percentage of revenue decreased from 81.3% in 2006 to 71.8% in 2007, primarily reflecting the increased unit sales volume and percentage of total sales of lower-cost but higher-margin CECT-branded products such as the C1000 series ultra-long standby handsets.

(iii) Gross Profit

Analysis of our gross profit by business segment for fiscal years 2007 and 2006 is as follows:


			Year ended December 31
	2007				2006
	Rmb’000			%	Rmb’000		%
Mobile telephones		943,753		97		528,303	92
Indoor telephones		31,390		3		41,517	8

Total		975,143		100		569,820	100

Gross profit for fiscal year 2007 was Rmb 975.1 million (US$ 133.7 million), representing an increase of Rmb 405.3 million from Rmb 569.8 million in fiscal year 2006.

In 2006, the gross profit from the mobile phone business segment was Rmb 528.3 million, while it amounted to Rmb 943.8 million (US$ 129.4 million) in 2007, representing an increase of Rmb 415.5 million. The increase was mainly attributable to the increase in gross profit from our CECT-branded mobile phone business.

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Our gross profit from our CECT-branded mobile phone business increased by 86.4% from RMB475.0 million in 2006 to RMB885.3 million ($121.4 million) in 2007, primarily due to increased sales volume of higher-margin handset products. Our gross margin relating to our CECT-branded mobile phone business increased from 18.7% in 2006 to 28.2% in 2007, primarily reflecting the launch of several successful higher-margin products in 2007, including the C1000 series ultra-long standby models, the T100 fingerprint recognition information security models and the W100 wrist watch handset. In addition, our increased use of TV direct sales programs and our use of internet direct sales in 2007 also contributed to the increase in our gross margin as we were able to charge a higher price for our CECT-branded products due to the increased advertisement exposures.

Gross profit for the indoor telephone business segment decreased by Rmb 10.2 million from Rmb 41.6 million in fiscal year 2006 to Rmb 31.4 million (US$ 4.3 million) in fiscal year 2007. The decrease was primarily attributable to the decrease in gross margin from 17.6% for 2006 to 13.2% for 2007. This was due mainly to the clearance of the inventory of conventional indoor phone sets at low prices to expedite the shift in the composition of the product portfolio from conventional phones to higher-end value-added products.

(iv) Selling expenses

Selling expenses increased by Rmb 31.4 million from Rmb 28.4 million for fiscal year 2006 to Rmb 59.8 million (US$ 8.2 million) for fiscal year 2007. The increase consisted mainly of an increase of Rmb 21.5 million relating to the CECT-branded mobile phones and an increase of Rmb 10.7 million relating to the COSUN-branded mobile phones.

Our selling and distribution expenses relating to the CECT-branded mobile phones increased by 145.3% from RMB14.8 million in 2006 to RMB36.3 million ($5.0 million) in 2007. The significant increase was driven primarily by an increase in advertising and promotional expenses by RMB13.5 million from RMB12.9 million in 2006 to RMB26.4 million ($3.6 million) in 2007 and sales commissions of RMB6.1 million ($0.8 million) paid to our TV infomercial direct sales distributors in 2007. The higher advertising and promotional expenses in 2007 mainly resulted from an increased use of TV direct sales programs to sell and market our products and higher expenditures on advertising and promotional activities. The commission of RMB6.1 million paid in 2007 was to reward our TV infomercial partners for the sales that the TV infomercials helped to generate in our traditional sales channels. Share-based compensation expenses recognized in selling and distribution expenses relating to the CECT-branded mobile phones in 2007 amounted to RMB0.5 million ($0.1 million). No share-based compensation expenses relating to sales and marketing personnel relating to CECT-branded mobile phones were incurred in 2006.

The increase in selling expenses for the COSUN-branded mobile phones related mainly to advertising.

(v) General and administrative expenses including stock-based compensation

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General and administrative expenses including stock-based compensation increased by Rmb 5.0 million from Rmb 126.1 million in fiscal year 2006 to Rmb 131.1 million (US$ 18.0 million) in fiscal year 2007.

General and administrative expenses other than stock-based compensation increased by Rmb 27.4 million from Rmb 67.4 million in fiscal year 2006 to Rmb 94.8 million (US$ 13.0 million) in fiscal year 2007. The increase consisted mainly of an increase of Rmb15.2 relating to the CECT-branded mobile phone business, an increase of Rmb 4.4 million relating to the COSUN-branded mobile phone business, and an increase of Rmb 7.9 million relating to the corporate head office.

Regarding the CECT-branded mobile phone business, auditing, legal, investor relation and other professional service expenses increased from RMB1.9 million in 2006 to RMB5.6 million ($0.8 million) in 2007, primarily due to increased expenditures associated with Qiao Xing Mobile Communication Co., Ltd. the immediate holding company of CEC Telecom Co., Ltd. (which is in the business of the manufacture and sale of the CECT-branded mobile phone handsets), being a public company in 2007. In 2007, we incurred a provision for doubtful debts of RMB3.4 million ($0.5 million) compared to a bad debt recovery of RMB0.6 million in 2006. In addition, salaries and other payroll-related expenses increased from RMB4.3 million in 2006 to RMB6.2 million ($0.8 million) in 2007 while office rental and other office-related expenses increased from RMB1.6 million in 2006 to RMB2.9 million ($0.4 million) in 2007.

The increase relating to the COSUN-branded mobile phone handset business was mainly attributable to the increase in salary expenses, owing to an increased headcount in the administration staff.

The increase relating to the corporate head office was mainly attributable to the increase in professional service expenses.

Stock-based compensation decreased by Rmb 22.4 million from Rmb 58.7 million in 2006 to Rmb 36.3 million (US$ 5.0 million) in 2007.

The stock-based compensation recorded in general and administration expenses for 2006 related to the grant of share options to certain employees and consultants of the Company in February 2006.

The stock-based compensation recorded in general and administration expenses for 2007 related to the grant of share options to employees and a director of Qiao Xing Mobile Communication Co., Ltd. and its subsidiary CEC Telecom Co., Ltd. in March 2007.

(vi) Research and development

Research and development expenses increased by Rmb 3.8 million from Rmb 30.7 million for fiscal year 2006 to Rmb 34.5 million (US$ 4.7 million) for fiscal year 2007. The increase consisted mainly of the increase of Rmb 2.3 million relating to the CECT-branded mobile phone handset business and an increase of Rmb 2.1 million relating to the COSUN-branded mobile phone handset business.

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Our research and development expenses relating to the CECT-branded mobile phone business increased by 14.1% from RMB16.3 million in 2006 to RMB18.6 million ($2.6 million) in 2007. The increase in research and development expenses was mainly due to the recognition of share-compensation expenses of RMB1.9 million ($0.3 million) in 2007. No share-based compensation expenses relating to research and development personnel were incurred in 2006.

The increase in research and development expenses relating to the COSUN-branded mobile phone business was primarily due to introducing talents in research and development to the Company.

(vii) In-process research and development

We recorded an in-process research and development charge of RMB41.7 million in 2006.

We did not have similar charges in 2007.

(viii) Amortization of intangible assets

As a result of the acquisition of the remaining 20% minority interest in the Company’s subsidiary Qiao Xing Mobile Communication Co., Ltd. on November 30, 2006, amortization of other intangible assets increased by 112.5% from RMB15.2 million in 2006 to RMB32.3 million ($4.4 million) in 2007.

(ix) Interest income

Interest income increased by Rmb 34.0 million from Rmb 8.1 million in 2006 to Rmb 42.1 million (US$ 5.8 million) in 2007.

The increase was mainly attributable to:

Interest income for 2007 of Rmb 17.7 million at an interest rate of 5% per annum from loans to a third party. There were no such loans outstanding in 2006; and

Interest income of Rmb 10.4 million from bank deposits due to proceeds received from the initial public offering in May 2007 of the ordinary shares of our subsidiary Qiao Xing Mobile Communication Co., Ltd.

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(ix) Exchange difference

Assets and liabilities which are denominated in foreign currencies are translated into the functional currencies at the rates of exchange prevailing at the balance sheet date. Foreign currency transactions are translated using the exchange rates prevailing at the date of transactions. Foreign exchange gains or losses arising from the translation at year-end exchange rates of foreign currency intercompany balances that are of a long-term investment nature are included in shareholders’ equity separately as cumulative translation adjustments. All other foreign exchange gains or losses resulting from the settlement of foreign currency transactions and from the translation at financial year-end exchange rates of assets and liabilities denominated in foreign currencies are included in the consolidated statements of operations.

We recognized a foreign currency exchange gain of RMB3.2 million and RMB28.3 million ($3.9 million) in 2006 and 2007, respectively, primarily resulting from the translation of foreign currency denominated assets and liabilities.

(xi) Interest expenses

Interest expenses increased by Rmb 147.6 million from Rmb 100.4 million in 2006 to Rmb 248.0 million (US$ 34.0 million) in 2007. The increase related mainly to the convertible bonds.

In the corporate headquarters for the year 2006, we recorded interest expenses of Rmb 55.9 million relating to two convertible bonds issued in 2006.

Coupon interest for the two convertible bonds amounted to Rmb 7.7 million in 2006.

The discount arising from the Investors Warrants and the embedded derivatives associated with the two convertible notes, which totaled Rmb 244.4 million (US$ 31.3 million) on initial recognition, was accreted to interest expense over the expected terms of the Notes using the effective interest method. The related interest expenses amounted to Rmb 36.9 million (US$ 4.7 million) in 2006.

The deferred debt issuance costs associated with the two convertible notes, which totaled Rmb 66.8 million (US$ 8.6 million) on initial recognition, were amortized to expense over the expected term of the Notes using the effective interest method. The related interest expenses amounted to Rmb 11.3 million (US$ 1.4 million) in 2006.

In the corporate headquarters for the year 2007, we recorded interest expenses of Rmb 193.0 million (US$ 26.5 million) relating to two convertible bonds issued in 2006, and one convertible bond issued in 2007.

Coupon interest for the three convertible bonds amounted to Rmb 15.4 million (US$ 2.1 million) in 2007.

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The discount associated with the three convertible notes arising from the Investors Warrants and the embedded derivatives on initial recognition and from the beneficial conversion amount on a conversion price reset, which totaled Rmb 300.9 million (US$ 41.3 million), was accreted to interest expense over the expected terms of the Notes using the effective interest method. The related interest expenses amounted to Rmb 140.3 million (US$ 19.2 million) in 2007.

The deferred debt issuance costs associated with the three convertible notes, which totaled Rmb 90.4 million (US$ 12.4 million) on initial recognition, were amortized to expense over the expected term of the Notes using the effective interest method. The related interest expenses amounted to Rmb 37.3 million (US$ 5.1 million) in 2007.

(xii) Loss on re-measurement of embedded derivatives

We recognized a loss on re-measurement of embedded derivatives relating to the convertible bonds of RMB134.4 million and RMB129.1 million ($17.7 million) in 2006 and 2007, respectively, the fair value of the embedded derivative being most sensitive to the market price on the re-measurement date of the share of the Company, to which the bonds are convertible.

(xiii) Loss on extinguishment of convertible debts

On May 3, 2007, the investors of US$40,000,000 senior convertible notes issued by the Company exercised an option to exchange the entire US$40,000,000 notes into 7,800,000 ordinary shares of Qiao Xing Mobile Communication Co., Ltd. that were owned by the Company and as a result, the Company’s equity interest in Qiao Xing Mobile Communication Co., Ltd. was decreased from 100.0%, or 40,000,000 shares, to 80.5%, or 32,200,000 shares, representing a disposal of 19.5% interest in Qiao Xing Mobile Communication Co., Ltd.. The fair value of the shares of Qiao Xing Mobile Communication Co., Ltd. given up by the Company in the Exchange was estimated to be approximately RMB721,188,000. The exchange resulted in a loss on the extinguishment of the US$40,000,000 senior convertible notes of RMB 142,090,000 (US$19,479,000) during the year ended December 31, 2007, being the difference between the fair value of the shares given up and the carrying value of the debt, the embedded derivatives and the unamortized deferred debt issuance costs relating to the convertible notes.

There was no such loss in 2006.

(xiv) Gain on disposal of interests in subsidiaries

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decreased from 100.0%, or 40,000,000 shares, to 80.5%, or 32,200,000 shares, representing a disposal of 19.5% interest in Qiao Xing Mobile Communication Co., Ltd.. The fair value of the shares of Qiao Xing Mobile Communication Co., Ltd. given up by the Company in the exchange was estimated to be approximately RMB 721,188,000.

The gain on disposal of the 19.5% equity interest in Qiao Xing Mobile Communication Co., Ltd. of RMB482,614,000 (US$66,160,000), as recognized in the consolidated statements of operations for the year ended December 31, 2007, is calculated as follows:


	RMB’000
Deemed proceeds from disposal		721,188
Less: Share of net assets relating to minority interest disposed of		(221,659	)
Less: Goodwill relating to minority interest disposed of		(16,915	)

Gain on disposal		482,614

There was no such gain on disposal of interests in subsidiaries in 2006.

(xv) Gain on sale of stocks by subsidiary

As a consequence of the Company’s subsidiary Qiao Xing Mobile Communication Co., Ltd.’s IPO on May 8, 2007, the Company’s equity interest in Qiao Xing Mobile Communication Co., Ltd. was diluted from approximately 80.5% immediately prior to the IPO to approximately 61.3% upon the completion of the IPO. In connection with this reduction in the Company’s ownership interest in Qiao Xing Mobile Communication Co., Ltd., the Company recorded a gain of RMB383,965,000 (US$52,637,000), which is calculated as follows:


	RMB’000
Share of net assets of Qiao Xing Mobile Communication Co., Ltd. after IPO		1,315,647
Less: Share of net assets of Qiao Xing Mobile Communication Co., Ltd. before IPO		(915,057	)

Increase in share of net assets after IPO		400,590
Less: Goodwill relating to equity interest deemed disposed of		(16,625	)

Gain on deemed disposal		383,965

There was no such gain on the sale of stocks by a subsidiary in 2006.

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(xvi) Provision for litigation settlement

In connection with the restatement of the Company’s financial statements for the years ended December 31, 2003, 2004 and 2005, five putative class actions were filed against the Company in the United States District Court for the Southern District of New York during the year ended December 31, 2007. The complaints alleged violations of the United States federal securities laws by the Company and certain of its executives and sought unspecified damages, attorney fees and other unspecified litigation costs.

A mediation was held on January 10, 2008 and the parties agreed to settle the case for US$2,400,000. The Company’s Director and Officer (“D&O”) insurance carrier has agreed to contribute US$300,000 of the settlement amount. A Stipulation of Settlement was executed on February 25, 2008 and the preliminary order was signed on April 2, 2008. In April 2008, US$1,200,000 of the agreed settlement amount was paid into an escrow account, of which US$900,000 was paid by the Company and the balance of US$300,000 by the Company’s D&O insurance carrier. The final fairness hearing is scheduled for July 11, 2008.

In accordance with SFAS No.5, “Accounting for Contingencies,” the Company has made a provision of US$2,100,000 (RMB 15,319,000) for the losses that may result from the class actions.

There was no such provision for litigation settlement in 2006.

(xvii) Other income

Other income increased by Rmb 54.6 million from Rmb 4.5 million in 2006 to Rmb 59.1 million (US$ 8.1 million) in 2007.

The increase related mainly to the gain on the disposal of certain land use rights and construction-in-progress which were not being used in the Company’s business operations.

(xviii) Income tax expense

Income tax expense increased by Rmb 65.9 million from Rmb 58.2 million in 2006 to Rmb 124.1 million (US$ 17.0 million) in 2007. The increase consisted mainly of the increase of Rmb 53.2 million relating to the CECT-branded mobile phone handset business carried out by our subsidiary CEC Telecom Co., Ltd and the increase of Rmb 14.7 million in our subsidiary Huizhou Qiao Xing Property, Limited.

Income tax expense in CEC Telecom Co., Ltd. increased by RMB53.2 million from RMB60.2 million in 2006 to RMB113.4 million ($15.5 million) in 2007, primarily due to the increase in its taxable income.

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Huizhou Qiao Xing Property, Limited recorded an income tax expense of Rmb 14.7 million in 2007, mainly in relation to the gain on the disposal of certain of its land use rights and construction-in-progress. There was no such income tax expense in 2006.

(xix) Minority interests

Minority interest charges increased by Rmb 84.1 million from Rmb 84.5 million for 2006 to Rmb 168.6 million (US$ 23.1 million) for 2007. The change related primarily to the minority shareholder’s share of the consolidated results of Qiao Xing Mobile Communication Co., Ltd. It was mainly the result of the changes in the shareholding percentage. We owned 80% of Qiao Xing Mobile Communication Co., Ltd. for the first eleven months of 2006, 100% for the last month of 2006, 100% for the first four months of 2007 and 61.3% for the last eight months of 2007. There also was significant growth in Qiao Xing Mobile Communication Co., Ltd. during 2007.

(xx) Extraordinary gain on acquisitions of minority interests - net of nil tax

The Company’s subsidiary Qiao Xing Mobile Communication Co., Ltd. recorded an extraordinary gain of RMB17.8 million in connection with Qiao Xing Mobile Communication Co., Ltd.’s capital injection of $18.8 million into its subsidiary CEC Telecom Co., Ltd. in July 2006 because the other minority shareholder of CEC Telecom Co., Ltd., who sold all its remaining 6.6% equity interest in CEC Telecom Co., Ltd. to Qiao Xing Group in December 2006, did not participate in the capital injection at that time. The Company’s share in the extraordinary gain was Rmb 14.2 million after minority interests.

In June 2007, Qiao Xing Mobile Communication Co., Ltd. made another capital contribution of $50 million into CEC Telecom Co., Ltd.. The transaction resulted in an extraordinary gain of RMB28.7 million as the minority shareholder, Qiao Xing Group, did not participate in the capital injection. The Company’s share in the extraordinary gain was Rmb 17.6 million (US$ 2.4 million) after minority interests.

(xxi) Net results

As a result of the foregoing, our net results increased by RMB923.8 million from a net loss of RMB 19.8 million in 2006 to a net income of RMB903.9 million ($123.9 million) in 2007. Our basic loss per share after extraordinary gain was RMB0.84 in 2006; our basic earnings per share after extraordinary gain was RMB 24.95 (US$3.42) in 2007.

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Fiscal 2006 compared to Fiscal 2005

(i) Net sales

Analysis of our sales revenue by business segment for fiscal year 2006 and 2005 is as follows:


	Year ended December 31
	2006				2005 (Restated)
	Rmb’000		%		Rmb’000		%
Mobile telephones		2,985,432		93		2,380,531		90
Indoor telephones		235,780		7		254,653		10

Total		3,221,212		100		2,635,184		100

Net sales revenue increased by Rmb 586 million from Rmb 2,635 million for fiscal year 2005 to Rmb 3,221 million (US$ 413 million) for fiscal year 2006, representing an increase of 22.2%.

In 2005, the revenue from the mobile phone business segment was Rmb 2,381 million, while it amounted to Rmb 2,985 million (US$ 382.5 million) in 2006, representing an increase of Rmb 605 million. The increase was mainly attributable to the increase in revenue from the sale of CECT-branded handsets and accessories.

Revenue from the sale of CECT-branded handsets and accessories increased by 38.1% from Rmb 1,806.1 million in 2005 to Rmb 2,494.0 million ($319.6 million) in 2006, primarily due to increases in unit sales volume and the average selling price of the CECT-branded handsets. Sales volume of CECT-branded handsets increased by 30.7% from approximately 1,730,000 units in 2005 to approximately 2,262,000 units in 2006. The increase in unit sales volume of CECT-branded handsets was primarily driven by the commercial launch of a number of new models, including the A1000 and IP1000, which generated aggregate sales volume of approximately 1,894,000 units in 2006. The average selling price of the CECT-branded handsets increased from Rmb 1,012 per unit in 2005 to Rmb 1,094 ($140) per unit in 2006, primarily reflecting the increased percentage of total sales of higher-end and differentiated products that generally have higher unit selling prices.

Net sales of the COSUN-branded mobile phone handsets for 2006 were Rmb 491 million (US$ 62.9 million), representing a decrease of Rmb 83 million. The decrease was primarily due to (1) the reduction of the range of COSUN-branded higher-end products so as to reduce direct competition with the CECT brand, in accordance with the group-wide product positioning strategy of the Company, and (2) the fact that the license was granted by NDRC 6 months later than we expected, which had impact on our R&D and product launch plan of HZQXCI in 2006.

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Net sales of indoor telephones for 2006 were Rmb 236 million (US$ 30.2 million), representing a decrease of Rmb 19 million.

As the role played by telecommunication operators in the distribution of indoor telephones becomes more important, the Company has been adjusting its mix of distribution channels to favor telecommunication operators at the expense of traditional distributors. However, it takes time to gain acceptance from telecommunication operators in new regions. Therefore, temporarily in this adjustment process, the gain in sales to telecommunication operators did not adequately make up for the loss of distributor sales.

(ii) Cost of Goods Sold

Analysis of our cost of goods sold by business segment for fiscal years 2006 and 2005 is as follows:


	Year ended December 31
	2006				2005 (Restated)
	Rmb’000		%		Rmb’000		%
Mobile telephones		2,457,129		93		1,941,313		90
Indoor telephones		194,263		7		215,485		10

Total		2,651,392		100		2,156,798		100

Cost of goods sold increased by Rmb 495 million from Rmb 2,157 million for fiscal year 2005 to Rmb 2,651 (US$ 339.7 million) for fiscal year 2006, representing an increase of 22.9%.

In 2005, the cost of goods sold for the mobile phones business segment was Rmb 1,941 million, while it amounted to Rmb 2,457 million (US$ 314.8 million) in 2006, representing an increase of Rmb 516 million. The increase was mainly attributable to the increase in the cost of goods sold relating to CECT-branded handsets and accessories.

Cost of goods sold relating to the CECT-branded handsets and accessories increased by 35.1% from Rmb 1,526.4 million in 2005 to Rmb 2,062.2 million ($264.2 million) in 2006, primarily driven by increased unit sales volume of the CECT-branded handset products, which resulted in, among others, a Rmb 315.1 million increase in raw materials and components cost. After-sales service related expenses for the CECT-branded handsets and accessories also increased from Rmb 9.2 million in 2005 to Rmb 14.7 million ($1.9 million) in 2006, mainly reflecting increased sales volume.

Cost of goods sold relating to the COSUN-branded mobile phone handsets for 2006 were Rmb 395 million (US$50.6 million), representing a decrease of Rmb 20 million. The decrease was the net result of the following two factors, operating in opposite directions: decrease in sales revenue on the one hand, and increase in unit cost as a result of reduced scale on the other hand.

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Cost of goods sold for the indoor telephone business segment for 2006 were Rmb 194 million (US$ 24.9 million), representing a decrease of Rmb 21 million. The decrease in the cost of goods sold primarily reflected the decrease in sales revenue. It was also to a lesser extent attributable to improved cost control particularly in the area of supply-chain management.

(iii) Gross Profit

Analysis of our gross profit by business segment for fiscal years 2006 and 2005 is as follows:


	Year ended December 31
	2006				2005 (Restated)
	Rmb’000		%		Rmb’000		%
Mobile telephones		528,303		92		439,218		92
Indoor telephones		41,517		8		39,168		8

Total		569,820		100		478,386		100

Gross profit for fiscal year 2006 was Rmb 570 million (US$ 73.0 million), representing an increase of Rmb 91 million from Rmb 478 million in fiscal year 2005.

In 2005, the gross profit from the mobile phone business segment was Rmb 439 million, while it amounted to Rmb 528 million (US$ 67.7 million) in 2006, representing an increase of Rmb 89 million. The increase was mainly attributable to the increase in gross profit from the sale of CECT-branded handsets and accessories.

Gross profit from the sale of CECT-branded handsets and accessories increased by 40.6% from Rmb 337.7 million in 2005 to Rmb 475.0 million ($60.9 million) in 2006, primarily due to increased sales volume of the CECT-branded handset products.

Gross profit for the COSUN-branded mobile phone handsets decreased by Rmb 48 million from Rmb 102 million in fiscal year 2005 to Rmb 53 million (US$ 6.8 million) in fiscal year 2006. The decrease was mainly attributable to the decrease in sales volume and the trend of reducing unit selling prices in the market for lower-end mobile phone handsets among which there is not much differentiation.

Gross profit for the indoor telephone business segment increased by Rmb 2 million from Rmb 39 million in fiscal year 2005 to Rmb 42 million (US$ 5.4 million) in fiscal year 2006. The increase was the net result of the following two factors, operating in opposite directions: decrease in sales revenue on the one hand, and increase in the gross profit ratio on the other hand. Three major factors contributed to the increase in gross profit ratio: (1) an adjusted product mix with a higher proportion of higher-end and value-added products that generally have higher unit selling prices and command higher gross margins, (2) our improved cost control particularly in the area of supply chain management, and (3) the fact that the direct sales to telecommunication operators took a larger portion.

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(iv) Selling expenses

Selling expenses increased by Rmb 3.7 million from Rmb 24.7 million for fiscal year 2005 to Rmb 28.4 million (US$ 3.6 million) for fiscal year 2006. The increased expenses were mainly in the following areas:

	•		COSUN-branded mobile phone handsets: brand building and maintenance and the expansion of the distribution network subsequent to the receipt of a separate mobile phone handsets manufacturing license from the PRC government in June 2006;

	•		Indoor phones: additional sales force and the establishment of provincial offices for a stronger relationship with our telecommunication operator clients.

