KONGZHONG CORPORATION

Table of Contents

Table of Contents

Table of Contents

1934 Act Registration No. 000-50826

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 6-K

Report of Foreign Issuer
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934

For the Month of August 2005

KONGZHONG CORPORATION

(Translation of registrant’s name into English)

35/F, Tengda Plaza, No. 168 Xizhimenwai Street
Beijing, China 100044
(Address of principal executive offices)

(Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.)

Form 20-F þ Form 40-F o

(Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1): ___)

(Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): ___)

(Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.)

Yes o No þ

(If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b):82- .)

TABLE OF CONTENTS


EXHIBITS
SIGNATURES
EX-1.1 AGM NOTICE TO ORDINARY SHAREHOLDERS
EX-1.2 FORM OF PROXY
EX-1.3 DEPOSITARY'S NOTICE OF SHAREHOLDERS MEETING
EX-1.4 KONGZHONG CORPORATION ANNUAL REPORT

EXHIBITS


Exhibit Number
1.1		AGM Notice to Ordinary Shareholders

1.2		Form of Proxy

1.3		Depositary’s Notice of Shareholders’ Meeting of KongZhong Corporation

1.4		KongZhong Corporation Annual Report

FORWARD-LOOKING STATEMENTS

The Annual Report, AGM Notice to Ordinary Shareholders and other materials relating to the annual general meeting of KongZhong Corporation (the “Company”), constituting Exhibits 1.1-1.4 to this Form 6-K, contain statements that may be viewed as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Such forward-looking statements are, by their nature, subject to significant risks and uncertainties that may cause the actual performance, financial condition or results of operations of the Company to be materially different from any future performance, financial condition or results of operations implied by such forward-looking statements. Such forward-looking statements include, without limitation, statements that are not historical fact relating to the financial performance and business operations of the Company, the continued growth of the telecommunications industry in China, the development of the regulatory environment, the Company’s ability to successfully execute its business strategies and the effect of the proposals that the Board of Directors is placing before the shareholders.

Such forward-looking statements reflect the current views of the Company with respect to future events and are not a guarantee of future performance. Actual results may differ materially from information contained in the forward-looking statements as a result of a number of factors, including, without limitation, any changes in the regulatory policies of the Ministry of Information Industry and other relevant government authorities; changes in the Company’s relationships with the telecommunications operators; changes in customer preference or demand; changes in telecommunications and related technology and applications based on such technology; and changes in political, economic, legal and social conditions in China, including the Chinese government’s policies with respect to economic growth, foreign exchange, foreign investment and entry by foreign companies into China’s telecommunications market. Please also see the “Risk Factors” section of the Company’s registration statement on Form F-1 (File No. 333-116172), as filed with the Securities and Exchange Commission.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Date: August 9, 2005	KONGZHONG CORPORATION
	By:	/s/ Yunfan Zhou
	Name:	Yunfan Zhou
	Title:	Chairman and Chief Executive Officer

KongZhong Corporation
35th Floor, Tengda Plaza
No. 168 Xizhimenwai Street
Beijing, China 100044
(NASD: KONG)

FORM OF PROXY FOR USE AT THE ANNUAL GENERAL MEETING OF SHAREHOLDERS TO BE HELD AT THE 35TH FLOOR, TENGDA PLAZA, NO. 168 XIZHIMENWAI STREET, BEIJING, CHINA ON TUESDAY, SEPTEMBER 6, 2005 AT 2 P.M.

I/We^{Note 1}
of
being the registered holder(s) of                                                                             shares of par value
US$0.0000005 each^{Note 2} in the capital of KongZhong Corporation (the “Company”) HEREBY APPOINTS THE CHAIRMAN OF THE MEETING or^{Note 3}
of                                                                                                                                  or failing him                                                                                       of                                                                                                                                                       to act as my/our proxy to attend, act and vote on my/our behalf at the Annual General Meeting of the Company to be held at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China on Tuesday, September 6, 2005 at 2 p.m. and at any adjournment thereof, as the case may be, for the purpose of considering and, if thought fit, passing the following resolutions set out in the Notice of 2005 Annual General Meeting of Shareholders.

Please indicate with a “þ” in the spaces provided how you wish your votes to be cast on a poll. If you wish to vote for the below resolutions, check the appropriate boxes marked “For”. If you wish to vote against the below resolutions, check the appropriate boxes marked “Against”. Should this form be returned duly signed but without a specific direction, the proxy will vote or abstain at his or her discretion.


Special Resolutions	For	Against
Proposal No. 1. To Allow for Shareholder Voting by a Show of Hands

IT WAS RESOLVED, as a Special Resolution, THAT:

Article 66 of the Articles of Association of the Company be and is hereby amended by the deletion of the words “the holder of each Share issued and


		Special Resolutions	For	Against
outstanding shall have one vote for each Share held by such holder” and the addition, after the words “Except as otherwise required by law or as set forth herein,” of the words “on a show of hands every Member of record present in person or by proxy at a general meeting shall have one vote and on a poll every Member of record present in person or by proxy shall have one vote for each Share held by such Member.”

Proposal No. 2. To Create a Staggered Board

IT WAS RESOLVED, as a Special Resolution, THAT:

(i)	Article 81 of the Articles of Association of the Company be and is hereby amended by the addition of the words “Subject to Article 118(a)” before the words “Each Director;” and

(ii)	Article 82 of the Articles of Association of the Company be and is hereby deleted in its entirety; and

(iii)	Article 117 of the Articles of Association of the Company be and is hereby substituted in its entirety with the following:

		“The Directors shall be divided into three classes, designated Class I, Class II, and Class III, as nearly equal in number as the then total number of directors permits. At the 2005 annual meeting of shareholders, all Directors shall stand for election. Class I Directors shall be elected for a one-year term, Class II Directors for a two-year term and Class III Directors for a three-year term. At each succeeding annual meeting of shareholders beginning in 2006, successors to the class of Directors whose terms expire at that annual meeting shall be elected for a three-year term. If the number of Directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of Directors in each class as nearly equal as possible, and any additional Directors of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent Director. Notwithstanding the foregoing, whenever the holders of any one or more classes or series of preferred share issued by the Company shall have the right, voting separately by class or series, to elect Directors at an annual or special meeting of shareholders, the election, term of office, filling of vacancies and other features of such directorships shall be governed by the applicable terms of these Articles and any certificate of designation creating such class or series of preferred share, and such Directors so elected shall not be divided into classes


		Special Resolutions		For	Against
		pursuant to this Article 117 or considered part of such classes unless expressly provided by such terms.”

	and

(iv)	Article 118(a) of the Articles of Association of the Company be and is hereby substituted in its entirety with the following:

		“The Members may by Special Resolution at any time remove any Director for negligence or other reasonable cause before the expiration of his period of office notwithstanding anything in these Articles or in any agreement between the Company and such Director, and may by ordinary resolution elect another person in his stead. Any person so elected shall hold office during such term only as the Director in whose place he is elected would have held the same if he had not been removed. Subject to Article 117, the Directors shall have power at any time and from time to time to appoint any person to be a Director, either as an addition to the existing Directors or to fill a vacancy resulting from death, resignation, retirement, disqualification, removal from office or any other reason, but so that the total amount of Directors (exclusive of alternate directors) shall not at any time exceed the number fixed in accordance with these Articles.”

Proposal No. 3. To End Directors’ Terms Due to Conflict of Interest

IT WAS RESOLVED, as a Special Resolution, THAT:

Article 116 of the Articles of Association of the Company be and is hereby amended by adding the word “or” at the end of clause (d) and adding new clause (e) as follows:

		“(e)	if (i) he becomes an agent, employee, officer, manager or controlling person, or the owner (either of record or beneficially) of twenty percent (20%) or more of any outstanding class of shares, of any corporation (other than one controlled by the Company) or any business that the Directors, at a meeting duly convened, determine by at least a majority of the vote to be competitive or adverse to that of the Company or any of its subsidiaries, and (ii) the Directors, at a meeting duly convened, deem such Director to have a conflict of interest. In determining whether or not a person is a controlling person or beneficial owner, the Directors may take into account such factors as business and family relationships.

Proposal No. 4. To Authorize Share Repurchases


Special Resolutions	For	Against
IT WAS RESOLVED, as a Special Resolution, THAT:

Article 19(b) of the Articles of the Company be and is hereby substituted in its entirety with the following: “Subject to the Companies Law and the Memorandum, the Directors may from time to time cause the Company to repurchase its own shares (including fractions of a share) and may make payment therefore in any manner authorized by the Companies Law, including out of capital. Such repurchases shall be made in such amount, in such manner and at such price as the Directors deem to be in the best interests of the Company and the Members. The Company shall have no obligation to repurchase such shares on a pro rata basis.”


	Ordinary Resolutions		For	Against
Proposal No. 5. To Re-elect Directors (on the condition that Proposal No. 2 has been approved)

IT WAS RESOLVED, as an Ordinary Resolution, THAT:

	(a)	Hanhui Sun be and hereby is re-elected as a director for a one-year term.

	(b)	Yunfan Zhou be and hereby is re-elected as a director for a two-year term.

	(c)	Yongqiang Qian be and hereby is re-elected as a director for a two-year term.

	(d)	Nick Yang be and hereby is re-elected as a director for a three-year term.

	(e)	Charlie Y. Shi be and hereby is re-elected as a director for a three-year term.

Proposal No. 6. To Increase the Number of Shares that May be Issued Under the Equity Option Plan

IT WAS RESOLVED, as an Ordinary Resolution, THAT:

The KongZhong Corporation 2002 Equity Incentive Plan (the “Plan”) be and is hereby amended to increase the number of shares that may be issued pursuant to the Plan from the current total of 105,000,000 shares to a new total of 137,000,000 shares.


Ordinary Resolutions	For	Against
Proposal No. 7. To Reappoint Our Independent Auditors

IT WAS RESOLVED, as an Ordinary Resolution, THAT:

Deloitte Touche Tohmatsu be and hereby is reappointed as the Company’s independent auditor for the fiscal year 2005, to hold office until the next Annual General Meeting.

Dated Signature(s)^{Note 4}


^{Note 1}		Full name(s) and address(es) to be inserted in BLOCK CAPITALS. In the case of joint holders of a share, any one of such persons may vote at the Annual General Meeting, either personally or by proxy, in respect of such share as if he or she was solely entitled thereto, but if more than one such joint holders is present at the Annual General Meeting, personally or by proxy, that one of the said persons so present whose name stands first on the register of Members of the Company in respect of such shares shall alone be entitled to vote in respect thereof.

^{Note 2}		Please insert the number of share registered in your name(s). If no number is inserted, this form of proxy will be deemed to relate to all the shares in the capital of the Company registered in your name(s).

^{Note 3}		If any proxy other than the Chairman is preferred, strike out THE CHAIRMAN OF THE MEETING and insert the name and address of the proxy desired in the space provided. ANY ALTERNATION MADE TO THIS FORM OF PROXY MUST BE INITIALLED BY THE PERSON WHO SIGNS IT. The proxy need not be a Member of the Company but must attend the Annual General Meeting in person to represent you.

^{Note 4}		This form of proxy must be signed by your or your attorney duly authorized in writing or, in the case of a corporation, must be either under its common seal or under the hand of an officer, attorney or other person duly authorized the sign the same.

To be valid, this form of proxy, together with the power of attorney or other authority (if any) under which it is signed or a notarially certified copy thereof, must be deposited at the Company offices at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China 100044 no later than August 30, 2005, 10 a.m. Beijing time. Completion and delivery of this form will not preclude you from attending and voting at the Annual General Meeting in person if you so wish, but the authority of your proxy will become invalid forthwith.

KongZhong Corporation

35th Floor, Tengda Plaza
No. 168 Xizhimenwai Street
Beijing, China 100044

August 9, 2005

Dear Shareholder:

You are cordially invited to attend the 2005 Annual General Meeting of Shareholders of KongZhong Corporation. We will hold the meeting on September 6, 2005 at 2 p.m., Beijing time, at our offices on the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China. We hope that you will be able to attend.

Enclosed you will find a notice setting forth the business expected to come before the Annual General Meeting, our Proxy Statement, a form of proxy card and a copy of our 2004 Annual Report. At this year’s Annual General Meeting, the agenda includes proposals relating to creating a staggered Board of Directors with a three-year term of office, re-electing the five-member Board, authorizing the board to cause the Company to repurchase its own shares from time to time, increasing the number of shares that may be issued under the Company’s equity option plan and reappointing the Company’s independent auditors to hold that office until the next annual general meeting.

Our Board of Directors has decided that each of the proposals is in the best interests of the Company and its shareholders and therefore recommends that you vote FOR each of these proposals.

Your vote is very important to us. Whether or not you plan to attend the Annual General Meeting in person, your shares should be represented and voted. After reading the enclosed Proxy Statement, please complete, sign, date and promptly return the proxy card in the self-addressed envelope that we have included for your convenience. Submitting the proxy before the Annual General Meeting will not preclude you from voting in person at the Annual General Meeting should you decide to attend.

Sincerely,

Yunfan Zhou
Chief Executive Officer
Beijing, China

KongZhong Corporation

35th Floor, Tengda Plaza
No. 168 Xizhimenwai Street
Beijing, China 100044

Notice of 2005 Annual General Meeting of Shareholders

August 9, 2005

The 2005 Annual General Meeting of Shareholders of KongZhong Corporation will be held at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China, on September 6, 2005, at 2 p.m., Beijing time, for the following purposes:

	1.		To receive the financial statements for the fiscal year ended December 31, 2004 and the auditors’ report thereon;

	2.		To approve a Special Resolution amending the Articles of Association to permit voting at shareholder meetings by a show of hands if a poll is not demanded;

	3.		To approve a Special Resolution amending the Articles of Association so as to create a staggered Board of Directors with all directors serving three-year terms, authorize the directors to appoint additional directors, and allow shareholders to remove any director during his term only for negligence or other reasonable cause;

	4.		To approve a Special Resolution amending the Articles of Association so that the office of a director shall be vacated if he develops a conflict of interest with the Company;

	5.		To approve a Special Resolution amending the Articles of Association so as to authorize the Board of Directors to cause the Company to repurchase its own shares from time to time;

	6.		To elect to our Board of Directors: Hanhui Sun for a one-year term, Yunfan Zhou and Yongqiang Qian for two-year terms and Nick Yang and Charlie Y. Shi for three-year terms;

	7.		To increase the number of shares that may be issued under the Company’s equity option plan;

	8.		To reappoint our independent auditors to hold office until the next annual general meeting; and

	9.		To transact such other business as may properly come before the Annual General Meeting.

Additional information regarding the matters to be acted on at the Annual General Meeting can be found in the accompanying Proxy Statement. All holders of record of the Company’s ordinary shares on August 1, 2005 will be entitled to attend and vote at the Annual General Meeting. This notice of 2005 Annual General Meeting of Shareholders, the Proxy Statement, a form of proxy card and a copy of the Company’s 2004 Annual Report have been sent on or about August 9, 2005 to all holders of record of ordinary shares as of the close of business on August 1, 2005, Beijing time. This notice of 2005 Annual General Meeting of Shareholders, the Proxy Statement and a copy of the Company’s 2004 Annual Report are also available through our website at http://ir.kongzhong.com.

By Order of the Board of Directors,




		Yunfan Zhou
		Chief Executive Officer
		Beijing, China

FOR SHAREHOLDERS: PLEASE MARK, SIGN, DATE AND PROMPTLY RETURN THE PROXY CARD IN THE
ENCLOSED ENVELOPE SO IT IS RECEIVED NO LATER THAN AUGUST 30, 2005, 10 A.M., BEIJING TIME.

KongZhong Corporation

35th Floor, Tengda Plaza
No. 168 Xizhimenwai Street
Beijing, China 100044

PROXY STATEMENT

ANNUAL GENERAL MEETING OF SHAREHOLDERS

September 6, 2005

INTRODUCTION

This Proxy Statement is furnished in connection with a solicitation of proxies by the Board of Directors of KongZhong Corporation, a company incorporated under the laws of the Cayman Islands (the “Company”), to be used at our 2005 Annual General Meeting of Shareholders (the “Annual General Meeting”) to be held at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China, on September 6, 2005, at 2 p.m., Beijing time, and at any adjournments or postponements of the Annual General Meeting. The approximate date on which this Proxy Statement and the accompanying form of proxy card are being sent to shareholders is August 9, 2005.

The Board of Directors has established August 1, 2005 (the “Record Date”) as the date used to determine those record holders of the Company’s ordinary shares to whom the notice of 2005 Annual General Meeting will be sent. On the Record Date, there were 1,375,187,160 ordinary shares outstanding.

If you properly cast your vote by executing and returning the enclosed proxy card and your proxy is not subsequently revoked, your vote will be voted in accordance with your instructions. If you execute and return the enclosed proxy card but do not give instructions as to how to vote, your proxy will be voted FOR each proposal described in this Proxy Statement and otherwise in accordance with the judgment of the person or persons voting the proxy on any other matter properly brought before the Annual General Meeting.

A shareholder executing a proxy may revoke it before it is exercised by giving written notice revoking the proxy to our Secretary, by subsequently filing another proxy bearing a later date or by attending the Annual General Meeting and voting in person. A vote cast in accordance with the instructions of a proxy shall be valid notwithstanding (i) the death or unsoundness of mind, subsequent to the execution of the proxy but prior to the Annual General Meeting, of the shareholder who executes the proxy, or (ii) revocation of the proxy, if no written instrument setting forth such death, insanity or revocation shall have been received by the Company at its office as specified in the Notice of 2005 Annual General Meeting of Shareholders no later than one hour prior to the commencement of the Annual General Meeting or any adjournments or postponements of the Annual General Meeting. Attending the Annual General Meeting without further action will not automatically revoke your proxy.

Quorum and Voting Requirements

Two shareholders present in person or by proxy and holding shares representing in the aggregate no less than 33 1/3% of the outstanding voting shares will constitute a quorum for the transaction of business at the Annual General Meeting.

The affirmative vote of two-thirds of the outstanding voting shares present in person or by proxy is required to approve Special Resolutions. The affirmative vote of a majority of the outstanding voting shares present in person or by proxy is required to approve all other proposals.

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Expenses of Solicitation

We will pay the expenses of the preparation of proxy materials and the solicitation of proxies for the Annual General Meeting. We will reimburse the depositary bank for our ADSs, Citibank, N.A., for costs incurred by it in mailing proxy materials to ADS holders in accordance with our Deposit Agreement.

Annual Report

A copy of our 2004 Annual Report is enclosed. Our 2004 Annual Report is also available through our website at http://.ir.kongzhong.com. Our Annual Report does not constitute proxy soliciting material.

PROPOSALS

Proposal No. 1. Special Resolution to Allow for Shareholder Voting by a Show of Hands

Our Articles of Association currently provide for one vote per share. This means that each vote taken at a shareholders’ meeting requires a poll, or a count of each shareholder’s share holding, which can be a relatively time-consuming process. Most Cayman Islands companies also have the option of conducting shareholder votes by a show of hands, which gives each shareholder one vote regardless of the number of shares the shareholder owns. A show of hands may be the preferred method of voting when the issue to be decided is procedural, such as accepting the meeting minutes or deciding to adjourn.

