Attached files
file | filename |
---|---|
EX-5.1 - ZST Digital Networks, Inc. | v170889_ex5-1.htm |
EX-23.1 - ZST Digital Networks, Inc. | v170889_ex23-1.htm |
EX-23.3 - ZST Digital Networks, Inc. | v170889_ex23-3.htm |
As
filed with the Securities and Exchange Commission on January 14,
2010 Registration No. 333-164107
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Pre-Effective
Amendment No. 1 on
FORM
S-1/A
REGISTRATION
STATEMENT UNDER THE SECURITIES ACT OF 1933
ZST
DIGITAL NETWORKS, INC.
(Name of
Registrant as Specified in Its Charter)
Delaware
|
3663
|
20-8057756
|
(State
or Other Jurisdiction of
|
(Primary
Standard Industrial
|
(I.R.S.
Employer
|
Incorporation
or Organization)
|
Classification
Code Number)
|
Identification
No.)
|
206
Tongbo Street, Boyaxicheng Second Floor
Zhengzhou
City, Henan Province
People’s
Republic of China 450007
(86)
371-6771-6850
(Address
and Telephone Number of Principal Executive Offices)
Corporation
Service Company
2711
Centerville Road
Suite
400
Wilmington,
DE 19808
(800)
222-2122
(Name,
Address and Telephone Number of Agent for Service)
Copies
to:
Thomas
J. Poletti, Esq.
|
Ayla
A. Nazli, Esq.
|
K&L
Gates LLP
|
10100
Santa Monica Blvd., 7 th
Floor
|
Los
Angeles, CA 90067
|
Telephone
(310) 552-5000
|
Facsimile
(310) 552-5001
|
Approximate Date of Proposed Sale to
the Public: From time to time after the effective date of this
Registration Statement.
If any of
the securities being registered on this form are to be offered on a delayed or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, check
the following box. x
If this
form is filed to register additional securities for an offering pursuant to Rule
462(b) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. o
If this
form is a post-effective amendment filed pursuant to Rule 462(c) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same
offering. o
If this
form is a post-effective amendment filed pursuant to Rule 462(d) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement the same
offering. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer o
|
Smaller
reporting
company
x
|
CALCULATION
OF REGISTRATION FEE
Proposed
|
Proposed
|
|||||||||||||||
Maximum
|
Maximum
|
Amount of
|
||||||||||||||
Title of Each Class of
|
Amount to Be
|
Offering Price
|
Aggregate
|
Registration
|
||||||||||||
Securities to Be Registered
|
Registered
(1)
|
Per Share
(2)
|
Offering Price
(2)
|
Fee
|
||||||||||||
Common
Stock, $0.0001 par value per share
|
1,086,400 | (3) | $ | 7.78 | $ | 8,452,192 | $ | 602.64 | ||||||||
Total
Registration Fee
|
$ | 602.64 | (4) |
(1)
|
In
accordance with Rule 416(a), the Registrant is also registering hereunder
an indeterminate number of additional shares of common stock that shall be
issuable pursuant to Rule 416 to prevent dilution resulting from stock
splits, stock dividends or similar
transactions.
|
(2)
|
Estimated
pursuant to Rule 457(c) of the Securities Act of 1933, as amended, solely
for the purpose of computing the amount of the registration fee based on
the average of the high and low sales prices reported on the NASDAQ Global
Market on December 29, 2009.
|
(3)
|
Represents
shares of the Registrant’s common stock being registered for resale that
have been issued to the selling stockholders named in the prospectus or
prospectus supplement.
|
(4)
|
This
amount has been previously
paid.
|
The
Registrant amends this registration statement on such date or dates as may be
necessary to delay its effective date until the registrant shall file a further
amendment which specifically states that this registration statement shall
hereafter become effective in accordance with Section 8(a) of the Securities Act
of 1933, or until the registration statement shall become effective on such date
as the Commission, acting pursuant to Section 8(a), may
determine.
The
information in this prospectus is not complete and may be changed. We may not
sell these securities until the registration statement filed with the Securities
and Exchange Commission becomes effective. This prospectus is not an offer to
sell these securities and we are not soliciting offers to buy these securities
in any state where the offer or sale is not permitted.
PRELIMINARY
PROSPECTUS
|
Subject
to Completion
|
January
14, 2010
|
1,086,400
Shares
ZST
DIGITAL NETWORKS, INC.
Common
Stock
This
prospectus relates to the resale by the selling stockholders of up to 1,086,400
shares of our common stock. The selling stockholders may sell common stock from
time to time in the principal market on which the stock is traded at the
prevailing market price or in negotiated transactions. We will not receive any
proceeds from the sales by the selling stockholders. The selling stockholders
named herein may be deemed underwriters of the shares of common stock which they
are offering.
Our
shares of common stock are traded on the NASDAQ Global Market under the ticker
symbol “ZSTN.” On January 7, 2010, the closing sales price for our
common stock on the NASDAQ Global Market was $10.09 per share.
The
selling stockholders holding an aggregate of 1,086,400 shares of common stock
offered through this prospectus have agreed not sell any of the shares until six
(6) months after our common stock began to be listed on the NASDAQ Global
Market.
Investing
in our common stock involves a high degree of risk. Before buying any
shares, you should carefully read the discussion of material risks of investing
in our common stock in “Risk Factors” beginning on page 7 of this
prospectus.
Neither
the U.S. Securities and Exchange Commission nor any state securities commission
has approved or disapproved of anyone’s investment in these securities or
determined if this prospectus is truthful or complete. Any representation to the
contrary is a criminal offense.
The
date of this prospectus is __________________, 2010
TABLE
OF CONTENTS
Page
|
||
Prospectus
Summary
|
1
|
|
Summary
Financial Data
|
5
|
|
Risk
Factors
|
7
|
|
Cautionary
Statement Regarding Forward-Looking Statements
|
26
|
|
Use
of Proceeds
|
27
|
|
Dividend
Policy
|
27
|
|
Market
for Common Equity and Related Stockholder Matters
|
27
|
|
Accounting
for the Share Exchange
|
27
|
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
28
|
|
Description
of Business
|
39
|
|
Management
|
50
|
|
Certain
Relationships and Related Transactions
|
55
|
|
Security
Ownership of Certain Beneficial Owners and Management
|
57
|
|
Description
of Securities
|
58
|
|
Shares
Eligible for Future Sale
|
62
|
|
Selling
Stockholders
|
65
|
|
Plan
of Distribution
|
68
|
|
Legal
Matters
|
70
|
|
Experts
|
70
|
|
Additional
Information
|
70
|
|
Financial
Statements
|
F-1
|
|
Part
II Information Not Required in the Prospectus
|
II-1
|
|
Signatures
|
|
II-8
|
Please
read this prospectus carefully. It describes our business, our financial
condition and results of operations. We have prepared this prospectus so that
you will have the information necessary to make an informed investment
decision.
You
should rely only on information contained in this prospectus. We have not
authorized any other person to provide you with different information. This
prospectus is not an offer to sell, nor is it seeking an offer to buy, these
securities in any state where the offer or sale is not permitted. The
information in this prospectus is complete and accurate as of the date on the
front cover, but the information may have changed since that
date.
PROSPECTUS
SUMMARY
Because
this is only a summary, it does not contain all of the information that may be
important to you. You should carefully read the more detailed information
contained in this prospectus, including our financial statements and related
notes. Our business involves significant risks. You should carefully consider
the information under the heading “Risk Factors” beginning on page 7. Unless
otherwise indicated, all share and per share information gives effect to the
conversion of all of our outstanding shares of Series A Convertible Preferred
Stock into shares of our common stock (the “Series A Conversion”).
As used
in this prospectus, unless otherwise indicated, the terms “we”, “our”, “us”,
“Company” and “ZST” refer to ZST Digital Networks, Inc., a Delaware corporation,
formerly known as SRKP 18, Inc. (“SRKP 18”), its wholly-owned subsidiary, World
Orient Universal Limited, a company organized in the British Virgin Islands
(“World Orient”), its wholly-owned subsidiary, Global Asia Universal Limited, a
company organized in the British Virgin Islands (“Global Asia”), its
wholly-owned subsidiary, Everfair Technologies, Ltd., a company organized in
Hong Kong (“Everfair”), and its wholly-owned subsidiary, Zhengzhou Shenyang
Technology Company Limited, a company organized in the People’s Republic of
China (“Zhengzhou ZST”). “China” or “PRC” refers to the People’s Republic of
China. “RMB” or “Renminbi” refers to the legal currency of China and “$” or
“U.S. Dollars” refers to the legal currency of the United States.
ZST
Digital Networks, Inc.
We are
principally engaged in supplying digital and optical network equipment to cable
system operators in the Henan Province of China. We have developed a line of
internet protocol television (“IPTV”) set-top boxes that are used to provide
bundled cable television, Internet and telephone services to residential and
commercial customers. We have assisted in the installation and construction of
over 400 local cable networks covering more than 90 municipal districts,
counties, townships, and enterprises. Our services and products have been
recognized with various certifications, including “integrated computer
information system qualification class III” issued by the Ministry of Industry
Information, “communication user cable construction enterprise qualification”
issued by the Henan Province Administration of Communication, “Henan Province
Security Technology Prevention Engineering Qualification Class III”, a
certificate of “ISO9001: 2000 Quality System Authentication”, and “Double High”
certification, high-tech product and high-tech enterprise issued by the Henan
Province government.
At
present, our main clients are broadcasting TV bureaus and cable network
operators serving various cities and counties. We have over 30 main customers,
including the broadcasting TV bureaus and cable network operators of the cities
of Nanyang, Mengzhou, Xuchang, Pingdingshan, Kaifeng, Zhoukou and Gongyi, and
the counties of Yuanyang, Luoning, Neihuang, Yinyang, Xixia, Kaifeng, Nanzhao,
and Gushi.
In the
near future, we plan to joint venture with cable network operators to provide
bundled television programming, Internet and telephone services to residential
customers in cities and counties located in the Henan Province of China. In
addition, we are currently in the process of establishing a partnership with
China Unicom, a wireless network provider, in connection with the Company’s
development and sale of its GPS tracking units. In March 2009, the Company
entered into a network access right agreement with the Henan Subsidiary of China
Unicom that allows the Company to use the China Unicom wireless network for
providing GPS location and tracking services to third parties. In the near
future, the Company intends to negotiate a reseller agreement with the Henan
Subsidiary of China Unicom whereby GPS tracking units supplied by the Company
would be sold in the Henan Subsidiary of China Unicom retail stores, with the
Company receiving a share of subscriber revenue collected by the Henan
Subsidiary of China Unicom.
Corporate
Information
We were
incorporated in the State of Delaware on December 7, 2006. We were originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation.
On
January 9, 2009, we closed a share exchange transaction pursuant to which we (i)
issued 806,408 shares of our common stock to acquire 100% equity ownership of
World Orient, (ii) assumed the operations of World Orient and its subsidiaries,
including Zhengzhou ZST, and (iii) changed our name from SRKP 18, Inc. to ZST
Digital Networks, Inc.
Our
corporate offices are located at 206 Tongbo Street, Boyaxicheng Second Floor,
Zhengzhou City, Henan Province, People’s Republic of China 450007. Our telephone
number is (86) 371-6771-6850.
We are a
reporting company under Section 13 of the Securities Exchange Act of 1934, as
amended. Our shares of common stock are traded on the NASDAQ Global Market under
the ticker symbol “ZSTN.” On January 7, 2010, the closing sales price
for our common stock on the NASDAQ Global Market was $10.09 per
share.
1
Recent
Events
Reverse Stock
Split
On
October 6, 2009, we effected a 1-for-2.461538462 reverse stock split of all of
our issued and outstanding shares of common stock and Series A Convertible
Preferred Stock (the “Reverse Stock Split”) by filing an amendment to our
Certificate of Incorporation with the Secretary of State of Delaware. The par
value and number of authorized shares of our common stock and Series A
Convertible Preferred Stock remained unchanged. The number of shares and per
share amounts included in the consolidated financial statements and the
accompanying notes included in the F- section have been adjusted to reflect the
Reverse Stock Split retroactively. Unless otherwise indicated, all references to
number of shares, per share amounts and earnings per share information contained
in this prospectus give effect to the Reverse Stock Split.
Share
Exchange
On
December 11, 2008, we entered into a share exchange agreement, as amended on
January 9, 2009 (the “Exchange Agreement”), with World Orient and its
stockholders, pursuant to which the stockholders would transfer all of the
issued and outstanding shares of World Orient to the Company in exchange for
806,408 shares of our common stock (the “Share Exchange”). On January 9, 2009,
the Share Exchange closed and World Orient became our wholly-owned subsidiary
and we immediately changed our name from “SRKP 18, Inc.” to “ZST Digital
Networks, Inc.” A total of 806,408 shares were issued to the former stockholders
of World Orient.
Purchase
Right
On
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”)
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management agreed to purchase an aggregate of
5,090,315 shares of our common stock at a per share purchase price of $0.6907
(the “Purchase Right”). The purchase price for the shares was paid in full on
May 25, 2009. Each of the stockholders and warrantholders of the Company prior
to the Share Exchange agreed to cancel 0.3317 shares of common stock and
warrants to purchase 0.5328 shares of common stock held by each of them for each
one (1) share of common stock purchased by the ZST Management pursuant to the
Purchase Right (the “Share and Warrant Cancellation”). Pursuant to the Share and
Warrant Cancellation, an aggregate of 1,688,532 shares of common stock and
warrants to purchase 2,712,283 shares of common stock held by certain of our
stockholders and warrantholders prior to the Share Exchange were
cancelled.