(v) General and administrative expenses including stock-based compensation

General and administrative expenses including stock-based compensation increased by Rmb 70.7 million from Rmb 55.3 million in fiscal year 2005 to Rmb 126.1 million (US$ 16.2 million) in fiscal year 2006.

General and administrative expenses other than stock-based compensation increased by Rmb 12.8 million from Rmb 54.6 million in fiscal year 2005 to Rmb 67.4 million (US$ 8.6 million) in fiscal year 2006. The increase was mainly in connection with the following:

	•		office expenses relating to new offices set up in provinces to serve clients of the indoor phone business segment who are telecommunication operators, and

	•		increased number of after-sales service points and workshops for the COSUN-branded mobile phone handsets.

Stock-based compensation increased by Rmb 58.0 million from Rmb 0.7 million in 2005 to Rmb 58.7 million (US$ 7.5 million) in 2006. The increase was mainly due to the grant of stock options in 2006. In February 2006, pursuant to the Company’s 2005 Stock Plan, 2,000,000 incentive stock options, exercisable during a 10-year period commencing on February 24, 2006, were issued to certain employees and consultants of the Company at an exercise price of US$7.00 per share,. All the options granted were exercised during 2006. In accordance with the requirements of SFAS No. 123-R and EITF 96-18, the fair value of the options, which amounted to approximately Rmb58,707,000 (US$7,523,000) as computed using the Black-Scholes option-pricing model on the grant date, has been recognized as share-based compensation expenses in the year ended December 31, 2006.

(vi) Research and development

Research and development expenses increased by Rmb 10.0 million from Rmb 20.7 million for fiscal year 2005 to Rmb 30.7 million (US$ 3.9 million) for fiscal year 2006. The increase related mainly to the increase in research and development effort subsequent to the receipt of a separate mobile phone handset manufacturing license from the PRC government relating to

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the COSUN-branded mobile phone handsets in June 2006. HZQXCI spent more in research and development following the receipt of the separate license. More than ten models were developed by HZQXCI for commercial launch in 2007.

(vii) In-process research and development

There was a write-off of in-process research and development expenses of Rmb 41.7 million (US$ 5.3 million) at the date of acquisition of the remaining 20% minority interest in QX Mobile on November 30, 2006. We did not have similar charges in 2005.

(viii) Amortization of intangible assets

As a result of the acquisition of the remaining 20% minority interest in QX Mobile on November 30, 2006, amortization of intangible assets increased by Rmb 3.3 million from Rmb 11.9 million in 2005 to Rmb 15.2 million ($1.9 million) in 2006.

(ix) Interest expenses

Interest expenses increased by Rmb 58.7 million from Rmb 1.8 million in 2005 to Rmb 100.4 million ($12.9 million) in 2006.

We recorded interest expenses of Rmb 55.9 million (US$ 7.2 million) in 2006 relating to two convertible bonds issued in 2006. We did not have similar charges in 2005.

Coupon interest for the two convertible bonds amounted to Rmb 7.7 million (US$ 1.0 million) in 2006.

(x) Loss on re-measurement of embedded derivatives

The two convertible notes issued in 2006 are hybrid instruments that come with embedded derivatives, including the right to convert the notes by the note holders, a premium put, a put option conditional upon certain events of default and a put option conditional upon a change of control. In accordance with the guidance of SFAS No. 133, as amended, “Accounting for

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Derivative Instruments and Hedging Activities,” and EITF Issue No. 00-19, the embedded derivatives must be removed from the debt host and accounted for separately as derivative instruments. Based on EITF No. 00-19, the embedded derivatives were determined to be classified as liabilities on the balance sheet. The value of the embedded compound derivatives, which totaled approximately Rmb 211.3 million (US$ 27.1 million) on the dates of initial recognition, has been deducted as a discount to the total face value of the US$66 million for the two convertible bonds and recorded as a liability on the balance sheet. The valuation of the embedded derivatives was derived by using various valuation methods, which included Monte Carlo Simulation and Backward Dynamic Programming.

The embedded derivatives will be marked-to-market at the end of each reporting period with the resulting gain or loss recognized in the statement of operations. The Company conducted a valuation of the embedded derivatives as of December 31, 2006 using the same valuation methods as those used on initial recognition and due principally to the change in the Company’s stock price from US$7.21 at June 13, 2006 and from US$15.45 at October 31, 2006 to US$13.19 at December 29, 2006, the valuation conducted resulted in a non-cash net charge of approximately Rmb 134.4 million (US$17.2 million) and a corresponding change in the embedded derivative liabilities. As of December 31, 2006, the fair value of the embedded derivative liability amounted to approximately Rmb 340.9 million (US$43.7 million).

We did not record similar loss on re-measurement of embedded derivatives in 2005.

(xi) Gain on disposal of subsidiary

In July 2005, we recognized a RMB10.3 million gain on disposal of a 90.0% equity interest in Beijing Jinxin Hengtong Technology Company Limited originally held through CECT, in connection with the acquisition of an additional 25.0% equity interest in CECT by QX Mobile.

We did not record similar gains on disposals in 2006.

(xii) Impairment of investment at cost

During the year ended December 31, 2005, we recorded an impairment charge of RMB7.3 million in respect of CECT’s 10% equity investment in CEC Mobile Co. Ltd. The provision was necessitated due to a slow-down in the business of CEC Mobile Co. Ltd. that resulted from difficult market conditions in the PRC’s CDMA mobile phone market.

We did not record similar impairment of investment at cost in 2006.

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(xiii) Income tax expense

Income tax expense increased by Rmb 32.7 million from RMB25.5 million in 2005 to Rmb 58.2 million ($7.5 million) in 2006. The increase was due primarily to increases in taxable income and applicable tax rate in our indirectly-owned subsidiary, CECT, which manufactures and sells CECT-branded mobile phone handsets. CECT was subject to a 15% enterprise income tax rate in 2006, compared to 7.5% in 2005.

(xiv) Extraordinary gain on acquisition of minority interests - net of nil tax

The Company’s subsidiary QX Mobile acquired the 25.0% minority interest in CECT in July 2005 for a total consideration of Rmb 75.0 million. The fair value of the underlying net assets representing the 25.0% interest in CECT exceeded our acquisition price. This favorable purchase price primarily reflects the facts that (i) CEC sought to dispose of its interest in CECT on an accelerated basis to complete its own group restructuring plans, and (ii) it became easier for domestic enterprises to manufacture mobile handsets in China due to regulatory changes, which reduced the marketability and demand for the license held by CECT. QX Mobile recognized the unallocated portion of the excess of the fair value of the acquired assets over the acquisition price of Rmb 47.0 million as an extraordinary gain in 2005. The Company’ share in the extraordinary gain was Rmb 37.6 million after minority interests.

QX Mobile also recorded an extraordinary gain of Rmb 17.8 million ($2.3 million) in connection with QX Mobile’s capital injection of $18.8 million (equivalent to Rmb 149.6 million) into CECT in July 2006 because the other shareholder of CECT, who sold all its remaining 6.6% equity interest in CECT to Qiao Xing Group in December 2006, did not participate in the capital injection at that time. The Company’s share in the extraordinary gain was Rmb 14.2 million (US$ 1.8 million) after minority interests.

(xv) Net income

Net loss of Rmb 19.8 million (US$2.5 million) was recorded for fiscal year 2006, compared with net income of Rmb 244.9 million for fiscal year 2005. The decrease of Rmb 264.7 million between fiscal years 2005 and 2006 was mainly due to the net effect of the following in fiscal year 2006:

	(i)		increase in gross profit of Rmb 91.4 million (US$ 11.7 million);

	(ii)		increase in general and administrative expenses of Rmb 70.7 million (US$ 9.1 million);

	(iii)		increase in research and development costs of Rmb 10.1 million (US$1.3 million);

	(iv)		increase in in-process research and development of Rmb 41.7 million (US$ 5.3 million);

	(v)		increase in interest expense of Rmb 58.7 million (US$ 7.5 million);

	(vi)		increase in loss on re-measurement of embedded derivative of Rmb 134.4 million (US$ 17.2 million);

	(vii)		decrease in gain on disposal of subsidiary of Rmb 10.3 million (US$ 1.3 million);

	(viii)		increase in provision for income tax of Rmb32.7 million (US$ 4.2 million);

	(ix)		decrease in minority interests of Rmb 14.8 million (US$ 1.9 million); and

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(x)

decrease in extraordinary gain on acquisition of minority interests of Rmb 23.4 million (US$ 3.0 million).

Based on a weighted average of 23,712,000 shares outstanding during fiscal year 2006, the Company reported basic loss after extraordinary gain per common share of Rmb 0.84 (US$0.11), compared to basic earnings after extraordinary gain per common share of Rmb 13.37 on 18,319,000 weighted-average shares outstanding during fiscal year 2005.

B. LIQUIDITY AND CAPITAL RESOURCES.

During fiscal year 2007, we were principally engaged in (i) the sales of telecommunication terminal products, including cord and cordless indoor telephone sets and other internet-related products in Mainland China; and (ii) production and sales of mobile phones and accessories in Mainland China. We did not declare or pay dividends in fiscal year 2007.

In summary, about Rmb 954.7 million (US$ 130.9 million) was provided by operating activities, about Rmb 650.3million (US$ 89.2 million) was used in investing activities and about Rmb 1,675.9 million (US$ 229.7 million) was provided by financing activities during the year ended December 31, 2007. Consequently, cash and cash equivalents increased by Rmb 1,936.5 million (US$ 265.5 million) from Rmb 1,096.5 million at the beginning to Rmb 3,033 million (US$ 415.8 million) at the end of year 2007.

(i) Cash flows from operating activities

There was a net operating cash inflow of Rmb 954.7 million (US$ 130.9 million) while the income before minority interests and extraordinary gain was Rmb 1,054.9 million (US$ 144.6 million) for the fiscal year of 2007. The difference of Rmb 100.2 million (US$ 13.7 million) stemmed mainly from the following:

	•		Interest expense relating to the accretion of convertible note discounts of Rmb 140.3 million (US$ 19.2 million) which did not involve any outflow of cash;

	•		loss on re-measurement of embedded derivatives of Rmb 129.1 million (US$ 17.7 million) which did not involve any outflow of cash;

	•		Loss on extinguishment of convertible debts of Rmb 142.1 million (US$ 19.5 million) which did not involve any outflow of cash;

	•		Gain on disposal of interests in subsidiaries of Rmb 482.6 million (US$ 66.2 million) which did not involve any inflow of cash;

	•		Gain on sale of stocks by subsidiary of Rmb 384.0 million (US$ 52.6 million) which did not involve any inflow of cash;

	•		decrease in accounts and bills receivable of Rmb 201.6 million (US$ 27.6 million); and

	•		decrease in prepaid expenses of Rmb 167.4 million (US$ 22.9 million).

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The decrease in accounts and bills receivable, which related primarily to the CECT-branded mobile phone handset business, was due mainly to an improvement in our collection of accounts receivable during 2007.

The decrease in prepaid expenses resulted primarily from the decrease in advances to suppliers in the mobile phone handset business.

(ii) Cash flows from investing activities

Net cash used in investing activities amounted to Rmb 650.3 million (US$ 89.2 million) during the year ended December 31, 2007. This was mainly attributable to a cash inflow of Rmb 180.0 million (US$ 24.7 million) in connection with proceeds from disposal of land use rights and construction-in-progress, a cash outflow of Rmb 998.3 million (US$ 136.9 million) in connection with interest-bearing advances to a third party and a cash inflow of Rmb 175.8 million (US$ 24.1 million) in connection with a decrease in restricted cash.

During the year ended December 31, 2007, the Company disposed of certain parcels of land and the related construction-in-progress to an independent third party for a total cash consideration of RMB288,904,000. As of December 31, 2007, a total of RMB180,000,000 had been received by the Company. The balance of the consideration of RMB108,904,000 is receivable within seven days after the completion of the legal transfer of the relevant titles to the purchaser. There was no such disposal of land use rights and construction-in-progress in 2006.

Advances to a third party are secured by a floating charge over all the assets of the borrower, bear interest at 5.0% per annum and are repayable on demand. All advances made and interest accrued thereon have been received subsequent to the end of the financial year. There were no such advances in 2006.

Restricted cash related to bank deposits pledged to secure short-term bank borrowing in connection with bills payable. Restricted cash decreased with the decreased use of bills payable as a means of settlement with suppliers in the indoor phone set business and in the COSUN-branded mobile phone handset business.

(iii) Cash flows from financing activities

Net cash inflow from financing activities amounted to Rmb 1,675.9 million (US$ 229.7 million) for the year ended December 31, 2006. It related mainly to the cash inflow in connection with the net increase of short-term borrowings of Rmb 323.2 million (US$ 44.3 million), the net proceeds from issuance of convertible notes of Rmb 175.1 million (US$ 24.0 million), the net proceeds from issuance of common stock of Rmb 114.5 million (US$ 15.7 million) and the net proceeds from the IPO of common stocks by a subsidiary of Rmb 1,026.6 million (US$ 140.7 million).

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For the year ended December 31, 2007, we financed our operations and investments principally through cash generated from operating activities, short-term bank borrowings, issuance of new shares and convertible notes and the IPO of common stocks by a subsidiary. Outstanding bank borrowings accounted for 28% and 23% of our total assets as of December 31, 2006 and December 31, 2007, respectively. Seasonal working capital needs have been met through short-term borrowings under revolving lines of credit. As of December 31, 2007, our consolidated working capital was Rmb 3,946.5 million (US$ 541.0 million) as compared to Rmb 1,498.7 million as of December 31, 2006. We believe that our working capital is sufficient for our present requirements.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, we must make a variety of estimates that affect the reported amounts and related disclosures. The following accounting policies are currently considered most critical to the preparation of our consolidated financial statements.

Sales recognition

The Group recognizes sales in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 101 “Revenue Recognition in Financial Statements,” as amended by SAB No. 104 “Revenue Recognition.”

Sales represent the invoiced value of goods, net of value added tax (“VAT”), discounts, returns and price guarantees supplied to customers, and are recognized upon delivery of goods and passage of title. The liability for sales returns and price guarantees is estimated based on historical rates.

All of the Group’s sales made in Mainland China are subject to Mainland Chinese VAT at a rate of 17% (“output VAT”). Such output VAT is payable after offsetting VAT paid by the Group on its purchases (“input VAT”).

Trade accounts receivable

Trade accounts receivable are recorded at invoiced amounts less allowances for doubtful accounts. The Group reviews its accounts receivables on a periodic basis and makes allowances when there is doubt as to the collectibility of the balances. In evaluating the collectibility of a receivable balance, the Company considers many factors, including the age of the balance, the customer’s historical payment history, its current credit-worthiness and current economic trends. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Inventories

Costs of work-in-process and finished goods are composed of direct materials, direct labor and an attributable portion of manufacturing overhead. Net realizable value is the estimated selling

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price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale, and after making allowances for damaged, obsolete and slow-moving items. Allowances for damaged, obsolete and slow-moving items are determined by management based on a consideration of several factors, including the aging of the inventories, current and expected future market trends and conditions, and the physical condition of the goods observed during periodic inventory counts.

When inventories are sold, their carrying amount is charged to expense in the year in which the revenue is recognized. Write-downs for declines in net realizable value or for losses of inventories are recognized as an expense in the year the impairment or loss occurs.

Product warranties

The Group guarantees that products will meet the stated functionality as agreed to in each sales arrangement. The Company provides for the estimated warranty costs under these guarantees based upon historical experience and management’s estimate of the level of future claims, and accrues for specific items at the time their existence is known and the amounts are estimable.

Valuation of Long-lived Assets

The Group tests its investment in long-lived assets, including property, machinery and equipment and amortizable intangible assets, for recoverability whenever events or changes in circumstances indicate that the net carrying amount may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to result from its use and eventual disposition. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying value of the asset exceeds its fair value. If a readily determinable market price does not exist, fair value is estimated using discounted expected cash flows attributable to the assets.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired in business combinations accounted for under the purchase method. The Group adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill be tested for impairment upon first adoption and annually thereafter, or more frequently if events or changes in circumstances indicate that it might be impaired, using the prescribed two-step process. The first step screens for potential impairment of goodwill to determine if the fair value of the reporting unit is less than its carrying value, while the second step measures the amount of goodwill impairment, if any, by comparing the implied fair value of goodwill to its carrying value.

The Group completed its annual goodwill impairment test during the year ended December 31, 2007 and determined that no adjustment to the carrying value of goodwill was required.

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Other acquired intangible assets

Other acquired intangible assets are required to be determined separately from goodwill based on the assets’ fair value. The Group adopted SFAS No. 141, “Business Combinations,” which requires an intangible asset that is acquired in a business combination to be recognized as an asset apart from goodwill if it satisfies either the “contractual-legal” or “separability” criterion. SFAS No. 141 specifically excludes an assembled workforce acquired in a business combination from recognition apart from goodwill.

With the adoption of SFAS No. 142, intangible assets with indefinite useful lives are no longer amortized, while intangible assets with finite useful lives will continue to be amortized over their useful lives.

The Group adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires intangible assets with finite useful lives to be tested for impairment if events or changes in circumstances indicate that the asset might be impaired, using the prescribed two-step process. The first step is a recoverability test which screens for potential impairment of an asset based on whether the undiscounted sum of estimated future cash flows from an asset is less than its carrying value. The second step measures the amount of impairment, if any, by comparing the fair value of the asset to its carrying value.

For intangible assets with indefinite useful lives, the Group adopted SFAS 142 which requires an intangible asset that is not subject to amortization to be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Such impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount and an impairment loss is recognized when the carrying amount of an intangible asset exceeds its fair value.

For impairment testing purposes, the fair value of the “CECT” brand of the Group’s subsidiary, CECT, is estimated using the Relief-from-Royalty Method, a discounted cash flow approach which brings into play, in the case of CECT, a single set of estimated cash flows and a discount rate commensurate with the risk. The cash flow contribution from the brand comes from savings in royalty that CECT would have to pay to a third party for the use of its brand name if CECT had not had the “CECT” brand but nevertheless had wanted its products to have a recognized brand. The cash flow contribution of the “CECT” brand is linked to the cash inflow from the sales revenue of CECT. As there is a lack of publicly available information about comparable licensing transactions in Mainland China suitable for the Group’s purpose, the royalty savings as a percentage of sales revenue is estimated by comparing the operational profit margin as a percentage of sales revenue of CECT with its superior “CECT” brand with those of comparable companies in China which operate on an OEM sub-contractor basis or with an inferior brand. Also, marketing expense is required to maintain the brand name for CECT. An average of marketing expense as a percentage of sales revenue is taken from the income statements of CECT in the medium term forecast. This percentage is then used to estimate cash outflow relating to marketing expense in the cash flow forecast under the Relief-from Royalty Method.

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The Group completed its annual impairment test for other acquired intangible assets during the year ended December 31, 2007 and determined that no adjustment to the carrying value of other acquired intangible assets was required.

Depreciation and amortization of long-lived assets

We have a substantial amount of property, machinery and equipment, and intangible assets, and the depreciation/amortization of these assets constitutes a significant operating cost for us. The useful lives of our long-lived assets represent our estimate of the periods during which we expect to derive economic benefits from the assets. In estimating the useful lives and also the recoverable salvage values of these assets and in determining whether subsequent revisions to the useful lives and salvage values are necessary, we consider the likelihood of technological obsolescence arising from changes in production techniques, technology, market demand and intended use. We routinely review the remaining estimated useful lives and salvage values of our long-lived assets to determine if such lives and values should be adjusted. However, actual economic lives and salvage values may differ from our estimates and any future revisions to these estimates will impact our depreciation/amortization expenses, and hence our operating results, in future periods. In the years ended December 31, 2005, 2006 and 2007, we have not made any changes to the estimated useful lives or salvage values for our long-lived assets.

Stock-based compensation

The Group adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), to account for share-based payments beginning January 1, 2006. The Group has elected the modified prospective transition method as permitted by SFAS 123R and accordingly, prior periods’ financial statements have not been restated to reflect the impact of SFAS 123R. Under this method, the Group is required to recognize share-based compensation for all new and unvested share-based awards that are ultimately expected to vest as the requisite service is rendered beginning January 1, 2006. Share-based compensation is measured based on the fair value of all share-based awards on the dates of grant and is recognized using the straight-line method over the requisite service period, which is generally the same as the vesting period.

The Company accounts for share-based awards issued to non-employees in accordance with the provisions of SFAS 123R and EITF 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” The Company values share-based awards issued using either the Black-Scholes option-pricing model or the binomial option pricing model, and recognizes the value over the period in which the awards vest.

Debt issuance costs and borrowing costs

Costs related to the issuance of debt are capitalized and amortized to interest expense using the effective interest method over the expected term of the related debt. All other borrowing costs are recognized as an expense in the period in which they are incurred, except to the extent that they

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are attributable to the acquisition, construction or production of an asset that necessarily involves a substantial period of time before the asset is ready for its intended use or sale, in which case the borrowing costs are capitalized as part of the costs of the asset.

Income taxes

The Group accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred income taxes are provided using the liability method and are recognized for all significant temporary differences between the tax and financial statement bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates or laws is recognized in the statement of operations in the period that the change in tax rates or tax laws is enacted. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Group is able to realize their benefits or that future deductibility is uncertain.

On January 1, 2007, the Group adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertain tax positions. This interpretation requires that an entity recognizes in the consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained upon examination, based on the technical merits of the position. The Group has elected to classify interest and penalties related to income tax matters, if and when required, as part of income tax expense in the statement of operations. The adoption of FIN 48 on January 1, 2007 did not have any effect on the Group’s consolidated financial statements.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board, or the FASB, issued SFAS No. 157, “Fair Value Measurements,” or SFAS No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. In November 2007, the FASB proposed a one-year deferral of SFAS No. 157’s fair value measurement requirements for non-financial assets and liabilities that are not required or permitted to be measured at fair value on a recurring basis. Except to the extent that it will affect the disclosures concerning fair value measurements, the initial adoption of SFAS No. 157 is not expected to have a material impact on our consolidated financial statements.

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In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115,” or SFAS No. 159. SFAS No. 159 permits companies to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective on January 1, 2008, although earlier adoption is permitted. We have elected not to adopt the fair value option, as permitted under SFAS No. 159.

In December 2007, the FASB issued SFAS No. 141R, a revision of SFAS No. 141, “Business Combinations,” or SFAS No. 141R . SFAS No. 141R establishes requirements for the recognition and measurement of acquired assets, liabilities, goodwill, and non-controlling interests (formerly minority interests). SFAS No. 141R also provides disclosure requirements related to business combinations. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008. SFAS No. 141R will be applied prospectively to business combinations with an acquisition date on or after the effective date.

In December 2007, the FASB issued SFAS No. 160, “Non-Controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51,” or SFAS No. 160. SFAS No. 160 establishes new standards for the accounting for and reporting of non-controlling interests and for the loss of control of partially owned and consolidated subsidiaries. SFAS No. 160 does not change the criteria for consolidating a partially owned entity. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The provisions of SFAS No. 160 will be applied prospectively upon adoption except for the presentation and disclosure requirements, which will be applied retrospectively. SFAS No. 160 states that accounting and reporting for minority interests will be recharacterized as non-controlling interests and classified as a component of equity. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more partially owned and consolidated subsidiaries. Except for the classification of minority interest as a component of equity, we do not expect the initial adoption of SFAS No. 160 to have a material impact on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133,” or SFAS No. 161. SFAS No. 161 requires enhanced disclosures for derivative instruments and hedging activities that include how and why an entity uses derivatives, how these instruments and the related hedged items are accounted for under SFAS No. 133 and related interpretations, and how derivative instruments and related hedged items affect the entity’s financial position, results of operations and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.

In May 2008, the FASB issued FASB Staff Position (“FSP”) No. Accounting Principles Board 14-1, or FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP No. APB 14-1 requires the issuer of convertible debt instruments with cash settlement features to account

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separately for the liability and equity components of the instrument. The debt would be recognized at the present value of its cash flows discounted using the issuer’s nonconvertible debt borrowing rate at the time of issuance. The equity component would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability. FSP No. APB 14-1 will also require an accretion of the resultant debt discount over the expected life of the debt. The proposed transition guidance requires retrospective application to all periods presented, and does not grandfather existing instruments. FSP No. APB 14-1 is effective for fiscal years beginning after December 15, 2008. We are currently evaluating the impact of the adoption of FSP No. APB 14-1 on our consolidated financial statements.

C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.

During each of the last three fiscal years, we spent the following amounts on company-sponsored research and development activities:


Year ended December 31, 2007		Rmb 34,452,000
Year ended December 31, 2006		Rmb 30,747,000
Year ended December 31, 2005		Rmb 20,694,000

D. TREND INFORMATION.

Other than as disclosed elsewhere in this annual report, we are not aware of any known trends, uncertainties, demands, commitments or events for the period from January 1, 2007 to December 31, 2007 that are reasonably likely to have a material adverse effect on our net sales or revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

E. OFF-BALANCE SHEET ARRANGEMENTS.

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

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F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.