The Board proposes that the Articles be amended to allow for the option of voting by a show of hands. If this proposal is approved, voting by poll, or one vote per share, will still be available as an option and may be demanded before or on the declaration of the result of a show of hands by:

	•		the chairman of the AGM; or

	•		any other shareholder or shareholders collectively present in person or by proxy and holding at least ten percent in par value of the shares giving a right to attend and vote at the meeting.

This proposal does not change the proportion of votes needed to pass a resolution, which is two-thirds for a Special Resolution and a simple majority for all other proposals.

The Board recommends a vote FOR allowing shareholder voting by a show of hands.

Proposal No. 2. Special Resolution to Create a Staggered Board

Our Board of Directors (the “Board”) currently consists of five directors. Our Articles of Association (the “Articles”) are silent as to their terms. The Articles allow for the board to consist of as many as 11 directors, but do not currently authorize the Board to appoint new directors to fill the authorized but unfilled Board seats. The Articles currently allow shareholders to remove directors by Special Resolution at any time during their term with or without cause.

The Board proposes that the Articles be amended by Special Resolution to:

	•		create a board with three classes of directors, each class as nearly equal in number as the then total number of directors permits;

	•		set the term of each class of directors at three years, although as part of the process of setting up a staggered board, the initial terms of two classes of directors elected at the 2005 Annual General Meeting would be set at one year and two years, respectively. At each succeeding Annual General Meeting of shareholders beginning in 2006, the terms of one class of directors would expire and their successors would be elected to full three-year terms;

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	•		authorize the Board to appoint directors as additions to the existing directors, up to a total of 11 directors; and

	•		allow shareholders to remove any director during his term only for negligence or other reasonable cause and not without cause.

The purpose of setting a three-year term for directors is to allow for shareholder input in deciding the composition of the Board, whose current members could otherwise continue indefinitely in office.

The purpose of creating a staggered board, authorizing the Board to appoint additional directors and allowing shareholders to remove any director during his term only for cause is to prevent any shareholder from taking control of the Board by removing incumbent directors and filling the vacancies with his own nominees. The proposed amendments to the Articles will encourage any person who wishes to take over the Company to negotiate with the Board, giving the Board an opportunity to examine the takeover offer, determine if it is in the best interests of the Company and the shareholders, and, if the Board determines such a course is warranted, negotiate for the best possible offer.

The Board recommends a vote FOR the creation of a staggered board and related amendments to the Articles.

Proposal No. 3. Special Resolution to End Directors’ Terms Due to Conflict of Interest

Our Articles currently provide that the office of a director shall be vacated if he (a) gives notice in writing that he resigns the office of director, (b) absents himself (without being represented by proxy or an alternate director appointed by him) from three consecutive meetings of the Board without special leave of absence from the directors, and they pass a resolution that he has by reason of such absence vacated office, (c) dies, becomes bankrupt or makes any arrangement or composition with his creditors generally, or (d) is found to be or becomes of unsound mind.

The Board proposes the addition of a fifth circumstance under which the office of a director shall be vacated: namely, if (i) such director becomes an agent, employee, officer, manager or controlling person, or the owner (either of record or beneficially) of twenty percent (20%) or more of any outstanding class of shares, of any corporation (other than one controlled by the Company) or any business that the directors, at a meeting duly convened, determine by at least a majority of the vote to be competitive or adverse to that of the Company or any of its subsidiaries, and (ii) the directors, at a meeting duly convened, deem such director to have a conflict of interest. In determining whether or not a person is a controlling person or beneficial owner, the directors may take into account such factors as business and family relationships.

The Board recommends a vote FOR the vacating of a director’s office due to conflict of interest.

Proposal No. 4. Special Resolution to Authorize Share Repurchases

The Articles currently allow the Company to repurchase its own shares provided that the manner of purchase has first been authorized by the shareholders in a general meeting. The Board proposes that the shareholders give the Board general authority to cause the Company to repurchase its own shares from time to time, in such amount, in such manner and at such price as the Board deems to be in the best interests of the Company. Such share repurchases may lead to an enhancement of the net asset value of the Company, earnings per share or both. A share repurchase may also have the effect of delaying, deferring or preventing a change in control of the Company by raising the price of the Company’s shares on the open market.

In repurchasing shares, the Board may only apply funds legally available for such purpose in accordance with the Memorandum and Articles and the Companies Law of the Cayman Islands. No repurchases of its own shares have been made by the Company to date.

The Board recommends a vote FOR giving the Board general authority to cause the Company to repurchase its own shares.

Proposal No. 5. Ordinary Resolutions to Re-elect Directors (on the condition that Proposal No. 2 has been approved)

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Our Board consists of five directors. Our Articles are currently silent as to the terms of our directors, with the result that they could serve indefinitely. The Board has proposed as Proposal No. 2 that a three-year term be set for directors and also that a staggered board be created. Should Proposal No. 2 be approved, shareholders will be entitled at the 2005 Annual General Meeting to elect all five directors, who will be divided into three classes. As part of the process of creating staggered board, one class of directors will be elected for an initial term of one year only, a second class of directors will be elected for an initial term of two years only, and a third class of directors will be elected for a full three-year term. At each succeeding Annual General Meeting of shareholders beginning in 2006, the terms of one class of directors will expire and their successors will be elected to full three-year terms.

On the condition that Proposal No. 2 has been approved, the Board proposes that Hanhui Sun be elected for a one-year term, Yunfan Zhou and Yongqiang Qian be elected for two-year terms and Nick Yang and Charlie Y. Shi be elected for three-year terms.

All five nominees are currently members of the Board. Set forth below is information regarding the nominees.

Nominee for Election to the Board of Directors for an Initial One-Year Term Expiring in 2006

Hanhui Sun, 32, has been an independent director of the Company since July 1, 2005, when he replaced Fan Zhang, who resigned. Mr. Sun is deputy general manager of the Associated Container Business of Maersk (China) Shipping and is responsible for financial reporting and for the operation of several subsidiaries. He was financial controller of SouFun.com, a real estate portal in China, from 2004 to 2005. From 1995 to 2004, he worked in KPMG’s auditing practice, including eight years at KPMG in Beijing, China, where he was an audit senior manager, and two years at KPMG in Los Angeles, U.S. Mr. Sun earned a bachelor’s degree in business administration from the Beijing Institute of Technology in 1993. He is a certified public accountant in China. Mr. Sun is a member of the Audit Committee. The Board has determined that he is an “Audit Committee financial expert” under the definition of the U.S. Securities and Exchange Commission.

Nominees for Election to the Board of Directors for an Initial Two-Year Term Expiring in 2007

Yunfan Zhou, 30, one of our founders, has served as the chairman of the board of directors of the Company and our chief executive officer since our inception in May 2002. Prior to establishing the Company, Mr. Zhou served as vice president, executive vice president and general manager of Sohu.com Inc., an Internet portal company, from October 2000 to March 2002. In June 1999, Mr. Zhou co-founded ChinaRen Inc., an Internet portal and community company, and served as chief operating officer and general manager until October 2000, when ChinaRen Inc. merged into Sohu.com Inc. Mr. Zhou holds a master’s degree in electrical engineering from Stanford University and a bachelor’s degree in electronic engineering from Tsinghua University.

Yongqiang Qian, 32, has been an independent director of the Company since April 2004. Mr. Qian is also the chief executive officer of New Oriental Online Company, an entity specializing in online education that he founded in December 2000, and the chief executive officer of Beijing Liandong Weiye Development Co. Ltd., an entity specializing in wireless value-added services that he co-founded in October 2000. He was also a director and vice president of Beijing New Oriental Education and Technology Group, the parent company of New Oriental Online Company, from 2000 to 2004. From 1993 to 1997, he was a co-founder and project manager at Beijing New Oriental School, a company providing educational and training services, and an affiliate of Beijing New Oriental Education and Technology Group. Mr. Qian holds an MBA degree from Yale University School of Management and a bachelor’s degree from North China University of Technology. Mr. Qian is a member of the Audit Committee, Nominations Committee and Compensation Committee.

Nominees for Election to the Board of Directors for a Full Three-Year Term Expiring in 2008

Nick Yang, 30, one of our founders, has served as president, director and chief technology officer of the Company since our inception in May 2002. Prior to establishing our Company, Mr. Yang served as vice president of technology and chief technology officer of Sohu.com Inc. from October 2000 to March 2002. In June 1999, Mr. Yang

- 4 -

co-founded ChinaRen Inc. and served as chief technology officer until October 2000, when ChinaRen Inc. merged into Sohu.com Inc. Mr. Yang holds a master’s degree in electrical engineering from Stanford University and a bachelor’s degree from the University of Michigan.

Charlie Y. Shi, 43, has been a director of the Company since September 2002 and an independent director since April 2004. Mr. Shi has been a member of the Investment Committee of CMT China Value Capital Advisors Limited since May 2004. From April 2001 to April 2004, Mr. Shi served as a managing director of China Assets Investment Management Limited, a Hong Kong-based investment management company. China Assets Investment Management Limited is the sole investment manager of China Assets (Holding) Limited, a Hong Kong registered investment fund that owns 100% of the shares of Global Lead Technology Limited, a holding company that held 13.3% of the shares of our Company before our initial public offering and 9.1% immediately afterward. From February 2000 to March 2001, Mr. Shi was the senior vice president of SOFTBANK China Venture Capital Limited. He served as deputy managing director of Toplap Investments Limited, an investment advisory and management subsidiary of China Insurance (Hong Kong) Group, from February 1998 to December 1999, and served at Merrill Lynch & Co. from March 1992 to January 1998, where his last position was assistant vice president. Mr. Shi holds an MBA degree from California Lutheran University and a bachelor’s degree in economics from Fudan University in Shanghai. He is also a graduate of the Harvard Business School Advanced Management Program. Mr. Shi is a member of the Audit Committee, Nominations Committee and Compensation Committee.

The Board recommends a vote FOR the election of each of Hanhui Sun, Yunfan Zhou , Yongqiang Qian, Nick Yang, and Charlie Y. Shi.

Proposal No. 6. Ordinary Resolution to Increase the Number of Shares that May be Issued Under the Equity Option Plan

The KongZhong Corporation 2002 Equity Incentive Plan (the “Plan”) was adopted by the shareholders at a meeting held on June 6, 2002. The Plan initially reserved a total of 70,000,000 ordinary shares for issuance under two categories of options: incentive share options, which may be granted only to officers and employees of the Company or any related corporation, and non-qualified options, which may be granted to any employee, officer, director, consultant or advisor of the Company or any related corporation. On February 15, 2004, the Board increased the number of ordinary shares reserved for issuance under the Plan to 105,000,000, and such increase was approved by the shareholders. As of December 31, 2004, the Company had granted a total of 96,910,000 options that were outstanding, of which 25,737,500 were exercisable as of that date.

The Board proposes that the number of ordinary shares reserved for issuance under the Plan be increased by 32,000,000 to a new total of 137,000,000 so that the Company may continue to use stock options to attract and retain employees, officers and directors.

The Board recommends a vote FOR increasing the number of shares that may be issued under the equity option plan.

Proposal No. 7. Ordinary Resolution to Reappoint Our Independent Auditors

The Board proposes that Deloitte Touche Tohmatsu be reappointed as the Company’s independent auditors for the fiscal year 2005, to hold office until the next Annual General Meeting.

If the appointment of Deloitte Touche Tohmatsu is not approved by the shareholders, Deloitte Touche Tohmatsu will nevertheless remain the Company’s independent auditor until another independent auditor is appointed by the shareholders or until it resigns from such position.

Audit Fees

The table below summarizes the fees that the Company paid or accrued for services provided by Deloitte Touche Tohmatsu for the years ended December 31, 2003 and 2004.

- 5 -


	2003		2004
	(In U.S. dollars)
Audit Fees	$	52,500	$	100,000

Audit Related Fees		¾		549

Tax Fees		—		—

All Other Fees		—		15,224


Total	$	52,500	$	115,773

The Board of Directors recommends a vote FOR appointing Deloitte Touche Tohmatsu as the Company’s independent auditors for the fiscal year 2005, to hold office until the next Annual General Meeting.

OTHER MATTERS

At the date hereof, there are no other matters that the Board of Directors intends to present, or has reason to believe others will present, at the Annual General Meeting. If other matters properly come before the Annual General Meeting, the persons named in the accompanying form of proxy card will vote in accordance with their best judgment with respect to such matters.


		By Order of the Board of Directors,



						Yunfan Zhou

						Chief Executive Officer

Beijing, China
Dated: August 9, 2005

- 6 -

Depositary’s Notice of
Shareholders’ Meeting of
KongZhong Corporation


ADSs:		American Depositary Shares evidenced by American Depositary Receipts (“ADRs”).

ADS CUSIP No.:		50047P104.

ADS Record Date:		August 1, 2005.

Meeting Specifics:		2005 Annual General Meeting of Shareholders - -September 6, 2005 at 2:00 P.M. (local time) at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China.

Meeting Agenda:		Please refer to the Company’s Notice of Meeting enclosed.

ADS Voting Instructions Deadline:		On or before 10:00 A.M. (New York City time) on August 30, 2005.

Deposited Securities:		Ordinary shares, par value U.S. $0.0000005 per share, of KongZhong Corporation, a company incorporated and existing under the laws of the Cayman Islands, and its successors (the “Company”).

ADS Ratio:		40 Ordinary shares to 1 ADS.

Depositary:		Citibank, N.A.

Custodian of Deposited Securities:		Citibank, N.A. — Hong Kong Office.

Deposit Agreement:		Deposit Agreement, dated as of July 14, 2004, by and among the Company, the Depositary and all Holders and Beneficial Owners from time to time of ADRs, evidencing ADSs, issued thereunder.

To be counted, your Voting Instructions need to be received by the Depositary
prior to 10:00 A.M. (New York City time) on August 30, 2005.

Note that if you do not timely return the Voting Instructions to the
Depositary, the Deposited Securities represented by your ADSs may
nevertheless be voted upon the terms set forth in the Deposit Agreement.

The Company has announced that an Annual General Meeting of Shareholders (the “Meeting”) will be held at the date, time and location identified above. A copy of the Notice of Meeting from the Company which includes the agenda for such Meeting is enclosed.*

Holders of ADRs wishing to give voting instructions to the Depositary must sign, complete and return the enclosed Voting Instructions prior to the ADS Voting Instructions Deadline in the enclosed pre-addressed envelope.

Upon timely receipt of signed and completed Voting Instructions from a Holder of ADRs, the Depositary shall endeavor insofar as practicable and permitted under applicable law and the provisions of the Deposited Securities to cause the Custodian to vote (or to cause to be voted by means of the appointment of a proxy or otherwise) the Deposited Securities in respect of which Voting Instructions have been received in accordance with the instructions contained therein.

Please note that pursuant to Section 4.10, of the Deposit Agreement, under the Memorandum of Association and Articles of Association of the Company (as in effect on the date hereof), a poll may be demanded by the Chairman or any other member present in person or by proxy holding at least 10% in nominal value of the total issued shares giving the right to attend and vote at a meeting.

Please further note that, as set forth in Section 4.10 of the Deposit Agreement, in the event voting takes place by show of hands, the Depositary will instruct the Custodian to vote all Deposited Securities in accordance with the voting instructions received from a majority of holders of ADSs who provided voting instructions. In the event of voting by poll, Deposited Securities for which no timely voting instructions have been received will not be voted (but all Deposited Securities will be represented at the meeting for quorum purposes if any timely voting instructions have been received from Holders).

Please also note that, in accordance with and subject to the terms of Section 4.10 of the Deposit Agreement, if the Depositary timely receives voting instructions from a Holder which fail to specify the manner in which the Depositary is to vote the Deposited Securities represented by such Holder’s ADSs, the Depositary will deem such Holder (unless otherwise specified in the notice distributed to Holders) to have instructed the Depositary to vote in favor of the items set forth in such voting instructions. The Depositary shall, if so requested in writing by the Company, represent all Deposited Securities for the sole purpose of establishing a quorum at a meeting of shareholders.

Voting instructions may be given only in respect of a number of ADSs representing an integral number of Deposited Securities.

The information contained herein with respect to the Meeting has been provided by the Company. Citibank, N.A. is forwarding this information to you solely as Depositary and in accordance with the terms of the Deposit Agreement and disclaims any responsibility with respect to the accuracy of such information. Citibank, N.A. does not, and should not be deemed to, express any opinion with respect to the proposals to be considered at the Meeting. The rights and obligations of Holders and Beneficial Owners of ADSs, the Company


*		As set forth in Section 4.10 of the Deposit Agreement, Holders of record of ADRs as of the close of business on the ADS Record Date, will be entitled, subject to any applicable law, the provisions of the Deposit Agreement, the Memorandum of Association and Articles of Association of the Company, and the provisions of or governing the Deposited Securities, to instruct the Depositary as to the exercise of the voting rights, if any, pertaining to the Deposited Securities represented by such Holders’ ADSs.

and the Depositary are set forth in its entirety in the Deposit Agreement and summarized in the ADRs. If you wish to receive a copy of the Deposit Agreement, please contact the Depositary at the number set forth below.

If you have any questions about the way in which Voting Instructions may be delivered to the Depositary, please contact Citibank, N.A. — ADR Shareholder Services at 1-877-CITI-ADR (1-877-248-4237).

Citibank, N.A., as Depositary

POWER OF ATTORNEY

Citibank, N.A. solely as depositary (the “Depositary”) under the Deposit Agreement, dated as of July 14, 2004 (the “Deposit Agreement”), by and among KongZhong Corporation (the “Company”), the Depositary and all Holders and Beneficial Owners, from time to time, of American Depositary Receipts (“ADRs”) evidencing American Depositary Shares (“ADSs”) issued thereunder, hereby appoints ______ as its proxy and attorney to vote at his or her discretion ______ Ordinary shares, par value U.S. $0.0000005 each, of the Company represented by ADSs evidenced by ADRs for which no voting instructions have been received, on behalf of the holders of ADSs, with respect to all agenda items except for those items for which the vote is on a show of hands at the 2005 Annual General Meeting of Shareholders — September 6, 2005 at 2:00 P.M. (local time) at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China, (the “Meeting”).

This Power of Attorney shall automatically expire at the end of the aforementioned Meeting.


		Citibank, N.A.
		solely as Depositary

		By:

		Name:
		Title: Vice President

Date: , 2005

Special Resolutions

1.		Approval to Amend the Articles of Association to allow for Shareholder Voting by a show of hands, as set forth in the Company’s Notice of Meeting enclosed herewith.

2.		Approval to Amend the Articles of Association to create a Staggered Board, as set forth in the Company’s Notice of Meeting enclosed herewith.

3.		Approval to Amend the Articles of Association to end directors’ terms due to conflict of interest, as set forth in the Company’s Notice of Meeting enclosed herewith.

4.		Approval to Amend the Articles of Association to authorize share repurchases, as set forth in the Company’s Notice of Meeting enclosed herewith.

Ordinary Resolutions

Approval to re-elect the following directors (on the condition that Resolution No. 2 has been approved), as set forth in the Company’s Notice of Meeting enclosed herewith.