Private
Placement
On May 5,
2009, we completed the final closing in a series of five closings beginning
January 9, 2009 of a private placement transaction (the “Private Placement”).
Pursuant to subscription agreements entered into with the investors, we sold an
aggregate of 1,263,723 shares of Series A Convertible Preferred Stock at $3.94
per share. As a result, we received gross proceeds in the amount of
approximately $4.98 million. As of the date of this prospectus, the conversion
price of the Series A Convertible Preferred Stock is equal to
$3.94. See “Description of Securities — Preferred Stock” on
page 58 for a more complete description of our Series A Convertible
Preferred Stock.
Restructuring
Our BVI
subsidiary, World Orient, its wholly-owned BVI subsidiary, Global Asia, and
Global Asia’s wholly-owned Hong Kong subsidiary, Everfair, were owned by non-PRC
individuals. Everfair obtained all the equity interests of Zhengzhou ZST further
to an Equity Purchase Agreement dated October 10, 2008 (the “Equity Purchase
Agreement”) by and among Everfair, Zhong Bo, our Chief Executive Officer and
Chairman of the Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST
Management”).
2
The
corporate structure of the Company is illustrated as follows:
Following
the full exercise of the Purchase Right and Share and Warrant Cancellation, Mr.
Zhong beneficially owned approximately 59.87% of our outstanding common stock
(after giving effect to the Series A Conversion). See “Risk Factors” beginning
on page 7 for a more complete description of the aforementioned
restructuring and risks associated therewith.
Public
Offering
In
October 2009, we completed a public offering consisting of 3,125,000 shares of
our common stock. Rodman & Renshaw, LLC (“Rodman”) and WestPark
Capital, Inc. (“WestPark” and together with Rodman, the “Underwriters”) acted as
co-underwriters in the public offering. Our shares of common stock
were sold to the public at a price of $8.00 per share, for gross proceeds of $25
million. Compensation for the Underwriters’ services included
discounts and commissions of $1,875,000, a $250,000 non-accountable expense
allowance, roadshow expenses of approximately $10,000, and legal counsel fees
(excluding blue sky fees) of $40,000. The Underwriters also received
warrants to purchase an aggregate of 156,250 shares of our common stock at an
exercise price of $10.00 per share. The warrants, which have a term
of five years, are not exercisable until at least one year from the date of
issuance. The warrants also carry registration
rights.
3
THE
OFFERING
Common
stock offered by selling stockholders
|
1,086,400
shares
|
|
Common
stock outstanding
|
11,650,442
shares (1)
|
|
Use
of proceeds
|
We
will not receive any proceeds from the sale of the common stock by the
selling stockholders.
|
|
Risk
factors
|
Investing
in these securities involves a high degree of risk. As an investor you
should be able to bear a complete loss of your investment. You should
carefully consider the information set forth in the “Risk Factors” section
beginning on page 7.
|
(1)
|
Based on 11,650,442 shares of
common stock issued and outstanding as of the date of this
prospectus. Excludes 156,250 shares of common stock that are
issuable upon the exercise of outstanding
warrants.
|
The
selling stockholders holding an aggregate of 1,086,400 shares of common stock
have agreed not to sell any of these shares until six (6) months after our
common stock began to be listed on the NASDAQ Global
Market.
4
SUMMARY
FINANCIAL DATA
The
following summary financial information contains consolidated statement of
operations data for the nine months ended September 30, 2009 and 2008
(unaudited) and for each of the years in the five-year period ended December 31,
2008 and the consolidated balance sheet data as of September 30, 2009 and
year-end for each of the years in the five-year period ended December 31, 2008.
The consolidated statement of operations data and balance sheet data were
derived from the audited consolidated financial statements, except for data for
the nine months ended and as of September 30, 2009 and 2008 and the years ended
and as of December 31, 2005 and 2004. Such financial data should be read in
conjunction with the consolidated financial statements and the notes to the
consolidated financial statements starting on page F-1 and with “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.”
Consolidated
Statements of Operations (U.S. Dollars in
Thousands)
For
the Year
|
||||||||||||||||||||||||||||
For
the Nine Months Ended
|
Ended
|
|||||||||||||||||||||||||||
September
30,
|
December
31,
|
|||||||||||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
(unaudited)
|
(unaudited)
|
(unaudited)
|
(unaudited)
|
|||||||||||||||||||||||||
Revenue
|
$
|
70,067
|
40,987
|
$
|
55,431
|
$
|
28,717
|
$
|
5,650
|
$
|
2,129
|
$
|
1,585
|
|||||||||||||||
Cost
of goods sold
|
58,774
|
33,563
|
45,594
|
23,221
|
4,478
|
1,501
|
1,325
|
|||||||||||||||||||||
Gross
Profit
|
11,293
|
7,424
|
9,837
|
5,496
|
1,172
|
628
|
260
|
|||||||||||||||||||||
Operating
Costs and Expenses
|
||||||||||||||||||||||||||||
Selling
expenses
|
35
|
107
|
146
|
3
|
19
|
57
|
144
|
|||||||||||||||||||||
Depreciation
|
28
|
34
|
21
|
44
|
42
|
26
|
42
|
|||||||||||||||||||||
General
and administrative
|
725
|
614
|
1,006
|
715
|
230
|
-
|
374
|
|||||||||||||||||||||
Merger
cost
|
567
|
—
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||||||||
Research
and development
|
109
|
—
|
-
|
89
|
-
|
304
|
-
|
|||||||||||||||||||||
Total
operating costs and expenses
|
1,464
|
755
|
1,173
|
851
|
291
|
387
|
560
|
|||||||||||||||||||||
Income
from operations
|
9,829
|
6,669
|
8,664
|
4,645
|
881
|
241
|
(300
|
)
|
||||||||||||||||||||
Other
income (expenses)
|
||||||||||||||||||||||||||||
Gain
on disposal of assets
|
—
|
—
|
(11
|
)
|
-
|
48
|
-
|
-
|
||||||||||||||||||||
Interest
income
|
44
|
15
|
10
|
3
|
-
|
44
|
-
|
|||||||||||||||||||||
Interest
expense
|
(141
|
) |
(261
|
) |
(339
|
)
|
(196
|
)
|
(12
|
)
|
(7
|
)
|
-
|
|||||||||||||||
Imputed
interest
|
(31
|
) |
(49
|
) |
(71
|
)
|
(70
|
)
|
(20
|
)
|
-
|
-
|
||||||||||||||||
Sundry
income (expense), net
|
(7
|
) |
(1
|
) |
(11
|
)
|
-
|
55
|
-
|
(2
|
)
|
|||||||||||||||||
Total
other income (expenses)
|
(135
|
) |
(296
|
) |
(422
|
)
|
(263
|
)
|
71
|
37
|
(2
|
)
|
||||||||||||||||
Income
before income taxes
|
9,694
|
6,373
|
8,242
|
4,382
|
952
|
278
|
(302
|
)
|
||||||||||||||||||||
Income
taxes
|
(2,594
|
) |
(1,566
|
) |
(2,133
|
)
|
(1,515
|
)
|
(314
|
)
|
(92
|
)
|
-
|
|||||||||||||||
Net
income
|
$
|
7,100
|
4,807
|
$
|
6,109
|
$
|
2,867
|
$
|
638
|
$
|
186
|
$
|
(302
|
)
|
||||||||||||||
Basic
earnings per share
|
$
|
1.01
|
0.82
|
$
|
1.04
|
$
|
0.49
|
$
|
0.11
|
$
|
0.03
|
$
|
(0.05
|
)
|
||||||||||||||
Weighted
average shares outstanding, basic
|
7,056,103
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
|||||||||||||||||||||
Diluted
earnings per share
|
$
|
0.86
|
0.82
|
$
|
1.04
|
$
|
0.49
|
$
|
0.11
|
$
|
0.03
|
$
|
(0.05
|
)
|
||||||||||||||
Weighted
average shares outstanding, diluted
|
8,265,403
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
5,896,723
|
5
Consolidated Balance Sheets
(U.S. Dollars in Thousands)
September
30,
|
September
30,
|
December
31,
|
December
31,
|
December
31,
|
December
31,
|
December
31,
|
||||||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
(unaudited)
|
(unaudited)
|
(unaudited)
|
(unaudited)
|
|||||||||||||||||||||||||
Total
current assets
|
$
|
32,028
|
19,722
|
$
|
17,270
|
$
|
16,918
|
$
|
8,069
|
$
|
3,103
|
$
|
3,055
|
|||||||||||||||
Total
assets
|
32,980
|
19,743
|
17,304
|
16,980
|
8,150
|
4,189
|
3,788
|
|||||||||||||||||||||
Total
current liabilities
|
10,666
|
12,108
|
8,321
|
14,413
|
6,381
|
1,786
|
1,884
|
|||||||||||||||||||||
Total
liabilities
|
10,666
|
12,108
|
8,321
|
14,413
|
6,381
|
2,042
|
1,885
|
|||||||||||||||||||||
Total
stockholders' equity
|
22,314
|
7,635
|
8,983
|
2,567
|
1,769
|
2,147
|
1,903
|
6
RISK
FACTORS
Any
investment in our common stock involves a high degree of
risk. Investors should carefully consider the risks described below
and all of the information contained in this prospectus before deciding whether
to purchase our common stock. Our business, financial condition or
results of operations could be materially adversely affected by these risks if
any of them actually occur. The trading price could decline due to
any of these risks, and an investor may lose all or part of his
investment. Some of these factors have affected our financial
condition and operating results in the past or are currently affecting our
company. This prospectus also contains forward-looking statements
that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including the risks we face as described below and
elsewhere in this prospectus.
Risks
Related to Our Operations
We
derive substantially all of our revenues from sales in the PRC and any downturn
in the Chinese economy could have a material adverse effect on our business and
financial condition.
Substantially
all of our revenues are generated from sales in the PRC. We anticipate that
revenues from sales of our products in the PRC will continue to represent the
substantial portion of our total revenues in the near future. Our sales and
earnings can also be affected by changes in the general economy since purchases
of cable television services are generally discretionary for consumers. Our
success is influenced by a number of economic factors which affect disposable
consumer income, such as employment levels, business conditions, interest rates,
oil and gas prices and taxation rates. Adverse changes in these economic
factors, among others, may restrict consumer spending, thereby negatively
affecting our sales and profitability.
We
are and will continue to be subject to rapidly declining average selling prices,
which may harm our results of operations.
Set-top
boxes and networking products such as those we offer are often subject to
declines in average selling prices due to rapidly evolving technologies,
industry standards and consumer preferences. These products are also subject to
rapid technological changes which often cause product obsolescence. Companies
within our industry are continuously developing new products with heightened
performance and functionality. This puts pricing pressure on existing products
and constantly threatens to make them, or causes them to be, obsolete. Our
typical product’s life cycle is short, typically generating lower average
selling prices as the cycle matures. If we fail to accurately anticipate the
introduction of new technologies, we may possess significant amounts of obsolete
inventory that can only be sold at substantially lower prices and profit margins
than we anticipated. In addition, if we fail to accurately anticipate the
introduction of new technologies, we may be unable to compete effectively due to
our failure to offer products most demanded by the marketplace. If any of these
failures occur, our sales, profit margins and profitability will be adversely
affected.
In
addition, network systems operators expect suppliers, such as our Company, to
cut their costs and lower the price of their products to lessen the negative
impact on their own profit margins. As a result, we have previously reduced the
price of some of our products and expect to continue to face market-driven
downward pricing pressures in the future. Our results of operations will suffer
if we are unable to offset any declines in the average selling prices of our
products by developing new or enhanced products with higher selling prices or
gross profit margins, increasing our sales volumes or reducing our production
costs.
If
we do not correctly forecast demand for our products, we could have costly
excess production or inventories and we may not be able to secure sufficient or
cost effective quantities of our products or production materials and our
revenues, cost of revenues and financial condition could be adversely
affected.
The
demand for our products depends on many factors, including pricing and inventory
levels, and is difficult to forecast due in part to variations in economic
conditions, changes in consumer and business preferences, relatively short
product life cycles, changes in competition, seasonality and reliance on key
third party carriers. It is particularly difficult to forecast demand by
individual product. Significant unanticipated fluctuations in demand, the timing
and disclosure of new product releases or the timing of key sales orders could
result in costly excess production or inventories or the inability to secure
sufficient, cost-effective quantities of our products or production materials.
These inventory risks are particularly acute during end product transitions in
which a new generation of set-top boxes is being deployed and inventory of older
generation set-top boxes is at a higher risk of obsolescence. Furthermore,
because of the competitive nature of the set-top box business and the short-term
nature of our purchase orders, we could in the future be required to reduce the
average selling-prices of our set-top boxes, which in turn would adversely
affect our gross margins and profitability. This could adversely impact our
revenues, cost of revenues and financial condition.
7
We
depend on sales of set-top boxes for a substantial portion of our revenue, and
if sales of our set-top boxes decline or we are not able to penetrate new
markets for set-up boxes, our business and financial position will
suffer.
The
substantial portion of our revenues consists primarily of sales of our set-top
boxes. In addition, we currently derive, and expect to continue to derive in the
near term, revenue from sales of our set-top boxes to a limited number of
customers. Continued market acceptance of our set-top boxes is critical to our
future success. If we are not able to expand sales of our set-top boxes to other
providers of digital television, our growth prospects will be limited, and our
revenues will be substantially impacted.