(a) Capital commitments

Capital commitments not provided for in the consolidated financial statements include the following:


	2007
	Rmb’000		US$’000
Capital expenditures authorized and contracted for:
- Purchase of machinery and equipment		130		18

(b) Operating lease commitments

The Group has operating lease agreements for office and factory premises, which extend through December 2010. As of December 31, 2007, the Group’s future minimum lease payments required under non-cancelable operating leases are as follows:


	Amount
	Rmb’000		US$’000
For the years ending December 31,

- 2008		5,274		723
- 2009		3,052		418
- 2010		3,052		418


Total		11,378		1,559

On October 31, 2006, pursuant to a securities purchase agreement dated October 31, 2006, the Company issued and sold to two institutional investors US$26 million aggregate principal amount of 4.5% unsecured senior convertible notes (the “4.5% Note”).

On August 17, 2007, pursuant to a securities purchase agreement dated August 17, 2007, the Company issued and sold to two institutional investors US$25 million aggregate principal amount of 5.5% unsecured senior convertible notes (the “5.5% Note”).

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The Group’s total future payments relating to (i) the service of debt of the 4.5% Note assuming that the notes are repaid at maturity and (ii) the service of debt of the 5.5% Note assuming that the notes are redeemed one year after the issuance at 100% of the principal are as follows:


	Amount
	Rmb’000		US$’000
For the years ending December 31,

- 2008		200,930		27,545
- 2009		193,927		26,585


Total		394,857		54,130

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. DIRECTORS AND SENIOR MANAGEMENT.

Our current senior management and directors are as follows:


Name	Age		Position
Rui Lin Wu		56	Chairman and Chief Executive Officer
Zhi Yang Wu		35	Vice Chairman and Secretary
Albert Leung		51	Chief Financial Officer
Ze Yun Mu		42	Non-Executive Director
Edward Tsai		51	Non-Executive Director
Yi Hong Zhang		66	Non-Executive Director

None of our directors and officers was selected pursuant to any agreement or understanding with any other person. There is no family relationship between any director or executive officer and any other director or executive officer, except Rui Lin Wu and his son Zhi Yang Wu.

Mr. Rui Lin Wu is our chairman and chief executive officer. He is our founder and has over 18 years of experience in the telecommunication industry. He is responsible for our overall strategic planning, policy making and finance. Prior to his career in the telecommunications industry, he was a general manager of a fashion and garment factory from 1980 to 1986. Currently, Mr. Wu is the executive commissioner of the China National Association of Industry and Commerce, senior analyst of the China National Condition and Development Research Center, and a member of the Poverty Fund of China. Mr. Wu also serves as the vice chairman of QX Mobile (NYSE: QXM) and a director of CECT since February 2003.

Mr. Zhi Yang Wu is our vice chairman and the eldest son of Mr. Rui Lin Wu. Mr. Wu also serves as our secretary. Mr. Wu received a diploma in enterprise management from Huizhou University in China. He joined us in 1992 and is responsible for our overall strategic planning, policy making and the overseas market development. Mr. Wu also serves as the chairman of QX Mobile (NYSE: QXM) and CECT since February 2003.

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Mr. Albert Leung has served as our chief financial officer since his appointment in December 2003. Mr. Leung received a Higher Diploma in Accountancy from Hong Kong Polytechnic in 1980 and a Diploma in Advanced Commercial Studies from L’Ecole des Hautes Etudes Commerciales in France in 1984. He is a registered member of the Hong Kong Society of Accountants since 1988 and the Association of Chartered Certified Accountants, Great Britain, since 1986. Prior to joining us in December 2003, Mr. Leung served as chief financial officer of Yantai Dahua Holdings Company Limited (YDHCF.PK) (n/k/a China Agro — Technology Holdings Ltd., OTCBB: CAGTF.OB) from February 2003 until December 2003. From March 2001 until February 2003, he served as a consultant with AB Management Consulting Company, Hong Kong, providing accounting services, tax compliance and finance for small and medium enterprises in Hong Kong. From November 1999 to October 2000, Mr. Leung served as regional financial controller in Singapore for Euro RSCG Asia Pacific. From December 1998 to April 1999, he served as property manager (cost control) for The Hong Kong Jockey Club. Mr. Leung devotes his full working time to our affairs.

Mr. Ze Yun Mu has served as a non-executive director since September 15, 2003. Mr. Mu had also served since 1998 as the external affairs director for Huizhou Wei Guo Machinery Factory and served as a technician for them from 1990 to 1998.

Dr. Edward Tsai has served as a non-executive director since December 2007. Dr. Tsai is the chairman of Paradigm Venture Partners L.L.C. since August 2000, a business engaged in venture capital funds management. From February 1997 to February 2000, he served as president of Allianz President General Insurance Co. Dr. Tsai was president and chief executive officer of President Investment Trust Corp. from January 1994 to February 1997 engaged in mutual funds management. He was an attorney-at-law with Baker & McKenzie from October 1989 to January 1994 and with Diepenbrock, Wolff, Plant & Hannagen from August 1988 to October 1989. Dr. Tsai received his J.D. degree from Santa Clara University in 1998, his LL.M. degree from Tulane University in 1983, his LL.B. degree from Chinese Culture University in 1979 and the Executive Program of Business Management from National Cheng-Chi University.

Mr. Yi Hong Zhang has served as a non-executive director since December 2004. Since 2004, he has served as senior advisor and independent director of Guangzhou Hualin Enterprise Group. From 2001 through 2003, Mr. Zhang was the standing deputy director of the leadership panel for technical assessment under the Guangdong Science and Technology Institute. From 2000 to 2001, he served as chairman and general manager of Guangdong Zhongping Yueke Appraisal Co., Ltd. From 1994 to 1999, Mr. Zhang served as head of the Guangdong Science and Technology Appraisal Center.

B. COMPENSATION.

The aggregate compensation which we paid to all of our directors and executive officers as a group with respect to our fiscal year ended December 31, 2007 on an accrual basis, for services in all capacities, was Rmb 1,469,000 (US$201,000). During the fiscal year ended December 31, 2007, we contributed an aggregate amount of Rmb 22,000 (US$3,000) toward the pension plans of our directors and executive officers.

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We have not entered into an employment agreement with Mr. Rui Lin Wu. Currently, Mr. Wu serves as our chairman and chief executive officer at a director fee of Rmb 224,000 (US$31,000) and a salary of Rmb 0 (US$ 0) for 2007. Mr. Wu’s remuneration package includes benefits with respect to a motor car.

C. BOARD PRACTICES.

Each of our current directors was elected at our last annual meeting of shareholders held on December 7, 2007 to serve a one-year term or until their successor is elected and qualified.

There are no directors’ service contracts with us or any of our subsidiaries providing for benefits upon termination of employment.

Our board of directors has the responsibility for establishing broad corporate policies and for our overall performance, although it is not involved in day-to-day operating details. The board meets regularly throughout the year, including the annual organization meeting following the annual meeting of shareholders, to review significant developments affecting us and to act upon matters requiring board approval. It also holds special meetings as required from time to time when important matters arise requiring board action between scheduled meetings.

Audit Committee

We have established an audit committee, which currently consists of Dr. Edward Tsai, Ze Yun Mu and Yi Hong Zhang. Its functions are to:

	•		recommend annually to our board of directors the appointment of our independent public accountants;

	•		discuss and review the scope and the fees of the prospective annual audit and review the results with the independent public accountants;

	•		review and approve non-audit services of the independent public accountants;

	•		review compliance with our existing accounting and financial policies;

	•		review the adequacy of our financial organization; and

	•		review our management’s procedures and policies relative to the adequacy of our internal accounting controls and compliance with U.S. federal and state laws relating to financial reporting.

Nominating Committee

We have established a nominating committee, which currently consists of Dr. Edward Tsai, Ze Yun Mu and Yi Hong Zhang. Its purpose and functions are to:

	•		assess the size and composition of the board of directors in light of our operating requirements and existing social attitudes and trends;

	•		develop membership qualifications for the board of directors and all board committees;

	•		monitor compliance with board of director and board committee membership criteria;

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	•		review and recommend directors for continued service as required based on our evolving needs;

	•		coordinate and assist management and the board of directors in recruiting new members to the board of directors; and

	•		investigate suggestions for candidates for membership on the board of directors and recommend prospective directors, as required, to provide an appropriate balance of knowledge, experience and capability on the board of directors, including stockholder nominations for the board of directors.

Compensation Committee

We have established a compensation committee, which currently consists of Dr. Edward Tsai, Ze Yun Mu and Yi Hong Zhang. Its purpose and functions are to:

	•		review and approve corporate goals and objectives relevant to the compensation of the chief executive officer and other executive officers;

	•		evaluate the chief executive officer’s performance in light of such goals and objectives at least annually and communicate the results to the chief executive officer and the board of directors;

	•		set the chief executive officer’s compensation levels based on the foregoing evaluation (including annual salary, bonus, stock options and other direct and indirect benefits), with ratification by the independent directors of the full board of directors; and

	•		set the other executive officers’ compensation levels (including annual salary, bonus, stock options and other direct and indirect benefits).

Nasdaq Requirements

Our common shares are currently listed on the Nasdaq Global Market and, for so long as our securities continue to be listed, we will remain subject to the rules and regulations established by Nasdaq as being applicable to listed companies. Nasdaq has adopted amendments to its Rule 4350 to impose various corporate governance requirements on listed securities. Section (a) (1) of Rule 4350 provides that foreign private issuers such as our company are required to comply with certain specific requirements of Rule 4350, but, as to the balance of Rule 4350, foreign private issuers are not required to comply if the laws of their home country do not otherwise require compliance.

We currently comply with the specifically mandated provisions of Rule 4350. In addition, we have elected to voluntarily comply with certain other requirements of Rule 4350, notwithstanding that our home country does not mandate compliance; although we may in the future determine to cease voluntary compliance with those provisions of Rule 4350. However, we have determined not to comply with the following provisions of Rule 4350 since the laws of the British Virgin Islands do not require compliance:

•

our independent directors do not hold regularly scheduled meetings in executive session;

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	•		the compensation of our executive officers is not determined by an independent committee of the board or by the independent members of the board of directors, and our CEO may be present and participate in the deliberations concerning his compensation;

	•		related party transactions are not required to be reviewed or approved by our audit committee or other independent body of the board of directors; and

	•		we are not required to solicit shareholder approval of stock plans, including those in which our officers or directors may participate; stock issuances that will result in a change in control; the issuance of our stock in related party transactions or other transactions in which we may issue 20% or more of our outstanding shares; or, below market issuances of 20% or more of our outstanding shares to any person.

We may in the future determine to voluntarily comply with one or more of the foregoing provisions of Rule 4350.

D. EMPLOYEES.

As of December 31, 2007 and giving effect to the staff of CECT, our indirectly majority-owned subsidiary, we had a total of 1,338 full time employees, of which 10 are key management staff, 287 are engaged in sales and marketing, 103 are engaged in finance and administration, 690 are engaged in production and 248 are engaged in research and development. None of our employees is represented by a labor union and we believe that our working relationship with our employees is good.

E. SHARE OWNERSHIP.

The following table sets forth certain information regarding the beneficial ownership of our shares of common stock as of July 8, 2008 by:

	•		each person who is known by us to own beneficially more than 5% of our outstanding common stock;

	•		each of our current executive officers and directors; and

	•		all current directors and executive officers as a group.

As of July 8, 2008, we had 30,948,836 shares of our common stock issued and outstanding.

This information gives effect to securities deemed outstanding pursuant to Rule 13d-3(d)(l) under the Securities Exchange Act of 1934, as amended.


	Number			Percent
Name of Beneficial Holder	Shares Beneficially Owned
Wu Holdings Limited		6,819,000	(1)		22.0
Rui Lin Wu		6,819,000	(1)		22.0
Zhi Yang Wu		0			0
Zhi Zhong Wu		0			0

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	Number		Percent
Name of Beneficial Holder	Shares Beneficially Owned
Albert Leung		0		0
Ze Yun Mu		0		0
Edward Tsai		0		0
Yi Hong Zhang		0		0
All directors and executive officers as a group (6 persons)		6,819,000		22.0
Galbo Enterprises Limited (2)		1,562,348		5.0


(1)		Wu Holdings Limited is a British Virgin Islands corporation which is wholly owned by the Qiao Xing Trust. The Qiao Xing Trust is a Cook Islands trust which was formed for the primary benefit of Zhi Jian Wu Li, the youngest son of Rui Lin Wu, our chairman. The 6,819,000 shares of common stock owned of record and beneficially by Wu Holdings Limited may be deemed to also be beneficially owned by Rui Lin Wu (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934, as amended) since he may be deemed to have and/or share the power to direct the voting and disposition of such shares.

(2)		Their address is 8^th Floor, Kat Cheung Mansion, 1 Lai Shun Street, North Point, Hong Kong.

The 2005 Stock Compensation Plan

On September 19, 2005, our board of directors adopted and approved our 2005 Stock Compensation Plan, which our shareholders approved on December 2, 2005. The purpose of the plan is to:

	•		encourage ownership of our common stock by our officers, directors, employees and advisors;

	•		provide additional incentive for them to promote our success and our business; and

	•		encourage them to remain in our employ by providing them an opportunity to benefit from any appreciation of our common stock through the issuance of stock options.

Options constitute either incentive stock options within the meaning of Section 422 of the United States Internal Revenue Code of 1986, as amended, or options which constitute nonqualified options at the time of issuance of such options. The plan provides that incentive stock options and/or nonqualified stock options may be granted to our officers, directors, employees and advisors selected by the compensation committee. A total of 2,000,000 shares of common stock are authorized and reserved for issuance during the term of the plan, which expires in September 2015. The compensation committee has the sole authority to interpret the plan and make all determinations necessary or advisable for administering the plan. The exercise price for any option may be less than the fair market value of the shares as of the date of grant. Upon the exercise of the option, the exercise price must be paid in full either in cash, shares of our stock or a combination. If any option is not exercised for any reason, such shares shall again become available for the purposes of the plan.

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On February 24, 2006, the compensation committee approved the grant and issuance of 2,000,000 options at an exercise price of $7.00 per share to eleven persons, including the following officers, directors and related parties:

	•		545,000 options – Rui Lin Wu, Chairman

	•		400,000 options – Zhi Yang Wu, Vice Chairman

	•		400,000 options – Zhi Zhong Wu, son of Chairman

	•		400,000 options – Zhi Jian Wu, son of Chairman

As of December 31, 2006, all 2,000,000 options had been exercised and no options to purchase shares of our common stock under the plan remained outstanding.

Other Options and Warrants Outstanding

As of July 8, 2008, the following options and warrants to purchase shares of our common stock were outstanding:

	•		warrants to purchase an aggregate of 375,000 shares of common stock at $9.86 per share at any time until February 17, 2010 which we granted to two accredited investors and the placement agent and finders in February 2005 in connection with a stock purchase agreement (“February 2005 SPA Warrants”)

	•		warrants to purchase an aggregate of 37,494 shares of common stock at $9.86 per share at any time until April 13, 2010 which we granted to three accredited investors and two finders in April 2005 in connection with a stock purchase agreement (“April 2005 SPA Warrants”)

	•		warrants to purchase an aggregate of 400,000 shares of common stock at $8.125 per share at any time until January 17, 2010 which we granted to an accredited investor in January 2006 in connection with a stock purchase agreement (“January 2006 SPA Warrants”)

	•		warrants to purchase an aggregate of 35,500 shares of common stock at $8.125 per share at any time until January 17, 2010 which we granted to a financial consultant and its employees and related parties in February 2006 in connection with certain corporate finance consulting and advisory services rendered to the Company during 2005 (“February 2006 Warrants”)

	•		warrants to purchase an aggregate of 18,753 shares of common stock at $7.00 per share at any time until February 22, 2010 which we granted to an accredited investor in February 2006 in connection with a stock purchase agreement (“February 2006 SPA Warrants”)

	•		warrants to purchase an aggregate of 600,000 shares of common stock at $14.30 per share at any time until October 31, 2010 which we granted to two accredited investors

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			and the placement agent in October 2006 in connection with the sale of 2,000,000 shares of our common stock at US$12.00 per share (“October 2006 SPA Warrants”)

	•		warrants to purchase an aggregate of 545,455 shares of common stock at $14.30 per share at any time until October 31, 2011 which we granted to two accredited investors and the placement agent in October 2006 in connection with the sale of $26,000,000 of our senior convertible notes (“October 2006 CB Warrants”)

	•		warrants to purchase an aggregate of 736,016 shares of common stock at $10.19 per share at any time until August 17, 2012 which we granted to two accredited investors and the placement agent in August 2007 in connection with the sale of $25,000,000 of our senior convertible notes (“August 2007 CB Warrants”)

	•		warrants to purchase an aggregate of 473,814 shares of common stock at $13.00 per share at any time until November 2, 2011 which we granted to an accredited investor and a finder in November 2007 in connection with a stock purchase agreement (“November 2007 SPA Warrants”)

Each of the foregoing warrants contains provisions for the adjustment of exercise price and number of warrant shares in the event of “Dilutive Issuances” as defined therein.

Accordingly, the number of warrants and the exercise price of the following warrants have been adjusted pursuant to the “Dilutive Issuances” provisions thereof as follows:

1.		February 2005 SPA Warrants – 436,254 warrants at $8.4756 per warrant

2.		April 2005 SPA Warrants – 43,618 warrants at $8.4756 per warrant

3.		January 2006 SPA Warrants – 438,828 warrants at $7.4061 per warrant

4.		February 2006 Warrants – 38,946 warrants at $7.4061 per warrant

5.		February 2006 SPA Warrants – 19,815 warrants at $6.6249 per warrant

6.		October 2006 SPA Warrants – 1,543,165 warrants at $ 5.5600 per warrant

7.		October 2006 CB Warrants – 1,402,879 warrants at $5.5600 per warrant

8.		August 2007 CB Warrants – 1,348,921 warrants at $5.5600 per warrant

9.		November 2007 SPA Warrants – 1,107,838 warrants at $ 5.5600 per warrant

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. MAJOR SHAREHOLDERS.

Please see Item 6.E. for share ownership information regarding our major shareholders. Our major shareholders do not have different voting rights.

We do not have available information as to the portion of our common stock held in the host country and the number of record holders in the host country.

As of December 31, 2007, we had 70 record holders of our common stock. Of the 30,948,836 shares outstanding as of December 31, 2007, 22,503,239 shares were held by CEDE & Co.

To the extent known to us, we are not directly or indirectly owned or controlled by another corporation, by any foreign government or by any other natural or legal persons severally or jointly.

To our knowledge, there are no arrangements the operation of which may at a subsequent date result in a change in control of our company.

B. RELATED PARTY TRANSACTIONS.


Name of related parties		Existing relationship with the Company
Mr. Zhi Jian Wu Li		Major shareholder
Mr. Rui Lin Wu		Director and father of Mr. Zhi Jian Wu Li
Wu Holdings Limited		Intermediate holding company
Exquisite Jewel Limited		Minority shareholder
Metrolink Holdings Limited		Minority shareholder
Specialist Consultants Limited		Minority shareholder
Qiao Xing Group Limited (“QXGL”)		Common director and minority shareholder of CECT, QXCI and QXPL
Huizhou Qiaoxing Famous Science & Technology Co., Ltd. (“QFST”)		A company 80% owned by QXGL
China Electronics Corporation (“CEC”)		Minority owner of CECT until July 29, 2005
China Electronics Beijing Real Estate Management Co., Ltd. (“CEBREM”)		CEC is a shareholder

Summary of related party transactions is as follows:


	2005		2006		2007
	RMB’000		RMB’000		RMB’000		US$’000
Operating lease rentals charged by CEC		1,325		—		—		—

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	2005		2006		2007
	RMB’000		RMB’000		RMB’000		US$’000
Property management fees paid and payable to:
- CEBREM		852		—		—		—
- QXGL		61		90		100		14
Sales to:
- QFST		41,928		69,232		95,514		13,094

Other transactions with related parties are set out in Note 1, 9, 11(a), 14 and 18 to the consolidated financial statements.

Summary of related party balances is as follows:


	2006		2007
	RMB’000		RMB’000		US$’000
Due from:
- Exquisite Jewel Limited		5		5		1
- Wu Holdings Limited		24		22		3

		29		27		4


Due to:
- Mr. Rui Lin Wu		4,516		608		83


Accounts receivable from:
- QFST		44,443		97,070		13,307

Other balances with related parties are disclosed in Note 9 and 18 to the consolidated financial statements.

Except for the balances owing to the Company’s shareholders as disclosed in Note 18, all other balances with related parties are unsecured, non-interest bearing and without pre-determined repayment terms.

C. INTERESTS OF EXPERTS AND COUNSEL.

Not applicable.

ITEM 8. FINANCIAL INFORMATION

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.

The Consolidated Financial Statements are filed in this annual report as Item 18.

Export sales do not constitute a significant portion of our total sales volume.

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Except as set forth below, there are no legal or arbitration proceedings, including those relating to bankruptcy, receivership or similar procedures and those involving any third party, which may have, or have had in the recent past, significant effects on our financial position or profitability. We are not aware of any material governmental proceedings pending or known to be contemplated.

In August and September 2007, we were named as a defendant in five putative class actions filed in United States District Court for the Southern District of New York. Various of the lawsuits also named Rui Lin Wu, Albert Leung, Zhi Yang Wu, Sonny Kwok Wing Hung, Ze Yun Mu and Yi Hong Zhang as individual defendants. Grobstein, Horwath & Company LLP was also named as a defendant in two of the complaints. The allegations in the complaint relate to the Company’s restatement of prior financial statements that was disclosed on July 16, 2007 in the Form 20-F and in a press release on July 17, 2007. The Company and the individual defendants were named in all five of the cases pursuant to Section 10(b) of the Securities Exchange Act of 1934, and other related provisions. The complaints seek unspecified damages, attorney fees, and other unspecified litigation costs. By Order, dated November 1, 2007, Judge Denise Cote consolidated the five cases and appointed lead plaintiff and lead plaintiff’s counsel. A mediation was held on January 10, 2008 in front of Magistrate Judge Henry Pitman and the parties agreed to settle the case for $2.4 million. The Company’s D&O insurance carrier agreed to contribute $300,000 to the settlement. A Stipulation of Settlement was executed on February 25, 2008. The Stipulation of Settlement was filed with the Court on February 26, 2008 and the preliminary approval order was signed on April 2, 2008. The final fairness hearing is scheduled for July 11, 2008. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the matter.

We have no direct business operations, other than the ownership of our subsidiaries. While we have no current intention of paying dividends, should we, as a holding company, decide in the future to do so, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions.

B. SIGNIFICANT CHANGES.

Except as otherwise disclosed herein, we do not believe that any significant change has occurred since the date of the annual financial statements included in this annual report.

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ITEM 9. THE OFFER AND LISTING

A. OFFER AND LISTING DETAILS.

Our common stock is listed and quoted for trading on The Nasdaq Global Market under the symbol “XING.” The following table sets forth, during the periods indicated, the high and low last sale prices for the common stock as reported by Nasdaq:


Period	High		Low
Year ended December 31, 2003	$	14.33	$	1.90
Year ended December 31, 2004	$	14.98	$	6.50
Year ended December 31, 2005	$	8.50	$	5.04
Year ended December 31, 2006	$	17.09	$	6.49
Year ended December 31, 2007	$	19.56	$	7.16

Quarter ended March 31, 2006	$	8.85	$	6.49
Quarter ended June 30, 2006	$	12.40	$	7.21
Quarter ended September 30, 2006	$	14.15	$	9.81
Quarter ended December 31, 2006	$	17.09	$	11.79

Quarter ended March 31, 2007	$	19.56	$	12.58
Quarter ended June 30, 2007	$	18.40	$	12.26
Quarter ended September 30, 2007	$	13.97	$	7.78
Quarter ended December 31, 2007	$	12.44	$	7.16

Quarter ended March 31, 2008	$	8.11	$	5.18
Quarter ended June 30, 2008	$	7.52	$	4.39

Month ended January 31, 2008	$	8.11	$	6.77
Month ended February 29, 2008	$	7.75	$	6.62
Month ended March 31, 2008	$	6.43	$	5.18
Month ended April 30, 2008	$	7.52	$	5.72
Month ended May 31, 2008	$	7.07	$	6.14
Month ended June 30, 2008	$	5.99	$	4.39
Month ended July 31, 2008*	$	4.22	$	4.07


*		Through July 8, 2008

B. PLAN OF DISTRIBUTION.

Not applicable.

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C. MARKETS.

Our common stock is listed and quoted for trading on The Nasdaq Global Market System (formerly the Nasdaq National Market System) since February 16, 1999.

D. SELLING SHAREHOLDERS.

Not applicable.

E. DILUTION.

Not applicable.

F. EXPENSES OF THE ISSUE.

Not applicable.

ITEM 10. ADDITIONAL INFORMATION

A. SHARE CAPITAL.

Not applicable.

B. MEMORANDUM AND ARTICLES OF ASSOCIATION.

Corporate Powers. We have been registered in the British Virgin Islands since December 6, 1994, under British Virgin Islands International Business Companies number 135241. Clause 4 of our Memorandum of Association states that the objects for which we are established are to engage in any businesses which are not prohibited by law in force in the British Virgin Islands.