	(a)		Hanhui Sun be and hereby is re-elected as a director for a one-year term.

	(b)		Yunfan Zhou be and hereby is re-elected as a director for a two-year term.

	(c)		Yongqiang Qian be and hereby is re-elected as a director for a two-year term.

	(d)		Nick Yang be and hereby is re-elected as a director for a three-year term.

	(e)		Charlie Y. Shi be and hereby is re-elected as a director for a three-year term.

6.		Approval to increase the Number of Shares that may be issued under the Equity Option Plan, as set forth in the Company’s Notice of Meeting enclosed herewith.

7.		Approval to reappoint our independent auditors, as set forth in the Company’s Notice of Meeting enclosed herewith.


		DETACH HERE			000001


x		PLEASE MARK VOTES AS IN THIS EXAMPLE

KongZhong Corporation

For

Against

Abstain

For

Against

Abstain

Resolution 1

Resolution 4

Resolution 2

Resolution 5(a)

Resolution 3

Resolution 5(b)


	For	Against	Abstain
Resolution 5(c)	o	o	o
Resolution 5(d)	o	o	o
Resolution 5(e)	o	o	o
Resolution 6	o	o	o
Resolution 7	o	o	o

If these Voting Instructions are signed and timely returned to the Depositary but no specific direction as to voting is marked below as to an issue, the undersigned shall be deemed to have directed the Depositary to give voting instructions “FOR” the unmarked issue (unless otherwise specified in the notice distributed to holders).

Please be sure to sign and date this Voting Instruction Card.

Please sign your name to the Voting Instructions exactly as printed. When signing in a fiduciary or representative capacity, give full title as such. Where more than one owner, each MUST sign. Voting Instructions executed by a corporation should be in full corporate name by a duly authorized officer with full title as such.


		DETACH HERE		000002

The Voting Instructions must be signed, completed and received at the indicated address prior to
10:00 A.M. (New York City time) on August 30, 2005 for action to be taken.


*2005 VOTING INSTRUCTIONS*		*AMERICAN DEPOSITARY SHARES*

KongZhong Corporation (the “Company”)


ADS CUSIP No.:		50047P104.
ADS Record Date:		August 1, 2005.
Meeting Specifics:		Annual General Meeting of Shareholders — September 6, 2005 at 2:00 P.M. (local time) at the 35th Floor, Tengda Plaza, No. 168 Xizhimenwai Street, Beijing, China.
Meeting Agenda:		Please refer to the Company’s Notice of Meeting enclosed herewith.
Depositary:		Citibank, N.A.
Deposit Agreement:		Deposit Agreement, dated as of July 14, 2004.
Deposited Securities:		Ordinary shares, par value U.S. $0.0000005 per share, of the Company.
Custodian(s):		Citibank, N.A. — Hong Kong Office.

The undersigned holder, as of the ADS Record Date, of the American Depositary Receipt(s) issued under the Deposit Agreement and evidencing the American Depositary Shares identified on the reverse side hereof (such American Depositary Shares, the “ADSs”), acknowledges receipt of a copy of the Depositary’s Notice of Shareholders’ Meeting and hereby irrevocably authorizes and directs the Depositary to cause to be voted at the Meeting (and any adjournment or postponement thereof) the Deposited Securities represented by the ADSs in the manner indicated on the reverse side hereof.

Voting instructions may be given only in respect of a number of ADSs representing an integral number of Deposited Securities.

Please indicate on the reverse side hereof how the Deposited Securities are to be voted.

The Voting Instructions must be marked, signed and returned on time in order to be counted.

By signing on the reverse side hereof, the undersigned represents to the Depositary and the Company that the undersigned is duly authorized to give the Voting Instructions contained herein.


About
KongZhong Corporation


		3

		Annual report 2004

About KongZhong Corporation

KongZhong Corporation (Nasdaq: KONG), is a leading provider of advanced second generation (2.5G) wireless value-added services in China. To provide customer-oriented services, instant information and convenient communication are our main goals. As a close partner of China Mobile which has the largest mobile subscriber base in the world, we have gained our leading position in each of its 2.5G technology platforms including WAP, MMS and JAVA™. We deliver a broad range of services in three major categories: interactive entertainment, media and community.

KongZhong is registered in the Cayman Islands and conducts most of its business in China. We are headquartered in Beijing and have over 600 employees throughout China.


Chairman and
Chief Executive Officer’s Letter


		5

		Annual report 2004

Chairman and Chief Executive Officer’s Letter

Dear Shareholders:

On behalf of the Board of Directors and management team, we are pleased to present you with our first annual report after our initial public offering on the NASDAQ Stock Market. 2004 was an exciting and record-breaking year for us. I am proud to highlight some of our achievements.

Initial public offering

We completed our initial public offering of $100 million on July 9, 2005. Net proceeds before expenses to the Company were $74.4 million. The IPO validated our business model, market leadership position, execution capability, and integrity. It also raised our profile and brand recognition. Through the IPO process, we have improved our corporate governance, operational management, financial reporting, and internal control standards. We will continue to hold ourselves to the high standards required of a public company. Enhancing shareholder value and delivering superior returns for shareholders will always be our top priorities.

Strong financial performances

In 2004, we reported gross revenues of US$48.0 million, an increase of 514% from 2003. In fact, we have achieved sequential quarterly revenue growth every quarter since our inception. In addition, our 2004 net income reached US$20.4 million, an increase of 746% from 2003. We generated $15.8 million in operating cash flow in 2004. Furthermore, we have a very strong balance sheet — more than $96 million in cash as of March 31, 2005 and no debt. I am very proud of our strong financial performances in 2004.

Maintained our leadership position in 2.5G

We have always been focused on 2.5G wireless technology and are a pioneer in 2.5G wireless value-added services (WVAS) in China. I am pleased to report to you that we continue to hold the leading position in terms of revenue on each of the WAP, MMS, and JAVA™ technology platforms on China Mobile’s network in 2004. Our leadership position is due to the success of our three main product lines — interactive entertainment, media and community. We believe we have one of the broadest, most interesting and popular wireless product offerings in China. Gradually, we have built up KongZhong brand recognition among the telecommunication operators, content providers, distribution partners, and most importantly, our customers. We believe the value of our KongZhong brand will continue to appreciate.

Growing our organization while keeping entrepreneurial spirit

We have more than doubled our headcount from 229 at the beginning of 2004 to 541 as of December 31, 2004. We have strengthened our product development, sales, and marketing capabilities by adding a substantial number of employees in these areas. In addition, I am very pleased that we recruited JP Gan, Our Chief Financial Officer, and Hai Qi, our Senior Vice President of Sales and Marketing, and promoted Kingchuen Wong, our Vice President of Corporate Development, to the senior management team. These experienced executives will help us continue to grow the business and organization in a disciplined fashion while at the same time maintaining an entrepreneurial spirit within the Company, which I believe is essential to succeed in this young, fast-changing and dynamic industry.

6

Annual report 2004

Chairman and Chief Executive Officer’s Letter

Industry review and outlook

The WVAS industry has changed significantly since we founded the Company in 2002. Beginning in the second half of 2004, the Ministry of Information Industry (MII), China Mobile, and China Unicom have introduced a series of new regulations, policies, and guidelines in order to improve customer satisfaction. Although these changes in policies have temporally slowed our growth on some technology platforms to certain extent, we applaud these new policies because we think consumer satisfaction is essential to the long-term success and growth of the WVAS industry. As a result of these policies, the deployment of certain inappropriate customer acquisition tactics and the customer complaint rate have been substantially reduced. We will continue to work closely with our mobile operator partners to improve the consumer experience and satisfaction.

I continue to see enormous opportunities in the WVAS market. I am also confident that the industry will continue its growth momentum in the rest of 2005 and beyond. According to China Mobile, in 2004, WVAS providers generated a total of $845 million in revenue from China Mobile, up 68% from 2003. According to Analysys International, a Beijing-based information technology and telecommunication’s market research firm, the WVAS market in China will grow 30% in 2005 and reach $2.6 billion by 2008. I see more and more people in China buying mobile phones with color display, bigger screen, larger internal memory, external flash memory, audio and video features, digital cameras, and WAP browsers. All these rich features will help change consumer behavior and encourage the use of our WVAS. We saw this encouraging trend of transforming the mobile phone from a simple voice communication device to a multi-media entertainment terminal very early on. That is why we have been focusing on 2.5G services from the very beginning and we are glad that the market has proven us right.


		7

		Annual report 2004

Chairman and Chief Executive Officer’s Letter

Execution and strategic focuses

To take advantage of these extremely favorable market trends, and to solidify our leadership in the 2.5G market, we intend to seamlessly execute our strategies. More specifically, we will focus on the followings:

Diversifying our revenues across operators and platforms

While we are currently the market leader on China Mobile’s 2.5G technology platforms, there are big opportunities for us in several other markets. We want to expand our product offerings on China Unicom’s network and grow our revenues there. We have been formulating a detailed plan to enter into new operator relationships. I believe that China Unicom’s customers could become an important revenue contributor to us in the future. In addition, our 2G services such as SMS, IVR, and CRBT have lagged behind some of the industry peers. Despite of our low revenue base from 2G services, we continue to see substantial growth opportunities in the 2G space. We have devoted more resources to the 2G business and we hope that our growth in 2G will outpace the industry average.

Continuously enhancing product development capabilities and broadening product offerings

Our products are one of the most important factors to attract customers. They are also the key to our success. We will continue to invest in our product development team and broaden our product portfolio. Our interactive entertainment products allow users to personalize their phone features with a variety of ringtones and picture downloads. Our investment in mobile game development will reap significant dividends in the long run as we have become the leader in the Java™ market in China. We currently have an 80-person mobile game development team and will continue to add new titles to our existing library. We are also committed to further developing COTA Media as the leading wireless media brand in the industry. Through our dedicated editorial team, we will continue to offer our users customized and up-to-date media content. With our team’s years of accumulated experience in online community, we will also continue to leverage our existing community membership base and capitalize on the wireless community opportunities.

In addition to developing our own content and products, we will continue to partner with content providers or celebrities as we did in 2004 by entering into exclusive PRC license agreements for the popular movies “Hero” and “Kong Fu Hustle”, and the voice of Ge You, one of the best-known comedians in China. We will constantly analyze the cost/benefit of these licenses and approach them with discipline.

Continue to expand distribution channels

I believe the mobile handset manufacturers are an important distribution channel for us. We have established distribution agreements with 27 domestic and international handset manufacturers including Motorola, Samsung, Panasonic, and Amoi. We will continue to maintain and expand this important distribution channel while looking for new and innovative methods to distribute our services.

Strategic acquisitions

We have a very strong balance sheet with more than $96 million in cash and no debt. We have a deep management bench to find, analyze, acquire, and integrate acquisitions that fit into our execution and strategic focuses as discussed above. We have made two small but successful acquisitions

8

Annual report 2004

Chairman and Chief Executive Officer’s Letter

in the past twelve months. We have gained substantial experience in integrating these companies into our platform and retaining talent. I believe we are well positioned to grow not only organically but also through strategic acquisitions in the coming months. However, I do want to stress that we will approach acquisition opportunities with discipline and post-acquisition integration in mind. We will make accretive acquisitions or acquire companies that bring tremendous strategic value to our future.

Preparing for 3G

We realize that 2.5G is only the beginning of wireless internet development. 3G networks will spark a wave of exciting new products and business models. As the leader in 2.5G, we are the largest incumbent and best positioned to take advantage of new 3G opportunities in China. We have set up a dedicated team under the leadership of Nick Yang, our President, to study the overseas 3G markets, conceptualize the new business opportunities and models, and prepare for 3G product offerings. We have and will continue to invest in the future with a goal to become the immediate leader in the upcoming 3G world in China.

In conclusion, we have made significant progress and achieved key milestones in 2004. I appreciate the support from our mobile operator partners, content providers, and distribution partners. I am especially grateful to our employees. Their skills, dedication to customer satisfaction and execution form the foundation of our success. Their commitment to our mission and values is unswerving. Without them, we would not be where we are today. I strongly believe that together, we will continue to grow our business, maintain our market leadership position, and deliver superior returns for our shareholders who include myself, Nick, and many of our employees. We look forward to continuing our communication with you and receiving your continuous support.

Yunfan Zhou
Chairman and Chief Executive Officer

Key financial

information (ARROW)

Annual report 2004

Key financial information

Selected Financial Data

The following selected historical consolidated financial data should be read in conjunction with our audited historical consolidated financial statements and the uotes thereto. The selected historical consolidated statement of operations data for the period from May 6, 2002 to December 31, 2002 and for the years ended December 31, 2002, 2003 and 2004, and the selected historical consolidated balance sheet data as of December 31, 2002, 2003 and 2004 set forth below are derived from our audited historical consolidated financial statements included elsewhere in this annual report.

Our audited historical consolidated financial statements have been prepared and presented in accordance with US. GAAP.


	For the period from
	May 6, 2002 to			For the year ended December
Consolidated statements of operations data	December 31, 2002			2003			2004
	(in thousands of U.S. dollars, except for share and per share data)
Gross revenues	$	200.3		$	7,806.7		$	47,969.2
Cost of revenues		(84.3	)		(2,284.0	)		(15,704.8	)

Gross profit		116.0			5,522.7			32,264.4

Operating expenses:
Product development		164.2			1,369.5			4,357.6
Sales and marketing		128.9			841.4			3,228.3
General and administrative		317.3			882.7			4,407.2
Amortization of deferred stock compensation		—			22.0			482.8

Total operating expenses		610.4			3.115.6			12.475.9

(Loss) income from operations		(494.4	)		2,407.1			19,788.5
Other expenses, net		—			—			(21.1	)
Interest income, net		0.5			1.0			601.9

Net (loss) income before income taxes		(493.9	)		2,408.1			20,369.3
Income tax expense

Net (loss) income	$	(493.9	)	$	2.408.1		$	20.369.3

Net (loss) income per share:
Basic	$	0.00		$	0.01		$	0.02

Diluted	$	0.00	⁽¹⁾	$	0.00		$	0.02	⁽²⁾

Shares used in calculating net (loss) income per share:
Basic		415,547,794			469,000,000			903,010,929

Diluted		415,547,794	⁽¹⁾		1,094,824,434			1,250,640,982	⁽²⁾


(1)		Anti-dilutive preferred shares and options were excluded from the weighted average ordinary shares outstanding for the diluted per share calculation. For 2002, basic loss per share did not differ from diluted loss per share.

(2)		As of December 31, 2004, we had 33,260,000 ordinary share equivalents outstanding that could have potential diluted income per share in the future, but that were excluded in the computation of diluted income per share in the period, as their exercise prices were above the average market values in such period.

Annual report 2004

Key financial information


	As of December 31,
Consolidated balance sheet data	2002		2003		2004
	(in thousands of U.S. dollars)
Cash and cash equivalents	$	2,646.2	$	3,742.6	$	90,714.1
Accounts receivable		132.3		1,703.9		10,198.8
Property and equipment, net		251.0		848.5		2,484.2
Total assets		3,101.3		6,567.5		104,372.7
Total current liabilities		75.0		1,047.3		4,443.6
Series B redeemable convertible preferred shares		2,970.0		2,970.0		—
Total shareholders’ equity		56.3		2,550.1		99,808.3
Total liabilities and shareholders’ equity		3,101.3		6,567.5		104,372.7


	For the period from
	May 6, 2002 to			For the year ended December 31,
Other consolidated financial data	December 31, 2002			2003			2004
	(in thousands of U.S. dollars)
Net cash (used In) provided by:
Operating activities	$	(579.7	)	$	1,959.7		$	15,844.7
Investing activities		(292.4	)		(864.0	)		(2,430.2	)
Financing activities		3,520.3						73,555.5


	For the period from
	May 6, 2002 to		For the year ended December 31,
Unaudited operating data	December 31, 2002		2003		2004
	(in thousands)
2.5G⁽¹⁾
Subscriptions⁽²⁾		351.6		9,021.3		46,363.5
Downloads⁽³⁾		—		2,722.1		17,881.9
2G⁽⁴⁾
Subscriptions⁽²⁾		50.0		1,925.4		9,305.9
Downloads⁽³⁾		800.0		6,127.4		7,418.3
Total
Subscriptions⁽²⁾		401.6		10,946.7		55,669.4
Downloads⁽³⁾		800.0		8,849.5		25,300.2


(1)		Includes WAP, MMS and Java^TM. We began to provide WAP, MMS and Java^TM services on a paid basis in September 2002, April 2003 and November 2003, respectively.

(2)		Total number of paid monthly subscriptions in the relevant period.

(3)		Total number of paid downloads in the relevant period, excluding downloads made pursuant to subscriptions.

(4)		Includes SMS, IVR and CRBT. We began to provide SMS, IVR and CRBT services on a paid basis in July 2002, December 2003 and October 2003, respectively.

Business Overview (ARROW)

Annual report 2004

Business Overview

History and Development of the Company

We were incorporated on May 6, 2002 under the laws of the Cayman Islands as Communication Over The Air Inc., an exempted limited liability company. In March 2004, we changed our name to KongZhong Corporation. We are headquartered in Beijing, China, and provide wireless value-added services throughout China.

We conduct our business in China solely through our wholly-owned subsidiary, KongZhong Beijing. In order to meet domestic ownership requirements under PRC law, which restrict us and KongZhong Beijing, as a foreign or a foreign-invested company, respectively, from operating in certain value-added telecommunications and Internet services, we operate our wireless value-added services through Beijing Airlnbox, Beijing Boya Wuji and Beijing WINT, all of which are based in China and are wholly owned by PRC citizens. We do not have any equity interests in Beijing Airlnbox, Beijing Boya Wuji or Beijing WINT, but instead enjoy the economic benefits of these companies through a series of contractual arrangements as described below.

Our principal executive office is located at 35th Floor, Tengda Plaza, No. 168, Xizhimenwai Street, Beijing, China, 100044. Our telephone number is (8610) 8857-6000. Our primary website address is www.KongZhong.com. Information contained on our website does not constitute a part of this annual report. Our agent for service of process is CT Corporation System located at 111 Eighth Avenue, New York, New York, 10011.

In July 2004, we completed the initial public offering of our American Depositary Shares, representing our ordinary shares, and listed the ADSs on the Nasdaq Stock Market, Inc., or Nasdaq.

Business Overview

We are the leading provider of 2.5G wireless interactive entertainment, media and community services in terms of revenue to customers of China Mobile, which had 204.3 million mobile phone users as of December 31, 2004, the largest mobile subscriber base in the world. According to Analysys International, based on our revenues, we were the leading provider on China Mobile’s networks in 2004 of wireless value-added services on each of the WAP, MMS and Java™ technology platforms. In addition, in 2004 we began to provide wireless value-added services on the networks of China United Telecommunications Corporation, or China Unicom, China Telecom and China Netcom. Each of China Mobile, China Unicom, China Telecom and China Netcom is a state-owned enterprise, the majority of the equity interest of which is owned by the People’s Republic of China.