Our
set-up boxes were initially designed for, and have been deployed mostly by,
providers of cable-delivered digital television. To date, we have not made any
sales of our set-top boxes to direct-to-home satellite providers. In addition,
the set-top box market is highly competitive and we expect competition to
intensify in the future. In particular, we believe that most set-top boxes are
sold by a small number of well entrenched competitors who have long-standing
relationships with direct-to-home satellite providers. This competition may make
it more difficult for us to sell home satellite set-top boxes, and may result in
pricing pressure, small profit margins, high sales and marketing expenses and
failure to obtain market share, any of which could likely seriously harm our
business, operating results and financial condition.
Our
business may suffer if cable television operators, who currently comprise our
customer base, do not compete successfully with existing and emerging
alternative platforms for delivering digital television, including terrestrial
networks, internet protocol television and direct-to-home satellite service
providers.
Our
existing customers are cable television operators, which compete with
direct-to-home satellite video providers and terrestrial broadcasters for the
same pool of viewers. As technologies develop, other means of delivering
information and entertainment to television viewers are evolving. For example,
some telecommunications companies are seeking to compete with terrestrial
broadcasters, cable television network operators and direct-to-home satellite
services by offering internet protocol television, which allows
telecommunications companies to stream television programs through telephone
lines or fiber optic lines. To the extent that the terrestrial television
networks, telecommunications companies and direct-to-home satellite providers
compete successfully against cable television networks services for viewers, the
ability of our existing customer base to attract and retain subscribers may be
adversely affected. As a result, demand for our set-top boxes could decline and
we may not be able to sustain our current revenue levels.
Our
products may contain errors or defects, which could result in the rejection of
our products, damage to our reputation, lost revenues, diverted development
resources and increased service costs, warranty claims and
litigation.
Our
products are complex and must meet stringent user requirements. In addition, we
must develop our products to keep pace with the rapidly changing markets.
Sophisticated products like ours are likely to contain undetected errors or
defects, especially when first introduced or when new models or versions are
released. Our products may not be free from errors or defects after commercial
shipments have begun, which could result in the rejection of our products and
jeopardize our relationship with carriers. End users may also reject or find
issues with our products and have a right to return them even if the products
are free from errors or defects. In either case, returns or quality issues could
result in damage to our reputation, lost revenues, diverted development
resources, increased customer service and support costs, and warranty claims and
litigation which could harm our business, results of operations and financial
condition.
We
do not carry any business interruption insurance, products liability insurance
or any other insurance policy. As a result, we may incur uninsured losses,
increasing the possibility that you would lose your entire investment in our
company.
We could
be exposed to liabilities or other claims for which we would have no insurance
protection. We do not currently maintain any business interruption insurance,
products liability insurance, or any other comprehensive insurance policy. As a
result, we may incur uninsured liabilities and losses as a result of the conduct
of our business. There can be no guarantee that we will be able to obtain
additional insurance coverage in the future, and even if we are able to obtain
additional coverage, we may not carry sufficient insurance coverage to satisfy
potential claims. Should uninsured losses occur, any purchasers of our common
stock could lose their entire investment.
Because
we do not carry products liability insurance, a failure of any of the products
marketed by us may subject us to the risk of product liability claims and
litigation arising from injuries allegedly caused by the improper functioning or
design of our products. We cannot assure that we will have enough funds to
defend or pay for liabilities arising out of a products liability claim. To the
extent we incur any product liability or other litigation losses, our expenses
could materially increase substantially. There can be no assurance that we will
have sufficient funds to pay for such expenses, which could end our operations
and you would lose your entire investment.
8
We
intend to make significant investments in new products and services that may not
be profitable.
Companies
in our industry are under pressure to develop new designs and product
innovations to support changing consumer tastes and regulatory requirements. To
date, we have engaged in modest research and development activities and much of
our expenditures on research and development have been reimbursed by the local
government. However, we believe that substantial additional research and
development activities are necessary to allow us to offer
technologically-advanced products to serve a broader array of customers. We
expect that our research and development budget will substantially increase as
the scope of our operations expands and as we have access to additional working
capital to fund these activities. However, research and development and
investments in new technology are inherently speculative and commercial success
depends on many factors including technological innovation, novelty, service and
support, and effective sales and marketing. We may not achieve significant
revenue from new product and service investments for a number of years, if at
all. Moreover, new products and services may not be profitable, and even if they
are profitable, operating margins for new products and businesses may be
minimal.
We
are subject to intense competition in the industry in which we operate, which
could cause material reductions in the selling price of our products or losses
of our market share.
The
market for set-top boxes and networking products is highly competitive,
especially with respect to pricing and the introduction of new products and
features. Our products compete primarily on the basis of:
|
•
|
reliability;
|
|
•
|
brand
recognition;
|
|
•
|
quality;
|
|
•
|
price;
|
|
|
|
•
|
design;
and
|
|
•
|
quality
service and support to retailers and our
customers.
|
Currently,
there are many significant competitors in the set-top box business including
several established companies who have sold set-top boxes to major cable
operators for many years. These competitors include companies such as Motorola,
Cisco Systems, and Pace. In addition, a number of rapidly growing companies have
recently entered the market, many of them with set-top box offerings similar to
our existing set-top box products. We also expect additional competition in the
future from new and existing companies who do not currently compete in the
market for set-top boxes. As the set-top box business evolves, our current and
potential competitors may establish cooperative relationships among themselves
or with third parties, including software and hardware companies that could
acquire significant market share, which could adversely affect our business. We
also face competition from set-top boxes that have been internally developed by
digital video providers.
In recent
years, we and many of our competitors, have regularly lowered prices, and we
expect these pricing pressures to continue. If these pricing pressures are not
mitigated by increases in volume, cost reductions from our supplier or changes
in product mix, our revenues and profits could be substantially reduced. As
compared to us, many of our competitors have:
|
•
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significantly
longer operating histories;
|
|
•
|
significantly
greater managerial, financial, marketing, technical and other competitive
resources; and
|
|
•
|
greater
brand recognition.
|
As a
result, our competitors may be able to:
|
•
|
adapt
more quickly to new or emerging technologies and changes in customer
requirements;
|
|
•
|
devote
greater resources to the promotion and sale of their products and
services; and
|
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•
|
respond
more effectively to pricing
pressures.
|
9
These
factors could materially adversely affect our operations and financial
condition. In addition, competition could increase if:
|
•
|
new
companies enter the market;
|
|
•
|
existing
competitors expand their product mix;
or
|
|
•
|
we
expand into new markets.
|
An
increase in competition could result in material price reductions or loss of our
market share.
Changes
in existing technologies or the emergence of new products or technologies could
significantly harm our business.
Our
businesses change rapidly as new technologies are developed. These new
technologies may cause our services and products to become obsolete. Changes in
existing technologies could also cause demand for our products and services to
decline. For example, if changes in technology allow digital television
subscribers to use devices such as personal computers, cable ready televisions
and network based digital video recording services in place of set-top boxes,
our customers may not need to purchase our set-top boxes to provide their
digital television subscribers with digital video recording and other set-top
box features. One or more new technologies also could be introduced that compete
favorably with our set-top boxes or that cause our set-top boxes to no longer be
of significant benefit to our customers.
We and
our suppliers also may not be able to keep pace with technological developments.
Alternatively, if the new technologies on which we intend to focus our research
and development investments fail to achieve acceptance in the marketplace, we
could suffer a material adverse effect on our future competitive position that
could cause a reduction in our revenues and earnings. Our competitors could also
obtain or develop proprietary technologies that are perceived by the market as
being superior to ours. Further, after we have incurred substantial research and
development costs, one or more of the technologies under development could
become obsolete prior to its introduction. Finally, delays in the delivery of
components or other unforeseen problems may occur that could materially and
adversely affect our ability to generate revenue, offer new products and
services and remain competitive.
Technological
innovation is important to our success and depends, to a significant degree, on
the work of technically skilled employees. Competition for the services of these
types of employees is intense. We may not be able to attract and retain these
employees. If we are unable to attract and maintain technically skilled
employees, our competitive position could be materially and adversely
affected.
The
loss or significant reduction in business of any of our key customers could
materially and adversely affect our revenues and earnings.
We are
highly dependent upon sales of our products to certain of our customers. During
our fiscal year ended December 31, 2008, Neihuang Radio & Television Bureau
and Kaifeng Radio & Television Bureau each accounted for approximately 10%
of our net revenues. During the fiscal year ended December 31, 2007, Nanyang
Radio & Television Bureau, Mengzhou Radio & Television Bureau and
Xuchang Radio & Television Bureau accounted for approximately 16%, 14% and
13%, respectively, of our net revenues. During the fiscal year December 31,
2006, Kaifeng Radio & Television Bureau, Xinye Radio & Television
Bureau, Xuchang Radio & Television Bureau, Huaxian Radio & Television
Bureau and Nanyang Radio & Television Bureau accounted for approximately
24%, 24%, 19%, 13% and 10%, respectively, of our net revenues. No other customer
accounted for greater than 5% of our net revenues during these periods. All
purchases of our products by customers are made through purchase orders and we
do not have long-term contracts with any of our customers. The loss of Neihuang
County Broadcasting Television Information Network Center and Henan Cable TV
Network Group Co., Ltd. Kaifeng Branch, or any of our other customers to which
we sell a significant amount of our products or any significant portion of
orders from Cable TV Station of Pingdingshan and Cable TV Station of Nanyang, or
such other customers or any material adverse change in the financial condition
of such customers could negatively affect our revenues and decrease our
earnings.
We cannot
rely on long-term purchase orders or commitments to protect us from the negative
financial effects of a decline in demand for our products. The limited certainty
of product orders can make it difficult for us to forecast our sales and
allocate our resources in a manner consistent with our actual sales. Moreover,
our expense levels are based in part on our expectations of future sales and, if
our expectations regarding future sales are inaccurate, we may be unable to
reduce costs in a timely manner to adjust for sales shortfalls. Cancellations or
reductions of customer orders could result in the loss of anticipated sales
without allowing us sufficient time to reduce our inventory and operating
expenses. Furthermore, because we depend on a small number of customers for the
vast majority of our sales, the magnitude of the ramifications of these risks is
greater than if our sales were less concentrated with a small number of
customers. As a result of our lack of long-term purchase orders and purchase
commitments we may experience a rapid decline in our sales and
profitability.
In
addition, there is a relatively small number of potential new customers for our
set-top boxes and we expect this customer concentration to continue for the
foreseeable future. Therefore, our operating results will likely continue to
depend on sales to a relatively small number of customers, as well as the
continued success of these customers. If we do not develop relationships with
new customers, we may not be able to expand our customer base or maintain or
increase our revenue.
10
We
depend on a limited number of suppliers for components for our products. The
inability to secure components for our products could reduce our revenues and
adversely affect our relationship with our customers.
We rely
on a limited number of suppliers for our component parts and raw materials.
Although there are many suppliers for each of our component parts and raw
materials, we are dependent on a limited number of suppliers for many of the
significant components and raw materials. This reliance involves a number of
significant potential risks, including:
|
•
|
lack
of availability of materials and interruptions in delivery of components
and raw materials from our
suppliers;
|
|
•
|
manufacturing
delays caused by such lack of availability or interruptions in
delivery;
|
|
•
|
fluctuations
in the quality and the price of components and raw materials, in
particular due to the petroleum price impact on such materials;
and
|
|
•
|
risks
related to foreign operations.
|
We
generally do not have any long-term or exclusive purchase commitments with any
of our suppliers. Hangzhou Jingbao Electronic Ltd., Farway Electronics Factory
and Henan Hui-ke Electronics Co., Ltd. are our largest suppliers of components
for our products, each of which accounted for more than 10% of our purchases of
components for our products for the fiscal year ended December 31, 2008 and the
fiscal year ended December 31, 2007. In addition, Henan Hui-ke Electronics Co.,
Ltd., Shenzhen Jiuzhou Technology, Co. Ltd. and Hangzhou Jingbao Co., Ltd. each
accounted for more than 10% of our purchases of components for our products for
the nine months ended September 30, 2009. Our failure to maintain
existing relationships with our suppliers or to establish new relationships in
the future could also negatively affect our ability to obtain our components and
raw materials used in our products in a timely manner. If we are unable to
obtain ample supply of products from our existing suppliers or alternative
sources of supply, we may be unable to satisfy our customers’ orders which could
materially and adversely affect our revenues and our relationship with our
customers.
Certain
disruptions in supply of and changes in the competitive environment for
components and raw materials integral to our products may adversely affect our
profitability.
We use a
broad range of materials and supplies, including LCD components, ICs, flash
memories, WiFi modules, GPS modules, capacitors, resistors, switches,
connectors, batteries and other electronic components in our products. A
significant disruption in the supply of these materials could decrease
production and shipping levels, materially increase our operating costs and
materially adversely affect our profit margins. Shortages of materials or
interruptions in transportation systems, labor strikes, work stoppages, war,
acts of terrorism or other interruptions to or difficulties in the employment of
labor or transportation in the markets in which we purchase materials,
components and supplies for the production of our products, in each case may
adversely affect our ability to maintain production of our products and sustain
profitability. If we were to experience a significant or prolonged shortage of
critical components and raw materials from any of our suppliers and could not
procure the components from other sources, we would be unable to meet our
production schedules for some of our key products and to ship such products to
our customers in a timely fashion, which would adversely affect our sales,
margins and customer relations.