Directors. A director who is materially interested in any transaction with us shall declare the material facts of and nature of his interest at the meeting of the Board of Directors. A director may vote or be counted as the quorum on any resolution of the Board in respect of any transaction in which he is materially interested. With the prior or subsequent approval by a resolution of members, the directors may, by a resolution of directors, fix the emoluments of directors with respect to services to be rendered in any capacity to us. The directors may, by a resolution of directors, exercise all the powers of the Company to borrow money. There is no age limit requirement for retirement or non-retirement of directors. A director shall not require a share qualification.

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Share Rights, Preferences and Restrictions. Our authorized share capital consists of 50 million shares of par value US$0.001 per share. All dividends unclaimed for three years after having been declared may be forfeited by resolution of the directors for our benefit. All shares vote as one class and each whole share has one vote. We may redeem any of our own shares for such fair value as we by a resolution of directors determine. All shares have the same rights with regard to dividends and distributions upon our liquidation.

Changing Share Rights. The rights of each class and series of shares that we are authorized to issue shall be fixed by the resolution of directors. If the authorized capital is divided into different classes, the rights attached to any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class and of the holders of not less than three-fourths of the issued shares of any other class which may be affected by such variation.

Shareholder Meetings. The directors may convene meetings of our members at such times and in such manner and places as the directors consider necessary or desirable. The directors shall convene such a meeting upon the written request of members holding 10 percent or more of our outstanding voting shares. At least seven days’ notice of the meeting shall be given to the members whose name appears on the share register.

Restrictions on Rights to Own Securities. There are no limitations on the rights to own our securities.

Change in Control Provisions. There are no provisions of our Memorandum of Association and Articles of Association that would have an effect of delaying, deferring or preventing a change in our control and that would have operated only with respect to a merger, acquisition or corporate restructuring involving us.

Disclosure of Share Ownership. There are no provisions governing the ownership threshold above which shareholder ownership must be disclosed.

Applicable Law. Under the laws of most jurisdictions in the US, majority and controlling shareholders generally have certain fiduciary responsibilities to the minority shareholders. Shareholder action must be taken in good faith and actions by controlling shareholders which are obviously unreasonable may be declared null and void. BVI law protecting the interests of minority shareholders may not be as protective in all circumstances as the law protecting minority shareholders in US jurisdictions.

While BVI law does permit a shareholder of a BVI company to sue its directors derivatively, that is, in the name of and for the benefit of our company and to sue a company and its directors for his benefit and for the benefit of others similarly situated, the circumstances in which any such action may be brought, and the procedures and defenses that may be available in respect of any such action, may result in the rights of shareholders of a BVI company being more limited than those of shareholders of a company organized in the US.

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Our directors have the power to take certain actions without shareholder approval, including an amendment of our Memorandum of Association or Articles of Association or an increase or reduction in our authorized capital, which would require shareholder approval under the laws of most US jurisdictions. In addition, the directors of a BVI corporation, subject in certain cases to court approval but without shareholder approval, may, among other things, implement a reorganization, certain mergers or consolidations, the sale, transfer, exchange or disposition of any assets, property, part of the business, or securities of the corporation, or any combination, if they determine it is in the best interests of the corporation, its creditors, or its shareholders. Our ability to amend our Memorandum of Association and Articles of Association without shareholder approval could have the effect of delaying, deterring or preventing a change in our control without any further action by the shareholders, including a tender offer to purchase our common stock at a premium over then current market prices.

The International Business Companies Act of the British Virgin Islands permits the creation in our Memorandum and Articles of Association of staggered terms of directors, cumulative voting, shareholder approval of corporate matters by written consent, and the issuance of preferred shares. Currently, our Memorandum and Articles of Association only provide for shareholder approval of corporate matters by written consent, but not for staggered terms of directors, cumulative voting or the issuance of preferred shares.

As in most US jurisdictions, the board of directors of a BVI corporation is charged with the management of the affairs of the corporation. In most US jurisdictions, directors owe a fiduciary duty to the corporation and its shareholders, including a duty of care, under which directors must properly apprise themselves of all reasonably available information, and a duty of loyalty, under which they must protect the interests of the corporation and refrain from conduct that injures the corporation or its shareholders or that deprives the corporation or its shareholders of any profit or advantage. Many US jurisdictions have enacted various statutory provisions which permit the monetary liability of directors to be eliminated or limited. Under BVI law, liability of a corporate director to the corporation is primarily limited to cases of willful malfeasance in the performance of his duties or to cases where the director has not acted honestly and in good faith and with a view to the best interests of the corporation. However, under our Articles of Association, we are authorized to indemnify any director or officer who is made or threatened to be made a party to a legal or administrative proceeding by virtue of being one of our directors or officers, provided such person acted honestly and in good faith and with a view to our best interests and, in the case of a criminal proceeding, such person had no reasonable cause to believe that his conduct was unlawful. Our Articles of Association also enable us to indemnify any director or officer who was successful in such a proceeding against expense and judgments, fines and amounts paid in settlement and reasonably incurred in connection with the proceeding.

The above description of certain differences between BVI and US corporate laws is only a summary and does not purport to be complete or to address every applicable aspect of such laws. However, we believe that all material differences are disclosed above.

Changes in Capital. Requirements to effect changes in capital are not more stringent than is required by law.

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C. MATERIAL CONTRACTS.

Except for the agreements relating to our issuance of convertible notes, common stock and warrants and the non-competition agreement as described in Item 4. Information on the Company, we did not enter into any other material contracts for the years ended December 31, 2006 and 2007.

D. EXCHANGE CONTROLS.

There are no exchange control restrictions in China on the repatriation of dividends by our subsidiaries. In addition, there are no material British Virgin Islands laws that impose foreign exchange controls on us or that affect the payment of dividends, interest or other payments to nonresident holders of our capital stock. British Virgin Islands law and our Memorandum of Association and Articles of Association impose no limitations on the right of nonresident or foreign owners to hold or vote our common stock.

E. TAXATION.

The following is a summary of anticipated material U.S. federal income and British Virgin Islands tax consequences of an investment in our common stock. The summary does not deal with all possible tax consequences relating to an investment in our common stock and does not purport to deal with the tax consequences applicable to all categories of investors, some of which, such as dealers in securities, insurance companies and tax-exempt entities, may be subject to special rules. In particular, the discussion does not address the tax consequences under state, local and other non-U.S. and non-British Virgin Islands tax laws. Accordingly, each prospective investor should consult its own tax advisor regarding the particular tax consequences to it of an investment in the common stock. The discussion below is based upon laws and relevant interpretations in effect as of the date of this annual report, all of which are subject to change.

United States Federal Income Taxation

The following discussion addresses only the material U.S. federal income tax consequences to a U.S. person, defined as a U.S. citizen or resident, a U.S. corporation, or an estate or trust subject to U.S. federal income tax on all of its income regardless of source, making an investment in the common stock. For taxable years beginning after December 31, 1996, a trust will be a U.S. person only if:

	•		a court within the United States is able to exercise primary supervision over its administration; and

	•		one or more United States persons have the authority to control all of its substantial decisions.

In addition, the following discussion does not address the tax consequences to a person who holds or will hold, directly or indirectly, 10% or more of our common stock, which we refer to

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as a “10% Shareholder”. Non-U.S. persons and 10% Shareholders are advised to consult their own tax advisors regarding the tax considerations incident to an investment in our common stock.

A U.S. investor receiving a distribution of our common stock will be required to include such distribution in gross income as a taxable dividend, to the extent of our current or accumulated earnings and profits as determined under U.S. federal income tax principles. Any distributions in excess of our earnings and profits will first be treated, for U.S. federal income tax purposes, as a nontaxable return of capital, to the extent of the U.S. investor’s adjusted tax basis in our common stock, and then as gain from the sale or exchange of a capital asset, provided that our common stock constitutes a capital asset in the hands of the U.S. investor. U.S. corporate shareholders will not be entitled to any deduction for distributions received as dividends on our common stock.

Gain or loss on the sale or exchange of our common stock will be treated as capital gain or loss if our common stock is held as a capital asset by the U.S. investor. Such capital gain or loss will be long-term capital gain or loss if the U.S. investor has held our common stock for more than one year at the time of the sale or exchange.

A holder of common stock may be subject to “backup withholding” at the rate of 31% with respect to dividends paid on our common stock if the dividends are paid by a paying agent, broker or other intermediary in the United States or by a U.S. broker or certain United States-related brokers to the holder outside the United States. In addition, the proceeds of the sale, exchange or redemption of common stock may be subject to backup withholding, if such proceeds are paid by a paying agent, broker or other intermediary in the United States.

Backup withholding may be avoided by the holder of common stock if such holder:

	•		is a corporation or comes within other exempt categories; or

	•		provides a correct taxpayer identification number, certifies that such holder is not subject to backup withholding and otherwise complies with the backup withholding rules.

In addition, holders of common stock who are not U.S. persons are generally exempt from backup withholding, although they may be required to comply with certification and identification procedures in order to prove their exemption.

Any amounts withheld under the backup withholding rules from a payment to a holder will be refunded or credited against the holder’s U.S. federal income tax liability, if any, provided that amount withheld is claimed as federal taxes withheld on the holder’s U.S. federal income tax return relating to the year in which the backup withholding occurred. A holder who is not otherwise required to file a U.S. income tax return must generally file a claim for refund or, in the case of non-U.S. holders, an income tax return in order to claim refunds of withheld amounts.

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British Virgin Islands Taxation

Under the International Business Companies Act of the British Virgin Islands as currently in effect, a holder of common stock who is not a resident of BVI is exempt from BVI income tax on dividends paid with respect to the common stock and all holders of common stock are not liable for BVI income tax on gains realized during that year on sale or disposal of such shares; BVI does not impose a withholding tax on dividends paid by a company incorporated under the International Business Companies Act.

There are no capital gains, gift or inheritance taxes levied by BVI on companies incorporated under the International Business Companies Act. In addition, the common stock is not subject to transfer taxes, stamp duties or similar charges.

There is no income tax treaty or convention currently in effect between the United States and the British Virgin Islands.

F. DIVIDENDS AND PAYING AGENTS.

Not applicable.

G. STATEMENT BY EXPERTS.

Not applicable.

H. DOCUMENTS ON DISPLAY.

The documents concerning our company which are referred to in this annual report may be inspected at our principal executive offices at Qiao Xing Science Industrial Park, Tang Quan, Huizhou City, Guangdong, People’s Republic of China 516023.

I. SUBSIDIARY INFORMATION.

Not applicable.

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary risk exposures arise from changes in interest rates and foreign currency exchange rates.

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As of December 31, 2007, our aggregate bank loans, at various fixed interest rates, amounted to Rmb 1,207 million (US$165 million). Due to the relatively stable interest rate in the PRC, we do not believe that material risk on interest rates exists.

For the year ended December 31, 2007, about 97% of our products were sold in Mainland China and the great majority of our sales income are denominated in Rmb. Our major expenses are also denominated in Rmb. Accordingly, we believe that we are not exposed to material risk from changing foreign currency exchange rates so far as our operating activities are concerned. We have, however, a contractual obligation denominated in US$ of service of debt relating to the convertible notes outstanding as at December 31, 2007 in the amount of Rmb 394.9 million (US$54.1 million). If the debt is to be serviced by cash in Rmb provided by operating activities, any appreciation of US$ with respect to RMB will have an adverse effect on our cash flow.

Although we cannot accurately determine the precise effect of inflation on our operations, due to the stable economy of China, we do not believe inflation has had a material effect on our sales or results of operations.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

None.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

None.

ITEM 15. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.

-79-

Management’s Annual Report on Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended, for our company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with generally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of a company’s assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that a company’s receipts and expenditures are being made only in accordance with authorizations of a company’s management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance with respect to consolidated financial statement preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules as promulgated by the Securities and Exchange Commission, management assessed the effectiveness of the our internal control over financial reporting as of December 31, 2007 using criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Based on this assessment, management concluded that the our internal control over financial reporting was effective as of December 31, 2007 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

The effectiveness of internal control over financial reporting as of December 31, 2007 has been audited by Grobstein, Horwath & Company LLP, an independent registered public accounting firm, who has also audited our consolidated financial statements for the year ended December 31, 2007.

Additionally, there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of this evaluation. We have not identified any material weaknesses in our internal controls and, therefore, there were no corrective actions taken.

-80-

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

Our Board of Directors has determined that we currently have two audit committee financial experts serving on our audit committee, both of whom are “independent” as defined by the Nasdaq Stock Market listing standards: Dr. Edward Tsai and Yi Hong Zhang.

ITEM 16B. CODE OF ETHICS

We have adopted a code of ethics that applies to all of our employees, including our chief executive officer and our chief financial officer.

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

(a) Audit Fees. The aggregate fees billed for each of the last two fiscal years for professional services rendered by our principal accountant for the audit of our annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were $288,000 for the fiscal year ended December 31, 2006 and $500,000 for the fiscal year ended December 31, 2007.

(b) Audit — Related Fees. The aggregate fees billed in each of the last two fiscal years for assurance and related services by our principal accountant that are reasonably related to the performance of the audit or review of our financial statements and are not reported under paragraph (a) of this Item were $29,800 for the fiscal year ended December 31, 2006 and $10,000 for the fiscal year ended December 31, 2007.

(c) Tax Fees. The aggregate fees billed in each of the last two fiscal years for professional services rendered by our principal accountant for tax compliance, tax advice, and tax planning were $0 for the fiscal years ended December 31, 2006 and December 31, 2007.

(d) All Other Fees. The aggregate fees billed in each of the last two fiscal years for products and services provided by our principal accountant, other than the services reported in paragraphs (a) through (c) of this Item, were $0 for the fiscal years ended December 31, 2006 and December 31, 2007.

(e) Audit Committee Pre-Approval Policies and Procedures. To ensure continuing auditor objectivity and to safeguard the independence of our auditors, our audit committee has determined a framework for the type and authorization of non-audit services which our auditors may provide. The audit committee has adopted policies for the pre-approval of specific services that may be provided by our auditors. The dual objectives of these policies are to ensure that we benefit in a cost effective manner from the cumulative knowledge and experience of our auditors, while also ensuring that the auditors maintain the necessary degree of independence and objectivity.

Our audit committee approved the engagement of Grobstein, Horwath & Company to render audit and non-audit services before they were engaged by us.

-81-

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Qiao Xing Universal Telephone, Inc. and Subsidiaries

We have audited the accompanying consolidated statements of financial condition of Qiao Xing Universal Telephone, Inc. and Subsidiaries (the “Company”) as of December 31, 2007 and 2006 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also include performing such other procedures as we considered necessary in the circumstances.. We believe that our audits provide a reasonable basis for our opinions.

F-1

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Qiao Xing Universal Telephone, Inc. and Subsidiaries as of December 31, 2007 and 2006 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States. Also in our opinion, Qiao Xing Universal Telephone, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ GROBSTEIN, HORWATH & COMPANY LLP

GROBSTEIN, HORWATH & COMPANY LLP

Sherman Oaks, California
July 8, 2008

F-2

QIAO XING UNIVERSAL TELEPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2006 AND 2007


	Note		2006		2007
			RMB’000		RMB’000			US$’000
								(Note 2(v))
ASSETS
Current assets:
Cash and cash equivalents				1,096,477		3,033,010			415,788
Restricted cash		14		286,025		197,951			27,137
Restricted cash held in trust by a director		14		87,748		—			—
Accounts receivable, net (includes net amount receivable from a related party of RMB97,070,000 (2006: RMB44,443,000))		3		839,645		941,518			129,071
Bills receivable				421,647		115,261			15,800
Inventories		4		232,356		304,024			41,678
Prepaid expenses		5		453,024		273,881			37,546
Other current assets		6		4,182		1,111,408			152,360
Due from related parties		28		29		27			4
Deferred income taxes		21		5,924		13,350			1,830
Deferred debt issuance costs, net		17		22,847		14,579			1,999

Total current assets				3,449,904		6,005,009			823,213
Property, machinery and equipment, net		7		209,542		192,601			26,403
Construction-in-progress				60,295		—			—
Land use rights, net		8		207,206		36,106			4,950
Other non-current assets		9		8,249		—			—
Investment at cost		10		7,803		7,803			1,070
Goodwill		12		110,134		76,594			10,500
Other acquired intangible assets, net		13		93,008		60,728			8,325
Deferred debt issuance costs, net		17		31,845		—			—

Total assets				4,177,986		6,378,841			874,461


LIABILITIES, MINORITY INTERESTS AND SHAREHOLDERS’ EQUITY
Current liabilities:
Short-term bank borrowings		14		1,155,290		1,471,454			201,718
Accounts payable				225,639		180,573			24,755
Other payables		15		11,989		42,009			5,759
Accrued liabilities		16		61,688		104,984			14,392
Deposits received				2,036		4,539			622
Deferred revenues				15,389		26,402			3,620
Due to related parties		28		4,516		608			83
Taxation payable		21		46,272		73,301			10,049
Embedded derivative liability		17		340,899		19,004			2,605
Convertible notes		17		87,471		135,667			18,598

Total current liabilities				1,951,189		2,058,541			282,201
Convertible notes		17		222,087		189,660			26,000
Shareholders’ loans		18		7,697		7,194			986
Deferred income taxes		21		11,740		5,561			762

Total liabilities				2,192,713		2,260,956			309,949


Minority interests				115,224		1,095,917			150,237

Commitments and contingencies		25

Shareholders’ equity:
Common stock, par value RMB0.008 (equivalent of US$0.001); authorized 50,000,000 shares; outstanding and fully paid - 29,605,003 shares as of December 31, 2006 and 30,948,836 as of December 31, 2007		19		242		251			34
Additional paid-in capital				1,439,473		1,737,541			238,196
Retained earnings				422,036		1,325,984			181,776
Cumulative translation adjustments				8,298		(41,808	)		(5,731	)

Total shareholders’ equity				1,870,049		3,021,968			414,275

Total liabilities, minority interests and shareholders’ equity				4,177,986		6,378,841			874,461

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

F-3

QIAO XING UNIVERSAL TELEPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007


	Note			2005			2006			2007
				RMB’000			RMB’000			RMB’000			US$’000
													(Note 2(v))
Net sales					2,635,184			3,221,212			3,874,107			531,092
Cost of goods sold					(2,156,798	)		(2,651,392	)		(2,898,964	)		(397,412	)

Gross profit					478,386			569,820			975,143			133,680
Operating expenses:
Selling expenses					(24,726	)		(28,401	)		(59,820	)		(8,200	)
General and administrative expenses					(55,341	)		(126,076	)		(131,074	)		(17,969	)
Research and development					(20,694	)		(30,747	)		(34,452	)		(4,723	)
In process research and development		11	(b)		—			(41,739	)		—			—
Amortization of acquired intangible assets		13			(11,880	)		(15,178	)		(32,280	)		(4,425	)

Income from operations					365,745			327,679			717,517			98,363
Interest income					7,130			8,108			42,127			5,775
Exchange (loss) gain, net					(2,659	)		3,225			28,255			3,874
Interest expense		30			(41,752	)		(100,432	)		(248,014	)		(34,000	)
Loss on remeasurement of embedded derivatives		17			—			(134,439	)		(129,084	)		(17,696	)
Loss on extinguishment of convertible debts		11	(c)		—			—			(142,090	)		(19,479	)
Gain on disposal of interests in subsidiaries		11	(a) & (c)		10,307			—			482,614			66,160
Gain on sale of stocks by subsidiary		11	(c)		—			—			383,965			52,637
Provision for litigation settlement		25	(c)		—			—			(15,319	)		(2,100	)
Impairment of investment at cost					(7,348	)		—			—			—
Other income, net					640			4,453			59,055			8,096

Income before income tax					332,063			108,594			1,179,026			161,630
Provision for income tax		21			(25,486	)		(58,192	)		(124,120	)		(17,015	)

Income before minority interests					306,577			50,402			1,054,906			144,615
Minority interests					(99,270	)		(84,473	)		(168,554	)		(23,107	)

Net income (loss) before extraordinary items					207,307			(34,071	)		886,352			121,508
Extraordinary items:
Gains on acquisitions of minority interests, net of nil tax		11	(a)		37,592			14,237			17,596			2,412


Net income (loss)					244,899			(19,834	)		903,948			123,920


Other comprehensive income (loss) — Translation adjustments					1,821			7,203			(50,106	)		(6,869	)


Comprehensive income (loss)					246,720			(12,631	)		853,842			117,051


Basic earnings (loss) per common share:
Before extraordinary gain		23		RMB	11.32		RMB	(1.44	)	RMB	24.46		US$	3.35
Extraordinary gain		23		RMB	2.05		RMB	0.60		RMB	0.49		US$	0.07

After extraordinary gain		23		RMB	13.37		RMB	(0.84	)	RMB	24.95		US$	3.42


Diluted earnings (loss) per common share:
Before extraordinary gain		23		RMB	11.32		RMB	(2.03	)	RMB	24.17		US$	3.31
Extraordinary gain		23		RMB	2.05		RMB	0.59		RMB	0.48		US$	0.07

After extraordinary gain		23		RMB	13.37		RMB	(1.44	)	RMB	24.65		US$	3.38


Weighted average number of shares outstanding
Basic		23			18,319,000			23,712,000			29,836,000			29,836,000

Diluted		23			18,320,000			24,016,000			30,200,000			30,200,000

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

F-4

QIAO XING UNIVERSAL TELEPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007


	2005			2006			2007
	RMB’000			RMB’000			RMB’000			US$’000
										(Note 2(v))
Cash flows from operating activities:
Net income (loss)		244,899			(19,834	)		903,948			123,920
Adjustments to reconcile net income (loss) to net cash used in operating activities -
Depreciation of property, machinery and equipment		11,831			11,124			17,023			2,334
Land use right expense		4,062			4,130			4,539			622
Bad debt expense		111			2,116			2,961			406
Amortization of other acquired intangible assets		11,880			15,178			32,280			4,425
In process research and development		—			41,739			—			—
Stock-based compensation		700			58,707			38,626			5,295
Foreign exchange loss (gain)		2,659			(3,225	)		(27,447	)		(3,763	)
Interest expense on shareholders’ loans		473			459			487			67
Amortization of deferred debt issuance costs		—			11,339			37,321			5,116
Accretion of convertible note discounts		—			36,880			140,251			19,227
Loss on remeasurement of embedded derivatives		—			134,439			129,084			17,696
Loss on extinguishment of convertible debts								142,090			19,479
Gain on disposal of interests in subsidiaries		(10,307	)		—			(482,614	)		(66,160	)
Gain on sale of stocks by subsidiary		—			—			(383,965	)		(52,637	)
Impairment of investment at cost		7,348			—			—			—
Provision for litigation settlement		—			—			15,319			2,100
Net loss (gain) on disposal of property, machinery and equipment		(339	)		8			99			13
Net gain on disposal of land use rights and construction-in-progress		—			—			(58,199	)		(7,978	)
Deferred income tax		(2,327	)		(8,003	)		(11,938	)		(1,637	)
Minority interests		99,270			84,473			168,554			23,107
Extraordinary gains on acquisitions of minority interests		(37,592	)		(14,237	)		(17,596	)		(2,412	)
Changes in operating assets and liabilities -
Accounts receivable		(230,265	)		(185,469	)		(104,834	)		(14,371	)
Bills receivable		(162,814	)		(2,736	)		306,386			42,002
Inventories		59,686			2,418			(71,166	)		(9,756	)
Prepaid expenses		(12,171	)		(155,906	)		167,402			22,949
Other current assets		722			9,273			(19,081	)		(2,616	)
Accounts payable		34,670			(112,141	)		(45,066	)		(6,178	)
Other payables		7,348			(1,286	)		(1,907	)		(261	)
Accrued liabilities		24,726			3,074			31,552			4,325
Deposits received		3,330			(8,693	)		2,503			343
Deferred revenues		(7,675	)		(38,053	)		11,013			1,510
Taxation payable		66,457			(22,614	)		27,029			3,705

Net cash provided by (used in) operating activities		116,682			(156,840	)		954,654			130,872

F-5


	2005			2006			2007
	RMB’000			RMB’000			RMB’000			US$’000
										(Note 2(v))
Cash flows from investing activities:
Acquisitions of property, machinery and equipment		(8,926	)		(168,461	)		(8,017	)		(1,099	)
Acquisition of land use right		—			(39,004	)		—			—
Expenditures on construction-in-progress		(8,171	)		(1,190	)		—			—
Net cash inflow from disposal of equity investee (Note 27(a))		50,400			—			—			—
Net cash outflow from acquisition of minority interests (Note 11(a) and 27(b))		(126	)		(170,343	)		—			—
Proceeds from disposal of property, machinery and equipment		6,882			241			209			28
Proceeds from disposal of land use rights and construction-in-progress (Note 27(c ))		—			—			180,000			24,676
Interest-bearing advances to a third party		—			—			(998,331	)		(136,859	)
(Increase) decrease in restricted cash		(43,881	)		(224,252	)		175,822			24,103

Net cash used in investing activities		(3,822	)		(603,009	)		(650,317	)		(89,151	)


Cash flows from financing activities:
Increase in short-term borrowings		54,026			403,991			323,182			44,305
Repayment of capital lease obligation		(3,775	)		—			—			—
Net proceeds from issuance of convertible notes		—			482,041			175,088			24,002
Net proceeds from exercise of options and warrants		—			259,637			30,911			4,238
Net proceeds from issuance of common stocks by the Company		111,704			317,900			114,534			15,701
Net proceeds from IPO of common stocks by a subsidiary		—			—			1,026,610			140,735
Capital contributed by minority shareholders of a subsidiary		—			—			2,100			288
Net advances (to) from to related parties		(25,450	)		2,088			3,495			479

Net cash provided by financing activities		136,505			1,465,657			1,675,920			229,748


Effect of translation adjustments		1,405			(991	)		(43,724	)		(5,994	)


Net increase in cash and cash equivalents		250,770			704,817			1,936,533			265,475
Cash and cash equivalents, beginning of year		140,890			391,660			1,096,477			150,313

Cash and cash equivalents, end of year		391,660			1,096,477			3,033,010			415,788


Supplemental disclosure of cash flow information:
Interest paid		41,752			50,374			60,459			8,288
Income tax paid		8,687			63,383			103,834			14,234
Non-cash investing and financing activities:
- Consideration for acquisition of equity interest in a subsidiary paid in the form of common stocks		—			185,721			—			—
- Consideration for extinguishment of convertible notes liability paid in the form of common stocks of a subsidiary		—			—			721,188			98,866
- Stock issuance costs paid in the form of share-based payment		9,963			48,631			8,183			1,122
- Warrant issuance costs paid in the form of share-based payment		—			1,936			769			105
- Convertible note issuance costs paid in the form of share-based payment		—			28,796			9,891			1,356

Additional supplemental disclosure of cash flow information is set out in Note 27.