We provide interactive entertainment, media and community services through multiple technology platforms to mobile phone users. We provide most of our services through 2.5G technology platforms, including WAP, MMS and Java™, which offer higher quality graphics, richer content and interactivity compared to 2G wireless services. We also offer a range of data and voice services through 2G technology platforms, including SMS, IVR and CRBT.

We deliver a broad range of services that users can access directly from their mobile phones, including by choosing an icon embedded in select models of handsets, or from a mobile operator’s portal or web site. Our services are organized in three major categories, consisting of:

* Interactive entertainment. Our interactive entertainment services include mobile games, pictures, karaoke, electronic books and mobile phone personalization features, such as ringtones, wallpaper, clocks and calendars.

Annual report 2004

Business Overview

* Media. Our media services provide content such as domestic and international news, entertainment, sports, fashion, lifestyle and other special interest areas.

* Community. Our community services include interactive chat, message boards, dating and networking.

Users can purchase our value-added services on a per use basis and, in most cases, on a subscription basis. We provide our services mainly pursuant to our cooperation arrangements with the mobile operators and their provincial subsidiaries, the terms of which are generally for one year or less. We do not directly bill our users, and depend on the billing systems and records of the mobile operators to bill and collect all fees. We generally do not have the ability to independently verify the accuracy of the billing systems of the mobile operators. As mobile operators do not provide us with a detailed revenue breakdown on a service-by-service basis, we depend on our internal database system to monitor revenue derived from each of our services. We make our business decisions based on our internal data, taking into account our historical experience in reconciling our internal data to our actual results of operations and other factors including strategic considerations.

The following diagram illustrates how our services are provided through technology platforms to users.

Users have the option of ordering our services directly from our web site, www.KongZhong.com, or their mobile phones by ordering our services through our access code or by choosing the icon embedded in select models of handsets. Users may also order some of our services from a mobile operator’s portal or web site. Substantially all of our services are ordered by users directly through their mobile phones and all services are delivered through mobile phones. Depending on the type of service, users can order our services on a transaction basis or subscribe to our services on a monthly basis.

We continuously produce and source new content that appeals to our target consumers for advanced value-added services. Utilizing software we have developed, our experienced team of editors and producers edit, redesign and repackage our content for our different services and technology platforms in a manner that appeals to consumers and ensures a consistent user experience across different mobile handset models. We obtain our content through in-house writers, freelance writers and third-party suppliers. Through contractual arrangements, we have exclusive rights over the content produced by our in-house writers, the content specifically produced for us by freelance writers and some of the content sourced from third-party suppliers.

Annual report 2004

Business Overview

Our Business

Our Wireless Services

The following are the three major service areas on which we focus:

* Interactive Entertainment. We offer a wide range of interactive entertainment services, including mobile games, karaoke, electronic books and mobile phone personalization features, such as ringtones, wallpaper, icons, clocks and calendars. We provide our interactive entertainment services through all of our technology platforms. Our product development team tailors pictures and ringtones to maximize ease of use and ensure a consistency of user experience across different handset models. Mobile phone users can download on demand or subscribe for regular downloads of our interactive entertainment services, although most of our mobile games are offered on a transaction basis. Some of our most popular interactive entertainment services include:

Mobile Games. We focus on offering mobile games based on 2.5G platforms including WAP and Java™. Our mahjong game has networking capacity that enables mobile phone users to play this mobile game with other players through the China Mobile network. Other popular mobile games include a martial arts game, an interactive shooting game and a role-playing game in which players assume the roles of historical heroes engaged in various battles. In 2005, we established a dedicated mobile games product development team to develop and publish 2.5G mobile games.

Pictures and Logos. Mobile phone users can download pictures and logos to personalize the background of their mobile phone screens. Such pictures include cartoons, pets and scenic photos.

Polyphonic Ringtones. Our ringtones enable a mobile phone user to personalize their ringtones to the melodies of their favorite songs or special sound effects.

* Media. Users can download our media content on either a transaction basis or a monthly subscription basis. Mobile phone users can download information on demand or subscribe for periodic messages, which includes content covering international and domestic news, entertainment, sports, fashion, lifestyle and other special interest areas. Some of our most popular media services include:

News. We offer international and domestic news, delivered in a format easy for the reader to peruse. Our WAP version enables users to easily search for news that interests them.

Entertainment. Our entertainment magazine focuses on high-profile celebrities and includes star biographies, interviews and photos.

Sports. Our sports magazine features sports news, game scores and information about sports stars.

* Community. Users can engage in community-oriented activities such as interactive chatting, message boards, dating and networking. Users may only access our community services on a monthly subscription basis. Some of our most popular community services include:

Chat. We offer a variety of chat services. For instance, we have a virtual reality game that allows mobile phone users to choose the lifestyle they dream of and interact with the city’s other inhabitants/players.

Annual report 2004

Business Overview

Dating. Our dating mobile services are highly popular. We have a mobile chat and dating service available on WAP and MMS that allows users to utilize the enhanced features of advanced technology of 2.5G to choose their chatting partners from a selection of pictures taken with users’ mobile phone cameras. We also offer a WAP-based dating service designed to simulate a campus environment tailored for students.

Photo Albums. Our photo albums allow mobile users to post and arrange their photos take with their mobile handsets into albums accessible via their handsets. Utilizing the WAP technology platform, mobile users can access photo albums in a manner similar to accessing photo albums on the Internet.

Our Technology Platforms

2.5G Wireless Standard Services

We deliver our 2.5G services primarily to users of GSM-based mobile phones utilizing GPRS technology through the WAP, MMS and Java^™ technology platforms.

* Wireless Application Protocol (WAP). WAP allows users to browse content on their mobile phones so that users can request and receive information in a manner similar to accessing information on Internet web sites through personal computers. We provide our WAP service over GPRS networks, which allows users to download color and animated pictures, logos and wallpaper, interactive mobile games, customized ringtones and other Internet content. We launched WAP services in May 2002, but did not begin to receive revenue for such services until September 2002, when China Mobile started to allow service providers to charge fees for WAP services. As of December 31, 2004, we offered 573 WAP products, most of which are only available on a subscription basis. As of December 31, 2004, we had recorded a total of approximately 9.3 million mobile phone users who had used our WAP services at least once. In the fourth quarter of 2004, we had approximately 15.4 million WAP subscriptions.

* Multimedia Messaging Services (MMS). MMS is a messaging service that we deliver over GPRS networks and, in China, allows up to 50 kilobytes of data to be transmitted in a single message, compared to 140 bytes of data via SMS. As a result, MMS enables users to download colorful pictures and advanced ringtones. We launched MMS services in October 2002, but did not begin to receive revenue for such services until April 2003, when China Mobile started to allow service providers to charge fees for MMS. Our monthly subscription services automatically send information to users’ mobile phones, and include news, beauty, celebrity photographs and special collectible items. Our services that can be downloaded on a transaction basis include pictures, screensavers, ringtones and special sound effects. As of December 31, 2004, we offered 287 MMS products. As of December 31, 2004, we had recorded a total of approximately 5.5 million mobile phone users who had used our MMS services at least once. In the fourth quarter of 2004, we had approximately 3 million MMS subscriptions.

* Java^™. Java^™ technology allows mobile phone users to play interactive and networked mobile games and karaoke, and download applications to customize their mobile phone settings, such as screensavers and clocks. We launched services based on the Java^™ programming language in September 2003, but did not begin to receive

Annual report 2004

Business Overview

revenue for such services until November 2003, when China Mobile started to allow service providers to charge fees for Java^™ services. As of December 31, 2004, we offered 223 Java^™ products. In 2004, we had a total of approximately 1.6 million Java^™ downloads. We expect revenue from our Java^™-based services to increase as more models of mobile phones sold in China incorporate this technology and we develop new Java^™ services utilizing the Java^™ language.

2G Wireless Standard

We deliver our 2G services primarily through the SMS, IVR and CRBT technology platforms.

* Short Messaging Services (SMS). SMS is the basic form of mobile messaging service, and is supported by substantially all mobile phone models currently sold. Users can access our products through their mobile phones on a subscription or transaction basis. We launched and began receiving revenue from SMS in July 2002. As of December 31, 2004, we offered 471 SMS products, including jokes, entertainment and horoscopes. As of December 31, 2004, we recorded a total of approximately 18.1 million mobile phone users who had used our SMS services at least once. In the fourth quarter of 2004, we had approximately 1.3 million SMS subscriptions.

* Interactive Voice Response (IVR). Interactive voice response services allow users to access voice content from their mobile phones. We launched and began receiving revenue from IVR services in December 2003. As of December 31, 2004, we offered six IVR products, including entertainment, chat and English language education. As of December 31, 2004, we recorded a total of approximately 1.0 million mobile phone users who had used our IVR services at least once.

* Color Ring Back Tone (CRBT). Color ring back tones allow a mobile phone user to customize the sound that callers hear when ringing the user’s mobile phone. We offer a variety of entertaining content, including pre-recorded messages, movie dialogues and soundtracks and a wide range of classical and popular music. We launched and began receiving revenue from our CRBT services in October 2003 in Beijing and subsequently began to offer CRBT services in other provinces. We offered CRBT services through 12 provincial subsidiaries of China Mobile, China Unicom, China Netcom and China Telecom as of December 31, 2004, and through 32 provincial subsidiaries as of March 31, 2005.

Although our focus has been and remains on providing services based on 2.5G technology platforms, we have continued to pursue a diversified growth strategy. In 2005, our product development team is increasing its efforts in developing and supporting 2G services, especially the fast-growing IVR and CRBT services.

Management Discussion and Analysis (ARROW)

The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and the related notes thereto included elsewhere in this annual report. Our audited consolidated financial statements have been prepared in accordance with US. GAAP. Actual results could differ materially from those projected in the forward-looking statements.

Annual report 2004

Management Discussion and Analysis

Overview

We are the leading provider of 2.5G wireless interactive entertainment, media and community services in terms of revenue to customers of China Mobile, which has the largest mobile subscriber base in the world. According to Analysys International, based on our revenues, we were the leading provider on China Mobile’s networks in 2004 of wireless value-added services on each of the WAP, MMS and Java^™ technology platforms. We provide interactive entertainment, media and community services through multiple technology platforms to mobile phone users. We provide most of our services through 2.5G technology platforms, including WAP, MMS and Java^™, which offer higher quality graphics, richer content and interactivity compared to 2G wireless services. We also offer a range of data and voice services through 2G technology platforms, including SMS, IVR and CRBT.

We were incorporated under the laws of the Cayman Islands on May 6, 2002. Our gross revenues for the year ended December 31, 2004 were $48.0 million, whereas our gross revenues for the year ended December 31, 2003 were $7.8 million. Our net income for the year ended December 31, 2004 was $20.4 million, as compared to $2.4 million for the year ended December 31, 2003.

For each quarter since our founding, we have devoted significant resources to product development. We have steadily built up our product development team in order to analyze consumer demands and to expand the range of our service offerings to attract new customers and increase usage among our existing customers. The size of our product development team increased from 149 persons as of December 31, 2003 to 320 persons as of December 31, 2004. In particular, we have strengthened our product development capabilities in the rapidly growing areas of mobile games, IVR and CRBT. We expect to remain committed in the coming year to enhancing our product development capabilities through a managed enlargement of our product development team while focusing on research for and development of proprietary technology and content.

Annual report 2004

Management Discussion and Analysis

We have also committed significant resources since our founding to building our sales and marketing team, which we believe has been crucial in promoting our brand and placing our services in the hands of users by building our relationships with mobile operators and distribution channels. The size of our sales and marketing team increased from 36 persons in nine provinces as of December 31, 2003 to 110 persons in 21 provinces as of December 31, 2004. In addition to expanding our sales and marketing team, we also have participated in joint promotional arrangements to promote our brand and services. We expect our focus on sales and marketing efforts to continue in the coming year.

PRC regulations currently restrict foreign ownership of companies that provide value-added telecommunications services, which include wireless value-added services and Internet content services. According to PRC laws and regulations, as of December 11, 2003, foreign investors are permitted to hold up to 50% of a company in China engaged in value-added telecommunications services.

However, uncertainty exists as to how these regulations will be implemented. The PRC government authorities are still in the process of drafting detailed rules with respect to the procedures for the application for and approval of establishing a foreign-invested value-added telecommunications services enterprise. As a result, we conduct substantially all of our operations through Beijing AirInbox, Beijing Boya Wuji and Beijing WINT, which are owned by PRC citizens. We have entered into loan agreements with each of the shareholders of Beijing AirInbox, pursuant to which we provided interest-free loans to each of the shareholders of Beijing AirInbox for a term of 10 years, in an aggregate amount of $1.2 million (RMB$10 million) to be invested exclusively in Beijing AirInbox. We have also entered into a series of contractual arrangements with Beijing AirInbox, Beijing Boya Wuji, Beijing WINT and their shareholders, including the exclusive technical and consulting services agreements and trademark and domain name license agreements pursuant to which we are entitled to receive service and license fees. In addition, we have entered into equity pledge agreements with each of the shareholders of each of our operating companies, pursuant to which each of the shareholders pledged all of his or her interest in our operating companies to us as security for the performance by each of our operating companies of their obligations under the exclusive technical and consulting services agreements. As a result of these contractual arrangements, under US. GAAP, we are the primary beneficiary of the investments in our operating companies and we consolidate their results of operations in our consolidated financial statements.

We have a limited operating history on which to base an evaluation of our business and prospects. Our prospects should be considered in light of the risks, uncertainties, expenses and difficulties frequently encountered by companies in the early stages of their development, particularly in new and rapidly evolving markets such as wireless value-added services.

The major factors affecting our results of operations and financial condition include:

* Growth of the wireless value-added services consumer market in China;

* Technological advancement of the mobile telecommunications market, including the adoption of 2.5G and subsequent standards of mobile handsets and networks, in China;

* Attractiveness and variety of our services;

* Our product development efforts to capitalize on market opportunities;

* Expansion of our marketing and promotion activities;

* Change in the number, scope and terms of our cooperation arrangements with the mobile operators, content


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Management Discussion and Analysis

providers, mobile handset manufacturers, mobile handset distributors and other key players in China’s mobile telecommunications industry; and

* Changes in government or mobile operator regulatory policies.

In particular, our business may be adversely affected if the terms or conditions of our contractual arrangements with mobile operators should change with regard to any particular type of service. In order to reduce the risk that our results of operations and financial conditions would be overly dependent upon, and disproportionately impacted by, any particular service offering, technology platform or mobile operator, we have sought to broaden the range of our services, develop new relationships with mobile operators and expand our distribution channels. The growth of our product development and sales and marketing teams underscores our focus on enhancing our ability to bring new services to market quickly and effectively so that we can preserve our leading position on key 2.5G services with China Mobile. Meanwhile, we have also begun developing our relationship with China Unicom, China Telecom and China Netcom in order to broaden the base of our operation. In addition, we have increased the number of distribution arrangements we have with major mobile handset manufacturers to further enhance the distribution of our services and promote our brand.

Revenues

We derive revenues from providing wireless value-added services to mobile phone users, substantially all of whom are customers of China Mobile and its subsidiaries.

The following table sets forth the historical consolidated revenue attributable to services derived from each of our 2.5G and 2G technology platforms in terms of amount and as a percentage of our total gross revenues for the periods indicated:


	For the period from
	May 6, 2002 to					For the year ended December 31,
	December 31, 2002					2003					2004
	Amount		Percentage			Amount		Percentage			Amount		Percentage
			of revenue					of revenue					of revenue
	(in thousands of US. dollars, except percentages)
2.5G services
WAP		131.3		66	%		3,852.9		49	%		22,101.5		46	%
MMS							2,085.5		27	%		17,264.1		36	%
Java™							17.6		0	%		783.6		2	%

Total	$	131.3		66	%	$	5,956.0		76	%	$	40,149.2		84	%
2G services
SMS		69.0		34	%		1,839.2		24	%		6,629.6		14	%
IVR												1,068.1		2	%
CRBT							11.5		0	%		122.3		0	%

Total		69.0		34	%		1,850.7		24	%		7.820.0		16	%

Total gross revenues	$	200.3		100	%	$	7,806.7		100	%	$	47,969.2		100	%

We derive our revenue primarily through contracts with mobile operators that are nationwide in scope or that cover large geographic areas of China. However, we believe that users in Guangdong province and the coastal provinces of China constitute the most significant portion of our user base. As a result, we allocate additional resources to these areas, including establishing sales offices in most of these provinces.

Prior to 2004, we generated all of our revenues from fees paid by mobile phone users who use our services through

Annual report 2004

Management Discussion and Analysis

China Mobile’s network. In 2004, we began to receive revenue from services provided on the networks of China Unicom, China Netcom and China Telecom, but such revenue amounted to less than 1% of our total revenues during the year ended December 31, 2004. We recognize revenue derived from our services before deducting the service fees and the net transmission charges paid to the mobile operators. Fees for our services are charged on either a transaction or monthly subscription basis and vary according to the type of services delivered.

As mobile operators do not provide us detailed revenue breakdown on a service-by-service basis, we depend on our internal data management system to monitor revenue derived from each of our services. We make our business decisions including research and development of new services and reallocation of resources to popular services based on our internal data, taking into account other factors including strategic considerations.

Cosf of Revenues

Our cost of revenues includes the following:

* Service fees due to the mobile operators, which are generally 15% of the gross revenues with an additional 15% when the mobile operator provides customer services for us and an additional 35% when the mobile operator provides marketing and promotional services for us;

* Net transmission charges payable by us to the mobile operators, calculated as the number of messages we send to users in excess of the number of message requests received by us multiplied by a per message transmission fee,which varies depending on the total volume of messages sent in any given month;

* Payments to content providers for the use of their content, and to mobile handset manufacturers and other industry partners with whom we have cooperation arrangements, in the form of a fixed fee or a percentage of our aggregate net cash received from the mobile operators with respect to services provided through the cooperation arrangements; and

* Bandwidth leasing charges and depreciation and facility costs relating to equipment used to provide wireless-value added services.

Our cost of revenues for the years ended December 31, 2004 and December 31, 2003 was $15.7 million and $2.3 million, respectively. During the year ended December 31, 2004, our cost of revenues totaled 32.74% of gross revenues, of which service fees to mobile operators represented 15.47%, payments to handset manufacturers represented 6.62%, net transmission charges to mobile operators represented 4.69%, payments to content providers represented 4.10% and bandwidth leasing charges, depreciation and facility costs represented 1.86%.

Our cost of revenues increased substantially in 2004 as a result of an increase in the volume of our services. The cost of revenues as a percentage of total revenues also increased due to an increase in the number of mobile handset manufacturers and other business partners with which we have cooperation agreements and to which we pay a portion of the net cash that we receive from the mobile operators. We believe that such cooperation agreements provide users with an easy way to subscribe to our services and are a cost-effective way for us to acquire users. As part of our business strategy, we intend to pursue more such cooperation arrangements, which may decrease our gross margin in the future.


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Management Discussion and Analysis

Operating Expenses

Our operating expenses include product development, sales and marketing, general and administrative expenses and amortization of deferred stock compensation.