Substantial
defaults by our customers on accounts receivable or the loss of significant
customers could have a material adverse effect on our business.
A
substantial portion of our working capital consists of accounts receivable from
customers. If customers responsible for a significant amount of accounts
receivable were to become insolvent or otherwise unable to pay for products and
services, or to make payments in a timely manner, our business, results of
operations or financial condition could be materially adversely affected. An
economic or industry downturn could materially adversely affect the servicing of
these accounts receivable, which could result in longer payment cycles,
increased collection costs and defaults in excess of management’s expectations.
A significant deterioration in our ability to collect on accounts receivable
could also impact the cost or availability of financing available to
us.
In
addition, our business is characterized by long periods for collection from our
customers and short periods for payment to our suppliers, the combination of
which may cause us to have liquidity problems. We experience an average accounts
settlement period ranging from one month to as high as four months from the time
we sell our products to the time we receive payment from our customers. In
contrast, we typically need to place certain deposits and advances with our
suppliers on a portion of the purchase price in advance and for some suppliers
we must maintain a deposit for future orders. Because our payment cycle is
considerably shorter than our receivable cycle, we may experience working
capital shortages. Working capital management, including prompt and diligent
billing and collection, is an important factor in our results of operations and
liquidity. We cannot assure you that system problems, industry trends or other
issues will not extend our collection period, adversely impact our working
capital.
11
Our
operations would be materially adversely affected if third-party carriers were
unable to transport our products on a timely basis.
All of
our products are shipped through third party carriers. If a strike or other
event prevented or disrupted these carriers from transporting our products,
other carriers may be unavailable or may not have the capacity to deliver our
products to our customers. If adequate third party sources to ship our products
were unavailable at any time, our business would be materially adversely
affected.
Our
quarterly results may fluctuate because of many factors and, as a result,
investors should not rely on quarterly operating results as indicative of future
results.
Fluctuations
in operating results or the failure of operating results to meet the
expectations of public market analysts and investors may negatively impact the
value of our securities. Quarterly operating results may fluctuate in the future
due to a variety of factors that could affect revenues or expenses in any
particular quarter. Fluctuations in quarterly operating results could cause the
value of our securities to decline. Investors should not rely on
quarter-to-quarter comparisons of results of operations as an indication of
future performance. As a result of the factors listed below, it is possible that
in future periods results of operations may be below the expectations of public
market analysts and investors. This could cause the market price of our
securities to decline. Factors that may affect our quarterly results
include:
|
•
|
seasonal variations in operating
results;
|
|
•
|
variations in the sales of our
products to our significant
customers;
|
|
•
|
the discretionary nature of our
customers’ demands and spending
patterns;
|
|
•
|
variations in manufacturing and
supplier relationships;
|
|
•
|
fluctuation and unpredictability
of costs related to the components and raw materials used to manufacture
our products;
|
|
•
|
if we are unable to correctly
anticipate and provide for inventory requirements from quarter to quarter,
we may not have sufficient inventory to deliver our products to our
customers in a timely fashion or we may have excess inventory that we are
unable to sell;
|
|
•
|
competition from our
competitors;
|
|
•
|
changes in market and economic
conditions;
|
|
•
|
vulnerability of our business to
a general economic downturn in
China;
|
|
•
|
changes in the laws of the PRC
that affect our operations;
and
|
|
•
|
our ability to obtain necessary
government certifications and/or licenses to conduct our
business.
|
In
addition, our quarterly operating results could be materially adversely affected
by political instability, war, acts of terrorism or other
disasters.
As a
result of these and other factors, revenues for any quarter are subject to
significant variation, which may adversely affect our results of operations and
the market price for our common stock.
We
depend upon a patent we license from a third party, Zhong Bo, our Chief
Executive Officer and Chairman of the Board. The loss of this license, an
increase in the costs of this license or Mr. Zhong’s failure to properly
maintain or enforce the patent underlying such license may require us to suspend
our operations until we obtain replacements and/or redesign our
products.
We rely
upon certain patents licensed from our Chief Executive Officer and Chairman of
the Board, Zhong Bo, which gives us rights to third party intellectual property
that is necessary or useful for our business. On January 9, 2009, we
entered into a patent license agreement with Mr. Zhong for the right to use such
patent in the operation of our business. In addition, we also applied
to SIPO for the transfer of the patent to Zhengzhou ZST and SIPO accepted the
application regarding the patent transfer to Zhengzhou ZST on December 31, 2008.
The patent transfer to Zhengzhou ZST was approved on January 9,
2009. Mr. Zhong did not receive any additional consideration for the
transfer of the intellectual property rights to the Company, other than the
execution of the patent license agreement being a condition to the closing of
the Share Exchange.
12
We may
also enter into additional licenses to third party intellectual property in the
future. In addition, because we do not own any patents relating to our
technologies, we do not have the right to defend perceived infringements of
patents relating to such technologies. Thus, our success will depend in part on
the ability and willingness of our licensors to obtain, maintain and enforce
patent protection for our licensed intellectual property, in particular, those
patents to which we have secured exclusive rights. Our licensors may not
successfully prosecute the patent applications for the intellectual property we
have licensed. Even if patents issue in respect of these patent applications,
our licensors may fail to maintain these patents, may determine not to pursue
litigation against other companies that are infringing these patents, or may
pursue such litigation less aggressively than we would. Without protection for
the intellectual property we license, other companies might be able to offer
substantially identical products for sale, which could adversely affect our
competitive business position and harm our business prospects.
Our
ability to compete partly depends on the superiority, uniqueness and value of
our technologies, including both internally developed technology and technology
licensed from third parties. To protect our proprietary rights, we rely on a
combination of trademark, patent, copyright and trade secret laws,
confidentiality agreements with our employees and third parties, and protective
contractual provisions. Despite our efforts to protect our intellectual
property, any of the following occurrences may reduce the value of our
intellectual property:
|
•
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our applications for trademarks
or patents may not be granted and, if granted, may be challenged or
invalidated;
|
|
•
|
issued patents, copyrights and
trademarks may not provide us with any competitive
advantages;
|
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•
|
our efforts to protect our
intellectual property rights may not be effective in preventing
misappropriation of our technology or dilution of our
trademarks;
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our efforts may not prevent the
development and design by others of products or technologies similar to or
competitive with, or superior to those that we develop;
or
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another party may obtain a
blocking patent that would force us to either obtain a license or design
around the patent to continue to offer the contested feature or service in
our technologies.
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We
rely on trade secret protections through confidentiality agreements with our
employees, customers and other parties; the breach of such agreements could
adversely affect our business and results of operations.
We also
rely on trade secrets, which we seek to protect, in part, through
confidentiality and non-disclosure agreements with our employees, customers and
other parties. There can be no assurance that these agreements will not be
breached, that we would have adequate remedies for any such breach or that our
trade secrets will not otherwise become known to or independently developed by
competitors. To the extent that consultants, key employees or other third
parties apply technological information independently developed by them or by
others to our proposed projects, disputes may arise as to the proprietary rights
to such information that may not be resolved in our favor. We may be involved
from time to time in litigation to determine the enforceability, scope and
validity of our proprietary rights. Any such litigation could result in
substantial cost and diversion of effort by our management and technical
personnel.
We
intend to pursue future acquisitions. Our business may be adversely affected if
we cannot consummate acquisitions on satisfactory terms, or if we cannot
effectively integrate acquired operations.
Part of
our growth strategy involves the acquisition of other companies. Any future
growth through acquisitions will be partially dependent upon the availability of
suitable acquisition candidates at favorable prices and upon advantageous terms
and conditions. We intend to pursue acquisitions that we believe will present
opportunities consistent with our overall business strategy. However, we may not
be able to find suitable acquisition candidates to purchase or may be unable to
acquire desired businesses or assets on economically acceptable terms. In
addition, we may not be able to raise the capital necessary to fund future
acquisitions. In addition, acquisitions involve risks that the businesses
acquired will not perform in accordance with expectations and that business
judgments concerning the value, strengths and weaknesses of businesses acquired
will prove incorrect.
We
regularly engage in discussions with respect to potential acquisition and
investment opportunities. If we consummate an acquisition, our capitalization
and results of operations may change significantly. Future acquisitions could
likely result in the incurrence of additional debt and contingent liabilities
and an increase in interest and amortization expenses or periodic impairment
charges related to goodwill and other intangible assets as well as significant
charges relating to integration costs.
In
addition, we may not be able to successfully integrate any business we acquire
into our existing business. The successful integration of new businesses depends
on our ability to manage these new businesses and cut excess costs. The
successful integration of future acquisitions may also require substantial
attention from our senior management and the management of the acquired
business, which could decrease the time that they have to service and attract
customers and develop new products and services. In addition, because we may
actively pursue a number of opportunities simultaneously, we may encounter
unforeseen expenses, complications and delays, including difficulties in
employing sufficient staff and maintaining operational and management
oversight.
13
We
may need additional capital to implement our current business strategy, which
may not be available to us, and if we raise additional capital, it may dilute
your ownership in us.
We
currently depend on bank loans and net revenues to meet our short-term cash
requirements. In order to grow revenues and sustain profitability, we will need
additional capital. We recently completed a public offering of shares of common
stock, and we may conduct additional financing transactions in the
future. Obtaining additional financing will be subject to a number of
factors, including market conditions, our operating performance and investor
sentiment. These factors may make the timing, amount, terms and conditions of
additional financing unattractive to us. We cannot assure you that we will be
able to obtain any additional financing. If we are unable to obtain the
financing needed to implement our business strategy, our ability to increase
revenues will be impaired and we may not be able to sustain
profitability.
The
capital and credit markets have been experiencing extreme volatility and
disruption for more than twelve months. In recent months, the volatility and
disruption have reached unprecedented levels. In some cases, the markets have
exerted downward pressure on availability of liquidity and credit capacity for
certain issuers. We have historically relied on credit to fund our business and
we need liquidity to pay our operating expenses. Without sufficient liquidity,
we will be forced to curtail our operations, and our business will suffer.
Disruptions, uncertainty or volatility in the capital and credit markets may
also limit our access to capital required to operate our business. Such market
conditions may limit our ability to replace, in a timely manner, maturing
liabilities and access the capital necessary to operate and grow our business.
As such, we may be forced to delay raising capital or bear an unattractive cost
of capital which could decrease our profitability and significantly reduce our
financial flexibility. Our results of operations, financial condition, cash
flows and capital position could be materially adversely affected by disruptions
in the financial markets.
Our
failure to effectively manage growth could harm our business.
We have
rapidly and significantly expanded the number and types of products we sell, and
we will endeavor to further expand our product portfolio. We must continually
introduce new products and technologies, enhance existing products in order to
remain competitive, and effectively stimulate customer demand for new products
and upgraded versions of our existing products.
This
expansion of our products places a significant strain on our management,
operations and engineering resources. Specifically, the areas that are strained
most by our growth include the following:
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New Product
Launch.
With the growth of our product portfolio, we experience
increased complexity in coordinating product development, manufacturing,
and shipping. As this complexity increases, it places a strain on our
ability to accurately coordinate the commercial launch of our products
with adequate supply to meet anticipated customer demand and effective
marketing to stimulate demand and market acceptance. If we are unable to
scale and improve our product launch coordination, we could frustrate our
customers and lose retail shelf space and product
sales;
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Forecasting,
Planning and Supply Chain Logistics. With the growth of
our product portfolio, we also experience increased complexity in
forecasting customer demand and in planning for production, and
transportation and logistics management. If we are unable to scale and
improve our forecasting, planning and logistics management, we could
frustrate our customers, lose product sales or accumulate excess
inventory; and
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Support
Processes.
To manage the growth of our operations, we will need to
continue to improve our transaction processing, operational and financial
systems, and procedures and controls to effectively manage the increased
complexity. If we are unable to scale and improve these areas, the
consequences could include: delays in shipment of product, degradation in
levels of customer support, lost sales, decreased cash flows, and
increased inventory. These difficulties could harm or limit our ability to
expand.
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We
are dependent on certain key personnel and loss of these key personnel could
have a material adverse effect on our business, financial condition and results
of operations.
Our
success is, to a certain extent, attributable to the management, sales and
marketing, and operational and technical expertise of certain key personnel.
Each of the named executive officers performs key functions in the operation of
our business. The loss of a significant number of these employees could have a
material adverse effect upon our business, financial condition, and results of
operations.
14
We
are dependent on a technically trained workforce and an inability to retain or
effectively recruit such employees could have a material adverse effect on our
business, financial condition and results of operations.
We must
attract, recruit and retain a sizeable workforce of technically competent
employees to develop and manufacture our products and provide service support.
Our ability to implement effectively our business strategy will depend upon,
among other factors, the successful recruitment and retention of additional
highly skilled and experienced engineering and other technical and marketing
personnel. There is significant competition for technologically qualified
personnel in our business and we may not be successful in recruiting or
retaining sufficient qualified personnel consistent with our operational
needs.
Our
facilities and information systems could be damaged as a result of disasters or
unpredictable events, which could have an adverse effect on our business
operations.
Our
headquarters and major facilities including sales offices and research and
development centers are located in China. If major disasters such as
earthquakes, fires, floods, wars, terrorist attacks, computer viruses,
transportation disasters or other events occur, or our information system or
communications network breaks down or operates improperly as a result of such
events, our facilities may be seriously damaged, and we may have to stop or
delay production and shipment. We may incur expenses relating to such
damages.