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

F-6

QIAO XING UNIVERSAL TELEPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007


														Accumulated
														other
														comprehensive
														income (loss) –
				Common stock				Additional						cumulative
				Number of				paid-in			Retained			translation
	Note			shares		Amount		capital			earnings			adjustments			Total
				‘000		RMB’000		RMB’000			RMB’000			RMB’000			RMB’000
Balance as of December 31, 2004					16,645		138		445,089			196,971			(726	)		641,472
Issuance of common stock		19			2,000		16		119,994			—			—			120,010
Stock issuance costs					—		—		(22,041	)		—			—			(22,041	)
Issue of stock purchase warrants to investors and external consultants		20	(c)		—		—		9,963			—			—			9,963
Recognition of compensation expense		19, 20	(c)		2		—		700			—			—			700
Net income					—		—		—			244,899			—			244,899
Shareholders’ contribution		18			—		—		473			—			—			473
Translation adjustments					—		—		—			—			1,821			1,821


Balance as of December 31, 2005					18,647		154		554,178			441,870			1,095			997,297
Issuance of common stock		19			10,958		88		791,654			—			—			791,742
Stock issuance costs					—		—		(77,115	)		—			—			(77,115	)
Issue of stock purchase warrants to investors and external consultants		20	(c)		—		—		116,090			—			—			116,090
Warrant issuance costs					—		—		(4,500	)		—			—			(4,500	)
Recognition of compensation expense		20	(a)		—		—		58,707			—			—			58,707
Net loss					—		—		—			(19,834	)		—			(19,834	)
Shareholders’ contribution		18			—		—		459			—			—			459
Translation adjustments					—		—		—			—			7,203			7,203


Balance as of December 31, 2006					29,605		242		1,439,473			422,036			8,298			1,870,049
Issuance of common stock		19			1,344		9		115,375			—			—			115,384
Stock issuance costs					—		—		(9,032	)		—			—			(9,032	)
Issue of stock purchase warrants to investors and external consultants		20	(c)		—		—		32,546			—			—			32,546
Warrant issuance costs					—		—		(1,838	)		—			—			(1,838	)
Recognition of compensation expense		20	(b)		—		—		39,209			—			—			39,209
Net income					—		—		—			903,948			—			903,948
Reclassification of embedded derivative relating to 4.5% Notes		17	(b)		—		—		89,531			—			—			89,531
Beneficial conversion amount relating to 5.5% Notes		17	(c)		—		—		31,790			—			—			31,790
Shareholders’ contribution		18			—		—		487			—			—			487
Translation adjustments					—		—		—			—			(50,106	)		(50,106	)


Balance as of December 31, 2007					30,949		251		1,737,541			1,325,984			(41,808	)		3,021,968

Balance as of December 31, 2007 (in US$’000)							34		238,196			181,776			(5,731	)		414,275

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

F-7

QIAO XING UNIVERSAL TELEPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND NATURE OF OPERATIONS

Qiao Xing Universal Telephone, Inc. (the “Company”) was incorporated in the British Virgin Islands (the “BVI”) on December 6, 1994. Its shares were listed on the Nasdaq National Market in February 1999.

The Company and its subsidiaries (the “Group”) are principally engaged in (i) the sale of telecommunication terminals and equipment, including cord and cordless telephone sets, in the People’s Republic of China (the “PRC”); and (ii) the production and sale of mobile phones and accessories in the PRC.

Details of the Group’s subsidiaries and equity joint ventures are as follows:


					Percentage of equity
					interest attributable
				Place of	to the Group as of
Name	Note			incorporation	December 31,						Principal activities
					2006			2007
Qiao Xing Mobile Communication Co., Ltd. (“QXMC”)		(a	)	BVI		100.0	%		61.3	%	Investment holding

Qiao Xing Communication Holdings Limited (“QXCH”)		(b	)	BVI		100.0	%		100.0	%	Investment holding

CEC Telecom Co., Ltd. (“CECT”)		(c	)	PRC		93.4	%		59.2	%	Manufacture and sales of mobile phones and accessories

Beijing CECT Yitong Technology Co., Ltd (“BCYT”)		(d	)	PRC		—			39.5	%	Dormant

Hui Zhou Qiao Xing Communication Industry Limited (“QXCI”)		(e	)	PRC		90.0	%		90.0	%	Manufacture and sales of mobile phones and indoor phones

Hui Zhou Qiao Xing Property Limited (“QXPL”)		(f	)	PRC		90.0	%		90.0	%	Property and investment holding

F-8

Percentage of equity

interest attributable

Place of

to the Group as of

Name

Note

incorporation

December 31,

Principal activities

2006

2007

Chifeng Sanchuan Mining Co., Ltd. (“CSMC”)

)

PRC

90.0

Investment holding

Notes —

(a) QXMC was incorporated in the BVI on January 31, 2002 by the Group and Galbo Enterprises Limited (“Galbo”), an independent third party. As more fully described in Note 11(b), QXMC became a wholly-owned subsidiary of the Company on November 30, 2006 when the Company acquired the remaining 20% equity interest in QXMC from Galbo at a total consideration of RMB356,064,000.

Pursuant to a shareholders’ resolution of passed on January 8, 2007, the par value of QXMC’s ordinary shares was reduced to nil and the company was authorized to issue an unlimited number of ordinary shares. On April 13, 2007, QXMC executed a 40-for-one split of its ordinary shares and, as a result, its issued and paid-up capital, all of which were then fully-owned by the Company, became converted into 40,000,000 ordinary shares of nil par value each.

As more fully described in Note 11(c), due to the exchange of US$40,000,000 senior convertible notes into 7,800,000 ordinary shares of QXMC that were owned by the Company and the initial public offering (“IPO”) of 12,500,000 new ordinary shares issued by QXMC during the year ended December 31, 2007, the Company’s equity interest in QXMC was reduced to approximately 61.3% as of December 31, 2007.

(b) QXCH was incorporated in the BVI on May 21, 2002. Its authorized capital is US$50,000, of which US$1 has been issued and paid up on June 8, 2002.

(c) CECT is a limited liability company established in the PRC on May 22, 2000 with an initial permitted operating period of 30 years. QXMC completed the acquisition of an initial 65% equity interest in CECT from Tianjin Economic-Technological Development Area Co., Ltd. (''TEDA’’), China Electronics Corporation (''CEC’’) and other group companies of CEC at an aggregate cash consideration of RMB312,750,000 on February 8, 2003. Upon the acquisition, the permitted operating period of CECT was to February 7, 2033.

As more fully described in Note 11(a), on July 31, 2005, QXMC completed the acquisition of an additional 25% equity interest in CECT from CEC via QXCI. The Group structured the acquisition of the additional equity interest in CECT by QXMC through QXCI to facilitate the governmental approval process for the acquisition.

F-9

On July 31, 2006, QXMC injected additional capital of US$18,750,000 (RMB149,600,000) into CECT in the form of cash. The minority shareholder did not participate in the capital injection and as a result, QXMC’s equity interest in CECT was increased from 90% to 93.4%, which has been accounted for under the purchase method of accounting (Note 11(a)).

In December 2006, TEDA disposed of its remaining 6.6% interest in CECT to Qiao Xing Group Limited (“QXGL”), a company beneficially owned by Mr. Rui Lin Wu, and as of December 31, 2006, CECT was owned as to 93.4% by QXMC and 6.6% by QXGL.

On June 30, 2007, QXMC injected additional capital of US$50,000,000 (RMB380,425,000) into CECT in the form of cash. The minority shareholder did not participate in the capital injection and as a result, QXMC’s equity interest in CECT increased from 93.4% to 96.6%, which has been accounted for under the purchase method of accounting (Note 11(a)).

(d) BCYT is a limited liability company established in the PRC on September 7, 2007 to engage in the sales of mobile phones and related accessories. BCYT has a permitted operating period of 20 years. Its registered capital is RMB30,000,000, of which RMB22,100,000 has been fully paid up as of December 31, 2007. The Group’s interest in BCYT through December 31, 2007 was held through CECT, which owns a 66.7% equity interest in BCYT. BCYT has not commenced operations as of the date of this report.

(e) QXCI is an equity joint venture established in the PRC on December 2, 2002 between the Group and QXGL to be operated for a term of 15 years until December 1, 2017. Its registered capital is RMB187,485,500 which was fully paid up on June 19, 2006.

(f) QXPL is an equity joint venture established in the PRC on December 17, 2002 between the Group and QXGL to be operated for a term of 15 years until December 16, 2017. Its registered capital is RMB2,125,800 which was fully paid up on March 28, 2003.

(g) CSMC is a limited liability company established in the PRC on June 22, 2007 with a permitted operating period that ends on December 31, 2022. Its registered capital is RMB10,000,000 which was fully paid up on June 15, 2007. The Group’s interest in CSMC through December 31, 2007 was held through QXPL, which owns a 100% equity interest in CSMC.

The Group is subjected to, among others, the following operating risks:

Country risk

As substantially all of the Group’s operations are conducted in the PRC, the Group is subject to special considerations and significant risks not typically associated with companies operating in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Group’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

In addition, substantially all of the Group’s revenue is denominated in Renminbi (“RMB”) which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require the approval of the PRC government.

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Concentration of credit risk

The Group performs ongoing credit evaluations of each customer’s financial condition. It maintains reserves for potential credit losses and such losses in the aggregate have not exceeded management’s expectations. As of December 31, 2006 and 2007, the Group’s five largest accounts receivable accounted for approximately 43.3% and 38.0% of the Group’s total accounts receivable, respectively.

Technology risk

The new advanced products that the Group is developing incorporate complex and evolving technologies that require substantial expenditures and resources. However, these new products may fail to be accepted at the rates or levels the Group anticipates and the Group may fail to realize the expected benefits from its investments in these new technologies.

The Group may experience greater variability in its operating results than in the past, particularly depending on the general economic conditions and the pace of development and acceptance of new technologies.

Changes in the communication industry are expected to increase competition and change the competitive landscape and may adversely affect the Group’s operating results.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of consolidation

The consolidated financial statements include the financial statements of the Company and its majority-owned subsidiaries, including equity joint ventures. All material intra-group balances and transactions have been eliminated on consolidation.

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(b) Subsidiaries

A subsidiary is a company, including equity joint ventures, in which the Company holds, directly or indirectly, more than a 50% equity interest as a long-term investment and over which it can exercise control, as defined under U.S. GAAP.

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Cash and cash equivalents include cash on hand, amounts on deposit with banks and all highly liquid investments with maturity dates of three months or less at the time of acquisition.

(d) Accounts and bills receivable

Trade accounts receivable are recorded at invoiced amounts less allowances for doubtful accounts. The Group reviews its accounts receivable on a periodic basis and makes allowances when there is doubt as to the collectibility of the balances. In evaluating the collectibility of a receivable balance, the Company considers many factors, including the age of the balance, the customer’s historical payment history, its current credit-worthiness and current economic trends. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

To reduce the Group’s credit risk, the Group has required certain customers to pay for the purchase of the Group’s products using bills. Bills receivable represent non-interest bearing, short-term notes issued by financial institutions that entitle the Group to receive the full face amount of the bills from the issuing financial institutions at stated maturity dates.

In certain circumstances, the Group has sold, with recourse, bills receivable to banks. The recourse obligation represents the amount that the Group would be obligated to repay to the extent that the issuing financial institution does not make payment upon maturity. Because the discounted bills have not been legally isolated from the Group, the discounted bills sold with recourse have been accounted for as short-term secured borrowings until the bills receivable are paid. Upon payment of bills receivable, the discounted bills receivables and the related short-term secured borrowings are derecognized. Historically, the Group has experienced no losses on bills receivable.

(e) Inventories

Inventories are stated at the lower of cost or net realizable value. Costs of work-in-process and finished goods are composed of direct materials, direct labor and an attributable portion of manufacturing overhead. Net realizable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale, and after making allowances for damaged, obsolete and slow-moving items. Allowances for damaged, obsolete and slow-moving items are determined by management based on a consideration of several factors, including the aging of the inventories, current and expected future market trends and conditions, and the physical condition of the goods observed during periodic inventory counts.

(f) Property, machinery and equipment and construction-in-progress

Property, machinery and equipment are stated at cost less accumulated depreciation and accumulated impairment losses. Property, machinery and equipment acquired in a purchase business combination are initially recorded based on fair value for the acquired interest with the remaining amount recorded at the minority interest’s historical book values. In connection with the Group’s acquisition of additional equity interests in CECT (Note 11(a)), the value assigned to the portion of property, machinery and equipment acquired from the minority interest owner has been reduced to nil due to the excess of the fair value of the acquired additional net assets of CECT over the acquisition cost. In addition, as a result of the application of purchase accounting to account for the Company’s acquisition of an

F-12

additional 20% interest in QXMC on November 30, 2006, the Group’s interests in QXMC’s and CECT’s property, machinery and equipment have been adjusted to a new cost basis which reflects the Company’s original 80% interest at depreciated cost and the 20% acquired interest at the fair value of the assets as of November 30, 2006.

Major expenditures for betterments and renewals are capitalized. All ordinary repair and maintenance costs are expensed as incurred. Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of the assets after taking into account the asset’s estimated residual value. Leasehold improvements are amortized over the lease term if shorter than the assets’ useful life. The estimated useful lives are as follows: leasehold improvements — 5 years (or over the lease term, if shorter), buildings — 8 to 30 years, machinery and equipment — 5 to 12 years, furniture and office equipment — 5 to 10 years, and motor vehicles — 5 to 8 years.

Construction-in-progress represents factory and office buildings under construction. When material, the Group capitalizes interest during the construction phase of qualifying assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34, “Capitalization of Interest Cost.” No interest has been capitalized in construction-in-progress during the years ended December 31, 2005, 2006 and 2007.

Assets to be disposed of are separately presented on the balance sheet and reported at the lower of their carrying amount or fair value less costs to sell, and are no longer depreciated.

(g) Land use rights

Land use rights are carried at cost, subject to adjustments resulting from the effects of purchase accounting, and are charged to expense on a straight-line basis over the terms of the rights.

(h) Investments at cost

Investments in which the Group does not have control or significant influence are carried at cost less impairment for declines in value that are deemed to be other than temporary. Income from the investments is accounted for to the extent of dividends received and receivable.

(i) Goodwill

The Group completed its annual goodwill impairment test during the year ended December 31, 2007 and determined that no adjustment to the carrying value of goodwill was required.

F-13

(j) Other acquired intangible assets

The Group adopted SFAS No. 141, “Business Combinations,” which requires an intangible asset that is acquired in a business combination to be recognized as an asset apart from goodwill if it satisfies either the “contractual-legal” or “separability” criterion. Such intangible assets are initially measured and recorded at fair value. As a result of the application of purchase accounting to account for the Company’s acquisition of an additional 20% interest in QXMC on November 30, 2006, other acquired intangible assets have been adjusted to a new cost basis, which reflects the Company’s original 80% interest at amortized cost and the 20% acquired interest at fair value as of November 30, 2006.

Intangible assets with determinable useful lives are amortized as follows:


Customer relationships		3 — 5 years
Completed technology		1.8 — 5 years
Core technology		4 — 5 years
Backlog		4 — 5 months
Licenses		5 years

The Company has determined that the Group’s “CECT” brand held by its subsidiary, CECT, does not have a determinable useful life. Consequently, in accordance with SFAS No. 142, the carrying amount of this brand name is not amortized but rather tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired. Such impairment test consists of a comparison of the fair value of the brand name with its carrying amount and an impairment loss is recognized if and when the carrying amount of the brand name exceeds its fair value.

For impairment testing purposes, the fair value of the “CECT” brand is estimated using the Relief-from-Royalty Method, a discounted cash flow approach which brings into play, in the case of CECT, a single set of estimated cash flows and a discount rate commensurate with the risk. The cash flow contribution from the brand comes from savings in royalty that CECT would have to pay to a third party for the use of its brand name if CECT had not had the “CECT” brand but nevertheless had wanted its products to have a recognized brand. The cash flow contribution of the “CECT” brand is linked to the cash inflow from the sales revenue of CECT. As there is a lack of publicly available information about comparable licensing transactions in the PRC suitable for the Group’s purpose, the royalty savings as a percentage of sales revenue is estimated by comparing the operational profit margin as a percentage of sales revenue of CECT with its superior “CECT” brand with those of comparable companies in China which operate on an OEM sub-contractor basis or with an inferior brand. Also, marketing expense is required to maintain the brand name for CECT. An average of marketing expense as a percentage of sales revenue is taken from the income statements of CECT in the medium term forecast. This percentage is then used to estimate cash outflow relating to marketing expense in the cash flow forecast under the Relief-from-Royalty Method.

The Group completed its annual impairment test for its “CECT” brand during the year ended December 31, 2007 and determined that no adjustment to the carrying value of the intangible asset was required.

(k) Impairment of long-lived assets with determinable useful lives

Long-lived assets with determinable useful lives, including property, machinery and equipment and amortizable intangible assets, are tested for impairment whenever events or changes in circumstances indicate that the net carrying amount may not be recoverable. Recoverability of such assets to be held and used is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to result from its use and eventual disposition. If the carrying amount of an asset exceeds its estimated future cash flows, an

F-14

impairment charge is recognized for the amount by which the carrying value of the asset exceeds its fair value. If a readily determinable market price does not exist, fair value is estimated using discounted expected cash flows attributable to the assets.

(l) Sales recognition

The Group recognizes sales (or revenue) in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 101 “Revenue Recognition in Financial Statements,” as amended by SAB No. 104 “Revenue Recognition.”

Sales represent the invoiced value of goods, net of value added tax (“VAT”), discounts, returns and price guarantees supplied to customers, and are recognized upon delivery of goods and passage of title. Liability for sales returns and price guarantees is estimated taking into consideration historical experience and current conditions.

All of the Group’s sales made in the PRC are subject to PRC VAT at a rate of 17% (“output VAT”). Such output VAT is payable after offsetting VAT paid by the Group on its purchases (“input VAT”).

(m) Product warranties

The Group guarantees that its products will meet the stated functionality as agreed to in each sales arrangement. The Group provides for the estimated warranty costs under these guarantees based upon historical experience and management’s estimate of the level of future claims, and accrues for specific items at the time their existence is known and the amounts are estimable. Provisions for product warranty costs are charged to cost of goods sold and are summarized as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Balance at beginning of year		7,712			9,591			1,315
Provision		17,393			24,603			3,373
Utilized		(15,514	)		(23,071	)		(3,163	)

Balance at end of year		9,591			11,123			1,525

(n) Shipping and handling costs

The Group adopted Emerging Issues Task Force (“EITF”) Issue No. 00-10, “Accounting for Shipping and Handling Costs”, and has recorded its shipping and handling costs as a component of cost of sales.

(o) Advertising costs

Costs incurred for producing and communicating advertising are charged to expenses when incurred.

(p) Research and development expenditures

Research and development expenditures are charged to expenses as incurred.

F-15

(q) Operating leases

Operating leases represent those leases under which substantially all the risks and rewards of ownership of the leased assets remain with the lessors. Rental payments under operating leases are charged to expense on a straight-line basis over the period of the relevant leases.

(r) Stock-based compensation

(s) Debt issuance costs and borrowing costs

Costs related to the issuance of debts are capitalized and amortized to interest expense using the effective interest method over the expected term of the related debt. All other borrowing costs are recognized as an expense in the period in which they are incurred, except to the extent that they are attributable to the acquisition, construction or production of an asset that necessarily involves a substantial period of time before the asset is ready for its intended use or sale, in which case the borrowing costs are capitalized as part of the costs of the asset.

(t) Income taxes

F-16

classify interest and penalties related to income tax matters, if and when required, as part of income tax expense in the statement of operations. The adoption of FIN 48 on January 1, 2007 did not have any effect on the Group’s consolidated financial statements.

(u) Segment information

The Group adopted SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” which requires companies to report financial and descriptive information about their reportable operating segments, including segment profit or loss, certain specific revenue and expense items, and segment assets, as well as information about the revenues derived from the Group’s products and services, the countries in which the Group earns revenues and holds assets, and major customers. SFAS No. 131 requires the use of the management approach to determine the information to be reported. The management approach is based on the way management organizes the enterprise to assess performance and makes operating decisions regarding the allocation of resources. The Group classifies its operations into two core business segments, namely mobile phones and indoor phones. In view of the fact that the Group operates principally in the PRC, no geographical segment information is presented.

(v) Foreign currency translation

The reporting currency of the Group is Renminbi (“RMB”).

The Company’s functional currency is the United States dollar (“U.S. dollar” or “US$”) as a majority of its financing and cash is denominated in U.S. dollars. Through May 2, 2007, the functional currency of the Company’s subsidiary, QXMC, was Renminbi. Effective May 3, 2007, QXMC changed its functional currency to U.S. dollars due to the significant changes in the company’s economic facts and circumstances upon the completion of its listing on the NYSE, which resulted in the company’s financing activity being predominately denominated in and expected to continue to be predominately denominated in U.S. dollars. The change in the functional currency of QMXC has the effect of increasing of the foreign exchange gain of the Group for the year ended December 31, 2007 and the cumulative translation loss (included directly as a component of shareholders’ equity) of the Group as of December 31, 2007 by the same amount of RMB23,080,000. All other subsidiaries of the Company consider Renminbi to be their functional currency as they operate primarily in the PRC and most of their business activities are based in Renminbi.

F-17

The translation of the Company’s and QXMC’s financial statements into Renminbi is performed for balance sheet accounts using the closing exchange rate in effect at each of the balance sheet dates and for revenue and expense accounts using the average exchange rate during each reporting period. Gains and losses resulting from translation are included in shareholders’ equity separately as cumulative translation adjustments.

For the convenience of readers, certain 2007 Renminbi amounts included in the accompanying consolidated financial statements have been translated into United States dollars at the rate of US$1.00 = RMB7.2946, being the noon buying rate in New York City for cable transfers in foreign currencies as certified for custom purposes by the Federal Reserve Bank of New York on December 31, 2007. No representation is made that the Renminbi amounts could have been, or could be, converted into United States Dollars at that rate or at any other rate on December 31, 2007, or at any other date.

(w) Comprehensive income

The Group adopted SFAS No. 130, “Reporting Comprehensive Income,” which requires the Group to report all changes in equity during a period, except for those resulting from investment by owners and distribution to owners, in the consolidated financial statements as comprehensive income for the period in which they are recognized. The Group has presented comprehensive income, which encompasses net income and currency translation adjustments, in the consolidated statements of operations and comprehensive income (loss).

(x) Earnings (loss) per common share

Basic earnings (loss) per common share is computed using the “two-class” method by dividing earnings allocated to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per common share is computed by using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of outstanding stock options, warrants and convertible debentures to the extent such instruments are dilutive during the period.

(y) Financial instruments

The Group accounts for financial instruments under the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which requires that all derivative financial instruments be recognized in the financial statements and maintained at fair value regardless of the purpose or intent for holding them. Changes in fair value of derivative financial instruments are either recognized periodically in income or shareholders’ equity (as a component of comprehensive income) depending on whether the derivative is being used to hedge changes in fair value or cash flows.

The carrying amounts for cash and bank deposits, restricted cash, bills receivable, accounts receivable, prepaid and other assets, short-term borrowings, accounts payable, other payables, accrued liabilities and customer deposits approximate their fair values because of the short maturity of these instruments. The carrying amounts of shareholders’ loans approximate their fair value because the imputed interest rate on these instruments fluctuates with market interest rates. The Group’s convertible notes and the related embedded derivatives have a net carrying value of approximately RMB325,327,000 and RMB19,604,000, respectively at December 31, 2007, which approximate fair value. The estimated fair value of these amounts has been determined using available market information and appropriate valuation methodologies.

F-18

(z) Reclassifications

Certain reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation. These reclassifications had no effect on previously reported results of operations or retained earnings.

(aa) Recently issued accounting standards

(i) In September 2006, the FASB issued SFAS No. 157, ‘‘Fair Value Measurements.’’ SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. In November 2007, the FASB proposed a one-year deferral of SFAS No. 157’s fair value measurement requirements for non-financial assets and liabilities that are not required or permitted to be measured at fair value on a recurring basis. The adoption of SFAS No. 157 is not expected to have a material impact on the Group’s consolidated financial statements.