The following table sets forth certain consolidated operating expenses data in terms of amount and as a percentage of our gross revenues for the periods indicated:


	For the period from
	May 6, 2002 to					For the year ended December 31,
	December 31, 2002					2003					2004
	Amount		Percentage			Amount		Percentage			Amount		Percentage
			of revenue					of revenue					of revenue
	(in thousands of US. dollars, except percentages)
Product development	$	164.2		82.0	%	$	1,369.5		17.5	%	$	4,357.6		9.1	%
Sales and marketing		128.9		64.3	%		841.4		10.8	%		3,228.3		6.7	%
General and administrative		317.3		158.4	%		882.7		11.3	%		4,407.2		9.2	%
Amortization of deferred stock compensation		—		—			22.0		0.3	%		482.8		1 .0

Total	$	610.4		304.7	%	$	3,115.6		39.9	%	$	12,475.9		26.0	%

Product Development Expenses. Our product development expenses consist primarily of compensation and benefits for our product development team, which focuses on developing and improving our services and adapting them for next-generation technology platforms. While our product development expenses have increased since our formation due to the increase in the size of our product development team, our product development expenses as a percentage of our gross revenues have decreased significantly since our inception in May 2002. We expect our product development expenses to increase in absolute terms as our company grows, but expect such expenses to remain stable or decrease slightly as a percentage of our gross revenues.

Sales and Marketing Expenses. Our sales and marketing expenses consist primarily of advertising, sales and marketing expenses, including expenses associated with sponsoring promotional events, as well as compensation and benefits for our sales, marketing and customer service departments. Our sales and marketing expenses have increased since our inception, primarily due to the growth of our sales and marketing team as well as an expansion of our marketing efforts. We expect that our sales and marketing expenses will increase as we further promote our KongZhong brand name in future periods.

General and Administrative Expenses. Our general and administrative expenses consist primarily of business taxes, compensation and benefits for general management, finance and administrative personnel, professional fees, lease expenses and other office expenses. Our general and administrative expenses have increased since our inception, but have decreased significantly as a percentage of our gross revenues. Our legal and accounting expenses rose in 2004 because of the greater costs related to being a publicly listed company. We expect our general and administrative expenses to increase as our business expands in future periods because larger revenues will incur larger business taxes.

Amortization of Deferred Stock Compensation. In June 2002, we adopted our 2002 Plan, which governs the stock option grants we have made. We grant options to purchase our shares to our employees and we record a compensation charge for the excess of the fair value of the stock at the measurement date over the amount our employee must pay to acquire the stock. Deferred stock compensation is amortized on a straight-line basis and charged to expense over the vesting period of the underlying options, which is generally over four years.

Annual report 2004

Management Discussion and Analysis

Critical Accounting Policies

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Below we have summarized our accounting policies that we believe are both important to the portrayal of our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.

Revenue Recognition

Our revenues are primarily derived from providing wireless interactive entertainment, media and community value-added services to customers of China Mobile and its subsidiaries. The fees for such services are determined by us in consultation with the mobile operators, are charged on a transaction basis or on a monthly subscription basis and vary according to the type of services delivered.

We deliver wireless value-added services to users through the mobile operators’ networks and we rely upon the mobile operators to provide us with billing and collection services. We record revenues based on monthly statements from the mobile operators confirming the value of our services that they billed to users in the month. Before the second half of 2004, mobile operators usually sent such statements within 30 days after the end of each month. Beginning in the second half of 2004, China Mobile has introduced several new policies that have had the effect of lengthening the billing cycle. These new policies include the following:

* revenue collection for certain wireless value-added services has been decentralized from the parent to the provincial subsidiaries through which we provide services, and

* the subsidiaries have begun implementing the Mobile Information Service Center, or MISC, a mobile data management platform that records, processes and analyzes information relating to the provision of certain wireless value-added services, including usage, transmission and billing information.

Since implementation of the new policies, in general, within 45 days after the end of each month, each of the mobile operators delivers to us a statement confirming the value of the wireless value-added services provided by us for which they billed users in that month, and within 45 days after that each of the mobile operators pays us for the services, net of service and transmission fees.

A small portion of our reported revenues and related cost of revenues may involve estimations due to late billing confirmations by operators. In 2004, estimated revenue accounted for 4% of our reported gross revenues. In the first quarter of 2005, estimated revenue accounted for less than 1% of our reported gross revenues. Our estimations are based on:

* our internal data management system,

* our past experience, and

* our verbal communications with the mobile operators.


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Management Discussion and Analysis

We internally tabulate the value of a wireless value-added service provided based in part on delivery confirmations sent to us by the networks of the mobile operators with respect to each delivery of our services to a user within 72 hours of delivery. We record these confirmations in our internal data management system. There has historically been a discrepancy between the value that we estimate and the value that we are entitled to receive based on the monthly statements provided by the mobile operators. This discrepancy varies across different technology platforms and arises for various reasons:

* Late notification of delinquent customers. The mobile operators may from time to time classify certain customers as delinquent customers for non-payment of services. The mobile operators request all service providers to cease delivering services to customers once they are classified as delinquent. However, time lags often exist between when a customer is classified as delinquent and when we receive such information from the mobile operators. As a result, we occasionally unintentionally provide services to these delinquent customers for which the mobile operators will not make payments to us.

* Customer database out of synchronization. Customers may cancel their subscriptions through the mobile operators. Although we synchronize our and the mobile operators’ databases of customer information on an ongoing basis, our databases are not always completely in synchronization with those of the mobile operators. As a result, until our databases are synchronized with the mobile operators’, we could provide services to customers who have cancelled their subscriptions, for which we are not entitled to receive revenue.

* Duplicate billing. China Mobile typically generates system identification numbers to identify customers who use our WAP services, rather than directing the real phone numbers to us. Occasionally the platform operators inadvertently generate multiple identification numbers for one mobile number. In such case, the multiple bills for the multiple identification numbers have to be eliminated from the monthly statement the mobile operators provide to us.

* Delivery failure. When mobile operators send us delivery confirmations within 72 hours of our delivery of value-added services, the confirmations will indicate three possible outcomes: success, failure, or unknown. Our internal system recognizes successful confirmations as services provided. As a result, there exist discrepancies between our records and the monthly statement provided by the mobile operators for confirmations marked as “unknown“where our services were successfully delivered or where the confirmation was incorrect.

* Unbillable users. In 2005, certain provincial subsidiaries of China Mobile began to offer 2.5G services to customers who receive mobile telephone services on a pre-paid basis. Such customers may subscribe to our services or download our products, and our internal databases do not distinguish between these and other customers. However, the mobile operators do not yet have any means to bill these pre-paying customers for the wireless value-added services that they receive. As a result, the mobile operators’ monthly statements do not include fees for such users.

As the internal estimation may not be entirely consistent with the actual revenues confirmed by the monthly statements that we eventually receive, we would multiply our internal tabulation of expected revenue from mobile operators from whom we have not received monthly statements by a realization factor applicable to the relevant mobile operator and service and determined according to the average discrepancy over the previous 12 months between our internal tabulations of expected revenues and the actual revenues based on the monthly statements. In addition, our employees verbally communicate with the mobile operators’ billing personnel regarding the estimated revenue for the period in question. We may or may not get additional comfort from such verbal communications.

It is our practice to release our unaudited quarterly financial statements to the market. Due to our past experience with the timing of receipt of the monthly statements from the operators, we expect that we may need to rely on our own internal estimates for the portion of our reported revenues for which we will not have received monthly statements.

Annual report 2004

Management Discussion and Analysis

In such an instance, our internal estimates would be based on our own internal estimation of expected revenues from services provided. As a result of reliance on our internal estimates, we may overstate or understate our revenues for the relevant reporting period. Any difference between our estimated and actual revenues may result in subsequent adjustments to our revenues reported in our financial statements.

As China Mobile’s provincial subsidiaries increasingly implement MISC, we are adapting our own internal data management systems in order to align them with MISC and reduce the discrepancy between our revenue estimates and the revenue calculated by the mobile operators.

Beginning in the second half of 2004, China Mobile and its provincial subsidiaries have been gradually implementing a series of policies that are designed to improve customer service and satisfaction and that have had an impact on our revenue recognition. These policies include:

* not recognizing revenue to us and other SPs for MMS messages that cannot be delivered because of network or handset problems,

* canceling subscriptions of users who fail to access their wireless value-added service subscriptions for a certain period of time,

* requiring more complicated procedures for users to confirm new subscriptions to wireless value-added services, and

* removing from subscriber lists those users who fail to pay China Mobile or the provincial subsidiaries, or who cannot be billed because they use pre-paid telecommunications service cards.

As a result of these new policies, our 2G revenues, which accounted for approximately 16% of our total revenues for the year ended December 31, 2004, decreased 6% during the fourth quarter of 2004 as compared to the third quarter of 2004, and our MMS revenues, which accounted for 36% of our total revenues for the year ended December 31, 2004, declined approximately 54% in the first quarter of 2005 as compared to the fourth quarter of 2004. We cannot assure you that these new policies will not further adversely impact our financial performance in the future.

We evaluate our cooperation arrangements with the mobile operators to determine whether to recognize our revenue on a gross basis or net of the services fees and net transmission charges paid to the mobile operators. Our determination is based upon an assessment of whether we act as a principal or agent when providing our services. We have concluded that we act as a principal in the arrangement. Factors that support our conclusion include:

* We are able to establish prices within ranges prescribed by the mobile operators;

* We determine the service specifications of the services we will be rendering; and

* We are able to control the selection of our content suppliers.

Although the mobile operators must approve the prices of our services in advance, we have been able to adjust our prices from time to time to reflect or react to changes in the market. In addition, the mobile operators usually will not pay us if users do not receive the services or cannot be billed due to transmission and billing failures. As a result of these mobile operator policies, we bear a portion of the delivery and billing risks for our portion of the revenues generated with respect to our services. Based on these factors, we believe that recognizing revenues on a gross basis is appropriate.


		27

		Annual report 2004

Management Discussion and Analysis

Stock-based Compensation Expense

We grant stock options to our employees and we record a compensation charge for the excess of the fair value of the stock at the measurement date over the amount an employee must pay to acquire the stock. We amortize deferred stock compensation using the straight-line method over the vesting periods of the related options, which are generally four years.

We have recorded deferred stock-based compensation to represent the difference between the deemed fair value of our ordinary shares for accounting purposes and the option exercise price. We determined the deemed fair value of our ordinary shares based upon several factors, including a valuation report from an independent appraiser and the price of our then most recent preferred share placement. We recorded deferred stock-based compensation expense of $0, $0.2 million and $2.2 million for stock options granted to employees for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004, respectively, and we amortized $0, $21, 986 and $0.5 million for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004, respectively. If we had used different assumptions or criteria to determine the deemed fair value of our ordinary shares, materially different amounts of stock-based compensation could have been reported.

Pro forma information regarding net income (loss) and net income (loss) per share is required in order to show our net income (loss) as if we had accounted for employee stock options under the fair value method. We use the Black-Scholes option pricing model to compute the fair value. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility rates experienced by comparable public companies. Because our employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our management’s opinion the existing models do not necessarily provide a reliable single measure of the fair value of our stock options.

The historical pro forma net income (loss) and pro forma net income (loss) per share that we used in calculating the fair value of the options granted to employees may not be representative of the pro forma effects in future years of net income (loss) and earnings per share for the following reasons:

* The number of future shares to be issued under these plans is not known; and

* The assumptions used to determine the fair value can vary significantly.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”, or SFAS No. 123(R), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on the grant date fair value. Pro forma disclosure previously permitted under SFAS 123 is no longer an alternative. The new standard will be effective for us in the first interim or annual reporting period beginning after December 31, 2005. Under SFAS No. 123(R), we could elect the modified prospective or modified retroactive option for transition on the

Annual report 2004

Management Discussion and Analysis

adoption of this new standard. Under the modified retroactive option, prior periods are adjusted on a basis consistent with the pro forma disclosures previously required for those periods by SFAS No. 123. Under the modified prospective option, compensation expense for all unvested stock options must be recognized on or after the required effective date based on the grant date fair value of those stock options. We are still in the process of evaluating the impact. Prior to the adoption of SFAS No. 123(R), we will continue to utilize the accounting method prescribed by APB Opinion No. 25 and we have adopted the disclosure requirements of SFAS No. 148 as of December 31, 2003, as allowed by SFAS No. 123.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, or SFAS No. 150. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS No. 150 requires that certain financial instruments that, under previous guidance, issuers could account for as equity be classified as liabilities (or assets in some circumstances) in statement of positions or consolidated balance sheets, as appropriate. The financial instruments within the scope of SFAS No. 150 are: (i) mandatorily redeemable shares that an issuer is obligated to buy back in exchange for cash or other assets; (ii) financial instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets; and (iii) financial instruments that embody an obligation that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuer’s shares (excluding certain financial instruments indexed partly to the issuer’s equity shares and partly, but not predominantly, to something else). SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. SFAS No. 150 also re- quires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. The adoption of SFAS No. 150 did not have a material impact on our financial position, cash flows or results of operations.

In January 2003, the FASB issued FIN 46. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, and provides guidance on the identification of entities for which control is achieved through means other than voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIEs. This new model for consolidation applies to an entity in which either: (1) the equity investors (if any) lack one or more characteristics deemed essential to a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. FIN 46 was applicable for periods ending December 15, 2003. In December 2003 the FASB issued FIN 46 (revised) which provides for the deferral of the implementation date to the end of the first reporting period after December 15, 2004 unless we have a special purpose entity, in which case the provisions must be applied for fiscal years ending December 31, 2003. However, we have retroactively adopted the provisions from the inception of the VIE.

Results of Operations

Year ended December 31, 2004 compared to year ended December 31, 2003

The following table sets forth, for the periods presented, certain data from our consolidated results of operations.


		29

		Annual report 2004

Management Discussion and Analysis


	For the period from
	May 6, 2002 to						For the year ended December 31,
	December 31, 2002						2003						2004
	Amount			Percentage			Amount			Percentage			Amount			Percentage
				of revenue						of revenue						of revenue
	(in thousands of U.S. dollars, except percentages)
2.5G⁽¹⁾	$	131.3			65.6	%	$	5,956.0			76.3	%	$	40,149.2			83.7	%
2G⁽²⁾		69.0			34.4	%		1,850.7			23.7	%		7,820.0			16.3	%

Total gross revenues		200.3			100.0	%		7,806.7			100.0	%		47,969.2			100.0	%
Cost of revenues		(84.3	)		(42.1	)%		(2.284.0	)		(29.3	)%		(15,704.8	)		(32.7	%)

Gross profit		116.0			57.9	%		5,522.7			70.7	%		32,264.4			67.3	%
Operating expenses:
Product development		164.2			82.0	%		1,369.5			17.5	%		4,357.6			9.1	%
Sales and marketing		128.9			64.3	%		841.4			10.8	%		3,228.3			6.7	%
General and administrative		317.3			158.4	%		882.7			11.3	%		4,407.2			9.2	%
Amortization of deferred stock compensation								22.0			0.3	%		482.8			1.0	%

Total operating expenses		610.4			304.7	%		3,115.6			39.9	%		12,475.9			26.0	%

(Loss) income from operations		(494.4	)		(246.8	)%		2,407.1			30.8	%		19,788.5			41.3	%
Interest income, net		0.5			0.2	%		1.0			—			601.9			1.2	%
Other expenses, net		—			—			—			—			(21.2	)		0.0	%

Net (loss) income	$	(493.9	)		(246.6	)%	$	2,408.1			30.8	%		20,369.3			42.5	%


(1)		Includes WAP, MMS and Java™. We began to provide WAP, MMS and Java™ services on a paid basis in September 2002, April 2003 and November 2003, respectively.

(2)		Includes SMS, IVR and CRBT. We began to provide SMS, IVR and CRBT services on a paid basis in July 2002, December 2003 and October 2003, respectively.

This information should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this annual report.

Gross Revenues. Our gross revenues increased substantially to $48.0 million in 2004 from $7.8 million in 2003. The increase in our gross revenues was largely due to the rapid growth in China’s 2.5G wireless value-added services market and the usage volume of our WAP, MMS and SMS services in 2004. We offered a total of 1,278 2.5G-based products and 477 2G-based products in 2004, as compared to 470 products based on 2.5G platforms and 204 products based on 2G platforms in 2003. The number of subscriptions to our services increased to 55.5 million in 2004 from 10.9 million for 2003. The number of downloads of our services increased to 21.2 million in 2004 from 8.8 million in 2003.

Cost of Revenues. Our cost of revenues increased substantially to $15.7 million in 2004 from $2.3 million in 2003. As our revenues increased, the amount that we paid to the mobile operators in service fees and net transmission charges also increased. The service fees that we paid to other business partners, including mobile handset manufacturers, also increased as a result of the increase in our revenues and in the number and scope of our cooperation agreements.

Gross Profit. Our gross profit in 2004 increased substantially from 2003 primarily due to a substantial increase in the volume of our services and related revenues. We achieved a gross profit of $32.3 million in 2004 as compared to $5.5 million in 2003. Our gross profit as a percentage of total revenue decreased slightly to 67.3% in 2004 from 70.4% in 2003 due to the larger payments to mobile handset manufacturers.

Annual report 2004

Management Discussion and Analysis

Operating Expenses. Our operating expenses increased substantially to $12.5 million in 2004 from $3.1 million in 2003. This increase was primarily driven by the increase in general and administrative expenses and product development expenses. An increase in sales and marketing expenses and amortization of deferred stock compensation also contributed to the increase in our operating expenses. Our total number of employees increased to 541 as of December 31, 2004 from 229 as of December 31, 2003.

Our product development expenses increased to $4.4 million in 2004 from $1.4 million in 2003, primarily due to the

expansion of our product development team and depreciation of fixed assets as our business grew. We expanded our product development team to 320 employees of December 31, 2004 from 149 employees as of December 31, 2003.

Our sales and marketing expenses increased to $3.2 million in 2004 from $0.8 million in 2003 as a result of an increase in marketing activities to promote our brand name and the expansion of our marketing team as our business grew. We expanded our sales and marketing team to 110 employees as of December 31, 2004 from 36 employees as of December 31, 2003 and our customer service team to 53 employees as of December 31, 2004 from 18 employees as of December 31, 2003.

Our general and administrative expenses increased to $4.4 million in 2004 from $0.9 million in 2003 as a result of the expansion of our business. We recorded increases in our business tax, professional fees (including fees for legal and accounting services associated with being a public company), compensation and benefits for general management, finance and administrative personnel, travel expenses, lease expenses and other office expenses. Our general and administrative staff grew to 36 employees as of December 31, 2004 from 18 employees as of December 31, 2003.

Our amortization of deferred stock compensation increased to $0.5 million in 2004 from $21,986 in 2003 as a result of the issuance of stock options to our employees under the 2002 Plan.

Year ended December 31, 2003 compared to the period from May 6, 2002 (date of incorporation) through December 31, 2002

The following table sets forth, for the periods presented, certain data from our consolidated results of operations. This information should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this annual report.