15
Risks
Related to Doing Business in China
Substantially
all of our assets are located in the PRC and substantially all of our revenues
are derived from our operations in China, and changes in the political and
economic policies of the PRC government could have a significant impact upon the
business we may be able to conduct in the PRC and accordingly on the results of
our operations and financial condition.
Our
business operations may be adversely affected by the current and future
political environment in the PRC. The Chinese government exerts substantial
influence and control over the manner in which we must conduct our business
activities. Our ability to operate in China may be adversely affected by changes
in Chinese laws and regulations, including those relating to taxation, import
and export tariffs, raw materials, environmental regulations, land use rights,
property and other matters. Under the current government leadership, the
government of the PRC has been pursuing economic reform policies that encourage
private economic activity and greater economic decentralization. There is no
assurance, however, that the government of the PRC will continue to pursue these
policies, or that it will not significantly alter these policies from time to
time without notice.
Our
operations are subject to PRC laws and regulations that are sometimes vague and
uncertain. Any changes in such PRC laws and regulations, or the interpretations
thereof, may have a material and adverse effect on our business.
The PRC
legal system is a civil law system based on written statutes. Unlike the common
law system prevalent in the United States, decided legal cases have little value
as precedent in China. There are substantial uncertainties regarding the
interpretation and application of PRC laws and regulations, including but not
limited to, the laws and regulations governing our business, or the enforcement
and performance of our arrangements with customers in the event of the
imposition of statutory liens, death, bankruptcy or criminal proceedings. The
Chinese government has been developing a comprehensive system of commercial
laws, and considerable progress has been made in introducing laws and
regulations dealing with economic matters such as foreign investment, corporate
organization and governance, commerce, taxation and trade. However, because
these laws and regulations are relatively new, and because of the limited volume
of published cases and judicial interpretation and their lack of force as
precedents, interpretation and enforcement of these laws and regulations involve
significant uncertainties. New laws and regulations that affect existing and
proposed future businesses may also be applied retroactively.
Our
principal operating subsidiary, Zhengzhou Shenyang Technology Company Limited
(“Zhengzhou ZST”), is considered a foreign invested enterprise under PRC laws,
and as a result is required to comply with PRC laws and regulations, including
laws and regulations specifically governing the activities and conduct of
foreign invested enterprises. We cannot predict what effect the interpretation
of existing or new PRC laws or regulations may have on our businesses. If the
relevant authorities find us in violation of PRC laws or regulations, they would
have broad discretion in dealing with such a violation, including, without
limitation:
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levying
fines;
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revoking
our business license, other licenses or
authorities;
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requiring
that we restructure our ownership or operations;
and
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requiring
that we discontinue any portion or all of our
business.
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Investors
may experience difficulties in effecting service of legal process, enforcing
foreign judgments or bringing original actions in China based upon U.S. laws,
including the federal securities laws or other foreign laws against us or our
management.
Most of
our current operations, including the manufacturing and distribution of our
products, are conducted in China. Moreover, all of our directors and officers
are nationals and residents of China. All or substantially all of the assets of
these persons are located outside the United States and in the PRC. As a result,
it may not be possible to effect service of process within the United States or
elsewhere outside China upon these persons. In addition, uncertainty exists as
to whether the courts of China would recognize or enforce judgments of U.S.
courts obtained against us or such officers and/or directors predicated upon the
civil liability provisions of the securities laws of the United States or any
state thereof, or be competent to hear original actions brought in China against
us or such persons predicated upon the securities laws of the United States or
any state thereof.
The
scope of our business license in China is limited, and we may not expand or
continue our business without government approval and renewal,
respectively.
Our
principal operating subsidiary, Zhengzhou ZST, is a wholly foreign-owned
enterprise, commonly known as a WFOE. A WFOE can only conduct business within
its approved business scope, which ultimately appears on its business license.
Our license permits us to design, manufacture, sell and market portable
electronic products throughout the PRC and overseas. Any amendment to the scope
of our business requires further application and government approval. In order
for us to expand our business beyond the scope of our license, we will be
required to enter into a negotiation with the PRC authorities for the approval
to expand the scope of our business. We cannot assure investors that Zhengzhou
ZST will be able to obtain the necessary government approval for any change or
expansion of its business.
16
We
are subject to a variety of environmental laws and regulations related to our
manufacturing operations. Our failure to comply with environmental laws and
regulations may have a material adverse effect on our business and results of
operations.
We cannot
assure you that at all times we will be in compliance with environmental laws
and regulations or that we will not be required to expend significant funds to
comply with, or discharge liabilities arising under, environmental laws,
regulations and permits.
Recent
PRC regulations relating to acquisitions of PRC companies by foreign entities
may create regulatory uncertainties that could restrict or limit our ability to
operate. Our failure to obtain required prior approval for the share exchange,
reverse merger and the listing and trading of our common stock could have a
material adverse effect on our business, operating results, reputation and
trading price of our common stock.
The PRC
State Administration of Foreign Exchange, or “SAFE,” issued a public notice in
November 2005, known as Circular 75, concerning the use of offshore holding
companies controlled by PRC residents in mergers and acquisitions in China. This
circular requires that (1) a PRC resident shall register with a local branch of
the SAFE before he or she establishes or controls an overseas special purpose
vehicle, or SPV, for the purpose of overseas equity financing (including
convertible debt financing); (2) when a PRC resident contributes the assets of
or his or her equity interests in a domestic enterprise to an SPV, or engages in
overseas financing after contributing assets or equity interests to an SPV, such
PRC resident must register his or her interest in the SPV and any changes in
such interest with a local branch of the SAFE; and (3) when the SPV undergoes a
material change outside of China, such as a change in share capital or merger or
acquisition, the PRC resident shall, within 30 days from the occurrence of the
event that triggers the change, register such change with a local branch of the
SAFE. In addition, SAFE issued updated internal implementing rules, or the
Implementing Rules in relation to Circular 75. The Implementing Rules were
promulgated and became effective on May 29, 2007. Such Implementing Rules
provide more detailed provisions and requirements regarding the overseas
investment foreign exchange registration procedures. However, even after the
promulgation of Implementing Rules there still exist uncertainties regarding the
SAFE registration for PRC residents’ interests in overseas companies. If any PRC
resident stockholder of a SPV fails to make the required SAFE registration and
amended registration, the onshore PRC subsidiaries of that offshore company may
be prohibited from distributing their profits and the proceeds from any
reduction in capital, share transfer or liquidation to the offshore
entity. Failure to comply with the SAFE registration and amendment
requirements described above could result in liability under PRC laws for
evasion of applicable foreign exchange restrictions. Because of uncertainty in
how the SAFE notice will be interpreted and enforced, we cannot be sure how it
will affect our business operations or future plans. For example, Zhengzhou
ZST’s ability to conduct foreign exchange activities, such as the remittance of
dividends and foreign currency-denominated borrowings, may be subject to
compliance with the SAFE notice by our PRC resident beneficial holders over whom
we have no control. In addition, we cannot assure you that such PRC residents
will be able to complete the necessary approval and registration procedures
required by the SAFE regulations. Failure by any PRC resident beneficial holder
to register as required with the relevant branch of SAFE could subject these PRC
resident beneficial holders to fines or legal sanctions, restrict our overseas
or cross-border investment activities, limit Zhengzhou ZST’s ability to make
distributions or pay dividends or affect our ownership structure, which could
adversely affect our business and prospects.
On August
8, 2006, the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned
Assets Supervision and Administration Commission of the State Council, the State
Administration of Taxation, the State Administration for Industry and Commerce,
the China Securities Regulatory Commission and SAFE, released a substantially
amended version of the Provisions for Foreign Investors to Merge with or Acquire
Domestic Enterprises (the “Revised M&A Regulations”), which took effect
September 8, 2006. These new rules significantly revised China’s regulatory
framework governing onshore-to-offshore restructurings and foreign acquisitions
of domestic enterprises. These new rules signify greater PRC government
attention to cross-border merger, acquisition and other investment activities,
by confirming MOFCOM as a key regulator for issues related to mergers and
acquisitions in China and requiring MOFCOM approval of a broad range of merger,
acquisition and investment transactions. Further, the new rules establish
reporting requirements for acquisition of control by foreigners of companies in
key industries, and reinforce the ability of the Chinese government to monitor
and prohibit foreign control transactions in key industries.
Among
other things, the revised M&A Regulations include new provisions that
purport to require that an offshore special purpose vehicle, or a SPV, formed
for listing purposes and controlled directly or indirectly by PRC companies or
individuals must obtain the approval of the CSRC prior to the listing and
trading of such SPV’s securities on an overseas stock exchange. On September 21,
2006, the CSRC published on its official website procedures specifying documents
and materials required to be submitted to it by SPVs seeking CSRC approval of
their overseas listings. However, the application of this PRC regulation remains
unclear with no consensus currently existing among the leading PRC law firms
regarding the scope and applicability of the CSRC approval
requirement.
According
to the M&A Regulations, a “Related Party Acquisition” is defined as having
taken place when a PRC business that is owned by PRC individual(s) is sold to a
non-PRC entity that is established or controlled, directly or indirectly, by
those same PRC individual(s). Under the M&A Regulations, any Related Party
Acquisition must be approved by MOFCOM and any indirect arrangement or series of
arrangements which achieves the same end result without the approval of MOFCOM
is a violation of PRC law.
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Our BVI
subsidiary, World Orient, World Orient’s BVI subsidiary, Global Asia, and Global
Asia’s Hong Kong subsidiary, Everfair, were owned by non-PRC individuals.
Everfair obtained all the equity interests of Zhengzhou ZST (the
“Restructuring”) further to an Equity Purchase Agreement dated October 10, 2008
(the “Equity Purchase Agreement”) by and among Everfair, Zhong Bo, Wu Dexiu,
Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”). The Equity
Purchase Agreement received approval by the Zhengzhou Municipal Bureau of
Commerce on November 10, 2008 and Zhengzhou ZST filed all required applications
and received all appropriate SAFE approvals from the Henan branch of SAFE.
With respect to the Restructuring, the PRC legal counsel of Zhengzhou ZST, Han
Kun Law Offices, has opined on January 9, 2009 that: (1) the Equity Purchase
Agreement and the Restructuring have received all requisite approvals from the
competent authorities, and all required registrations, certifications and
approvals for the Equity Purchase Agreement and the Restructuring have been
received by Zhengzhou ZST; (2) Zhengzhou ZST has filed all required applications
for the Equity Purchase Agreement and the Restructuring and has received any and
all foreign exchange registrations, certifications and approvals as required,
including, but not limited to, those as required from the appropriate national
and local branches of SAFE and MOFCOM; and (3) to their best knowledge, the
Equity Purchase Agreement and the Restructuring do not (a) contravene or
circumvent any provision of applicable PRC laws and regulations, including
without limitation, the M&A Regulations, Circular 75 and its implementing
rules; or (b) contravene the articles of association, business license or other
constituent documents of Zhengzhou ZST.
On
January 14, 2009, Zhong Bo, our Chief Executive Officer, Wu Dexiu, Huang
Jiankang, Sun Hui and Li Yuting (the “ZST Management”) each entered into a
Common Stock Purchase Agreement pursuant to which the Company issued and the ZST
Management agreed to purchase an aggregate of 5,090,315 shares of our common
stock at a per share purchase price of $0.6907 (the “Purchase Right”). The
purchase price for the shares was paid in full on May 25, 2009. Each of the
stockholders and warrantholders of the Company prior to the Share Exchange
agreed to cancel 0.3317 shares of common stock and warrants to purchase 0.5328
shares of common stock held by each of them for each one (1) share of common
stock purchased by the ZST Management pursuant to the Purchase Right (the “Share
and Warrant Cancellation”). After giving effect to the Purchase Right and Share
and Warrant Cancellation, Mr. Zhong beneficially owned approximately 59.87% of
our outstanding common stock (after giving effect to the Series A
Conversion).
The PRC
regulatory authorities may take the view that the acquisition of Zhengzhou ZST
by Everfair, the Share Exchange, the Purchase Right and the Share and Warrant
Cancellation are part of an overall series of arrangements which constitute a
Related Party Acquisition, because at the end of these transactions, PRC
individuals become majority owners and effective controlling parties of a
foreign entity that acquired ownership of Zhengzhou ZST. The PRC regulatory
authorities may also take the view that the registration of the acquisition of
Zhengzhou ZST by Everfair with the Zhengzhou Municipal Bureau of Commerce and
the filings with the Henan SAFE may not evidence that the acquisition has been
properly approved because the relevant parties did not fully disclose to the
Zhengzhou Bureau of Commerce or Henan SAFE of the overall restructuring
arrangements, the existence of the Share Exchange and its link with the
acquisition of Zhengzhou ZST by Everfair .
We,
however, cannot assure you that the PRC regulatory authorities, MOFCOM in
particular, may take the same view as the PRC legal counsel with respect to the
Restructuring. If the PRC regulatory authorities take the view that the
acquisition constitutes a Related Party Acquisition under the M&A
Regulations, we cannot assure you we may be able to obtain the approval required
from the national offices of MOFCOM.