(ii) In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115.” SFAS 159 permits entities to choose to measure certain financial instruments and certain other items at fair value. FAS 159 is effective for fiscal years beginning after November 15, 2007. The Group has elected not to adopt the fair value option as permitted under SFAS No. 159.

(iii) In June 2007, the FASB issued EITF 06-11, “Accounting for Income Tax Benefits on Dividends on Share-Based Payment Awards.” This EITF indicates that tax benefits of dividends on unvested restricted stock are to be recognized in equity as an increase in the pool of excess tax benefits. Should the related awards forfeit or no longer become expected to vest, the benefits are to be reclassified from equity to the income statement. The EITF is effective for fiscal years beginning after December 15, 2007. The Group does not expect the EITF to have any impact on its consolidated financial statements.

(iv) In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R establishes requirements for the recognition and measurement of acquired assets, liabilities, goodwill, and non-controlling interests (formerly minority interests). SFAS No. 141R also provides disclosure requirements related to business combinations. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008. SFAS No. 141R will be applied prospectively to business combinations with an acquisition date on or after the effective date.

(v) In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51.” SFAS No. 160 establishes new standards for the accounting and reporting of non-controlling interests and for the loss of control of partially-owned and consolidated subsidiaries. SFAS No. 160 does not change the criteria for consolidating a partially-owned entity. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The provisions of SFAS No. 160 will be applied prospectively upon adoption except for the presentation and disclosure requirements, which will be applied retrospectively. SFAS No. 160 states that accounting and reporting for minority interests will be recharacterized as non-controlling interests and classified as a component of equity. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one

F-19

or more partially-owned and consolidated subsidiaries. Except for the classification of minority interest as a component of equity, the initial adoption of SFAS No. 160 is not expected to have a material impact on the Group’s consolidated financial statements.

(vi) In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” This statement requires enhanced disclosures for derivative instruments and hedging activities that include how and why an entity uses derivatives, how these instruments and the related hedged items are accounted for under SFAS 133 and related interpretations, and how derivative instruments and related hedged items affect the entity’s financial position, results of operations and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently reviewing the standard to assess the impact of the adoption of SFAS 161.

3. ACCOUNTS RECEIVABLE

Accounts receivable consists of:


	2006			2007
	RMB’000			RMB’000			US$’000
Trade receivables
- related party (Note 28)		44,443			97,070			13,307
- third parties		803,818			856,025			117,351

		848,261			953,095			130,658
Less: Allowance for doubtful accounts		(8,616	)		(11,577	)		(1,587	)

Accounts receivable, net		839,645			941,518			129,071

Changes in the allowance for doubtful accounts are as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Beginning of year		6,500			8,616			1,181
Bad debt expense		2,710			3,384			464
Bad debt recovery		(594	)		(423	)		(58	)

End of year		8,616			11,577			1,587

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6.		OTHER CURRENT ASSETS

		Other current assets consist of:


	2006		2007
	RMB’000		RMB’000		US$’000
Advances to staff		2,598		3,306		453
Advances to a third party (Note (a))		—		970,739		133,076
Interest receivable on advances to a third party (Note (a))		—		17,700		2,426
Rental and utility deposits		183		826		113
Receivable from sale of land use rights and construction-in-progress (Note 27(c))		—		108,904		14,930
Deposit for acquisition of land (Note (9))		—		8,000		1,097
Other		1,401		1,933		265

		4,182		1,111,408		152,360

Note -

(a) Advances to a third party are secured by a floating charge over all the assets of the borrower, bear interest at 5.0% per annum and are repayable on demand. All advances made and interest accrued thereon have been received subsequent to the end of the financial year.

7.		PROPERTY, MACHINERY AND EQUIPMENT

		Property, machinery and equipment consist of:


	2006			2007
	RMB’000			RMB’000			US$’000
Buildings and improvements		156,163			151,326			20,745
Machinery, equipment and software		81,054			83,384			11,431
Furniture and office equipment		5,892			6,231			854
Motor vehicles		1,466			2,149			295

		244,575			243,090			33,325
Less: Accumulated depreciation		(35,033	)		(50,489	)		(6,922	)

Property, machinery and equipment, net		209,542			192,601			26,403

All the Group’s property, machinery and equipment are principally located in the PRC.

Applications for the property ownership certificates of three buildings with net book value of approximately RMB2,557,000 as of December 31, 2007 were still in progress and have not been issued to the Group by the relevant office of the State-owned Land Bureau in the PRC.

F-22

8.		LAND USE RIGHTS, NET

		Land use rights consist of:


	2006			2007
	RMB’000			RMB’000			US$’000
Cost		242,051			37,806			5,183
Less: Accumulated amortization		(29,955	)		(870	)		(119	)

Land use rights, net		212,096			36,936			5,064
Amount classified as current portion (Note 5)		(4,890	)		(830	)		(114	)

Amount classified as non-current portion		207,206			36,106			4,950

Private ownership of land is not allowed in the PRC. Rather, entities acquire the right to use land for a designated term. As of December 31, 2007, land use rights of the Group, which are held through CECT, included certain parcels of land located at Langtou Village, Luoyang Town, Boluo County, Huizhou City, Guangdong Province, the PRC. The land has a total area of approximately 100,000 square meters and a lease term of 50 years. The land use right for approximately 77,410 square meters will expire in September 2051 and the remaining 22,590 square meters will expire in September 2052.

9.		OTHER NON-CURRENT ASSETS

		Other non-current assets consist of:


	2006		2007
	RMB’000		RMB’000		US$’000
Deposits for purchase of property, machinery and equipment		249		—		—
Deposit for acquisition of land (Note (a))		8,000		—		—

		8,249		—		—

Note –

(a) On March 27, 2004, QXPL signed an agreement with QXGL for the acquisition of the land use right of a parcel of land located in the PRC at a consideration of RMB66,700,000. Of the total consideration, RMB8,000,000 has been paid as a deposit as of December 31, 2006. The acquisition of the land use right was aborted in 2007 and the deposit has been refunded subsequent to the year ended December 31, 2007. As of December 31, 2007, the deposit paid has been classified as other current asset in Note 6 to the consolidated financial statements.

F-23

10.

INVESTMENT AT COST

Investment at cost represents the Group’s interest in CEC Mobile Co., Ltd. (“CECM”), a limited liability company established in the PRC to engage in the production and sale of mobile phones and accessories. The Group’s interest in CECM is held through CECT, which owns a 10.0% equity interest in the issued capital of CECM as of December 31, 2006 and 2007.

11. ACQUISITIONS AND DISPOSALS

(a) Acquisition of additional equity interests in CECT

Subsequent to the acquisition of an initial 65% equity interest in CECT on February 8, 2003, QXMC completed the following acquisitions of additional equity interests in CECT:

(i) On July 31, 2005, QXMC completed the acquisition of an additional 25% equity interest in CECT from QXCI, a subsidiary of the Company, for a total consideration of RMB75,000,000. QXCI acquired the 25% equity interest in CECT from CEC at the same consideration of RMB75,000,000 on July 29, 2005 on behalf of QXMC and in contemplation that the 25% equity interest in CECT acquired would be transferred to QXMC on the same terms shortly after the purchase. The transaction was structured to facilitate the governmental approval process for the acquisition.

(ii) On July 31, 2006, the Company injected additional capital of US$18,750,000 (RMB149,600,000) into CECT in the form of cash. The minority shareholder did not participate in the capital injection and as a result, QXMC’s equity interest in CECT was increased from 90% to 93.4%.

(iii) On June 30, 2007, the Company injected additional capital of US$50,000,000 (RMB380,425,000) into CECT in the form of cash. The minority shareholder did not participate in the capital injection and as a result, QXMC’s equity interest in CECT was increased from 93.4% to 96.6%.

The Group has accounted for QXMC’s step-up acquisitions of additional equity interests in CECT using the purchase method. This method requires the acquisition cost to be allocated to the assets acquired (including separately identifiable intangible assets) and liabilities assumed, based on a pro-rata share of their estimated fair values. For each of the acquisitions of additional equity interests in CECT completed during the years ended December 31, 2005, 2006 and 2007, the fair value of the underlying net assets, representing QXMC’s additional equity interest acquired in CECT, exceeded QXMC’s purchase price, giving rise to negative goodwill. Such negative goodwill was first allocated to reduce the purchase price allocated to certain non-financial assets. The remaining unallocated negative goodwill, net of minority interests, has been recognized as an extraordinary gain in the consolidated statements of operations of the Group in the year of acquisition.

F-24

The following table summarizes the purchase price allocated to QXMC’s share of the fair value of the net assets acquired for each acquisition at acquisition date:


	July 31,			July 31,
	2005			2006			June 30, 2007
	RMB’000			RMB’000			RMB’000			US$’000
Cash consideration		4,607			149,600			380,425			52,152
Less: Ownership interest in cash consideration		—			(139,742	)		(367,295	)		(50,352	)

Net cash consideration		4,607			9,858			13,130			1,800
Additional consideration:
- Investment in China Electronics Financial Co., Ltd. (“CEFCL”) (Note (i))		20,000			—			—			—
- Investment in Beijing Jinxin Hengtong Technology Company Limited (“BJHTCL”) (Note (ii))		50,393			—			—			—

Total purchase consideration		75,000			9,858			13,130			1,800


Fair value of net assets acquired:
- Property, machinery and equipment		9,810			1,511			5,929			813
- Land use rights		—			—			1,222			168
- Other tangible assets and liabilities acquired		121,990			27,654			41,819			5,733
- In-process research and development		65,237			6,287			7,981			1,094
- Other intangible assets		67,617			13,914			16,009			2,195

Fair value of net assets acquired		264,654			49,366			72,960			10,003


Negative goodwill		189,654			39,508			59,830			8,203

Allocation of negative goodwill:
- Property, machinery and equipment		(9,810	)		(1,511	)		(5,929	)		(813	)
- Land use rights		—			—			(1,222	)		(168	)
- In-process research and development		(65,237	)		(6,287	)		(7,981	)		(1,094	)
- Other intangible assets		(67,617	)		(13,914	)		(16,009	)		(2,195	)

Negative goodwill allocated to fair value of long-term assets		(142,664	)		(21,712	)		(31,141	)		(4,270	)


Extraordinary gain before minority interests		46,990			17,796			28,689			3,933
Less: Minority interests’ share of extraordinary gain		(9,398	)		(3,559	)		(11,093	)		(1,521	)

Extraordinary gain after minority interests		37,592			14,237			17,596			2,412

F-25

Notes -

(i) CECT’s 3.86% interest in CEFCL, which was invested prior to QXMC’s acquisition of its initial 65% interest in CECT on February 8, 2003, had an original investment cost of RMB20,000,000. The investment in CEFCL had continued to be accounted for under the cost method until July 29, 2005, when such investment was transferred to QXCI (and thereafter to CEC) at a consideration of RMB20,000,000. No dividends or other distributions were received from CEFCL during this holding period and accordingly, the carrying value of the investment remained at RMB20,000,000 as at July 29, 2005, when CEC offered to repurchase the 3.86% non-controlling interest at RMB20,000,000 and use that as part of the total consideration for QXMC’s acquisition of the additional 25% equity interest in CECT.

(ii) BJHTCL was 90%-owned by CECT at the date of QXMC’s acquisition of its initial 65% interest in CECT on February 8, 2003. Prior to the transfer to QXCI (and thereafter to CEC) as part of the consideration for QXMC’s acquisition of the additional 25% equity interest in CECT, the major assets of BJHTCL were buildings and structures located in Beijing, and the related land use rights. Based on an external valuation report, the aggregate fair value of buildings and structures, and the land use rights held by BJHTCL was RMB48,700,000 at July 29, 2005, which together with the aggregate carrying amount of cash and other receivables of RMB886,000 gave an estimated fair value of BJHTCL of RMB49,586,000. The Company has considered that the difference of RMB807,000 between the estimated fair value of RMB49,586,000 and the offer by CEC of RMB50,393,000 is immaterial.

The gain on disposal of BJHTCL of RMB10,307,000 as recognized in the consolidated statement of operations for the year ended December 31, 2005 is calculated as follows:


	RMB’000
Fair value of investment in BJHTCL		50,393
Less: Net assets disposed of (Note 27(b))		(40,086	)

Gain on disposal of subsidiary		10,307

F-26

(b) Acquisition of additional equity interest in QXMC

On November 30, 2006, the Company acquired the remaining 20% equity interest in QXMC from the minority shareholder, Galbo, at a total consideration of RMB356,064,000 and as a result, QXMC became a wholly-owned subsidiary of the Company.

The acquisition of the additional equity interest in QXMC was accounted for under the purchase method of accounting and the purchase price was allocated to the assets acquired and liabilities assumed based on their fair values as of the acquisition date. Details of 20% of the fair value of the net assets of QXMC on November 30, 2006 are as follows:


	RMB’000
Inventories		28,530
Property, machinery and equipment		36,737
Net deferred income tax liabilities		(8,746	)
Other tangible assets and liabilities acquired		100,048
Intangible assets:
- In-process research and development		41,739
- Other intangible assets		63,656
Goodwill (Note 12)		94,100

Fair value of net assets acquired		356,064


Satisfied by:
- Cash consideration		170,343
- Fair value of the Company’s share issued (1,562,348 shares @ US$15.17 each)		185,721

Total purchase consideration		356,064

In-process research and development of RMB41,739,000, representing the Company’s acquired interest in the estimated fair value of product technologies under development as of November 30, 2006, were charged to expense as these product development projects and the related research and development activities had no alternative future use. In-process research and development as of November 30, 2006 was valued using the multi-period excess earnings method. Under this method, the value of the in-process research and development asset was determined as the present value of the incremental after-tax cash flows attributable only to that asset. In accordance with EITF Issue No. 96-7, ''Accounting for Deferred Taxes on In-Process Research and Development Activities Acquired in a Purchase Business Combination,’’ in-process research and development is charged to expense on a gross basis and does not reflect any tax benefit.

F-27

On May 3, 2007, the Company’s subsidiary, QXMC, completed a listing of its ordinary shares on the New York Stock Exchange (the “NYSE”). On May 8, 2007, QXMC and certain selling shareholders completed an IPO, priced at US$12.00 per share, of 12,500,000 new ordinary shares issued by QXMC and 833,334 ordinary shares offered by the selling shareholders. The Company did not receive any proceeds from the IPO. Immediately prior to the listing of QXMC’s ordinary shares on the NYSE on May 3, 2007, the investors of US$40,000,000 senior convertible notes issued by the Company (Note 17(a)) exercised an option to exchange the entire US$40,000,000 notes into 7,800,000 ordinary shares of QXMC that were owned by the Company (the “Exchange”) and as a result, the Company’s equity interest in QXMC was decreased from 100.0%, or 40,000,000 shares, to 80.5%, or 32,200,000 shares, representing a disposal of 19.5% interest in QXMC. Based on the issue price of US$12.00 per share that was obtained during QXMC’s IPO, the fair value of QXMC’s shares given up by the Company in the Exchange was estimated to be approximately US$93,600,000 (RMB721,188,000).

The Exchange resulted in a loss on the extinguishment of the US$40,000,000 senior convertible notes of RMB142,090,000 (US$19,479,000) during the year ended December 31, 2007, which is calculated as follows:


	RMB’000
Cost of extinguishment (7,800,000 shares @ US$12.00 per share)		721,188
(Less) add: Carrying value of:
- Convertible notes (Note 17(a))		(238,325	)
- Embedded derivatives (Note 17(a))		(365,476	)
- Deferred debt issuance costs (Note 17(a))		24,703

Loss on extinguishment		(142,090	)

The gain on disposal of the 19.5% equity interest in QXMC of RMB482,614,000 (US$66,160,000), as recognized in the consolidated statements of operations for the year ended December 31, 2007, is calculated as follows:


	RMB’000
Deemed proceeds from disposal (7,800,000 shares @ US$12.00 per share)		721,188
Less: Share of net assets relating to minority interest disposed of		(221,659	)
Less: Goodwill relating to minority interest disposed of (Note 12)		(16,915	)

Gain on disposal		482,614

F-28

As a consequence of the QXMC’s IPO on May 8, 2007, the Company’s equity interest in QXMC was further diluted from approximately 80.5% immediately prior to the IPO to approximately 61.3% upon the completion of the IPO. In connection with this reduction in the Company’s ownership interest in QXMC, the Company recorded a gain of RMB383,965,000 (US$52,637,000), which is calculated as follows:


	RMB’000
Share of net assets of QXMC after IPO		1,315,647
Less: Share of net assets of QXMC before IPO		(915,057	)

Increase in share of net assets after IPO		400,590
Less: Goodwill relating to equity interest deemed disposed of (Note 12)		(16,625	)

Gain on deemed disposal		383,965

12. GOODWILL

Goodwill is analyzed as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Beginning of year		20,714			110,134			15,098
Adjustment (Note (a))		(4,680	)		—			—
Amount arising on acquisition of the remaining 20.0% interest in QXMC by the Company (Note 11(b))		94,100			—			—
Amount disposed of due to the disposition of minority interest in QXMC (Note 11(c))		—			(16,915	)		(2,319	)
Amount deemed disposed of due to the sale of stocks by QXMC (Note 11(c))		—			(16,625	)		(2,279	)

End of year		110,134			76,594			10,500

Note -

(a) The historical goodwill that arose from QXMC’s acquisition of its initial 65% interest in CECT on February 8, 2003 was reduced by RMB4,680,000 due to the application of purchase accounting to account for the Company’s acquisition of the remaining 20.0% equity interest in QXMC on November 30, 2006 (Note 11(b)).

F-29

13. OTHER ACQUIRED INTANGIBLE ASSETS, NET

Other acquired intangible assets, which arose from the acquisition by QXMC of its initial 65.0% equity interest in CECT on February 8, 2003, and as subsequently adjusted for the purchase accounting of the Company’s acquisition of the remaining 20.0% interest in QXMC on November 30, 2006 (Note 11(c)), consist of the following components:


	2006		2007
	RMB’000		RMB’000		US$’000
Cost:
- “CECT” brand		39,835		39,835		5,461
- Customer relationship		5,418		5,418		743
- Completed technology		16,950		16,950		2,324
- Core technology		24,193		24,193		3,316
- Backlog		9,175		9,175		1,258
- License		1,725		1,725		236

		97,296		97,296		13,338


Less: Accumulated amortization
- Customer relationship		306		4,470		613
- Completed technology		823		10,866		1,490
- Core technology		742		10,455		1,433
- Backlog		2,294		9,175		1,258
- License		123		1,602		219

		4,288		36,568		5,013


Other acquired intangible assets, net		93,008		60,728		8,325

The expected future amortization expense of other acquired intangible assets is as follows:


	Amount
	RMB’000		US$’000
Year ending December 31,
- 2008		11,727		1,607
- 2009		4,733		649
- 2010		4,433		608

Total		20,893		2,864

F-30

14. SHORT-TERM BANK BORROWINGS

Short-term bank borrowings consist of:


	2006		2007
	RMB’000		RMB’000		US$’000
Bills payable		419,778		264,335		29,383
Bank loans		717,787		1,157,119		165,481
Other borrowings, secured by bills receivable		17,725		50,000		6,854

		1,155,290		1,471,454		201,718

Bills payable are a form of bank borrowing with payment terms of not more than 180 days and are non-interest bearing unless they become trust receipt loans which then bear interest at the prevailing interest rate of bank loans.

During each of the periods presented, the Group entered into various loan agreements with commercial banks in the PRC at terms ranging from three months to one year. The weighted average interest rate on these bank loans was 5.6%, 5.8% and 6.4% per annum during the years ended December 31, 2005, 2006 and 2007, respectively. The principal amounts of these short-term loans are repayable at the end of the loan period, while the related interest expense is payable on a monthly or quarterly basis.

Short-term bank borrowings are secured by the following:


	2006		2007
	RMB’000		RMB’000		US$’000
Pledged of:
- Bank deposits of the Group		286,025		197,951		27,137
- Bank deposits of the Group held in trust by a director		87,748		—		—
- Bank deposits of a director		15,057		36,519		5,006
- Bank deposits of an unrelated third party		53,000		—		—
- Bills receivable of the Group		17,725		50,000		6,854

Guarantees provided by:
- QXGL		449,000		160,000		21,934
- QXGL and directors		630,000		570,000		78,140
- QXGL, directors and third parties		—		400,000		54,835
- Directors		279,300		150,000		20,563

F-31

15. OTHER PAYABLES

Other payables consist of:


	2006		2007
	RMB’000		RMB’000		US$’000
Payables for purchase and construction of property, machinery and equipment		6,922		5,692		780
Rental payable		2,067		645		88
Expenses relating to QXMC’s IPO		—		1,285		176
Proceeds received from employees for the exercise of share options (Note 26(a))		—		30,911		4,238
Others		3,000		3,476		477

		11,989		42,009		5,759

16. ACCRUED LIABILITIES

Accrued liabilities consist of:


	2006		2007
	RMB’000		RMB’000		US$’000
Accruals for:
- Design, licensing and tooling fees		38,094		48,491		6,648
- Salaries		4,833		5,027		689
- Staff benefits		2,762		2,761		378
- Advertising		515		35		5
- Warranty (Note 2(m))		9,591		11,123		1,525
- Interest		1,379		10,876		1,491
- Professional service fees		—		9,756		1,337
- Listing fees (Note 5(a))		3,575		—		—
- Others		939		1,596		219
Provision for litigation settlement (Note 25(c))		—		15,319		2,100

		61,688		104,984		14,392

F-32

17. CONVERTIBLE NOTES

Convertible notes consist of:


	2006			2007
	RMB’000			RMB’000			US$’000
3.5% unsecured senior convertible notes (Note (a))		222,087			—			—
4.5% unsecured senior convertible notes (Note (b))		87,471			189,660			26,000
5.5% unsecured senior convertible notes (Note (c))		—			135,667			18,598

Total debts		309,558			325,327			44,598
Less: Amount classified as current liabilities		(87,471	)		(135,667	)		(18,598	)

Amount classified as non-current liabilities		222,087			189,660			26,000

Notes -

(a) 3.5% unsecured senior convertible notes

On June 13, 2006, pursuant to a securities purchase agreement dated April 27, 2006, the Company issued and sold to two institutional investors US$40,000,000 aggregate principal amount of 3.5% unsecured senior convertible notes (the “3.5% Notes”). In addition, the Company also issued common stock purchase warrants to the investors (the “June Investor Warrants”) and its placement agent (the “June Agent Warrants”) to purchase up to 996,637 and 848,318 shares of common stock of the Company, respectively.

The material terms and conditions of the 3.5% Notes are summarized as follows:

	•		the notes bear interest at the rate of 3.5% per annum, payable in cash in arrears on a calendar quarterly basis beginning June 30, 2006;

	•		the notes mature on June 12, 2009;

	•		the notes are unsecured and are guaranteed by the Company’s subsidiary, QXMC;

	•		the notes are convertible, at the investor’s option, into common stock of the Company at an initial conversion price of US$8.027 per share, or into common stock of QXMC in the event of its initial public offering at a price equal to 7 times QXMC’s 2005 consolidated earnings per share. The conversion price for the Company’s common stock is subject to reset when the volume weighted average price (“VWAP”) of the Company’s common stock for the five trading days ending on each two-month anniversary from June 13, 2006 until maturity of the Notes (each a “Reset Date”) is less than US$6.98 (or such previously reset price). In the event of a reset, the conversion price will be set equal to the greater of US$5.15 or 90.0% of the VWAP of the Company’s common stock for the five trading days ending on the applicable Reset Date;

	•		the notes will not be convertible to the extent that after giving effect to such conversion, the investors (together with their affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to the conversion;

	•		the holders of the notes have the right to require the Company to redeem the notes after two years in an amount equal to the sum of (a) the outstanding principal of the Notes, (b) the accrued and unpaid interest thereon, and (c) 6.0% on the sum of (a) and (b); and

F-33

•

the Company has the right, subject to certain terms and conditions, to deliver shares of its common stock in lieu of cash on redemption or maturity of the Notes, and the number of shares would be determined by dividing the face amount and accrued interest by the average closing price of the Company’s common stock for the 10 days prior to redemption, and then multiplying that amount by 0.975.

The material terms and conditions of the warrants are summarized as follows:

	•		the warrants have an initial exercise price of US$8.027 per share and may be exercised at any time during a 5-year period commencing from June 13, 2006;

	•		the warrants will not be exercisable to the extent that after giving effect to such exercise, the holder (together with its affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to such exercise; and

	•		the warrants require an automatic repricing of the exercise price if the Company makes certain sales of its common stock or common stock equivalents in a capital-raising transaction at a price below the warrant exercise price.

The 3.5% Notes included on the consolidated balance sheet are analyzed as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Gross proceeds from 3.5% Notes		320,136			320,136			43,887
Discount on notes:
- Equity-classified June Investor Warrants (Note (i))		(18,519	)		(18,519	)		(2,539	)
- Liability-classified embedded derivatives (Note (ii))		(99,969	)		(99,969	)		(13,705	)

Value of debt component at date of issue		201,648			201,648			27,643
Foreign currency realignment		(5,522	)		(8,453	)		(1,159	)
Accretion of discount (Note (iii))		25,961			45,130			6,187
Extinguishment of debt (Note 11(c))		—			(238,325	)		(32,671	)

Value of debt component at end of year		222,087			—			—
Less: Amount classified as current liabilities		—			—			—

Amount classified as non-current liabilities		222,087			—			—

Notes -

(i) The terms and features of the June Investor Warrants were evaluated under the guidance set forth in EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to a Company’s Own Stock” and the Company concluded that all indicators for equity classification provided in EITF Issue No. 00-19 were present.