Gross Revenues. Our gross revenues substantially increased to $7.8 million in 2003 from $0.2 million for the period from May 6, 2002 to December 31, 2002. The increase in our gross revenues was largely due to the additional services that we provided in 2003, which generated $2.1 million in revenue in 2003. We offered a total of 470 2.5G

Annual report 2004

Management Discussion and Analysis

based services and 204 2G based services in 2003, as compared to 16 services based on 2.5G platforms and 41 services based on 2G platforms in 2002. The increase was also due to the full year effect of our operating results in 2003, during which we expanded our business to develop additional services and establish more distribution channels and partners. The number of subscriptions of our services increased to 10.9 million in 2003 from 0.4 million for the period from May 6, 2002 to December 31, 2002. The number of downloads of our services increased to 8.8 million in 2003 from 0.8 million for the period from May 6, 2002 to December 31, 2002.

Cost of Revenues. Our cost of revenues increased substantially to $2.3 million in 2003 from $84,335 for the period from May 6, 2002 to December 31, 2002. This increase was driven by the increase in the service fees and net transmission charges paid to the mobile operators as a result of the increase in our revenue and usage volume. An increase in the service fees relating to our cooperation arrangements with other business partners also resulted in an increase in our cost of revenues as we increased the number and scope of our cooperation arrangements.

Gross Profit. Our gross profit in 2003 increased substantially from 2002 primarily due to a substantial increase in the volume of our services and related revenues. We achieved a gross profit of $5.5 million in 2003 as compared to $0.1 million in 2002. As our gross revenues increased at a higher rate than our cost of revenues, our gross margin increased in 2003.

Operating Expenses. Our operating expenses increased substantially to $3.1 million in 2003 from $0.6 million for the period from May 6, 2002 to December 31, 2002. This increase was primarily driven by an increase in our product development expenses and sales and marketing expenses. Increases in our general and administrative expenses and amortization of deferred stock compensation also contributed to the increase in our operating expenses. Our total number of employees increased to 229 as of December 31, 2003 from 51 as of December 31, 2002.

Our product development expenses increased to $1.4 million in 2003 from $0.2 million for the period from May 6, 2002 to December 31, 2002, primarily due to the expansion of our product development team as our business grew. We expanded our product development team to 149 employees as of December 31, 2003 from 27 employees as of December 31, 2002.

Our sales and marketing expenses increased to $0.8 million in 2003 from $0.1 million for the period from May 6,

Annual report 2004

Management Discussion and Analysis

2002 to December 31, 2002 as a result of an increase in marketing activities to promote our brand name and to establish additional distribution channels. We expanded our sales and marketing team to 36 employees as of December 31, 2003 from 11 employees as of December 31, 2002, and our customer service team to 18 employees as of December 31, 2003, from 3 employees as of December 31, 2002.

Our general and administrative expenses increased to $0.9 million in 2003 from $0.3 million for the period from May 6, 2002 to December 31, 2002 as a result of the expansion of our business, including increases in our professional fees, business tax, the compensation and benefits for general management, finance and administrative personnel, travel expenses, lease expenses and other office expenses. Our general and administrative staff grew to 18 employees as of December 31, 2003 from 8 employees as of December 31, 2002.

Our amortization of deferred stock compensation increased to $21,986 in 2003 from $0 for the period from May 6, 2002 to December 31, 2002 as a result of the issuance of stock options to our employees under the 2002 Plan.

Liquidity and Capital Resources

Cash Flows and Working Capital

The following table sets forth our cash flows with respect to operating, investing and financing activities for the periods indicated.


	For the period from			For the year ended December 31,
	May 6, 2002 to
	December 31, 2002			2003			2004
	(in thousands of US. dollars,)
Net cash (used in) provided by operating activities	$	(579.7	)	$	1,959.8		$	15,844.7
Net cash used in investing activities		(292.3	)		(864.0	)		(2,430.2	)
Net cash provided by financing activities		3,520.3			—			73,555.5
Effect of exchange rate changes		(2.0	)		0.6			1.5
Net increase in cash and cash equivalents		2,646.2			1,096.4			86,971.5
Cash and cash equivalents, beginning of period		—			2,646.2			3,742.6
Cash and cash equivalents, end of period	$	2,646.2		$	3,742.6		$	90,714.1

Prior to our initial public offering in July 2004, our primary sources of liquidity were capital contributions from our founders, private placements of preferred shares to investors and cash generated from operating activities. After the completion our initial public offering, our primary sources of liquidity have been cash flow from operating activities and the proceeds of our initial public offering. As we are continuously examining opportunities to expand our business through acquisitions, we anticipate that part of the proceeds of our initial public offering may be used to fund our acquisition activities. As of December 31, 2003 and December 31, 2004, our cash and cash equivalents were $3.7 million and $90.7 million, respectively.

We do not bill or collect payment from users of our services directly, but instead depend on the billing systems and records of China Mobile and other mobile operators to record the volume of our services provided, charge our users, collect payments and remit to us our revenue, less transmission fees and service fees. If China Mobile ceases to continue to cooperate with us, we will explore further cooperation with other mobile service providers and explore alternative billing systems to collect bills from users.

Annual report 2004

Management Discussion and Analysis

Net cash provided by operating activities was $15.8 million in 2004 compared to net cash used in operating activities of $2.0 million in 2003. This difference was primarily due to the net income that we generated.

Net cash used in investing activities increased significantly to $2.4 million in 2004 from $0.9 million in 2003, due primarily to investment in fixed assets including servers, computers and vehicles in connection with the expansion of our business.

Net cash provided by financing activities in 2004 was $73.6 million, which mainly represents the net proceeds from our initial public offering in July 2004.

We believe that our current cash and cash equivalents, cash flow from operations and the proceeds from our initial public offering will be sufficient to meet our anticipated cash needs, including for working capital purposes, capital expenditures and various contractual obligations, for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debt securities or additional equity or to obtain a credit facility. The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations. Given our short operating history, we currently do not have any lines of credit or loans with any commercial banks. As a result, we are unlikely to rely on any bank loans to meet our liquidity needs. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

Indebtedness

As of December 31, 2004, we did not have any indebtedness, and we did not have any material debt securities, material contingent liabilities or material mortgages or liens.

We intend to meet our future funding needs through cash flow generated from operating activities and the proceeds of our initial public offering. Our treasury objective is to maintain safety and liquidity of our cash. Therefore, we have kept our cash and cash equivalents in short-term deposits and short-term government bills or bonds.

The following table sets forth our indebtedness as of the dates indicated:


	As of December 31,
	2002		2003		2004
	(in thousands of US. dollars)
Short-term debt	$	5.0	$	90.0	$	—

Total debt	$	5.0	$	90.0	$	—

As of December 31, 2004, we did not have any outstanding loan capital issued or agreed to be issued, bank overdrafts, loans, debt securities or other similar indebtedness, liabilities under acceptance (other than normal trade bills) or acceptance credits, debentures, mortgages, charges, finance leases or purchase commitments, guarantees or other material contingent liabilities.

Annual report 2004

Management Discussion and Analysis

Contractual Obligations and Commercial Commitments

The following table sets forth our contractual obligations as of December 31, 2004:


	Payments due by period
	Total		Within
			1 year		1-3 years		3-5 years		Thereafter
	(in thousands of US. dollars,)
Short-term debt	$	—	$	—	$	—	$	—	$	—
Operating lease obligations	$	1,423.3	$	1,022.5	$	400.8		—		—
Other contractual commitments*		—		—		—		—		—

Total	$	1,423.3	$	1,022.5	$	400.8	$	—	$	—


*		Represents facility service fees.

We have entered into certain leasing arrangements relating to our office premises. Pursuant to our additional leasing arrangements entered into in April 2005, as of April 30, 2005, our operating lease obligations are $1.0 million and $0.4 million in 2005 and 2006, respectively, and $1.4 million in total. As of December 31, 2004, we do not have any long-term debt obligations or purchase obligations.

Capital Expenditures

Our total capital expenditures for equipment and motor vehicles in 2004, 2003 and for the period from May 6, 2002 to December 31, 2002 were $2.4 million, $0.9 million and $0.3 million, respectively. We currently have approximately $0.2 million worth of capital expenditures in progress, which will primarily be used in China. Our capital expenditures in progress are financed primarily from cash flows from our operating activities.

Our capital expenditures are spent primarily on servers, computers, office equipment, leasehold improvement and vehicles. In general, there is a positive correlation between our revenue and the amount of traffic that passes through our servers and transmission equipment. From time to time we need to purchase additional servers and transmission equipment as a result of increased business traffic. Our purchase of personal computers is primarily driven by headcount increases.

As mobile operators do not provide us detailed revenue breakdown on a service-by-service basis, we depend on our internal database system to monitor revenue derived from each of our services. We make our business decisions based on our internal data, taking into account other factors including strategic considerations.

Off-balance Sheet Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholder’s equity, or that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Annual report 2004

Management Discussion and Analysis

Income Taxation

The Cayman Islands currently do not levy any taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. In addition, pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, we have obtained an undertaking from the Governor-in-Council that (i) no law which is enacted in the Cayman Islands imposing any tax to be levied on profits or income or gains or appreciation shall apply to us or our operations and (ii) no tax to be levied on profits, income gains or appreciations or which is in the nature of estate duty or inheritance tax shall be payable by us on or in respect of our shares, debentures or other obligations or by way of the withholding in whole or in part of any relevant payment as defined in Section 6(3) of the Tax Concessions Law (1999 Revision). This undertaking is for a period of 20 years from May, 21, 2002.

KongZhong Beijing, Beijing AirInbox, Beijing Boya Wuji and Beijing WINT are incorporated in the PRC and subject to the Income Tax Law of the PRC Concerning Foreign Investment and Foreign Enterprises and various local income tax laws. Generally, PRC companies are subject to an enterprise income tax of 33%. However, KongZhong Beijing and the three operating companies each benefit from preferential tax treatment as a high technology enterprise. As such, KongZhong Beijing’s net income is tax exempt until 2005, subject to a 7.5% enterprise income tax for the following three years and subject to a 15% enterprise income tax thereafter. Beijing AirInbox’s net income was tax exempt until the end of 2004, is subject to a 7.5% enterprise income tax for three years beginning in January 2005 and subject to a 15% enterprise income tax thereafter. Beijing Boya Wuji’s net income tax is tax exempt until 2006, is subject to a 7.5% enterprise income tax for three years beginning in 2009 and subject to a 15% enterprise income tax thereafter. Beijing WINT is in the process of applying for preferential tax treatment as a high technology enterprise. Each of KongZhong Beijing, Beijing AirInbox, Beijing Boya Wuji and Beijing WINT’s high technology enterprise status is subject to periodic review by the relevant PRC governmental authority. If any of these entities is found not to qualify as a high technology enterprise for PRC tax purposes, then such entity will not be eligible for the preferential tax treatment.

KongZhong Beijing and Beijing AirInbox recorded net losses in 2002 and 2003, and Beijing Boya Wuji and Beijing WINT recorded net losses in 2004, which they may carry forward for five years from the end of the period in which the loss was recorded to offset future net income for tax purposes. KongZhong Beijing and Beijing AirInbox recorded net profits in 2004 that are sufficient to realize the full tax benefit of the carry forward net losses. We cannot, however, give any assurances that Beijing Boya Wuji or Beijing WINT will record sufficient net income within the carry forward periods to realize the full tax benefit of their past net losses, and therefore, have recorded a full valuation allowance on the deferred tax asset balance. The tax losses carried forward as of December 31, 2004 amounted to $61,793 and will expire by 2009.

In addition, our revenues are subject to business taxes. Since August 2003, each of Beijing AirInbox and Beijing Boya Wuji is subject to a 3% business tax for wireless value-added services and a 5% business tax for other services. Beijing WINT is also subject to a 3% business tax for wireless value-added service and a 5% business tax for other services after our acquisition in February 2005. KongZhong Beijing is subject to a 5% business tax. In future periods, we expect that a substantial portion of our revenues will be generated through Beijing AirInbox, Beijing Boya Wuji and Beijing WINT. In addition, pursuant to the arrangements that KongZhong Beijing has entered into with each of Beijing AirInbox, Beijing Boya Wuji and Beijing WINT, each of Beijing AirInbox, Beijing Boya Wuji and Beijing WINT pays us service and license fees. The amount of such payments will be subject to the 5% business tax payable by KongZhong Beijing.


Report of Independent Registered
Public Accounting Firm

37

Annual report 2004

Report of Independent Registered Public Accounting firm

To the Board of Directors and Shareholders
of KongZhong Corporation:

We have audited the accompanying consolidated balance sheets of KongZhong Corporation and its subsidiaries (the “Company”) as of December 31, 2002, 2003 and 2004 and the related consolidated statements of Operations, shareholders’ equity and comprehensive income (loss), and cash flows for the period from May 6, 2002 to December 31 , 2002 and the two years ended December 31, 2003 and 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit Included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2002, 2003 and 2004 and the results of its operations and its cash flows for the above stated periods in conformity with accounting principles generally accepted in the United States of America.

Deloitte Touche Tohmatsu
Certified Public Accountants
Hong Kong
March 28, 2005 except for Note 16
May 24, 2005

Annual report 2004

KONGZHONG CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS

(In US dollars, except per share amount)


	For the period from
	May 6, 2002 to			For the year ended December 31
	December 31, 2002			2003			2004
Gross revenues	$	200,319		$	7,806,689		$	47,969,217
Cost of revenues		(84,335	)		(2,283,972	)		(15,704,767	)

Gross profit		115,984			5,522,717			32,264,450

Operating expenses:
Product development		164,215			1,369,503			4,357,616
Selling and marketing		128,894			841,448			3,228,368
General and administrative		317,288			882,635			4,407,175
Amortization of deferred stock compensation*		—			21,986			482,766

Total operating expenses		610,397			3,115,572			12,475,925
(Loss) income from operations		(494,413	)		2,407,145			19,788,525
Other expenses, net		—			—			(21,198	)
Interest income, net		539			991			601,934

Net (loss) income before income taxes		(493,874	)		2,408,136			20,369,261
Income taxes expense

Net (loss) income	$	(493,874	)	$	2,408,136		$	20,369,261

Net (loss) income per share, basic	$	0.00		$	0.01		$	0.02

Net (loss) income per share, diluted	$	0.00		$	0.00		$	0.02

Shares used in calculating basic net (loss) income per share		415,547,794			469,000,000			903,010,929

Shares used in calculating diluted net (loss) income per share		415,547,794			1,094,824,434			1,250,640,982

*Amortization of deferred stock compensation related to:
Product development	$	—		$	13,229		$	125,777
Selling and marketing		—			8,389			59,506
General and administrative		—			368			297,483

	$	—		$	21,986		$	482,766

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


39 Annual report 2004

KONGZHONG CORPORATION
CONSOLIDATED BALANCE SHEETS

(In US dollars, except per share amount)


	December 31,
	2002			2003			2004
Assets
Current assets:
Cash and cash equivalents	$	2,646,216		$	3,742,607		$	90,714,082
Accounts receivable net of allowance of $Nil as of December 31, 2002, 2003 and 2004		132,327			1,703,864			10,198,786
Prepaid expenses and other current assets		71,754			198,286			719,654

Total current assets		2,850,297			5,644,757			101,632,522
Rental deposits		—			74,234			256,025
Property and equipment, net		251,041			848,461			2,484,192

Total assets	$	3,101,338		$	6,567,452		$	104,372,739


Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	23,455		$	563,615		$	2,498,617
Accrued expenses and other current liabilities		46,586			393,682			1,898,776
Due to a related party		5,000			90,000			46,203

Total current liabilities	$	75,041		$	1,047,297		$	4,443,596
Minority interest	$	—		$	—		$	120,815

Series B redeemable convertible preferred shares, net of issuance costs of $30,000 ($0.0000005 par value; 350,000,000 shares authorized, 350,000,000 and Nil issued and outstanding in 2003 and 2004, respectively)	$	2,970,025		$	2,970,025		$	—


Commitments (Note 13)
Shareholders’ equity
Series A convertible preferred shares ($0.0000005 par value; 231,000,000 shares authorized, 231,000,000, 231,000,000 and Nil shares issued and outstanding in 2002, 2003 and 2004, respectively)	$	115		$	115		$	—
Ordinary shares ($0.0000005 par value; 999,419,000,000 shares authorized, 469,000,000,469,000,000 and 1,371,600,000 shares issued and outstanding in 2002, 2003 and 2004, respectively)		235			235			685
Additional paid-in capital		551,842			826,035			79,206,751
Deferred stock compensation		—			(189,086	)		(1,682,643	)
Accumulated other comprehensive (loss) income		(2,046	)		(1,431	)		12
(Accumulated deficit) Retained earnings		(493,874	)		1,914,262			22,283,523

Total shareholders’ equity		56,272			2,550,130			99,808,328

Total liabilities and shareholders’ equity	$	3,101,338		$	6,567,452		$	104,372,739

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

KONGZHONG CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)

(In US dollars, except per share amount)


																		Accumulated			(Accumulated
	Series A convertible											Additional			Deferred			other			deficit)			Total
	preferred shares						Ordinary shares					paid-in			stock			comprehensive			retained			shareholders’			Comprehensive
	Shares			Amount			Shares		Amount			capital			compensation			(loss) income			earnings			equity			income (loss)
Issuance of common shares to founders		—		$	—			469,000,000	$	235		$	—		$	—		$	—		$	—		$	235		$	—
Issuance of Series A convertible preferred shares		231,000,000			115			—		—			549,896			—			—			—			550,011			—
Stock options issued to consultants		—			—			—		—			1,946			—			—			—			1,946			—
Foreign currency translation adjustments		—			—			—		—			—			—			(2,046	)		—			(2,046	)		(2,046	)
Net loss		—			—			—		—			—			—						(493,874	)		(493,874	)		(493,874	)

Balance as of December 31, 2002		231,000,000			115			469,000,000		235			551,842						(2,046	)		(493,874	)		56,272		$	(495,920	)

Stock options issued to consultants		—			—			—		—			63,121			—			—			—			61,121		$	—
Deferred stock-based compensation		—			—			—		—			211,072			211,(072	)		—			—			—			—
Amortization of deferred stock compensation		—			—			—		—			—			21,986			—			—			21,986			—
Foreign currency translation adjustments		—			—			—		—			—			—			615			—			615			615
Net income		—			—			—		—			—			—			—			2,408,136			2,408,136			2,408,136

Balance as of December 31, 2003		231,000,000			115			469,000,000		235			826,035			(189,086	)		(1431	)		1,914,262			2,550,130		$	2,408,751

Issuance of ordinary shares upon initial public offering, net of issuance costs of $6,760,110		—			—			320,000,000		160			73,434,123			—			—			—			73,434,283		$	—
Conversion of the Series A convertible preferred shares upon initial public offering		(231,000,000	)		(115	)		231,000,000		(115	)		—			—			—			—			—			—
Conversion of the Series B redeemable convertible preferred shares upon initial public offering		—			—			350,000,000		175			2,969,850			—			—			—			2,970,025			—
Issuance of common share upon exercise of options		—			—			1,600,000		—			420			—			—			—			420			—
Reversal of deferred stock compensation for employee terminations		—			—			—		—			(229,337	)		229,337			—			—			—			—
Deferred stock-based compensation		—			—			—		—			2,205,660			(2,205,660	)		—			—			—			—
Amortization of deferred stock compensation		—			—			—		—			—			482,766			—			—			482,766			—
Foreign currency translation adjustments		—			—			—		—			—			—			1,443						1,443			1,443
Net income		—			—			—		—			—			—			—			20,369,261			20,369,261			20,369,261