If the
PRC regulatory authorities take the view that the acquisition of Zhengzhou ZST
by Everfair constitutes a Related Party Acquisition without the approval of the
national offices of MOFCOM, they could invalidate our acquisition and ownership
of Zhengzhou ZST. Additionally, the PRC regulatory authorities may take the view
that the Share Exchange constitutes a transaction which requires the prior
approval of the China Securities Regulatory Commission, or CSRC. If this takes
place, we would attempt to find a way to re-establish control of Zhengzhou ZST’s
business operations through a series of contractual arrangements rather than an
outright purchase of Zhengzhou ZST. But we cannot assure you that any such
contractual arrangements will be protected by PRC law or that the Company can
receive as complete or effective economic benefit and overall control of
Zhengzhou ZST’s business than if the Company had direct ownership of Zhengzhou
ZST. In addition, we cannot assure you that any such contractual arrangements
can be successfully effected under PRC law. If we cannot obtain MOFCOM or CSRC
approval if required by the PRC regulatory authorities to do so, and if we
cannot put in place or enforce relevant contractual arrangements as an
alternative and equivalent means of control of Zhengzhou ZST, our business and
financial performance will be materially adversely affected.
If the
CSRC approval is not obtained, we may face regulatory actions or other sanctions
from the CSRC or other PRC regulatory agencies. These regulatory agencies may
impose fines and penalties on our operations in the PRC, limit our operating
privileges in the PRC, delay or restrict the repatriation of the proceeds from
any financings into the PRC, or take other actions that could have a material
adverse effect on our business, financial condition, results of operations,
reputation and prospects, as well as the trading price of our common stock. The
CSRC or other PRC regulatory agencies also may take actions requiring us, or
making it advisable for us, to halt the proposed public offering before
settlement and delivery of the common stock offered thereby. Consequently, if
investors engage in market trading or other activities in anticipation of and
prior to settlement and delivery, they do so at the risk that settlement and
delivery may not occur.
Any
uncertainties and/or negative publicity regarding this CSRC approval requirement
could have a material adverse effect on the trading price of our common stock.
Furthermore, published news reports in China recently indicated that the CSRC
may have curtailed or suspended overseas listings for Chinese private companies.
These news reports have created further uncertainty regarding the approach that
the CSRC and other PRC regulators may take with respect to us.
18
It is
uncertain how our business operations or future strategy will be affected by the
interpretations and implementation of the aforementioned rules and regulations.
It is anticipated that application of the new rules will be subject to
significant administrative interpretation, and we will need to closely monitor
how MOFCOM and other ministries apply the rules to ensure that our domestic and
offshore activities continue to comply with PRC law. Given the uncertainties
regarding interpretation and application of the new rules, we may need to expend
significant time and resources to maintain compliance.
Our
labor costs are likely to increase as a result of changes in Chinese labor
laws.
We expect
to experience an increase in our cost of labor due to recent changes in Chinese
labor laws which are likely to increase costs further and impose restrictions on
our relationship with our employees. In June 2007, the National People’s
Congress of the PRC enacted new labor law legislation called the Labor Contract
Law and more strictly enforced existing labor laws. The new law, which became
effective on January 1, 2008, amended and formalized workers’ rights concerning
overtime hours, pensions, layoffs, employment contracts and the role of trade
unions. As a result of the new law, the Company has had to reduce the number of
hours of overtime its employees can work, substantially increase the salaries of
its employees, provide additional benefits to its employees, and revise certain
other of its labor practices. The increase in labor costs has increased the
Company’s operating costs, which increase the Company has not always been able
to pass through to its customers. As a result, the Company has incurred certain
operating losses as its cost of manufacturing increased. In addition, under the
new law, employees who either have worked for the Company for 10 years or more
or who have had two consecutive fixed-term contracts must be given an
“open-ended employment contract” that, in effect, constitutes a lifetime,
permanent contract, which is terminable only in the event the employee
materially breaches the Company’s rules and regulations or is in serious
dereliction of his duty. Such non-cancelable employment contracts will
substantially increase its employment related risks and limit the Company’s
ability to downsize its workforce in the event of an economic downturn. No
assurance can be given that the Company will not in the future be subject to
labor strikes or that it will not have to make other payments to resolve future
labor issues caused by the new laws. Furthermore, there can be no assurance that
the labor laws will not change further or that their interpretation and
implementation will vary, which may have a negative effect upon our business and
results of operations.
The
ability of our Chinese operating subsidiaries to pay dividends may be restricted
due to foreign exchange control and other regulations of China.
Under
applicable PRC regulations, foreign-invested enterprises in China may pay
dividends only out of their accumulated profits, if any, determined in
accordance with PRC accounting standards and regulations. In addition, a
foreign-invested enterprise in China is required to set aside at least 10.0% of
its after-tax profit based on PRC accounting standards each year to its general
reserves until the accumulative amount of such reserves reach 50.0% of its
registered capital. These reserves are not distributable as cash dividends. The
board of directors of a foreign-invested enterprise has the discretion to
allocate a portion of its after-tax profits to staff welfare and bonus funds,
which may not be distributed to equity owners except in the event of
liquidation.
Furthermore,
the ability of our Chinese operating subsidiaries to pay dividends may be
restricted due to the foreign exchange control policies and availability of cash
balance of the Chinese operating subsidiaries. Because substantially all of our
operations are conducted in China and a substantial majority of our revenues are
generated in China, a majority of our revenue being earned and currency received
are denominated in Renminbi (RMB). RMB is subject to the exchange control
regulation in China, and, as a result, we may unable to distribute any dividends
outside of China due to PRC exchange control regulations that restrict our
ability to convert RMB into U.S. Dollars.
Our
inability to receive dividends or other payments from our Chinese operating
subsidiary could adversely limit our ability to grow, make investments or
acquisitions that could be beneficial to our business, pay dividends, or
otherwise fund and conduct our business. Zhengzhou ZST’s funds may not be
readily available to us to satisfy obligations which have been incurred outside
the PRC, which could adversely affect our business and prospects or our ability
to meet our cash obligations. Accordingly, if we do not receive dividends from
our Chinese operating subsidiary, our liquidity, financial condition and ability
to make dividend distributions to our stockholders will be materially and
adversely affected.
The
foreign currency exchange rate between U.S. Dollars and Renminbi could adversely
affect our financial condition.
To the
extent that we need to convert U.S. Dollars into Renminbi for our operational
needs, our financial position and the price of our common stock may be adversely
affected should the Renminbi appreciate against the U.S. Dollar at that time.
Conversely, if we decide to convert our Renminbi into U.S. Dollars for the
operational needs or paying dividends on our common stock, the dollar equivalent
of our earnings from our subsidiaries in China would be reduced should the U.S.
Dollar appreciate against the Renminbi.
Until
1994, the Renminbi experienced a gradual but significant devaluation against
most major currencies, including U.S. Dollars, and there was a significant
devaluation of the Renminbi on January 1, 1994 in connection with the
replacement of the dual exchange rate system with a unified managed floating
rate foreign exchange system. Since 1994, the value of the Renminbi relative to
the U.S. Dollar has remained stable and has appreciated slightly against the
U.S. Dollar. Countries, including the United States, have argued that the
Renminbi is artificially undervalued due to China’s current monetary policies
and have pressured China to allow the Renminbi to float freely in world markets.
In July 2005, the PRC government changed its policy of pegging the value of the
Renminbi to the U.S. Dollar. Under the new policy the Renminbi is permitted to
fluctuate within a narrow and managed band against a basket of designated
foreign currencies. While the international reaction to the Renminbi revaluation
has generally been positive, there remains significant international pressure on
the PRC government to adopt an even more flexible currency policy, which could
result in further and more significant appreciation of the Renminbi against the
U.S. Dollar.
19
Inflation
in the PRC could negatively affect our profitability and growth.
While the
PRC economy has experienced rapid growth, such growth has been uneven among
various sectors of the economy and in different geographical areas of the
country. Rapid economic growth can lead to growth in the money supply and rising
inflation. During the past decade, the rate of inflation in China has been as
high as approximately 20% and China has experienced deflation as low as
approximately minus 2%. If prices for our products and services rise at a rate
that is insufficient to compensate for the rise in the costs of supplies such as
raw materials, it may have an adverse effect on our profitability. In order to
control inflation in the past, the PRC government has imposed controls on bank
credits, limits on loans for fixed assets and restrictions on state bank
lending. The implementation of such policies may impede economic growth. In
October 2004, the People’s Bank of China, the PRC’s central bank, raised
interest rates for the first time in nearly a decade and indicated in a
statement that the measure was prompted by inflationary concerns in the Chinese
economy. In April 2006, the People’s Bank of China raised the interest rate
again. Repeated rises in interest rates by the central bank would likely slow
economic activity in China which could, in turn, materially increase our costs
and also reduce demand for our products and services.
Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
As our
ultimate holding company is a Delaware corporation, we are subject to the United
States Foreign Corrupt Practices Act, which generally prohibits United States
companies from engaging in bribery or other prohibited payments to foreign
officials for the purpose of obtaining or retaining business. Foreign companies,
including some that may compete with us, are not subject to these prohibitions.
Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices
may occur from time-to-time in the PRC. We can make no assurance, however, that
our employees or other agents will not engage in such conduct for which we might
be held responsible. If our employees or other agents are found to have engaged
in such practices, we could suffer severe penalties and other consequences that
may have a material adverse effect on our business, financial condition and
results of operations.
If
we make equity compensation grants to persons who are PRC citizens, they may be
required to register with the State Administration of Foreign Exchange of the
PRC, or SAFE. We may also face regulatory uncertainties that could restrict our
ability to adopt an equity compensation plan for our directors and employees and
other parties under PRC law.
On April
6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic
Individuals Participating in the Employee Stock Ownership Plan or Stock Option
Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear
whether Circular 78 covers all forms of equity compensation plans or only those
which provide for the granting of stock options. For any plans which are so
covered and are adopted by a non-PRC listed company after April 6, 2007,
Circular 78 requires all participants who are PRC citizens to register with and
obtain approvals from SAFE prior to their participation in the plan. In
addition, Circular 78 also requires PRC citizens to register with SAFE and make
the necessary applications and filings if they participated in an overseas
listed company’s covered equity compensation plan prior to April 6, 2007. We
intend to adopt an equity compensation plan in the future and make substantial
option grants to our officers and directors, most of who are PRC citizens.
Circular 78 may require our officers and directors who receive option grants and
are PRC citizens to register with SAFE. We believe that the registration and
approval requirements contemplated in Circular 78 will be burdensome and time
consuming. If it is determined that any of our equity compensation plans are
subject to Circular 78, failure to comply with such provisions may subject us
and participants of our equity incentive plan who are PRC citizens, including or
Chief Executive Officer, to fines and legal sanctions and prevent us from being
able to grant equity compensation to our PRC employees. In that case, our
ability to compensate our employees and directors through equity compensation
would be hindered and our business operations may be adversely
affected.
Any
recurrence of Severe Acute Respiratory Syndrome (SARS), Avian Flu, or another
widespread public health problem in the PRC could adversely affect our
operations.
A renewed
outbreak of SARS, Avian Flu or another widespread public health problem in
China, where our manufacturing facilities are located and where the substantial
portion of our sales occur, could have a negative effect on our operations. Our
business is dependent upon its ability to continue to manufacture products. Such
an outbreak could have an impact on our operations as a result of:
•
|
quarantines
or closures of some of our manufacturing facilities, which would severely
disrupt our operations,
|
•
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the
sickness or death of our key officers and employees,
or
|
•
|
a
general slowdown in the Chinese
economy.
|
Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our operations.
20
A
downturn in the economy of the PRC may slow our growth and
profitability.
The
growth of the Chinese economy has been uneven across geographic regions and
economic sectors. There can be no assurance that growth of the Chinese economy
will be steady or that any downturn will not have a negative effect on our
business, especially if it results in either a decreased use of our products or
in pressure on us to lower our prices.
Because
our business is located in the PRC, we may have difficulty establishing adequate
management, legal and financial controls, which we are required to do in order
to comply with U.S. GAAP and securities laws, and which could cause a materially
adverse impact on our financial statements, the trading of our common stock
and our business.
PRC
companies have historically not adopted a Western style of management and
financial reporting concepts and practices, which includes strong corporate
governance, internal controls and, computer, financial and other control
systems. Most of our middle and top management staff are not educated and
trained in the Western system, and we may have difficulty hiring new employees
in the PRC with experience and expertise relating to U.S. GAAP
and U.S. public-company reporting requirements. In addition, we may have
difficulty in hiring and retaining a sufficient number of qualified employees to
work in the PRC. As a result of these factors, we may experience difficulty in
establishing management, legal and financial controls, collecting financial data
and preparing financial statements, books of account and corporate records and
instituting business practices that meet Western standards. Therefore, we may,
in turn, experience difficulties in implementing and maintaining adequate
internal controls as required under Section 404 of the Sarbanes-Oxley Act of
2002. This may result in significant deficiencies or material weaknesses in our
internal controls which could impact the reliability of our financial statements
and prevent us from complying with SEC rules and regulations and the
requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, material
weaknesses or lack of compliance could result in restatements of our historical
financial information, cause investors to lose confidence in our reported
financial information, have an adverse impact on the trading price of our common
stock, adversely affect our ability to access the capital markets and our
ability to recruit personnel, lead to the delisting of our securities from the
stock exchange on which they are traded, lead to litigation claims, thereby
diverting management’s attention and resources, and which may lead to the
payment of damages to the extent such claims are not resolved in our
favor, lead to regulatory proceedings, which may result in sanctions, monetary
or otherwise, and have a materially adverse effect on our reputation and
business.
21
Risks
Related to Our Capital Structure
Our
stock price is volatile and you might not be able to resell your securities at
or above the price you have paid.