Pursuant to APB Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” the gross proceeds of RMB320,136,000 from the issuance of the US$40,000,000 notes were allocated to the June Investors Warrants and the 3.5% Notes on a relative fair value basis. The fair value of the 996,637 June Investors Warrants applied for the purposes of the aforementioned allocation was computed using the Black-Scholes option-pricing model on the grant date of the warrants and amounted to approximately RMB22,778,000. As a result of the allocation, approximately RMB18,519,000 of the gross proceeds from the issuance of the 3.5% Notes was allocated to the value of the June Investor Warrants, which was recorded as a discount to the face value of the 3.5% Notes and credited to additional paid-in capital. The following assumptions were used to value the June Investor Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 54.92%, risk free interest rate of 4.95% and a contractual life of 3.25 years.

F-34

(ii) The 3.5% Notes are a form of hybrid instrument that comes with embedded derivatives, including the right to convert the notes by the note holders, an early redemption premium put, a put option conditional upon certain events of default and a put option conditional upon a change of control. In accordance with the guidance of SFAS No. 133, as amended, “Accounting for Derivative Instruments and Hedging Activities,” and EITF Issue No. 00-19, the embedded derivatives must be removed from the debt host and accounted for separately as derivative instruments. Based on EITF No. 00-19, the embedded derivatives were determined to be classified as liabilities on the balance sheet. The value of the embedded compound derivatives, which amounted to approximately RMB99,969,000 on the date of initial recognition, has been deducted as a discount to the face value of the 3.5% Notes and recorded as a liability on the balance sheet. The valuation of the embedded derivatives was derived by using various valuation methods, which included Monte Carlo Simulation and Backward Dynamic Programming.

The liability-classified embedded derivatives are marked-to-market at the end of each reporting period with the resulting gain or loss recognized in the statement of operations. Non-cash loss on remeasurement of the liability-classified embedded derivatives amounted to approximately RMB163,888,000 and RMB110,554,000 (US$15,156,000) for the years ended December 31, 2006 and 2007, respectively.

(iii) The discount arising from the June Investors Warrants and the embedded derivatives is accreted to interest expense to the first put date of the 3.5% Notes using the effective interest method.

Costs associated with the issuance of the 3.5% Notes, which have been classified as deferred debt issuance costs on the consolidated balance sheet, are analyzed as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Amount attributed to June Agent Warrants (Note (i))		18,267			18,267			2,504
Other cash costs		23,622			23,622			3,238

Total deferred debt issuance costs on initial recognition		41,889			41,889			5,742
Foreign currency realignment		(866	)		(1,231	)		(169	)
Accumulated amortization (Note (ii))		(9,178	)		(15,955	)		(2,187	)
Disposed of on extinguishment of 3.5% Notes (Note 11(c))		—			(24,703	)		(3,386	)

Net value at end of year		31,845			—			—

Notes -

(i) The fair value of the June Agent Warrants, as computed using the Black-Scholes option pricing model on the grant date, amounted to approximately RMB19,389,000. Of this amount, RMB18,267,000 was capitalized as deferred debt issuance costs on the consolidated balance sheet while the balance of RMB1,122,000 was debited to additional paid-in capital as cost associated with the issuance of the June Investor Warrants. The following assumptions were used to value the June Agent Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 54.92%, risk free interest rate of 4.95% and a contractual life of 3.25 years.

(ii) The deferred debt issuance costs are amortized to expense to the first put date of the 3.5% Notes using the effective interest method.

F-35

(b) 4.5% unsecured senior convertible notes

On October 31, 2006, the Company issued and sold to the same investors of the 3.5% Notes US$26,000,000 aggregate principal amount of 4.5% unsecured senior convertible notes (the “4.5% Notes”). In addition, the Company also issued common stock purchase warrants to the investors (the “October Investor Warrants”) and its placement agent (the “October Agent Warrants”) to purchase up to 363,637 and 181,818 shares of common stock of the Company, respectively.

The material terms and conditions of the 4.5% Notes are summarized as follows:

	•		the notes bear interest at the rate of 4.5% per annum, payable in cash in arrears on a calendar quarterly basis beginning December 31, 2006;

	•		the notes mature on April 30, 2009;

	•		the notes are convertible, at the investor’s option, into common stock of the Company at an initial conversion price of US$14.30 per share. The conversion price for the Company’s common stock is subject to reset when the volume weighted average price (“VWAP”) of the Company’s common stock for the five trading days ending on each six-month anniversary from October 31, 2006 until maturity of the Notes (each a “Reset Date”) is less than US$13.00 (or such previously reset price). In the event of a reset, the conversion price will be set equal to the greater of US$7.80 or 100% of the VWAP of the Company’s common stock for the five trading days ending on the applicable Reset Date. As of December 31, 2007, the conversion price of the 4.5% Notes had been reset to US$7.69 per share;

	•		the notes will not be convertible to the extent that after giving effect to such conversion, the investors (together with their affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to the conversion; and

	•		the holders of the notes have the right to require the Company to redeem the notes after one year in an amount equal to the sum of (a) the outstanding principal of the Notes, (b) the accrued and unpaid interest thereon, and (c) 3% on the sum of (a) and (b). Consequently, the 4.5% Notes were classified as current liabilities on the consolidated balance sheet as of December 31, 2006. Due to the expiry of the early redemption option in October 2007, the 4.5% Notes have been reclassified to non-current liabilities as of December 31, 2007;

The material terms and conditions of the warrants are summarized as follows:

	•		the warrants have an initial exercise price of US$14.30 per share and may be exercised at any time during a 5-year period commencing from October 31, 2006;

	•		the warrants will not be exercisable to the extent that after giving effect to such exercise, the holder (together with its affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to such exercise; and

	•		the warrants require an automatic repricing of the exercise price if the Company makes certain sales of its common stock or common stock equivalents in a capital-raising transaction at a price below the warrant exercise price.

The 4.5% Notes included on the consolidated balance sheets are analyzed as follows:


	2006		2007
	RMB’000		RMB’000		US$’000
Gross proceeds from 4.5% Notes		202,475		202,475		27,757

F-36


	2006			2007
	RMB’000			RMB’000			US$’000
Discount on notes:
- Equity-classified October Investor Warrants (Note (i))		(14,534	)		(14,534	)		(1,993	)
- Liability-classified embedded derivatives (Note (ii))		(111,341	)		(111,341	)		(15,263	)

Value of debt component at date of issue		76,600			76,600			10,501
Foreign currency realignment		(48	)		(10,242	)		(1,404	)
Accretion of discount (Note (iii))		10,919			123,302			16,903

Value of debt component at end of year		87,471			189,660			26,000

Notes -

(i) The terms and features of the October Investor Warrants were evaluated under the guidance set forth in EITF Issue No. 00-19 and the Company concluded that all indicators for equity classification provided in EITF Issue No. 00-19 were present.

Pursuant to APB Opinion No. 14, the gross proceeds of RMB202,475,000 from the issuance of the US$26,000,000 notes were allocated to the October Investors Warrants and the 4.5% Notes on a relative fair value basis. The fair value of the 363,637 October Investors Warrants applied for the purposes of the aforementioned allocation was computed using the Black-Scholes option-pricing model on the grant date of the warrants and amounted to approximately RMB22,686,000. As a result of the allocation, approximately RMB14,534,000 of the gross proceeds from the issuance of the 4.5% Notes was allocated to the value of the October Investor Warrants, which was recorded as a discount to the face value of the 4.5% Notes and credited to additional paid-in capital. The following assumptions were used to value the October Investor Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 67.52%, risk free interest rate of 4.60% and a contractual life of 3.25 years.

(ii) The 4.5% Notes are a form of hybrid instrument that comes with embedded derivatives, including the right to convert the notes by the note holders, an early redemption premium put, a put option conditional upon certain events of default and a put option conditional upon a change of control. In accordance with the guidance of SFAS No. 133 and EITF Issue No. 00-19, the embedded derivatives must be removed from the debt host and accounted for separately as derivative instruments. Based on EITF No. 00-19, the embedded derivatives were determined to be classified as liabilities on the balance sheet on the date of initial recognition. The value of the embedded compound derivatives, which amounted to approximately RMB111,341,000 on the date of initial recognition, has been deducted as a discount to the face value of the 4.5% Notes and recorded as a liability on the balance sheet. The valuation of the embedded derivatives was derived by using various valuation methods, which included Monte Carlo Simulation and Backward Dynamic Programming.

Due to the expiry of the early redemption premium put in October 2007, the Company reassessed the classification of the embedded conversion option of the 4.5% Notes and concluded that all indicators for equity classification provided in EITF Issue No. 00-19 were present. Consequently, the fair value of the embedded conversion option as of the date of expiry of the early redemption premium put option, which amounted to approximately RMB89,531,000, was reclassified to additional paid-in capital.

The liability-classified embedded derivatives are marked-to-market at the end of each reporting period with the resulting gain or loss recognized in the statement of operations. For the year ended December 31, 2006, the remeasurement of the liability-classified embedded derivatives resulted in a non-cash gain of RMB29,449,000 and for the year ended December 31, 2007, the remeasurement resulted in a non-cash loss of RMB18,865,000 (US$2,586,000). As of December 31, 2007, after taking into account foreign currency realignment, the fair value of the liability-classified embedded derivatives included in the consolidated balance sheet as a liability amounted to RMB8,715,000 (US$1,195,000) (2006: RMB82,699,000).

F-37

(iii) The discount arising from the October Investors Warrants and the embedded derivatives is accreted to interest expense to the first put date of the 4.5% Notes using the effective interest method.

Costs associated with the issuance of the 4.5% Notes, which have been classified as deferred debt issuance costs on the consolidated balance sheet, are analyzed as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Amount attributed to June Agent Warrants (Note (i))		10,529			10,529			1,443
Other cash costs		14,385			14,385			1,972

Total deferred debt issuance costs on initial recognition		24,914			24,914			3,415
Foreign currency realignment		94			(510	)		(70	)
Accumulated amortization (Note (ii))		(2,161	)		(24,404)	)		(3,345	)

Net value at end of year		22,847			—			—

Notes -

(i) The fair value of the October Agent Warrants, as computed using the Black-Scholes option pricing model on the grant date, amounted to approximately RMB11,343,000. Of this amount, RMB10,529,000 was capitalized as deferred debt issuance costs on the consolidated balance sheet while the balance of RMB814,000 was debited to additional paid-in capital as cost associated with the issuance of the October Investor Warrants. The following assumptions were used to value the June Agent Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 67.52%, risk free interest rate of 4.60% and a contractual life of 3.25 years.

(ii) The deferred debt issuance costs are amortized to expense to the first put date of the 4.5% Notes using the effective interest method.

F-38

On August 17, 2007, the Company issued and sold to the same investors of the 3.5% Notes and the 4.5% Notes US$25,000,000 aggregate principal amount of 5.5% unsecured senior convertible notes (the “5.5% Notes”). In addition, the Company also issued common stock purchase warrants to the investors (the “August Investor Warrants”) and its placement agent (the “August Agent Warrants”) to purchase up to 490,677 and 245,339 shares of common stock of the Company, respectively.

The material terms and conditions of the 5.5% Notes are summarized as follows:

	•		the notes bear interest at the rate of 5.5% per annum, payable in cash in arrears on a calendar semi-annual basis beginning December 31, 2007;

	•		the notes mature on February 17, 2010;

	•		the notes are convertible, at the investor’s option, into common stock of the Company at an initial conversion price of US$10.19 per share. The conversion price for the Company’s common stock is subject to reset when the volume weighted average price (“VWAP”) of the Company’s common stock for the five trading days ending on each two-month anniversary from August 17, 2007 until maturity of the Notes (each a “Reset Date”) is less than US$9.26 (or such previously reset price). In the event of a reset, the conversion price will be set equal to the greater of US$5.56 or 90% of the VWAP of the Company’s common stock for the five trading days ending on the applicable Reset Date. As of December 31, 2007, the conversion price had been reset to US$7.69 per share;

	•		the notes will not be convertible to the extent that after giving effect to such conversion, the investors (together with their affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to the conversion; and

	•		the holders of the notes have the right to require the Company to redeem the notes after one year in an amount equal to 100% of the sum of (a) the outstanding principal of the Notes, (b) the accrued and unpaid interest thereon. Consequently, the 5.5% Notes were classified as current liabilities on the consolidated balance sheet as of December 31, 2007.

The material terms and conditions of the warrants are summarized as follows:

	•		the warrants have an initial exercise price of US$10.19 per share and may be exercised at any time during a 5-year period commencing from August 17, 2007;

	•		the warrants will not be exercisable to the extent that after giving effect to such exercise, the holder (together with its affiliates) would beneficially own in excess of 9.99% of the Company’s common stock outstanding immediately after giving effect to such exercise; and

	•		the warrants require an automatic repricing of the exercise price if the Company makes certain sales of its common stock or common stock equivalents in a capital-raising transaction at a price below the warrant exercise price.

F-39

The 5.5% Notes included on the consolidated balance sheets are analyzed as follows:


	2006		2007
	RMB’000		RMB’000			US$’000
Gross proceeds from 5.5% Notes		—		189,900			26,033
Discount on notes:
- Equity-classified August Investor Warrants (Note (i))		—		(13,703	)		(1,878	)
- Equity-classified embedded derivative (Note (ii))
- Liability-classified embedded derivatives (Note (ii))		—		(11,064	)		(1,517	)

Value of debt component at date of issue		—		165,133			22,638
Foreign currency realignment		—		(6,375	)		(874	)
Beneficial conversion amount arising on conversion price reset (iii)				(31,790	)		(4,358	)
Accretion of discount (Note (iv))		—		8,699			1,192

Value of debt component at end of year		—		135,667			18,598
Less: Amount classified as current liabilities		—		(135,667	)		(18,598	)

Amount classified as non-current liabilities		—		—			—

Notes -

(i) The terms and features of the August Investor Warrants were evaluated under the guidance set forth in EITF Issue No. 00-19 and the Company concluded that all indicators for equity classification provided in EITF Issue No. 00-19 were present.

Pursuant to APB Opinion No. 14, the gross proceeds of RMB189,900,000 from the issuance of the US$25,000,000 notes were allocated to the August Investors Warrants and the 5.5% Notes on a relative fair value basis. The fair value of the 490,677 August Investors Warrants applied for the purposes of the aforementioned allocation was computed using a multi-period binomial option pricing model on the grant date of the warrants and amounted to approximately RMB21,319,000. As a result of the allocation, approximately RMB17,703,000 of the gross proceeds from the issuance of the 5.5% Notes was allocated to the value of the August Investor Warrants, which was recorded as a discount to the face value of the 5.5% Notes and credited to additional paid-in capital. The following assumptions were used to value the August Investor Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 60.55%, risk free interest rate of 4.22% and a contractual life of 2.5 years.

(ii) The 5.5% Notes are a form of hybrid instrument that comes with embedded derivatives, including the right to convert the notes by the note holders, an early redemption put option, a put option conditional upon certain events of default and a put option conditional upon a change of control. In accordance with the guidance of SFAS No. 133 and EITF Issue No. 00-19, the Company concluded that the conversion option and the early redemption put option embedded in the 5.5% Notes are exempted from derivative accounting and should not be bifurcated from the host debt instrument on initial recognition. For the default put and the change of control put, the Company determined that the terms of these event puts resulted in their treatment as derivative financial features and, accordingly, the value of the these embedded derivatives, which amounted to approximately RMB11,064,000 on the date of initial recognition, has been deducted as a discount to the face value of the 5.5% Notes and recorded as a liability on the balance sheet. The valuation of the liability-classified embedded derivatives was derived by using various valuation methods, which included Monte Carlo Simulation and Backward Dynamic Programming.

F-40

remeasurement of the liability-classified embedded derivatives resulted in a non-cash gain of RMB335,000 (US$46,000). As of December 31, 2007, after taking into account foreign currency realignment, the fair value of the liability-classified embedded derivatives included in the consolidated balance sheet as a liability amounted to RMB10,289,000 (US$1,410,000).

(iii) On December 17, 2007, pursuant to the terms of the 5.5% Notes, the price for the conversion of the notes into common stock of the Company was reset from US$10.19 to US$7.69. As a consequence of this reset, a beneficial conversion amount of RMB31,790,000 arose, which was recorded as a discount to the 5.5% Notes and credited to additional paid-in capital.

(iv) The discount arising from the August Investors Warrants, the liability-classified embedded derivatives and the equity-classified beneficial conversion feature is accreted to interest expense to the first put date of the 5.5% Notes using the effective interest method.

Costs associated with the issuance of the 5.5% Notes, which have been classified as deferred debt issuance costs on the consolidated balance sheet, are analyzed as follows:


	2006		2007
	RMB’000		RMB’000			US$’000
Amount attributed to August Agent Warrants (Note (i))		—		9,891			1,356
Other cash costs		—		13,743			1,884

Total deferred debt issuance costs on initial recognition		—		23,634			3,240
Foreign currency realignment		—		(754	)		(103	)
Accumulated amortization (Note (ii))		—		(8,301	)		(1,138	)

Net value at end of year		—		14,579			1,999

Notes -

(i) The fair value of the August Agent Warrants, as computed using a multi-period binomial option pricing model on the grant date, amounted to approximately RMB10,660,000. Of this amount, RMB9,891,000 was capitalized as deferred debt issuance costs on the consolidated balance sheet while the balance of RMB769,000 was debited to additional paid-in capital as cost associated with the issuance of the August Investor Warrants. The following assumptions were used to value the August Agent Warrants on the grant date: expected dividend yield of 0.00%, expected stock price volatility of 60.55%, risk free interest rate of 4.22% and a contractual life of 2.5 years.

(ii) The deferred debt issuance costs are amortized to expense to the first put date of the 5.5% Notes using the effective interest method.

F-41

18. SHAREHOLDERS’ LOANS

These represent unsecured loans from Mr. Rui Lin Wu (held in trust for Mr. Zhi Jian Wu Li), Exquisite Jewel Limited, Metrolink Holdings Limited and Specialist Consultants Limited, the Company’s shareholders. The loans are denominated in United States Dollar and are non-interest bearing. The shareholders have agreed not to make demand on the Group for repayment before January 1, 2009. For financial reporting purposes for the year ended December 31, 2007, interest expense of approximately RMB487,000 (US$67,000) (2006: RMB459,000; 2005: RMB473,000) was imputed based on the cost of borrowings in the PRC of approximately 6.5% (2006: 5.9%; 2005: 5.9%) per annum and was recorded as interest expense and shareholders’ contribution in the consolidated financial statements.

19. COMMON STOCK TRANSACTIONS

The Company issued common stock during the years ended December 31, 2005, 2006 and 2007 as follows:


			Weighted
	Number of		average issue
	shares		price
			US$
Balance as of December 31, 2004		16,645,176
Issuance of shares to private investors		2,000,000		7.25
Issuance of shares as compensation for services received (Note (a))		1,500		—

Balance as of December 31, 2005		18,646,676
Issuance of shares to private investors		5,000,000		8.70
Issuance of shares to option holders (Note 20(a))		2,000,000		7.00
Issuance of shares to warrant holders (Note 20(c))		2,395,979		7.83
Issuance of shares as part consideration for the acquisition of the remaining 20% interest in QXMC (Note 11(c))		1,562,348		15.17

Balance of December 31, 2006		29,605,003
Issuance of shares to private investors		1,300,000		11.80
Issuance of shares to warrant holders (Note 20(c))		43,833		4.54

Balance of December 31, 2007		30,948,836

Notes -

(a) The fair value of the 1,500 shares of approximately RMB105,000 was recorded as stock-based compensation expenses during the year ended December 31, 2005.

F-42

20. STOCK OPTIONS AND WARRANTS

(a) Stock purchase options of the Company

On December 2, 2005, the shareholders of the Company approved and adopted the 2005 Stock Compensation Plan of the Company (the “2005 Stock Plan”), which allows for the issuance of either incentive stock options and/or non-qualified stock options to certain officers, directors, employees and external advisors of the Group. A total of 2,000,000 common shares have been authorized and reserved for issuance under the 2005 Stock Plan.

In February 2006, pursuant to the 2005 Stock Plan, 2,000,000 incentive stock options, exercisable during a 10-year period commencing on February 24, 2006, were issued to certain directors, employees and consultants of the Company at an exercise price of US$7.00 per share. All the options granted were exercised during 2006. In accordance with the requirements of SFAS No. 123-R and EITF 96-18, the fair value of the options on the date of grant, which amounted to approximately RMB58,707,000 as computed using the Black-Scholes option-pricing model, has been recognized as share-based compensation expenses during the year ended December 31, 2006. The following weighted average assumptions were used in the computation of the grant date fair value of the options:


Risk-free interest rate		4.63	%
Expected dividend yield		0.00	%
Expected term	5 years
Expected stock price volatility		55.20	%

No options were granted by the Company pursuant to the 2005 Stock Plan during the years ended December 31, 2005 and 2007.

(b) Stock purchase options of a subsidiary

Pursuant to a shareholders’ resolution passed on March 19, 2007, the Company’s subsidiary, QXMC, adopted an equity incentive plan (the “QXMC 2007 Stock Plan”) under which QXMC may grant incentive stock options, nonstatutory stock options, restricted stock, stock appreciation rights, restricted stock units, performance units, performance shares and other stock-based awards to certain of its qualifying directors, employees and consultants.

The stock option activities of QXMC during the year ended December 31, 2007 were as follows:

Weighted

average

exercise

remaining

Aggregate

Underlying

price

contractual

intrinsic

Options

per share

term

Value

US$

US$’000

Balance as of January 1, 2007

—

Granted on March 19, 2007:

- To a director and employees (Note (i))

2,716,520

7.50

- To a consultant (Note (ii))

1,200,000

18.00

Balance as of December 31, 2007

3,916,520

10.72

3.7 years

2,581

Exercisable as of December 31, 2007

2,031,720

13.70

2.4 years

790

F-43

Notes -

(i) The options granted, which have terms of between 2 to 6 years from the date of grant, vest on various dates commencing from November 1, 2007. Compensation expense is recognized based on the grant date fair value of the options of US$14,199,000 over the period that the employees are required to provide services in exchange for the award. The amount of share-based compensation expense recognized during the year ended December 31, 2007 was approximately RMB38,626,000 (US$5,295,000). Of this amount, RMB26,350,000 (US$3,612,000) has been credited to additional-in capital while the balance of RMB12,276,000 (US$1,683,000) was credited to minority interests in the consolidated financial statements of the Group. As of December 31, 2007, the total unrecognized compensation cost relating to unvested share options amounted to approximately US$9,080,000, which is expected to be recognized over a remaining weighted average vesting periods of 2.2 years.

The fair value of the share options on the date of grant was estimated by management using the Black-Scholes option pricing based on the following weighted average assumptions:


Fair value of QXMC’s underlying ordinary share on grant date	US$	10.43
Risk-free interest rate		5.00	%
Expected dividend yield		0.00	%
Expected term	3.5 years
Expected stock price volatility		47.50	%

The estimated fair value of QXMC’s underlying shares on the date of grant was determined by management considering the valuation performed by an unrelated independent valuation firm.

(ii) On March 19, 2007, in consideration of services rendered in connection with its IPO, QXMC granted an option to a consultant to purchase up to 1,200,000 shares of its common stock at an exercise price of US$18.00 per share. The option, which has a term of four years commencing from the grant date, vested on April 1, 2007. The estimated fair value of the option, which amounted to approximately RMB12,859,000 (US$1,763,000) as computed using the Black-Scholes option-pricing model on the grant date, has been accounted for by QXMC as ordinary shares issuance cost and was credited to additional paid-in capital in the consolidated financial statements of the Group during the year ended December 31, 2007.

The fair value of the option on the date of grant was US$1.385 per share which was estimated by management using the Black-Scholes option pricing based on the following assumptions:


Fair value of QXMC’s underlying ordinary share on grant date	US$	10.43
Risk-free interest rate		5.10	%
Expected dividend yield		0.00	%
Expected term	2.0 years
Expected stock price volatility		48.90	%

F-44

The warrant activities of the Company during the years ended December 31, 2005, 2006 and 2007 were as follows:


				Weighted
	Number of			average
	stock			exercise
	warrants			price
				US$
Outstanding as of December 31, 2004		390,800			8.185
Lapsed		(390,800	)		8.185
Issued:
- To share investors and placement agent (Note (i))		505,000			9.860
- To consultants for services rendered (Note (ii))		30,000			8.500

Outstanding, as of December 31, 2005		535,000			9.784
Issued:
- To share investors and placement agents (Note (iii))		1,350,000			10.578
- To 3.5% Notes investors and placement agent (Note 17(a))		1,844,955			8.027
- To 4.5% Notes investors and placement agent (Note 17(b))		545,455			14.300
- To a consultant as settlement of outstanding accounts payable (Note (iv))		150,000			8.125
Repricing adjustment (Note (v))		128,703			—
Exercised		(2,395,979	)		7.835

Outstanding as of December 31, 2006		2,158,134			11.385
Issued:
- To share investors and placement agents (Note (vi))		473,814			13.000
- To 5.5% Notes investors and placement agent (Note 17(c))		736,016			10.190
Repricing adjustment (Note (vii))		1,555,191			—
Exercised (Note (viii))		(56,877	)		7.983

Outstanding as of December 31, 2007		4,866,278			7.763


Exercisable as of December 31, 2007		4,866,278			7.763

Exercisable as of December 31, 2006		2,158,134			11.385

Notes -

(i) The fair value of the 505,000 warrants, which amounted to approximately RMB9,963,000 as computed using the Black-Scholes option-pricing model on the grant date, was debited to additional paid-in capital as stock issuance costs during the year ended December 31, 2005.