Balance as of December 31, 2004		—		$	—			1,371,600,000	$	685		$	79,206,751		$	(1,682,634	)	$	12		$	22,283,523		$	99,808,328		$	20,370,704

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


41

Annual report 2004

KONGZHONG CORPORATION
CONSOLIDATED CASHFLOW STATEMENTS

(In US dollars, except per share amount)


	For the period from			For the			For the
	May 6, 2002 to			year ended			year ended
Consolidated statements of cash flows	December 31, 2002			December 31, 2003			December 31, 2004
Operating activities:
Net (loss) income	$	(493,874	)	$	2,408,136		$	20,369,261
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Amortization of deferred stock compensation		—			21,986			482,766
Stock options issued to consultants		1,946			63,121			—
Depreciation and amortization		41,310			266,539			793,749
Loss on disposal of property and equipment		—			—			743
Changes in operating assets and liabilities:
Accounts receivable		(132,327	)		(1,571,537	)		(8,494,922	)
Prepaid expenses and other current assets		(71,754	)		(126,532	)		(521,368	)
Rental deposits		—			(74,234	)		(181,791	)
Accounts payable		23,455			540,160			1,935,002
Accrued expenses and other current liabilities		46,586			347,096			1,505,094
Due to a related party		5,000			85,000			(43,797	)

Net cash (used in) provided by operating activities		(579,658	)		1,959,735			15,844,737


Investing activities
Purchase of property and equipment		(292,351	)		(863,959	)		(2,432,604	)
Proceeds from disposal of property and equipment		—			—			2,381

Net cash used in by investing activities		(292,351	)		(863,959	)		(2,430,223	)


Financing activities
Proceeds from issuance of ordinary shares		235			—			—
Proceeds from issuance of Series A convertible preferred shares		550,011			—			—
Proceeds from issuance of Series B redeemable convertible preferred shares, net of issuance costs		2,970,025			—			—
Capital injection from minority interest		—			—			120,815

Proceeds from issuance of ordinary shares upon initial public offering, net of issuance costs		—			—			73,434,703

Net cash provided by financing activities		3,520,271			—			73,555,518


Effect of foreign exchange rate changes		(2,046	)		615			1,443

Net increase in cash and cash equivalents		2,646,216			1,096,391			86,971,475
Cash and cash equivalents, beginning of year		—			2,646,216			3,742,607

Cash and cash equivalents, end of year	$	2,646,216		$	3,742,607		$	90,714,082

Supplemental disclosures of cash flow information
Income taxes paid	$	—		$	—		$	—

Interest paid	$	—		$	—		$	—

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

KONGZHONG CORPORATION (ARROW)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)


		43

		Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

ORGANIZATION AND PRINCIPAL ACTIVITIES

KongZhong Corporation (“KongZhong”) was incorporated under the laws of the Cayman Islands on May 6, 2002. KongZhong established a wholly foreign owned enterprise,[CHINESE CHARACTER] (“KongZhong Beijing”), on July 29, 2002 under the laws of the People’s Republic of China (the “PRC”) and it has an operating period of 30 years which commenced in July 2002. The Company and its consolidated entities (the “Company”) provide wireless interactive entertainment, media and community services to mobile phone users in the PRC and is specialized in the development, marketing and distribution of consumer wireless value-added services.

PRC regulations prohibit direct foreign ownership of business entities providing value-added telecommunications services in the PRC where certain licenses are required for the provision of such services. To comply with these regulations the Company conducts substantially all of its activities through [CHINESE CHARACTER] (“Beijing AirInbox”), a variable interest entity established on April 4, 2002 with an initial operating period of 30 years. Beijing AirInbox provides wireless value-added services to China’s cell phone users in the form of SMS, WAP, MMS, Java™, IVR and CRBT and is legally owned directly by three PRC citizens (the “Registered Shareholders”). Upon establishment, Yunfan Zhou, the Company’s Chief Executive Officer, Songlin Yang, the uncle of Nick Yang, the Company’s President, and Leilei Wang, held 35%, 35% and 30%, respectively of Beijing AirInbox’s total outstanding shares. In September 2003, Leilei Wang transferred his 30% equity interest in Beijing AirInbox to Yunfan Zhou and Zhen Huang, the wife of Nick Yang, in portions of 15% each. In April 2004, the registered capital of Beijing AirInbox was increased from RMB 2 million to RMB 10 million. The increased registered capital was contributed from Songlin Yang and Yang Cha, a PRC citizen and employee of the Company, for $0.4 million (RMB 3.5 million) and $0.5 million (RMB 4.5 million), respectively.

In March 2004, the Company established another variable interest entity named Beijing Boya Wuji Technologies Co. Ltd. (“Beijing Boya Wuji”) with an operating period of 20 years. Beijing Boya Wuji will provide wireless value-added services to China’s cell phone users in the form of SMS, WAP, MMS, Java™, IVR and CRBT and a license has been obtained from the PRC government in April 2004. Beijing Boya Wuji is legally owned directly by two PRC citizens (the “Registered Shareholders of Beijing Boya Wuji”). Upon establishement of Beijing Boya Wuji, Yunfan Zhou and Zhen Huang held 50% and 50% respectively of Beijing Boya Wuji. The investment by these two individuals has been done through their personal funds with no loans provided by the Company. Accordingly, the investment amount of $120,815 has been included as a minority interest.

KongZhong and KongZhong Beijing have entered into various operating agreements with Beijing AirInbox and Beijing Boya Wuji, including Exclusive Technical and Consulting Services Agreements. Under these agreements, Beijing AirInbox and Beijing Boya Wuji have the exclusive right and are required to pay the Company licensing and service fees for the use of each domain name and trademark and the technical and consulting services received. The Company is entitled to receive service fees in an amount up to all of the net income of Beijing AirInbox and Beijing Boya Wuji.

In addition, the Company has extended interest-free loan to the Registered Shareholders ($241,546 has been loaned as of December 31, 2002 and 2003) to finance their investments in Beijing AirInbox. In April 2004, Yang Cha and Songlin Yang drew down the loans for the amount of $0.5 million and $0.4 million, respectively for investment into Beijing AirInbox as contribution to the capital increase in Beijing AirInbox by Yang Cha and Songlin Yang. Principal terms of these loan agreements provide that (i) proceeds from the loans are to be used solely for the investment in Beijing AirInbox, (ii) the loans can only be repaid to the Company by transferring the shares of Beijing AirInbox to the Company, (iii) the shares of Beijing AirInbox cannot be transferred without the approval of the Company, (iv) the Company has the right to appoint all directors and senior management personnel of Beijing AirInbox, and (v) all shareholder rights including voting rights and rights to dividends are assigned to KongZhong Beijing. In addition,

44

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

the Company has the right to require the transfer of the shares of Beijing AirInbox to the Company or any party designated by the Company, at any time, for the amount of the loan outstanding. Since the Company consolidates Beijing AirInbox, the loans to the Registered Shareholders and Yang Cha are treated as investments in Beijing AirInbox and are eliminated upon consolidation for all periods presented.

The Company is the primary beneficiary of Beijing AirInbox because the Company holds all of the variable interests in Beijing AirInbox either directly or through related parties. The only variable interests not directly held by KongZhong Beijing are the shares which are held by Yunfan Zhou (10%), Songlin Yang (42%), Zhen Huang (3%) and Yang Cha (45%). Each of these individuals is a related party of the Company as described in FIN 46 (revised) either because they are officers of the Company (Yunfan Zhou), a member of the immediate family of management (Zhen Huang), or acting as a de facto agent of the Company (all). The de facto agent relationship is established through the loan agreement, under which the individuals assign all of their rights as shareholders to the Company. Because there are no unrelated variable interests in Beijing AirInbox, the Company is the primary beneficiary.

The Company is the primary beneficiary of Beijing Boya Wuji because the Company holds all of its variable interests in Beijing Boya Wuji through related parties. The only variable interests in Beijing Boya Wuji not directly held by KongZhong Beijing are the shares which are held by Yunfan Zhou (50%) and Zhen Hunang (50%). Each of these individuals is a related party of the Company as described in FIN 46 (revised) either because they are officers of the Company (Yunfan Zhou), a member of the immediate family of management (Zhen Huang), or acting as a de facto agent of the Company (all). The de facto agent relationship is established through the pledge agreement under which the individuals assign all of their rights as shareholders to the Company. Because there are no unrelated variable interests in Beijing Boya Wuji, the Company is the primary beneficiary.

In January 2003, the Financial Accounting Standard Board (“FASB”) issued Financial interpretation (“FIN”) No. 46, which required certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective for all new variable interest entities created or acquired after December 15, 2003. In December 2003, the FASB issue FIN 46 (revised) which provides for the deferral of the implementation date to the end of the first reporting period after March 15, 2004 unless the Company has a special purpose entity, in which case the provisions must be applied for fiscal years ending December 31, 2003. However, the Company has elected to retroactively apply FIN 46 and consolidate its variable interest entity, Beijing AirInbox from its inception.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of presentation

The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

(b) Basis of consolidation

The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiary and its variable interest entities, Beijing AirInbox and Beijing Boya Wuji. All inter-company transactions and balances have been eliminated upon consolidation.

(c) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand and highly liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months or less when purchased.


		45

		Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

(d) Use of estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses in the financial statements and accompanying notes. Significant accounting estimates reflected in the Company’s financial statements include useful lives for property and equipment, accruals for revenue adjustments, cost of revenues, other liabilities and stock-based compensation expense.

(e) Certain significant risks and uncertainties

The Company participates in a dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on the Company’s future financial position, results of operations, or cash flows: changes in the overall demand for entertainment-oriented wireless value-added services; advances and trends in new technologies and industry standards; changes in key suppliers; changes in certain strategic relationships or customer relationships; regulatory or other factors; risks associated with the ability to maintain strategic relationship with the mobile operators; and risks associated with the Company’s ability to attract and retain employees necessary to support its growth.

(f) Property and equipment, net

Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization is calculated on a straight-line basis over the following estimated useful lives:


Computer and transmission equipment		3 years
Furniture and office equipment		3 years
Motor vehicles		3 years
Leasehold improvements		Over the lease term
Communication equipment		1 year

(g) Impairment of long-lived assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the Company measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the fair value of the assets.

(h) Revenue recognition and cost of revenues

The Company’s revenues are primarily derived from entertainment-oriented wireless value-added services. Wireless value-added services revenues are derived from providing personalized interactive entertainment, media and community (including ring back services and downloadable ring tones, icons and screen savers) services primarily to mobile phone customers of China Mobile Communication Corporation and its various subsidiaries (“China Mobile” or the “Mobile Operator”). Fees, established by an arrangement with China Mobile and indicated in the message received on the mobile phone, for these services are charged on a transaction basis or on a monthly subscription basis, and vary according to the type of services delivered. The Company recognizes all revenues in the period in which the services are performed.

The Company contracts with the Mobile Operator for the transmission of wireless value-added services as well as for billing and collection services. The Mobile Operator provides the Company with a monthly statement that represents the principal evidence that service has been delivered and triggers revenue recognition for a substantial portion of the Company’s revenue. In certain instances, when a statement is not received within a reasonable period of time, the Company is required to make an estimate of the revenues and cost of revenues earned during the period

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

covered by the statement based on internally generated information, historical experience, verbal communication with Mobile Operator, and/or other assumptions that are believed to be reasonable under the circumstances.

The Company measures its revenues based on the total amount paid by its customers, for which the Mobile Operator bills and collects on the Company’s behalf. Accordingly, the 15 - 50% service fee paid to the Mobile Operator is included in the cost of revenues. In addition, the Mobile Operator charges the Company transmission charges based on a per message fee which varies depending on the volume of the messages sent in the relevant month, multiplied by the excess messages sent over messages received. These transmission charges are likewise retained by the Mobile Operator, and are reflected as costs of revenues in the financial statements.

The Company evaluates the criteria outlined in Emerging Issues Task Force Issue No. 99-19 “Reporting Revenue Gross as Principal Versus Net as an Agent,” in determining whether it is appropriate to record the gross amount of revenues and related costs or the net amount earned after deducting service fees and transmission charges paid to the Mobile Operator. The Company records the gross amounts billed to its customers as it is the primary obligor in these transactions as it has latitude in establishing prices, it is involved in the determination of the service specifications and it has the right to select suppliers.

(i) Foreign currency translation

The functional currency of the Company’s subsidiaries including its variable interest entities in the PRC is the Renminbi (“RMB”). Transactions denominated in currencies other than RMB are translated into RMB at the exchange rates quoted by the People’s Bank of China (the “PBOC”) prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into RMB using the applicable exchange rates quoted by the PBOC at the balance sheet dates. The resulting exchange differences are included in the statement of operations.

The Company has determined that the US. dollar is its functional and reporting currency. Accordingly, assets and liabilities are translated using exchange rates in effect at each year end and average exchange rates are used for the consolidated statements of operations. Translation adjustments resulting from translation of these consolidated financial statements are reflected as accumulated other comprehensive income (loss) included in the shareholders’ equity.

(j) Product development expenses

Product development expenses consist primarily of compensation and related costs for employees associated with the development and programming of mobile data content and are expensed as incurred.

(k) Income taxes

Deferred income taxes are recognized for temporary differences between the tax basis of assets and liabilities and their reported amount in the financial statements, net operating loss carryforwards and credits by applying enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

(I) Comprehensive income (loss)

Comprehensive income (loss) includes foreign currency translation adjustments. Comprehensive income (loss) is reported in the statements of shareholders’ equity.

(m) Fair value of financial instruments

Financial instruments include cash and cash equivalents. The carrying values of cash and cash equivalents approximate their fair values due to their short-term maturities.


		47

		Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

(n) Advertising costs

The Company expenses advertising costs as incurred. Total advertising expenses was $26,620, $52,922 and $176, 675 for the period from May 6, 2002 to December 31, 2002, the years ended December 31, 2003 and 2004, respectively and have been included as part of selling and marketing expenses.

(o) Stock-based compensation

The Company grants stock options to its employees and certain non-employees. The Company records a compensation charge for the excess of the fair value of the stock at the grant date or any other measurement date over the amount an employee must pay to acquire the stock. The compensation expense is recognized over the applicable service period, which is usually the vesting period. The Company accounts for stock-based awards to non-employees by recording a charge for the services rendered by the non-employees using the Black-Scholes option pricing model.

Had compensation cost for options granted to employees under the Company’s stock option plan (the “Plan”) been determined based on the fair value at the grant dates, the Company’s pro forma net income (loss) would have been as follows:


				For the year			For the year
	For the period from			ended			ended
	May 6, 2002 to			December 31,			December 31,
	December 31, 2002			2003			2004
Net (loss) income as reported:	$	(493,874	)	$	2,408,136		$	20,369,261
Add: Stock compensation as reported		—			21,986			482,766
Less: Stock compensation determined using the fair value method		(9.615	)		(70.165	)		(1.373.026	)

Pro forma net (loss) income	$	(503.489	)	$	2,359,957		$	19.479.001

Basic net (loss) income per share:
As reported	$	0.00		$	0.01		$	0.02
Pro forma	$	0.00		$	0.01		$	0.02
Diluted net (loss) income per share:
As reported	$	0.00		$	0.00		$	0.02
Pro forma	$	0.00		$	0.00		$	0.02

The fair value of each option grant and share granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period.


				December 31,
Option Grants	2002			2003			2004
Average risk-free rate of return		5.08	%		4.44	%		2.43	%
Weighted average expected option life	4 years			4 years			2.844 years
Volatility rate		70	%		70	%		75	%
Dividend yield		0	%		0	%		0	%

(p) Net (loss) income per share

Basic net (loss) income per share is computed by dividing net (loss) income by the weighted average number of ordinary shares outstanding during the period. Diluted net (loss) income per ordinary share reflects the potential dilution that could occur if securities or other contracts to issue ordinary shares were exercised or converted into ordinary shares. Ordinary share equivalents are excluded from the computation in loss years as their effect would be anti-dilutive.

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and
THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

(q) Segment reporting

The Company operates and manages its business as a single segment. The Company generates its revenues solely from mobile phone users in China, and accordingly, no geographical information is presented.

(r) Recently issued accounting standards

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)” “Share-Based Payment”, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123, However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on the grant-date fair values. Pro forma disclosure previously permitted under SFAS 123 is no longer an alternative. The new standard will be effective for the Company in the first interim or annual reporting period beginning after December 31, 2005. Under SFAS 132(R), the Company could elect the modified prospective or modified retroactive option for transition on the adoption of this new standard. Under the modified retroactive option, prior periods are adjusted on a basis consistent with the pro forma disclosures previously required for those periods by SFAS 123. Under the modified prospective option, compensation expense for all unvested stock options must be recognized on or after the required effective date based on the grant-date fair value of those stock options. The Company is still in the process of evaluate the impact. Prior to the adoption of SFAS 123(R), The Company will continue to utilize the accounting method prescribed by APB Opinion No. 25 and has adopted the disclosure requirements of SFAS No. 148 as of December 31, 2003 as allowed by SFAS No. 123.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. The Statement establishes standards for how an issuer classifies and measures certain financial instruments. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Statement requires that certain financial instruments that, under previous guidance, issuers could account for as equity and be classified as liabilities (or assets in some circumstances) in statement of positions or consolidated balance sheets, as appropriate. The financial instruments within the scope of this Statement are: (i) mandatorily redeemable shares that an issuer is obligated to buy back in exchange for cash or other assets; (ii) financial instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets; and (iii) financial instruments that embodies an obligation that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuer’s shares (excluding certain financial instruments indexed partly to the issuer’s equity shares and partly, but not predominantly, to something else). This Statement does not apply to features embedded in a financial instrument that is not a derivative in its entirety. The Statement also requires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. The adoption of SFAS No. 150 did not have a material impact on the Company’s financial position, cash flows or results of operations.

In January 2003, the FASB issued FIN 46. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and provides guidance on the identification of entities for which control is achieved through means other than voting rights (“Variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIEs. This new model for consolidation applies to an entity in which either: (1) the equity investors (if any) lack one or more characteristics deemed essential to a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. FIN 46 was applicable for periods ending December 15, 2003. In December 2003 the FASB issued FIN 46 (revised) which provides for the deferral of the implementation date to the end of the first reporting period after December 15, 2004 unless the Company has a special purpose

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004
(In US dollars, except per share amount)

entity, in which case the provisions must be applied for fiscal years ending December 31, 2003. However, the Company has retroactively adopted the provisions from the inception of the VIE.

3. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consists of the following:


	2002			2003			2004
Computer and transmission equipment	$	214,987		$	837,467		$	2,223,168
Furniture and office equipment		39,639			104,962			254,413
Motor vehicles		—			101,024			437,697
Leasehold improvements		29,258			85,601			582,274
Communication equipment		8,467			27,256			87,797

		292,351			1,156,310			3,585,349
Less: accumulated depreciation and amortization		(41,310	)		(307,849	)		(1,101,157	)

	$	251,041		$	848,461		$	2,484,192

4. PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist of the following:


	2002		2003		2004
Tax recoverable	$	—	$	88,968	$	—
Staff advances		—		40,907		71,958
Advance to suppliers		21,694		35,125		459,417
Prepayments		1,933		33,286		49,919
Rental and other deposits		48,127		—		86,526
Interest receivables		—		—		51,834

	$	71,754	$	198,286	$	719,654

5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following:


	2002		2003		2004
Accrued welfare benefits	$	19,395	$	124,214	$	276,720
Accrued payroll		—		128,265		571,445
Accrued expenses		—		—		592,729
Amounts due to directors		15,030		12,765		615
Other tax payables		12,161		128,438		457,267

	$	46,586	$	393,682	$	1,898,776

6. INCOME TAXES

The Company is a tax exempted company incorporated in the Cayman Islands. The subsidiaries incorporated in the PRC are governed by the Income Tax Law of the PRC Concerning Foreign Investment and Foreign Enterprises and various local income tax laws (the “Income Tax Laws”). Pursuant to the PRC Income Tax Law, the foreign investment enterprises are subject to income tax at a statutory rate of 33% (30% of state income tax plus 3% local income tax) on PRC taxable income. However, preferential tax treatment of KongZhong Beijing, Beijing AirInbox and Beijing Boya Wuji as “high technology” companies has been agreed with the relevant tax authorities. KongZhong Beijing is entitled to a preferential tax rate of 15% and is entitled to a three-year exemption from income tax commencing in 2003, after taking into account any tax losses brought from prior year, followed by a 50% reduction in tax rates for the

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

succeeding three years, in accordance with the Income Tax Law of the PRC. Beijing AirInbox is entitled to a two-year exemption from income tax commencing 2003. Beijing Boya Wuji is entitled to a two-year exemption from income tax after taking into account its tax losses brought from prior year.

The principal components of the deferred income tax assets are as follows:


	2002			2003			2004
Defened tax assets
Depreciation and amortization	$	2,101		$	20,973		$	27,105
Net operating loss carryforwards		22,612			80,521			4,634

Deferred tax asset		24,713			101,494			31,739
Valuation allowance		(24,713	)		(101,494	)		(31,739	)

Deferred tax assets, net	$	—		$	—		$	—

A full valuation has been established because the Company believes that either it is more likely than not that its deferred taxes assets will not be realized or the amount involved is not significant. The tax losses carried forward as of December 31, 2003 and 2004 amount to US$1,073,600 and US$61,793 and will expire by 2008 and 2009, respectively.

7. SHARE CAPITAL

In 2002, the Company issued:

(1) 231,000,000 shares of Series A convertible preference shares for cash proceeds of $550,011.

(2) 350,000,000 shares of Series B redeemable convertible preference shares for cash proceeds of $2,970,025 after share issuance cost of $30,000.

Each convertible preference share was convertible into one ordinary share at a conversion price of $0.002381 and $0.0085715 for Series A convertible preference shares and Series B redeemable convertible preference shares, respectively, and was automatically converted at the consummation of the Company’s sale of ordinary shares in public offering, on July 9, 2004. Upon the public offering, 231,000,000 and 350,000,000 has been converted from Series A convertible preference shares and Series B redeemable convertible preference shares, respectively. As of December 31, 2004, there are no Series A convertible preference shares or Series B redeemable convertible preference shares outstanding.

In July 2004, the Company completed the initial public offering of American Depositary Shares, representing the Company’s ordinary shares, and listed the ADSs on The Nasdaq Stock Market. Accordingly 320,000,000 ordinary shares were issued for total proceeds of $80,000,000, net of offering costs of $6,565,297.

8. STOCK OPTIONS

The Company’s employee stock option plan (the “Rlan”) allows the Company to offer a variety of incentive awards to employees, consultants or external service advisors of the Company. Options to purchase 105,000,000 ordinary shares are authorized under the Plan. Under the terms of the Plan, options are generally granted at prices equal to the fair market value of the Company’s shares listed on NASDAQ (for options granted before public listing which is determined by the Board of Directors) and expire 10 years from the date of grant and vest over 4 years. As of December 31, 2004, options to purchase 96,910,000 shares of ordinary shares were outstanding. As of December 31, 2004, options to purchase 6,490,000 ordinary shares were available for future grant.

In 2004, the Company granted 52,760,000 ordinary share options to new and existing employees. The Company determined that the market value of the ordinary shares was in excess of the exercise price on the measurement

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

date and recorded a deferred stock compensation for the difference between the market value of the ordinary shares and the exercise price of the employee stock options for certain stock options. Accordingly, the Company recorded a deferred stock compensation of approximately $2,206,000 as of December 31, 2004. The deferred stock compensation is amortized over the vesting period, which is generally 4 years.

For stock options granted prior to the initial public offering, the Company has obtained a valuation analysis performed by an independent appraiser to reassess the determination of the market value of the Company’s ordinary share. The valuation analysis utilizes generally accepted valuation methodologies such as the income and market approach and discounted cash flow approach to value the Company’s business. As a result, stock compensation expense was recorded for the difference between the market value of the ordinary shares and the exercise price of the employee stock options. For stock options granted following the initial public offering, options are granted at the fair market value of the ordinary share at the date of grant determined using the quoted market price of the Company’s stock. Accordingly, there was no compensation charges generated from these option grants under APB 25.

The Company recorded a stock compensation expense of $482,766, $21,986 and $Nil in 2004, 2003 and 2002, respectively.

A summary of the stock option activity is as follows:


	Ordinary shares
				Weighted
	Number of			average
	Options			exercise price
Granted		48,180,000		$	0.004

Options outstanding at December 31, 2002		48,180,000
Granted		6,000,000		$	0.050
Cancelled		(4,460,000	)	$	0.043

Options outstanding at December 31, 2003		49,720,000
Granted		52,760,000		$	0.227
Cancelled		(3,970,000	)	$	0.226
Exercised		(1,600,000	)	$	0.003

Options outstanding at December 31, 2004		96,910,000

The weighted average per share fair value of options as of the grant date was as follows:


	December 31,
	2002		2003		2004
Ordinary shares	$	0.011	$	0.066	$	0.139

The following table summarizes information with respect to stock options outstanding at December 31, 2004:


		Options outstanding			Options exercisable
		Number of		Weighted	Weighted		Number		Weighted
		Outstanding		average	average		exercisable		average
				remaining	exercise				exercise
				contractual Life	price				price
Ordinary shares:
$	0.0025		35,420,000	7.50 years	$	0.0025		19,923,750	$	0.0025
$	0.0100		6,920,000	7.96 years	$	0.0100		3,460,000	$	0.0100
$	0.0500		5,310,000	8.58 years	$	0.0500		2,353,750	$	0.0500
$	0.2500		33,260,000	9.13 years	$	0.2500		—	$	0.2500
$	0.1750		16,000,000	9.83 years	$	0.1750		—	$	0.1750

Total			96,910,000					25,737,500	$	0.0079

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

Options to non-employees

The Company granted 1,600,000 and 1,000,000 options to purchase ordinary shares to its external consultants in exchange for certain services in 2002 and 2003, respectively. The Company recorded compensation expense of $1, 946 and $63,121 for the period from May 6, 2002 to December 31, 2002 and the year ended December 31, 2003, respectively, estimated using the Black-Scholes option pricing model as such method provides a more accurate estimate of the fair value of services received by the external consultants. The following assumptions were used in the option pricing model:


	December 31,
	2002			2003
Average risk free rate of return		5.08	%		4.44	%
Weighted average contractual option term	4 years			4 years
Volatility rate		70	%		70	%
Dividend yield		0	%		0	%

9. SEGMENT AND GEOGRAPHIC INFORMATION

The Company is engaged primary in providing value-added services such as games and entertainment, communication services, media, and various other related products to mobile phone users. The Company’s chief operating decision maker has been identified as the Chief Executive Officer, who reviews consolidated results of manufacturing operations when making decisions about allocating resources and assessing performance of the Company. The Company believes it operates in one segment, and all financial segment information can be found in the consolidated financial statements.

Product lines

The Company derives revenues principally form providing value-added services, such as games and entertainment, communication services, personalized media, and various other related products to mobile phone users. These services are delivered through 2.5 G technology platforms including wireless access protocol (“WAP”), multimedia messaging services (“MMS”) and Java™ and 2 G technology platforms, incuding short messaging services (“SMS”), interactive voice response (“IVR”) and color ring back tone (“CRBT”). Revenues for the period from May 6, 2002 to December 31, 2002 and for the years ended December 31, 2003 and 2004 are as follows:


	For the period from		For the year ended		For the year ended
	May 6, 2002		December 31,		December 31 ,
	to December 31, 2002		2003		2004
2.5 Generation
-WAP	$	131,342	$	3,852,880	$	22,101,535
-MMS		—		2,085,500		17,264,109
-Java™		—		17,663		783,559

		131,342		5,956,043		40,149,203


2 Generation
-SMS	$	68,977	$	1,839,212	$	6,629,575
-IVR		—		—		1,068,109
-CRBT and others		—		11,434		122,330

		68,977		1,850,646		7,820,014

	$	200,319	$	7,806,689	$	47,969,217

Geographic Information

The Company operates in the PRC and all of the Company’s long lived assets are located in the PRC.

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

10. NET (LOSS) INCOME PER SHARE

The following table sets forth the computation of basic and diluted net (loss) income per share:


	2002			2003		2004
Net (loss) income (numerator), basic and diluted Shares (denominator):	$	(493,874	)	$	2,408,136	$	20,369,261

Weighted average ordinary shares outstanding used in computing basic net (loss) income per share		415,547,794			469,000,000		903,010,929

Effect of dilutive securities:
Weighted average preferred shares outstanding		—			581,000,000		301,612,022
Stock options		—			44,824,434		46,018,031

Weighted average shares used in computing diluted net (loss) income per share		415,547,794			1,094,824,434		1,250,640,982

Net (loss) income per share, basic	$	(0.001	)	$	0.01	$	0.02

Net (loss) income per share, diluted	$	(0.001	)	$	0.00	$	0.02

For 2002, the Company had the following securities outstanding which could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per shares in 2002 as their effects would have been antidilutive. On July 8, 2004, all of these shares are converted into ordinary shares upon the initial public offering:


	December 31, 2002
Series A convertible preferred shares		231,000,000
Series B redeemable convertible preferred shares		350,000,000
Outstanding employee options to purchase ordinary shares		48,180,000

		629,180,000

As of December 31, 2004, the Company had 33,260,000 ordinary shares equivalents outstanding that could have potential diluted income per share in the future, but which were excluded in the computation of diluted income share in the period, as their exercise prices were above the average market values in such period.

Common stock equivalents are calculated using the treasury stock method. Under the treasury stock method, the proceeds from the assumed conversion of options are used to repurchase outstanding ordinary stock using a yearly average market price.

11. CONCENTRATIONS

(a) Dependence on mobile phone operators

The revenue of the Company is primarily derived from cooperative arrangements with one mobile operator in Mainland China. The Mobile Operator is entitled to a portion of the revenues earned primarily from the transmission of wireless short message and WAP as well as for the billing and collection of service. If the strategic relationship with the mobile phone operator in the PRC is terminated or scaled-back, or if the mobile phone operator alter the revenue sharing arrangements, the Company’s wireless value-added service business would be adversely affected.

Revenue collected through China Mobile for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004 are approximately $200,000, $7,807,000 and $47,716,000 representing 100%, 100% and 99% of revenues, respectively.

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

Amounts due from China Mobile Communication Corporation as of December 31, 2002, 2003 and 2004 amounted to approximately $132,000, $1,704,000 and $10,131,000 representing approximately 100% and 99% of accounts receivable, respectively.

(b) Credit risk

The Company depends on the billing system of Mobile Operator to charge the mobile phone users through mobile phone bills and collect payments from users. The Company generally does not require collateral for its accounts receivable. The Company has not experienced any significant credit losses for any periods presented.

12. MAINLAND CHINA CONTRIBUTION PLAN AND PROFIT APPROPRIATION

Full time employees of the Company in the PRC participate in a government-mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the Company accrue for these benefits based on certain percentages of the employees’ salaries. The total provision for such employee benefit was $41,625, $267,578 and $573,812 for the period from May 6, 2002 to December 31, 2002 and the years ended December 31 2003 and 2004, respectively.

The Company is required to make contributions to the plan out of the amounts accrued for medical and pension benefits to relevant local labor bureaus. The contributions for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004 amounted to $6,203, $142,431 and $414,094, respectively. The local labor bureaus are responsible for the medical benefits and pension liability to be paid to these employees. The Company has no further commitments beyond its monthly contribution.

Pursuant to the laws applicable to the PRC’s Foreign Investment Enterprises and local enterprises, the Company’s subsidiaries in the PRC must make appropriations from after-tax profit to non-distributable reserve funds as determined by the Board of Directors of the Company.

For foreign enterprises, these reserve funds include (i) a general reserve fund, (ii) an enterprise expansion fund, and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the general reserve fund requires annual appropriations of 10% of after-tax profit (as determined under PRC GAAP at each year-end); the other fund appropriations are at the Company’s discretion. These reserve funds can only be used for specific purposes of enterprise expansion and staff welfare and bonus and are not distributable as cash dividends. As of December 31, 2002 and 2003, the three reserve fund balances were $0. As of December 31, 2004, the three reserve fund balances were $381,629, $0, and $0 respectively.

For local enterprises, these reserve funds include (i) a statutory surplus reserve fund, (ii) a statutory public welfare fund and (iii) a general surplus reserve fund. Subject to certain cumulative limits, the statutory surplus reserve fund and the statutory public welfare fund require annual appropriations of 10% and 5%, respectively, of after-tax profit (as determined under PRC GAAP at each year end). The statutory surplus reserve fund can be converted into paid-in capital or distributed as dividends to shareholders under certain conditions. When the total amount of statutory surplus reserve fund up to 50% of paid-in capital of the company, the company can stop accruing this reserve fund. The statutory public welfare fund can only be utilized on capital items for the collective benefits of the company’s employees such as the construction of dormitories, canteen, and other staff welfare facilities. The general surplus reserve fund can be used to distribute dividend to shareholders. As of December 31, 2002, the three reserve funds were Nil and, as of December 31, 2003, the three reserve funds were $215,063, $107,532 and $1,828,035 respectively. As of December 31, 2004, the three reserve funds were $604,115, $964,068 and $1,828,035 respectively.

Annual report 2004

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM MAY 6, 2002 to DECEMBER 31, 2002 and

THE YEARS ENDED DECEMBER 31, 2003 and 2004

(In US dollars, except per share amount)

13. COMMITMENTS

Operating lease as lessee

(a) The Company leases certain office premises under non-cancelable leases which expire in 2006. Rental expense under operating leases for the year ended December 31, 2003 and 2004 were $276,386 and $1,112,667, respectively.

Future minimum lease payments under non-cancelable operating leases agreements were as follows:


Year ending	$	1,022,492
2005		400,782

2006	$	1,423,274

(b) On December 23, 2004, the Company signed definitive agreement with eFriendsNet Entertainment Corporation to purchase 454,545 shares of its Series A Preferred Stock, which represented 10% of the outstanding shares of eFriendsNet for cash proceeds of $0.5 million. In January 2005, the Company completed its investment in eFriendsNet.

14. RELATED PARTY TRANSACTIONS

The Company has paid consultancy fees of $105,000 to a shareholder at the year ended December 31, 2003 and $Nil for the year ended December 31, 2004, respectively. Payable to such shareholder was $90,000 outstanding as of December 31, 2003 and $Nil as of December 31, 2004, respectively. The Company has another payable to other individual shareholders, which related to Initial Public Offer proceeds, was $46,203 outstanding as of December 31, 2004.

15. CONTINGENT LIABILITIES

Several class action lawsuits have been filed against the Company and certain of its officers on behalf of shareholders of the Company in the U.S. District Court for the Southern District of New York. The lawsuits claim that the Company failed to adequately disclose in its prospectus certain sanctions imposed by China Mobile against the Company. The Court recently appointed a lead plaintiff in the actions. Following this appointment, plaintiffs are expected to file a consolidated complaint. The Company is not able to assess the potential liability, if any, in this action at this very early stage of the matter.

16. SUBSEQUENT EVENTS

a) In February 2005, the Company entered into a series of contractual arrangements pursuant to which BeijingWireless Interactive Network Technology Co., Ltd., or Beijing Wireless Interactive, became the Company’s variable interest entity. Beijing Wireless Interactive provides wireless value-added services to China’s cell phone users. Beijing Wireless Interactive is legally owned directly by three PRC citizens. As of March 2005, Yang Yang holds 40%, Linguang Wu holds 30% and Guijun Wang holds 30%. The investment was made with $1,680,000 in cash provided by the Company.

b) In January 2005, Beijing AirInbox acquired 80% of the outstanding equity interest of Boya Wuji for an aggregate amount of RMB800,000.

c) On May 24, 2005, the Company’s variable interest entities, Beijing AirInbox and Beijing Wireless Interactive, acquired all the outstanding equity interest of Tianjin Mammoth Technology Company for cash proceeds of $725,000.

Corporate Information

Directors

Mr. Yunfan Zhou
Chairman of the Board of Directors, Chief Executive Officer

Mr. Nick Yang
Director, President and Chief Technology Officer

Mr. Charlie Y. Shi
Member of the Audit, Compensation and Nominating Committees

Mr. Yongqiang Qian
Member of the Audit, Compensation and Nominating Committees

Mr. Hanhui Sun
Member of the Audit Committees

Corporate Officers

Mr. Yunfan Zhou

Mr. Nick Yang

Mr. JP Gan
Chief Financial Officer

Mr. Hai Qi
Senior Vice President of Sales and Marketing

Ms. Kingchuen Wong
Vice President of Corporate Development

Corporate Headquarters

KongZhong Corporation
83 Floor, Tengda Plaza
No. 168 Xiwai Street,
Haidian District
Beijing, 100044
People’s Republic of China
Tel: (8610) 8857-6000
Fax: (8610) 8857-5900

Independent Accountant

Deloitte Touche Tohmatsu CPA Ltd.

US Legal Counsel

Sullivan & Cromwell LLP

Cayman Islands Legal Counsel
Maples and Calder

The Depository of ADS
Citi bank N.A.

Investor Relations
Ir. Kongzhong.com
Tel: 86-10-8857-6000-6916

Website
www.kongzhong.com

TABLE OF CONTENTS


02		Corporate Profile

04		Chairman and Chief Executive Officer’s Letter

09		Selected Financial Data

12		Business Overview

18		Management Discussion and Analysis

36		Report of Registered Public Accounting Firm

38		Consolidated Statements of Operations for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004

39		Consolidated Balance Sheets as of December 31, 2002, 2003 and 2004

40		Consolidated Statements of Changes in Shareholders’ Equity (Deficit) for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004

41		Consolidated Statements of Cash Flows for the period from May 6, 2002 to December 31, 2002 and the years ended December 31, 2003 and 2004

42		Notes to the Consolidated Financial Statements

ADR Holder(s)

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