Prior to
the listing of our common stock on the NASDAQ Global Market in October 2009,
there has been no public market for our securities in the United
States. Accordingly, we cannot assure you that an active trading
market will develop or be sustained or that the market price of our common stock
will not decline. The price at which our common stock has traded has
been highly volatile. You might not be able to sell the shares of our common
stock at or above the price you have paid. The stock market has experienced
extreme volatility that often has been unrelated to the performance of its
listed companies. Moreover, only a limited number of our shares are traded each
day, which could increase the volatility of the price of our stock. These market
fluctuations might cause our stock price to fall regardless of our performance.
The market price of our common stock might fluctuate significantly in response
to many factors, some of which are beyond our control, including the
following:
|
·
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actual
or anticipated fluctuations in our annual and quarterly results of
operations;
|
|
·
|
changes
in securities analysts’
expectations;
|
|
·
|
variations
in our operating results, which could cause us to fail to meet analysts’
or investors’ expectations;
|
|
·
|
announcements
by our competitors or us of significant new products, contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
|
|
·
|
conditions
and trends in our industry;
|
|
·
|
general
market, economic, industry and political
conditions;
|
|
·
|
changes
in market values of comparable
companies;
|
|
·
|
additions
or departures of key personnel;
|
|
·
|
stock
market price and volume fluctuations attributable to inconsistent trading
volume levels; and
|
|
·
|
future
sales of equity or debt securities, including sales which dilute existing
investors.
|
Shares
eligible for future sale may adversely affect the market price of our common
stock, as the future sale of a substantial amount of outstanding stock in the
public marketplace could reduce the price of our common stock.
The
market price of our common stock could decline as a result of sales of a large
number of shares of our common stock in the market or the perception that these
sales could occur. These sales, or the possibility that these sales may occur,
also might make it more difficult for us to sell equity securities in the
future at a time and at a price that we deem appropriate.
As of the
date of this prospectus, we had approximately 11,650,442 shares of common stock
outstanding. In October 2009, we conducted a registered public
offering of 3,125,000 shares of common stock, and all of these shares are now
freely tradable. Also in October 2009, we registered 1,263,723 shares
of common stock underlying shares of Series A Convertible Preferred Stock that
were issued in a series of equity financings that was conducted in
connection with the Share Exchange (the “Private Placement
Shares”). Each private placement investor may sell or transfer any
shares of the common stock pursuant to the effective registration statement,
except that they entered into a lock-up agreement pursuant to which holders
holding an aggregate of 868,930 shares agreed not to conduct any sales
until six (6) months after our common stock began to be listed on the NASDAQ
Global Market and holders of the remaining 394,793 shares agreed that
they will not sell any of such securities until 90 days after our common stock
began to be listed on the NASDAQ Global Market, when one-twelfth of their shares
will be released from the lock-up restrictions, and after which their shares
will automatically be released from the lock-up restrictions every 30 days in
eleven equal installments. We also registered with the Private
Placement Shares, 243,774 shares of common stock and 34,826 shares of common
stock underlying warrants held by certain of our stockholders immediately prior
to the Share Exchange (the “SRKP Shares”). The SRKP Shares may be
freely sold and transferred pursuant to the effective registration statement,
subject to a lock-up agreement pursuant to which the holders agreed not to
conduct any sales until six (6) months after our common stock began to be listed
on the NASDAQ Global Market. In addition, the Underwriters, in their
discretion, may release some or all the shares earlier than the schedule set
forth in this section. Any early release by the Underwriters will apply equally
to each of the investors in the Private Placement.
In
addition, in October 2009, we registered 156,250 warrants and the shares of
common stock underlying the warrants received by the Underwriters in connection
with the public offering. The warrants will become exercisable one year after
October 20, 2009 and expire five years from October 20, 2009. In addition,
unless an exemption is available under FINRA Rule 5110(g)(2), these securities
will be subject to lock-up restrictions under FINRA Rule 5110(g). FINRA Rule
5110(g) provides that the warrants and underlying shares shall not be sold,
transferred, assigned, pledged or hypothecated, or be the subject of any
hedging, short sale, derivative, put or call transaction that would result in
the effective economic disposition of the warrants or underlying shares by any
person for a period of 180 days immediately following the date of effectiveness
or commencement of sales of the public offering.
22
We
also agreed to register 1,086,400 shares of common stock held by affiliates of
WestPark, which are included in the registration statement of which this
prospectus is a part. When declared effective, all of the shares
included in an effective registration statement may be freely sold and
transferred, subject to a lock-up agreement pursuant to which the holders agreed
not to conduct any sales until six (6) months after our common stock began to be
listed on the NASDAQ Global Market.
Additionally,
the former stockholders of World Orient and/or their designees and the ZST
Management, may be eligible to sell all or some of our shares of common stock by
means of ordinary brokerage transactions in the open market pursuant to Rule
144, promulgated under the Securities Act (“Rule 144”) as early as January 2010,
subject to certain limitations. Under Rule 144, an affiliate stockholder who has
satisfied the required holding period may, under certain circumstances, sell
within any three-month period a number of securities which does not exceed the
greater of 1% of the then outstanding shares of common stock or the average
weekly trading volume of the class during the four calendar weeks prior to such
sale. As of the date of this prospectus, 1% of our issued and outstanding shares
of common stock was approximately 116,504 shares. Non-affiliate stockholders are
not subject to volume limitations. Any substantial sale of common stock pursuant
to any resale prospectus or Rule 144 may have an adverse effect on the market
price of our common stock by creating an excessive supply.
However,
each of our executive officers and directors, in additional to all of the
stockholders that received shares issued in the Share Exchange or pursuant to
the Purchase Right, holding an aggregate of 5,171,565 shares of common
stock, have agreed with the Underwriters not to directly or indirectly sell,
offer, contract or grant any option to sell, pledge, transfer (excluding
intra-family transfers, transfers to a trust for estate planning purposes or to
beneficiaries of officers, directors and stockholders upon their death), or
otherwise dispose of or enter into any transaction which may result in the
disposition of any shares of our common stock or securities convertible into,
exchangeable or exercisable for any shares of our common stock, without the
prior written consent of the Underwriters, for a period of 24 months after
October 20, 2009. Holders of 725,158 shares of common stock have agreed with the
Underwriters to be bound by the same transfer restrictions described above,
except that such restrictions shall be released on such dates and amounts as
follows: (i) 121,876 shares on the date that is six (6) months after our common
stock began to be listed on the NASDAQ Global Market, (ii) 121,876 shares on the
date that is twelve (12) months after such listing date, (iii) 353,438 shares on
the date that is two (2) years after such listing date, and (iv) 127,968 shares
shall be released from the restrictions as determined by WestPark, in its sole
discretion.
Compliance
with changing regulation of corporate governance and public disclosure will
result in additional expenses.
Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC
regulations, have created uncertainty for public companies and significantly
increased the costs and risks associated with accessing the public markets and
public reporting. Our management team will need to invest significant management
time and financial resources to comply with both existing and evolving standards
for public companies, which will lead to increased general and administrative
expenses and a diversion of management time and attention from revenue
generating activities to compliance activities.
If
we fail to maintain effective internal controls over financial reporting, it may
lead to a restatement of our financial information and the price of our common
stock may be adversely affected, as well as our ability to access the capital
markets and our business.
We are
required to establish and maintain appropriate internal controls over financial
reporting. Failure to establish those controls, or any failure of those controls
once established, could adversely impact our public disclosures regarding our
business, financial condition or results of operations. Any failure of these
controls could also prevent us from maintaining accurate accounting records and
discovering accounting errors and financial frauds. Rules adopted by the SEC
pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual
assessment of our internal control over financial reporting, and attestation of
this assessment by our independent registered public accountants. The SEC
extended the compliance dates for non-accelerated filers, as defined by the SEC.
Accordingly, the annual assessment of our internal controls requirement first
applied to our annual report for the 2007 fiscal year and the attestation
requirement of management’s assessment by our independent registered public
accountants will first apply to our annual report for the 2010 fiscal year. The
standards that must be met for management to assess the internal control over
financial reporting as effective are new and complex, and require significant
documentation, testing and possible remediation to meet the detailed standards.
We may encounter problems or delays in completing activities necessary to make
an assessment of our internal control over financial reporting. In addition, the
attestation process by our independent registered public accountants is new and
we may encounter problems or delays in completing the implementation of any
requested improvements and receiving an attestation of our assessment by our
independent registered public accountants. If we cannot assess our internal
control over financial reporting as effective, or our independent registered
public accountants are unable to provide an unqualified attestation report on
such assessment, investor confidence and share value may be negatively
impacted.
In
addition, management’s assessment of internal controls over financial reporting
may identify weaknesses and conditions that need to be addressed in our internal
controls over financial reporting or other matters that may raise concerns for
investors. Any actual or perceived weaknesses and conditions that need to be
addressed in our internal control over financial reporting, disclosure of
management’s assessment of our internal controls over financial reporting, or
disclosure of our public accounting firm’s attestation to or report on
management’s assessment of our internal controls over financial reporting may
cause investors to lose confidence in our reported financial information, have
an adverse impact on the trading price of our common stock, adversely affect our
ability to access the capital markets and our ability to recruit personnel, lead
to the delisting of our securities from the stock exchange on which they are
traded, lead to litigation claims, thereby diverting management’s attention and
resources, and which may lead to the payment of damages to the extent such
claims are not resolved in our favor, lead to regulatory proceedings,
which may result in sanctions, monetary or otherwise and have a materially
adverse effect on our reputation and business.
23
We
may be exposed to risks relating to our disclosure controls and our internal
controls and may need to incur significant costs to comply with applicable
requirements.
Based on
the evaluation done by our management at September 30, 2009, our disclosure
controls were deemed ineffective, in that we could not assure that information
required to be disclosed in our SEC reports is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms, and communicated to our management, so as to allow
timely decisions regarding required disclosures. Factors which led our
management to conclude that our disclosure controls and procedures were not
effective include, but are not limited to, the late filing of our Quarterly
Report on Form 10-Q for the quarter ended March 31, 2009. Our
controls and procedures were primarily adversely affected by the lack of
experience within the company in complying with the requirements of a publicly
reporting entity, specifically, having insufficient personnel resources with
sufficient technical accounting expertise within our accounting
function. We are seeking to engage experienced professionals to
further augment our financial staff to address issues of timeliness and
completeness in financial reporting when we are preparing SEC filings. No
assurances can be given that we will be able to adequately remediate existing
deficiencies in disclosure controls and not have deficiencies when we report on
internal controls. Although we believe that these corrective steps will enable
management to conclude that our disclosure controls are effective and these
measures will remediate the material weaknesses discussed above when all of the
additional financial staff positions are filled and other remediation plans are
implemented, we cannot assure you that this will be sufficient. Also, as
we hire more experienced staff and advisors, additional deficiencies may be
identified that will need to be remediated. These additional
deficiencies may also have caused our historical financial results to be
incorrect, which, if material, could require a restatement. As a
result, we may be required to expend additional resources to identify, assess
and correct any additional weaknesses in disclosure or internal control and to
otherwise comply with the internal controls rules under Section 404 of the
Sarbanes-Oxley Act, when applicable.
We
may not be able to achieve the benefits we expect to result from the Share
Exchange
On
December 11, 2008, we entered into the Exchange Agreement, as amended on January
9, 2009, with all of the stockholders of World Orient, pursuant to which we
agreed to acquire 100% of the issued and outstanding securities of World Orient
in exchange for shares of our common stock. On January 9, 2009, the Share
Exchange closed, World Orient became our 100%-owned subsidiary and our sole
business operations became that of World Orient and its subsidiaries. We also
have a new board of directors and management consisting of persons from
Zhengzhou ZST and changed our corporate name from SRKP 18, Inc. to ZST Digital
Networks, Inc.
We may
not realize the benefits that we hoped to receive as a result of the Share
Exchange, which include:
•
|
access
to the capital markets of the United
States;
|
•
|
the
increased market liquidity expected to result from exchanging stock in a
private company for securities of a public company that may eventually be
traded;
|
•
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the
ability to use registered securities to make acquisition of assets or
businesses;
|
•
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increased
visibility in the financial
community;
|
•
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enhanced
access to the capital markets;
|
•
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improved
transparency of operations; and
|
•
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perceived
credibility and enhanced corporate image of being a publicly traded
company.
|
There can
be no assurance that any of the anticipated benefits of the Share Exchange will
be realized in respect to our new business operations. In addition, the
attention and effort devoted to achieving the benefits of the Share Exchange and
attending to the obligations of being a public company, such as reporting
requirements and securities regulations, could significantly divert management’s
attention from other important issues, which could materially and adversely
affect our operating results or stock price in the future.
24
Our
common stock may be considered a “penny stock,” and thereby be subject to
additional sale and trading regulations that may make it more difficult to
sell.
Our
common stock, which is not currently listed or quoted for trading, may be
considered to be a “penny stock” if it does not qualify for one of the
exemptions from the definition of “penny stock” under Section 3a51-1 of the
Exchange Act once, and if, it starts trading. Our common stock may be a “penny
stock” if it meets one or more of the following conditions: (i) the stock trades
at a price less than $5.00 per share; (ii) it is NOT traded on a “recognized”
national exchange; (iii) it is NOT quoted on the NASDAQ Capital Market, or even
if so, has a price less than $5.00 per share; or (iv) is issued by a company
that has been in business less than three years with net tangible assets less
than $5 million.
The
principal result or effect of being designated a “penny stock” is that
securities broker-dealers participating in sales of our common stock will be
subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9
promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor’s account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any
investor for transactions in such stocks before selling any penny stock to that
investor. This procedure requires the broker-dealer to (i) obtain from the
investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult and time consuming for holders of our common stock to resell their
shares to third parties or to otherwise dispose of them in the market or
otherwise.