(ii) The fair value of the 30,000 warrants, which amounted to approximately RMB595,000 as computed using the Black-Scholes option-pricing model on the respective grant dates, was recognized as compensation expenses during the year ended December 31, 2005.

(iii) The fair value of the 1,350,000 warrants, which amounted to approximately RMB48,631,000 as computed using the Black-Scholes option-pricing model on the respective grant dates, was debited to additional paid-in capital as stock issuance costs during the year ended December 31, 2006.

F-45

(iv) The fair value of the 150,000 warrants, which amounted to approximately RMB3,674,000 as computed using the Black-Scholes option-pricing model on the grant date, was debited to accounts payable in settlement of an amount of RMB3,678,000 owing to the consultant.

(v) Due to the sales of common stocks and the issuance of the 3.5% Notes (Note 17(a)), the exercise prices and the shares underlying certain outstanding warrants were adjusted during the year ended December 31, 2006.

(vi) The fair value of the 473,814 warrants, which amounted to approximately RMB8,183,000 as computed using a multi-period binomial option pricing model on the grant date, was debited to additional paid-in capital as stock issuance costs during the year ended December 31, 2007.

(vii) Due to the issuance of the 5.5% Notes (note 17(c)), the exercise prices and the shares underlying certain outstanding warrants were adjusted during the year ended December 31, 2007.

(viii) Includes the cashless exercise of 30,000 warrants with an exercise price of US$8.50 per share. An aggregate of 16,956 shares of common stock were issued at no consideration to the warrant holder as settlement of the difference between the then quoted market price of the Company’s stock of US$19.55 per share and the warrant exercise price of US$8.50 per share.

The following table summarizes information about the warrants described above that are outstanding and exercisable at December 31, 2007:


			Weighted-average
			remaining
	Number of		contractual life
Exercise price (US$)	outstanding warrant		(years)
6.625		19,815		2.15
7.406		477,774		2.05
7.690		3,906,319		3.75
8.796		462,370		2.15

		4,866,278		3.42

The weighted average grant-date fair value of each warrant granted, as determined using the Black-Scholes option pricing model during the years ended December 31, 2005 and 2006 and the binomial option pricing model during the year ended December 31, 2007, and the weighted average assumptions used in computing such values were as follows:


	2005			2006			2007
Weighted average fair value	US$	2.39		US$	4.17		US$	4.54
Risk-free interest rate		3.60	%		4.76	%		4.00	%
Expected dividend yield		0.00	%		0.00	%		0.00	%
Expected term	2.61 years			3.05 years			2.30 years
Expected stock price volatility		65.71	%		57.41	%		62.07	%

F-46

21. INCOME TAXES

The Company and its subsidiaries are subject to income taxes on an entity basis on income arising in or derived from the tax jurisdictions in which they operate. The Company, QXMC and QXCH were incorporated under the International Business Companies Act of the BVI and, accordingly, are exempted from the payment of BVI income taxes. The Company’s branch office registered in Hong Kong is subject to Hong Kong income taxes at a rate of 17.5%.

At present, substantially all of the Group’s income is generated in the PRC by QXCI and CECT. QXCI, being located in Huizhou, the PRC, are subject to PRC enterprise income taxes at a rate of 15%. QXCI was exempted from PRC enterprise income tax for two years starting from January 1, 2003, and was entitled to a 50% reduction in state income tax and full exemption in local income tax for the following three years. CECT was regarded as a “Hi-tech” enterprise by the PRC government and was subject to PRC enterprise income taxes at a rate of 15%. CECT was exempted from PRC enterprise income tax for the period from May 22, 2000 to December 31, 2002, and was entitled to a 50% reduction in state income tax and full exemption in local income tax for the following three years.

On March 16, 2007, the Fifth Plenary Session of the Tenth National People’s Congress passed the PRC Enterprise Income Tax Law (the “New Tax Law”) which took effect on January 1, 2008. According to the New Tax Law, from January 1, 2008, domestic enterprises and foreign investment enterprises will be subject to a unified enterprise income tax rate of 25%. However, certain qualifying high-technology enterprises may still benefit from a preferential tax rate of 15% under the New Tax Law if they meet the definition of a “qualifying high-technology enterprise” to be set forth in the more detailed implementing rules when they are adopted. As a result, if CECT qualifies as a “qualifying high-technology enterprise”, it will continue to benefit from a preferential tax rate of 15%. Otherwise, CECT’s applicable tax rate will increase from its existing tax rate of 15% to the unified tax rate of 25% effective January 1, 2008. On the implementation of the preferential treatment for “qualifying high-technology enterprise” under the New Tax Law, the Chinese government has taken the first step in creating a mechanism to review the qualifications of “high-technology enterprise” with the issuance of “Circular 172” on April 14, 2008. This guidance, however, is not detailed enough and specifies that additional detailed guidelines will be issued.

Under the New Tax Law and before obtaining any “qualifying high-technology enterprise” status, the Group’s PRC subsidiaries would be subject to enterprise income tax at a rate of 25% commencing from the year beginning January 1, 2008. The deferred tax assets and liabilities of the Group’s PRC subsidiaries as of December 31, 2007 have been measured using the enacted tax rate of 25% that is expected to apply in the years in which those temporary differences are expected to be recovered or settled. In the event that any of the Group’s subsidiaries is subsequently granted the “qualifying high-technology enterprise” status under the New Tax Law, adjustments will be made to the deferred tax balance of the Group in the year that such status is obtained.

The New Tax Law also imposes a 10% withholding income tax on dividends distributed by a foreign invested enterprise to its immediate non-PRC tax resident holding company outside China for distribution of earnings generated after January 1, 2008. Under the New Tax law, the distribution of earnings generated prior to January 1, 2008 is exempt from the withholding tax and therefore, the Company has not recognized a deferred tax liability for the undistributed earnings of its subsidiaries through December 31, 2007.

F-47

Provision of income tax in the consolidated statement of operations and comprehensive income consists of:


	2005			2006			2007
	RMB’000			RMB’000			RMB’000			US$’000
PRC income tax on current year’s profit
- current		27,813			62,904			136,058			18,652
- deferred		(2,327	)		(8,003	)		(11,938	)		(1,637	)
Under provision of current income tax in respect of prior years		—			3,291			—			—

		25,486			58,192			124,120			17,015

The reconciliation of the PRC statutory income tax rate to the effective income tax rate based on income before income tax stated in the consolidated statements of operations and comprehensive income is as follows:


	2005			2006			2007
PRC statutory income tax rate		33.0	%		33.0	%		33.0	%
Tax effect of preferential tax rates		(28.1	%)		(71.1	%)		(11.8	%)
Losses (gains) of BVI companies not subject to tax		1.1	%		78.5	%		(11.0	%)
Non-deductible activities		0.4	%		16.2	%		0.9	%
Changes in valuation allowance		1.3	%		(6.0	%)		(0.2	%)
Effect of changes in expected future tax rates		—			—			(0.4	%)

Effective income tax rate		7.7	%		50.6	%		10.5	%

Deferred income tax assets reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of those amounts shown on the consolidated balance sheets as of December 31, 2006 and 2007 were as follows:

Deferred tax assets — current portion


	2006			2007
	RMB’000			RMB’000		US$’000
Allowance for doubtful accounts		845			2,405		330
Write-off of obsolete and slow-moving inventories		3,849			8,974		1,230
Provision for product warranties		1,230			1,971		270
Tax losses carried forward		2,451			—		—

		8,375			13,350		1,830
Valuation allowance		(2,451	)		—		—

Deferred income tax assets		5,924			13,350		1,830

Deferred tax liabilities — non-current portion

F-48


	2006			2007
	RMB’000			RMB’000			US$’000
Property, machinery and equipment		2,212			3,268			448
Land use rights		—			281			39
Other acquired intangible assets		(13,952	)		(9,110	)		(1,249	)

Deferred income tax liabilities		(11,740	)		5,561			762

Changes in the valuation allowance were as follows:


	2006			2007
	RMB’000			RMB’000			US$’000
Beginning of year		8,952			2,451			336
Increase in valuation allowance		617			—			—
Release of valuation allowance		(7,118	)		(2,451	)		(336	)

End of year		2,451			—			—

The release of the valuation allowance during the years ended December 31, 2006 and 2007 arose mainly from the reversal of allowances that were no longer required.

Taxation payable comprises:


	2006		2007
	RMB’000		RMB’000		US$’000
PRC enterprise income tax		32,342		64,566		8,851
PRC value-added tax		12,964		7,990		1,096
PRC other taxes		966		745		102

		46,272		73,301		10,049

As of December 31, 2007, the Group has no material unrecognized tax benefit which would favorably affect the effective income tax rate in future periods and does not believe that there will be any significant increases or decreases of unrecognized tax benefits within the next twelve months. No interest or penalties relating to income tax matters have been imposed on the Group during the year ended December 31, 2007 and no provision for interest and penalties is deemed necessary as of December 31, 2007.

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or its withholding agent. The statute of limitations extends to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion.

F-49

22. DISTRIBUTION OF INCOME

Substantially all of the Group’s income is contributed by QXCI and CECT, equity joint venture enterprises established in the PRC. Income of QXCI and CECT, as determined under PRC GAAP, is distributable to their joint venture partners after transfer to dedicated reserves, namely, the general reserve, the enterprise expansion fund and the staff welfare and bonus fund as required under the PRC Company Law and the articles of association of the respective company. Under the relevant regulations, QXCI and CECT are required to transfer at least 10% of their annual PRC GAAP income to the general reserve until such reserve reaches 50% of their registered capital.

23. EARNINGS (LOSS) PER COMMON SHARE

The following represents a reconciliation from basic earnings (loss) per common share to diluted earnings (loss) per common share:


	2005		2006			2007
	RMB		RMB			RMB			US$
Net income (loss) before extraordinary items		207,307,000		(34,071,000	)		886,352,000			121,508,000
Amount allocated to participating convertible notes		—		—			(156,417,000	)		(21,443,000	)

Net income (loss) before extraordinary items available to common stockholders		207,307,000		(34,071,000	)		729,935,000			100,065,000


Extraordinary items		37,592,000		14,237,000			17,596,000			2,412,000
Amount allocated to participating convertible notes		—		—			(3,105,000	)		(425,000	)

Extraordinary items available to common stockholders		37,592,000		14,237,000			14,491,000			1,987,000


Net income (loss) after extraordinary items available to common stockholders		244,899,000		(19,834,000	)		744,426,000			102,052,000


Net income (loss) before extraordinary items available to common stockholders		207,307,000		(34,071,000	)		729,935,000			100,065,000
Add: Interest on 4.5% Notes		—		14,636,000			—			—
Less: Gain on remeasurement of embedded derivatives relating to 4.5% Notes		—		(29,449,000	)		—			—

Fully diluted net income (loss) before extraordinary items available to common stockholders		207,307,000		(48,884,000	)		729,935,000			100,065,000
Extraordinary items available to common stockholders		37,592,000		14,237,000			14,491,000			1,987,000

Fully diluted net income (loss) after extraordinary items available to common stockholders		244,899,000		(34,647,000	)		744,426,000			102,052,000


Weighted average common shares basic		18,319,000		23,712,000			29,836,000			29,836,000
Effect of dilutive stock options, warrants and convertible notes		1,000		304,000			364,000			364,000

F-50


	2005		2006			2007
	RMB		RMB			RMB		US$
Weighted average common shares diluted		18,320,000		24,016,000			30,200,000		30,200,000


Basic earnings (loss) per common share:
Before extraordinary items		11.32		(1.44	)		24.46		3.35
Extraordinary items		2.05		0.60			0.49		0.07

After extraordinary items		13.37		(0.84	)		24.95		3.42


Diluted earnings(loss) per common share:
Before extraordinary items		11.32		(2.03	)		24.17		3.31
Extraordinary items		2.05		0.59			0.48		0.07

After extraordinary items		13.37		(1.44	)		24.65		3.38

Except for certain outstanding warrants of the Company, all common stock equivalents had an anti-dilutive effect and accordingly, were excluded from the computation of diluted loss per share for the year ended December 31, 2007. For the year ended December 31, 2006, only the 4.5% Notes had a dilutive effect on earnings per share.

24. RETIREMENT PLAN

Since December 1, 2000, the Group has arranged for its Hong Kong employees to join the Mandatory Provident Fund Scheme (the “MPF Scheme”), a defined contribution scheme managed by an independent trustee. Under the MPF Scheme, each company within the Group (employer) and their employees make monthly contributions to the scheme at 5.0% of the employees’ earnings as defined under the Mandatory Provident Fund legislation, subject to a maximum cap of HK$1,000 (RMB1,003) per month and additional contributions thereafter are voluntary.

Presently, the Group’s employees in the PRC are mainly employed by QXCI and CECT. As stipulated by PRC regulations, QXCI and CECT maintained defined contribution retirement plans for all of their employees who are residents of the PRC. All retired employees are entitled to an annual pension equal to their basic annual salary upon retirement. QXCI and CECT contribute to a state sponsored retirement plan with amounts stipulated by the local government of the PRC and have no further obligations for the actual pension payments or post-retirement benefits beyond the annual contributions. The state sponsored retirement plan is responsible for the entire pension obligations payable to all employees.

For the year ended December 31, 2007, the aggregate employer’s contributions made by the Group amounted to approximately RMB1,438,000 (US$197,000) (2006: RMB1,263,000; 2005; RMB1,181,000).

F-51

25. COMMITMENTS AND CONTINGENCIES

(a) Capital commitments

Capital commitments not provided for in the consolidated financial statements include the followings:


	2006		2007
	RMB’000		RMB’000		US$’000
Capital expenditures authorized and contracted for:
- Purchase of machinery and equipment		130		130		18
- Construction of factory premises and staff quarters		39,031		—		—
- Purchase of land use rights (Note 9(a))		58,700		—		—

		97,861		130		18

(b) Operating lease commitments


	Amount
	RMB’000		US$’000
For the years ending December 31,
- 2008		5,274		723
- 2009		3,052		418
- 2010		3,052		418

Total		11,378		1,559

Lease expense of the Group for the year ended December 31, 2007 was approximately RMB6,413,000 (US$879,000) (2006: RMB5,712,000; 2005: RMB4,445,000).

In connection with the restatement of the Company’s financial statements for the years ended December 31, 2003, 2004 and 2005, five putative class actions were filed against the Company in the United States District Court for the Southern District of New York during the year ended December 31, 2007. The complaints alleged violations of the United States federal securities laws by the Company and certain of its executives and seek unspecified damages, attorney fees and other unspecified litigation costs.

A mediation was held on January 10, 2008 and the parties agreed to settle the case for US$2,400,000. The Company’s Director and Officer (“D&O”) insurance carrier, has agreed to contribute US$300,000 of the settlement amount. A Stipulation of Settlement was executed on February 25, 2008 and the preliminary order was signed on April 2, 2008. In April 2008, US$1,200,000 of the agreed settlement amount was paid into an escrow account, of which US$900,000 was paid by the Company and the balance US$300,000 by the Company’s D&O insurance carrier. The final fairness hearing is scheduled for July 11, 2008.

F-52

In accordance with SFAS No.5, “Accounting for Contingencies,” the Company has made a provision of US$2,100,000 (RMB15,319,000) for the potential losses that may result from the class actions (Note 16).

26. SUBSEQUENT EVENTS

(a) On January 7, 2008, QXMC issued 565,000 shares of its common stock at US$7.50 per share further to the exercise of share options that were granted to a director and certain of its employees under the QXMC 2007 Stock Plan. Upon the completion of the share issuance, the Group’s equity interest in QXMC was reduced to approximately 60.7%.

(b) On January 21, 2008, CECT incorporated a wholly-owned subsidiary, Huizhou CEC Telecom Co., Ltd. (“HCECT”), in Huizhou, Guangdong Province, the PRC to engage in the manufacture of molds, cast components and other handset products. The registered and paid-up capital of HCECT, which has a permitted operating period of 10 years till January 21, 2018, amounted to RMB20,000,000.

(c) Pursuant to a Securities Purchase Agreement and Registration Rights Agreement signed on May 15, 2008, QXMC issued to two of its existing shareholders (the “Investors”) US$70,000,000 worth of 3-year senior convertible notes (the “Notes”) with warrants. The Notes have a 4% annual coupon and are redeemable at par on maturity. The consideration paid by the Investors for the Notes comprised a combination of 6,966,666 shares of the QXMC’s common stock that were owned by the Investors, valued at approximately US$48,349,000, and cash of US$21,651,000. All shares submitted by the Investors in exchange for the Notes were cancelled. Upon the completion of this transaction, the Group’s equity interest in QXMC was increased to approximately 69.9%.

F-53

27. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

(a) On June 30, 2004, CECT disposed of a 40% shareholding interest in CECM to an independent third party for cash consideration of RMB72,000,000. Thereafter, CECT’s shareholding interest in CECM was reduced to 10% (Note 10). Of the total consideration of RMB72,000,000, RMB21,600,000 was received during the year ended December 31, 2004 while RMB50,400,000 was received during the year ended December 31, 2005.

(b) As more fully described in Note 11(a), QXMC purchased an additional 25% equity interest in CECT on July 31, 2005. Part of the purchase consideration was the company’s investment in CEFCL, which had a carrying value of RMB20,000,000 at July 31, 2005, and the company’s net investment in BJHTCL. At July 31, 2005, the carrying amounts of BJHTCL’s assets and liabilities that were transferred to QXCI (and thereafter to CEC) in the above transaction consisted of:


	RMB’000
Cash and cash equivalents		126
Other receivables		751
Property, machinery and equipment		37,826
Land use rights		1,383

Net assets disposed of		40,086

The net cash outflow in respect of the acquisition of the minority interests of CECT and the disposal of BJHTCL during the year ended December 31, 2005 is as follows:


	RMB’000
Cash consideration		4,607
Cash and cash equivalents disposed of		126
Less: Prepaid consideration as of December 31, 2004		(1,000	)
Less: Unpaid consideration as at December 31, 2005		(3,607	)

Net cash outflow in respect of acquisition of minority interests		126

(c) During the year ended December 31, 2007, the Group disposed of certain parcels of land and the related construction-in-progress to an independent third party for a total cash consideration of RMB288,904,000. As of December 31, 2007, a total of RMB180,000,000 had been received by the Group. The balance of the consideration of RMB108,904,000 is receivable within seven days after the completion of the legal transfer of the relevant titles to the purchaser.

F-54

28. RELATED PARTY TRANSACTIONS

Name and relationship of related parties:


Name of related parties		Existing relationship with the Company
Mr. Zhi Jian Wu Li		Major shareholder
Mr. Rui Lin Wu		Director and father of Mr. Zhi Jian Wu Li
Wu Holdings Limited		Intermediate holding company
Exquisite Jewel Limited		Minority shareholder
Metrolink Holdings Limited		Minority shareholder
Specialist Consultants Limited		Minority shareholder
Qiao Xing Group Limited (“QXGL”)		Common director and minority shareholder of CECT, QXCI and QXPL
Huizhou Qiaoxing Famous Science & Technology Co., Ltd. (“QFST”)		A company 80% owned by QXGL
China Electronics Corporation (“CEC”)		Minority owner of CECT until July 29, 2005
China Electronics Beijing Real Estate Management Co., Ltd. (“CEBREM”)		CEC is a shareholder

Summary of related party transactions is as follows:


	2005		2006		2007
	RMB’000		RMB’000		RMB’000		US$’000
Operating lease rentals charged by CEC		1,325		—		—		—
Property management fees paid and payable to:
- CEBREM		852		—		—		—
- QXGL		61		90		100		14
Sales to:
- QFST		41,928		69,232		95,514		13,094

Other transactions with related parties are set out in Note 1, 9, 11(a), 14 and 18 to the consolidated financial statements.

F-55

29. SEGMENT ANALYSIS

The Group currently operates in two principal business segments. Management believes that the following table presents the useful information to the chief operation decision makers for measuring business performance and financing needs, and preparing the corporate budget, etc. The Group’s accounting systems do not capture the total assets for each segment. As most of the Group’s customers are located in the PRC and the Group’s revenues are generated in the PRC, no geographical segment information is presented.


	Mobile Phones		Indoor Phones		Corporate		Total
	RMB’000		RMB’000		RMB’000		RMB’000
2005
Revenue		2,380,531		254,653		—		2,635,184
Gross margin		439,218		39,168		—		478,386
Inventories		219,272		16,825		—		236,097
Property, machinery and equipment		50,506		2,158		—		52,664
Expenditures for long-lived assets		12,505		265		8,171		20,941

2006
Revenue		2,985,432		235,780		—		3,221,212
Gross margin		528,303		41,517		—		569,820
Inventories		213,688		18,668		—		232,356
Property, machinery and equipment		207,887		1,645		10		209,542
Expenditures for long-lived assets		207,379		109		1,200		208,688

2007
Revenue		3,636,431		237,676		—		3,874,107
Gross margin		943,753		31,390		—		975,143
Inventories		289,937		14,087		—		304,024
Property, machinery and equipment		190,785		1,709		107		192,601
Expenditures for long-lived assets		5,842		549		645		7,036

F-57

(b) The following exhibits are being filed as part of this annual report on Form 20-F:



Exhibit 1.1		Memorandum of Association of the Company — incorporated by reference to the Exhibits to our Registration Statement on Form F-1, SEC File No. 333-9274, declared effective on February 16, 1999.

Exhibit 1.2		Articles of Association of the Company — incorporated by reference to the Exhibits to our Registration Statement on Form F-1, SEC File No. 333-9274, declared effective on February 16, 1999.

Exhibit 4.1		Securities Purchase Agreement dated as of August 17, 2007 covering the sale of $25,000,000 of our 5.5% senior convertible notes and common stock purchase warrants*

Exhibit 4.2		Form of 5.5% Senior Convertible Note issued pursuant to the Securities Purchase Agreement dated as of August 17, 2007*

Exhibit 4.3		Form of Warrant issued pursuant to the Securities Purchase Agreement dated as of August 17, 2007*

Exhibit 4.4		Non-competition Agreement, dated April 12, 2007, among Qiao Xing Universal Telephone, Inc., Huizhou Qiao Xing Communication Industry, Ltd., Mr. Rui Lin Wu and Qiao Xing Mobile Communication Co., Ltd.**

Exhibit 8.1		List of Significant Subsidiaries of the Company

Exhibit 11.1		Code of Ethics***

Exhibit 12.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)

Exhibit 12.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)

Exhibit 13.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350

Exhibit 13.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350


*		- incorporated by reference to the Exhibits to our Report on Form 6-K filed with the SEC on August 21, 2007, SEC File No. 000-29946.

**		- incorporated by reference to the Exhibits to our annual report on Form 20-F for the fiscal year ended December 31, 2006.

***		- incorporated by reference to the Exhibits to our annual report on Form 20-F for the fiscal year ended December 31, 2003.

143

INDEX TO EXHIBITS

DESCRIPTION


Exhibit 1.1		Memorandum of Association of the Company — incorporated by reference to the Exhibits to our Registration Statement on Form F-1, SEC File No. 333-9274, declared effective on February 16, 1999.

Exhibit 1.2		Articles of Association of the Company — incorporated by reference to the Exhibits to our Registration Statement on Form F-1, SEC File No. 333-9274, declared effective on February 16, 1999.

Exhibit 4.1		Securities Purchase Agreement dated as of August 17, 2007 covering the sale of $25,000,000 of our 5.5% senior convertible notes and common stock purchase warrants*

Exhibit 4.2		Form of 5.5% Senior Convertible Note issued pursuant to the Securities Purchase Agreement dated as of August 17, 2007*

Exhibit 4.3		Form of Warrant issued pursuant to the Securities Purchase Agreement dated as of August 17, 2007*

Exhibit 4.4		Non-competition Agreement, dated April 12, 2007, among Qiao Xing Universal Telephone, Inc., Huizhou Qiao Xing Communication Industry, Ltd., Mr. Rui Lin Wu and Qiao Xing Mobile Communication Co., Ltd.**

Exhibit 8.1		List of Significant Subsidiaries of the Company

Exhibit 11.1		Code of Ethics***

Exhibit 12.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)

Exhibit 12.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)

Exhibit 13.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350

Exhibit 13.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350


*		- incorporated by reference to the Exhibits to our Report on Form 6-K filed with the SEC on August 21, 2007, SEC File No. 000-29946.

**		- incorporated by reference to the Exhibits to our annual report on Form 20-F for the fiscal year ended December 31, 2006

***		- incorporated by reference to the Exhibits to our annual report on Form 20-F for the fiscal year ended December 31, 2003


	QIAO XING UNIVERSAL TELEPHONE, INC. (Registrant)
Date: July 14, 2008	By:	/s/ RUI LIN WU
		Rui Lin Wu
		Chairman