We
do not foresee paying cash dividends in the foreseeable future and, as a result,
our investors’ sole source of gain, if any, will depend on capital appreciation,
if any.
We do not
plan to declare or pay any cash dividends on our shares of common stock in the
foreseeable future and currently intend to retain any future earnings for
funding growth. As a result, investors should not rely on an investment in our
securities if they require the investment to produce dividend income. Capital
appreciation, if any, of our shares may be investors’ sole source of gain for
the foreseeable future. Moreover, investors may not be able to resell their
shares of the Company at or above the price they paid for them.
25
The
information contained in this prospectus, including in the documents
incorporated by reference into this prospectus, includes some statement that are
not purely historical and that are “forward-looking statements” as defined by
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include, but are not limited to, statements regarding the Company,
World Orient and Zhengzhou ZST and its management’s expectations, hopes,
beliefs, intentions or strategies regarding the future, including Zhengzhou
ZST’s financial condition, results of operations, and the expected impact of the
Share Exchange on the parties’ individual and combined financial performance. In
addition, any statements that refer to projections, forecasts or other
characterizations of future events or circumstances, including any underlying
assumptions, are forward-looking statements. The words “anticipates,”
“believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,”
“should,” “will,” “would” and similar expressions, or the negatives of such
terms, may identify forward-looking statements, but the absence of these words
does not mean that a statement is not forward-looking.
The
forward-looking statements contained in this prospectus are based on current
expectations and beliefs concerning future developments and the potential
effects on the parties and the transaction. There can be no assurance that
future developments actually affecting us will be those anticipated. These
forward-looking statements involve a number of risks, uncertainties (some of
which are beyond the parties’ control) or other assumptions that may cause
actual results or performance to be materially different from those expressed or
implied by these forward-looking statements, including the
following:
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our ability to maintain and
increase revenues and sales of our
products;
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our ability to develop and market
new products;
|
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competitive nature of our
industry;
|
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·
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market acceptance of our
products;
|
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·
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our reliance on intellectual
property, some of which is owned by third
parties;
|
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·
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our strategic investments and
acquisitions;
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·
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compliance and changes in the
laws of the PRC that affect our
operations;
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·
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continued maintenance of
certificates, permits and licenses required to conduct business in
China;
|
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·
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vulnerability of our business to
general economic downturn, especially in the PRC;
and
|
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·
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the other factors referenced in
this Current Report, including, without limitation, under the sections
entitled “Risk Factors,” “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” and
“Business.
|
The risks
included above are not exhaustive. Other sections of this prospectus may include
additional factors that could adversely impact our business and operating
results. Moreover, we operate in a very competitive and rapidly changing
environment. New risk factors emerge from time to time and we cannot predict all
such risk factors, nor can we assess the impact of all such risk factors on our
business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward looking
statements.
You
should not rely upon forward-looking statements as predictions of future events.
We cannot assure you that the events and circumstances reflected in the
forward-looking statements will be achieved or occur. Although we believe that
the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Moreover, neither we nor any other person assume responsibility
for the accuracy and completeness of the forward-looking statements. Except as
required by law, we undertake no obligation to update publicly any
forward-looking statements for any reason after the date of this prospectus to
conform these statements to actual results or to changes in our
expectations.
You
should read this prospectus, and the documents that we reference in this
prospectus and have filed as exhibits to this prospectus with the Securities and
Exchange Commission, completely and with the understanding that our actual
future results, levels of activity, performance and achievements may materially
differ from what we expect. We qualify all of our
forward-looking statements by these cautionary statements.
26
USE
OF PROCEEDS
DIVIDEND
POLICY
We do not
expect to declare or pay any cash dividends on our common stock in the
foreseeable future, and we currently intend to retain future earnings, if any,
to finance the expansion of our business. The decision whether to pay cash
dividends on our common stock will be made by our board of directors, in their
discretion, and will depend on our financial condition, operating results,
capital requirements and other factors that the board of directors considers
significant. We declared cash dividends in the year ended December 31, 2007 and
paid the cash dividends in the year ended December 31, 2008. We did not pay any
cash dividends in the nine months ended September 30, 2009.
Under
applicable PRC regulations, foreign-invested enterprises in China may pay
dividends only out of their accumulated profits, if any, determined in
accordance with PRC accounting standards and regulations. In addition, a
foreign-invested enterprise in China is required to set aside at least 10.0% of
its after-tax profit based on PRC accounting standards each year to its general
reserves until the accumulative amount of such reserves reach 50.0% of its
registered capital. These reserves are not distributable as cash dividends. The
board of directors of a foreign-invested enterprise has the discretion to
allocate a portion of its after-tax profits to staff welfare and bonus funds,
which may not be distributed to equity owners except in the event of
liquidation.
Furthermore,
the ability of our Chinese operating subsidiaries to pay dividends may be
restricted due to the foreign exchange control policies and availability of cash
balance of the Chinese operating subsidiaries. Because substantially all of our
operations are conducted in China and a substantial majority of our revenues are
generated in China, a majority of our revenue being earned and currency received
are denominated in Renminbi (RMB). RMB is subject to the exchange control
regulation in China, and, as a result, we may unable to distribute any dividends
outside of China due to PRC exchange control regulations that restrict our
ability to convert RMB into US Dollars.
Our
inability to receive dividends or other payments from our Chinese operating
subsidiary could adversely limit our ability to grow, make investments or
acquisitions that could be beneficial to our business, pay dividends, or
otherwise fund and conduct our business. Zhengzhou ZST’s funds may not be
readily available to us to satisfy obligations which have been incurred outside
the PRC, which could adversely affect our business and prospects or our ability
to meet our cash obligations. Accordingly, if we do not receive dividends from
our Chinese operating subsidiary, our liquidity, financial condition and ability
to make dividend distributions to our stockholders will be materially and
adversely affected.
MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior
to the listing of our common stock on the NASDAQ Global Market on October 20,
2009, there has never been a public trading market for our common
stock. Our shares of common stock are traded on the NASDAQ Global
Market under the ticker symbol “ZSTN.” From October 20, 2009 to
January 7, 2010, the high and low closing trading price of our shares of common
stock as reported by the NASDAQ Global Market was a high of $10.09 per share and
a low of $5.60 per share. On January 7, 2010, the closing sales price
for our common stock on the NASDAQ Global Market was $10.09 per
share. As of January 7, 2010, we had 119 common stockholders of
record.
ACCOUNTING
FOR THE SHARE EXCHANGE
On
January 9, 2009, the Company completed the acquisition of all of the common
stock World Orient pursuant to a Share Exchange Agreement. In consideration, the
Company issued an aggregate of 806,408 shares of the Company’s common stock,
$0.0001 par value to the stockholders of World Orient. As a result of this
transaction, World Orient became a wholly-owned subsidiary of the Company. The
transaction is accounted for using the reverse merger acquisition method of
accounting in accordance with FASB Statement of Financial Accounting Standards
No. 141R, Business Combinations.
27
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-Looking
Statements
The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and the related notes, and
the other financial information included in this prospectus.
This
prospectus contains forward-looking statements. The words “anticipated,”
“believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,”
“may,” and similar expressions are intended to identify forward-looking
statements. These statements include, among others, information regarding future
operations, future capital expenditures, and future net cash flow. Such
statements reflect our management’s current views with respect to future events
and financial performance and involve risks and uncertainties, including,
without limitation, general economic and business conditions, changes in
foreign, political, social, and economic conditions, regulatory initiatives and
compliance with governmental regulations, the ability to achieve further market
penetration and additional customers, and various other matters, many of which
are beyond our control. Should one or more of these risks or uncertainties
occur, or should underlying assumptions prove to be incorrect, actual results
may vary materially and adversely from those anticipated, believed, estimated or
otherwise indicated. Consequently, all of the forward-looking statements made in
this prospectus are qualified by these cautionary statements and there can be no
assurance of the actual results or developments.
Overview
Business
Summary
The
Company is principally engaged in supplying digital and optical network
equipment to cable system operators in the Henan Province of
China. The Company has developed a line of internet protocol
television (“IPTV”) set-top boxes that are used to provide bundled cable
television, Internet and telephone services to residential and commercial
customers. The Company has assisted in the installation and
construction of over 400 local cable networks covering more than 90 municipal
districts, counties, townships, and enterprises. The Company’s
services and products have been recognized with various certifications,
including “integrated computer information system qualification class III”
issued by the Ministry of Industry Information, “communication user cable
construction enterprise qualification” issued by the Henan Province
Administration of Communication, “Henan Province Security Technology Prevention
Engineering Qualification Class III”, a certificate of “ISO9001:2000 Quality
System Authentication”, and “Double High” certification, high-tech product and
high-tech enterprise issued by the Henan Province government.
At
present, the Company’s main clients are broadcasting TV bureaus and cable
network operators serving various cities and counties. The Company
has over 30 main customers, including the broadcasting TV bureaus and cable
network operators of the cities of Nanyang, Mengzhou, Xuchang, Pingdingshan,
Kaifeng, Zhoukou and Gongyi, and the counties of Yuanyang, Luoning, Neihuang,
Yinyang, Xixia, Kaifeng, Nanzhao, and Gushi.
In the
near future, the Company plans to joint venture with cable network operators to
provide bundled television programming, Internet and telephone services to
residential customers in cities and counties located in the Henan Province. We
are also currently in the process of establishing a partnership with China
Unicom, a wireless network provider, in connection with the Company’s
development and sale of its GPS tracking units. In March 2009,
the Company entered into a network access right agreement with the Henan
Subsidiary of China Unicom that allows the Company to use the China Unicom
wireless network for providing GPS location and tracking services to third
parties. In the near future, the Company intends to negotiate a reseller
agreement with the Henan Subsidiary of China Unicom whereby GPS tracking units
supplied by the Company would be sold in the Henan Subsidiary of China Unicom
retail stores, with the Company receiving a share of subscriber revenue
collected by the Henan Subsidiary of China Unicom.
General
Factors
We expect
that for the foreseeable future that the largest source of revenue for our
business will be the sale of set-top boxes sold to cable system operators.
Because the number of potential new customers for our set-top box and fixed
satellite services businesses is small, our current customer concentration is
likely to continue for the foreseeable future and our operating results will
consequently likely continue to depend on sales to a relatively small number of
customers and on the continued success of these customers relative to their
competitors.
Our
profitability will be affected by costs associated with our efforts to expand
our sales, marketing, product development and general and administrative
capabilities in all of our businesses, as well as expenses that we incur as a
publicly-traded company. These costs include costs associated with,
among other things, financial reporting, information technology, complying with
federal securities laws (including compliance with the Sarbanes-Oxley Act of
2002), tax administration and human resources related functions. If
in the future we expand internationally, we may also incur additional costs
to conform our set-top boxes to comply with local laws or local specifications
and to ship our set-top boxes to our international customers.
28
In order
to grow or even maintain our current level of revenue we will be required to
attract new customers and to increase sales to existing customers which may
require us to design, market and sell new set-top boxes. If we do not
develop relationships with new customers, we may not be able to expand our
customer base and our ability to increase or even maintain our revenue will be
impacted.
We
believe that substantial opportunities for developing potential new customers
lie in international markets and if we were to expand our operations overseas,
we expect our performance in international markets would be a significant
factor in determining whether we would be able to generate revenue and income
growth in future periods. However, we do not currently intend to
expand our operations overseas and if we decide to do so in the future, there
can be no assurance we will be able to successfully commence or grow an
international business.
In
addition, unfavorable events in the economy, including a continuation or further
deterioration in the current downturn in real estate mortgage and credit
markets, could cause consumer demand for subscription TV services and
consequently sales of our set-top boxes to materially decline because consumers
may delay purchasing decisions or change or reduce their discretionary
spending.
Our
ability to sustain or increase profitability will also depend in large part on
our ability to control or reduce our costs of producing our set-top
boxes. The market for our set-top boxes, like other electronic
products, has been characterized by regular reductions in selling prices and
production costs. Therefore, we will likely be required to reduce
production costs in order to maintain the margins we earn on set-top boxes and
the profitability of our set-top box business.
Recent
Events
Reverse
Stock Split
On
October 6, 2009, we effected a 1-for-2.461538462 reverse stock split of all of
our issued and outstanding shares of common stock and Series A Convertible
Preferred Stock (the “Reverse Stock Split”) by filing an amendment to our
Certificate of Incorporation with the Secretary of State of Delaware. The par
value and number of authorized shares of our common stock and Series A
Convertible Preferred Stock remained unchanged. The number of shares and per
share amounts included in the consolidated financial statements and the
accompanying notes included in the F- section have been adjusted to reflect the
Reverse Stock Split retroactively. Unless otherwise indicated, all references to
number of shares, per share amounts and earnings per share information contained
in this prospectus give effect to the Reverse Stock Split.
Share
Exchange
On
December 11, 2008, we entered into a share exchange agreement, as amended on
January 9, 2009 (the “Exchange Agreement”), with World Orient and its
stockholders, pursuant to which the stockholders would transfer all of the
issued and outstanding shares of World Orient to the Company in exchange for
806,408 shares of our common stock (the “Share Exchange”). On January
9, 2009, the Share Exchange closed and World Orient became our wholly-owned
subsidiary and we immediately changed our name from “SRKP 18, Inc.” to “ZST
Digital Networks, Inc.” A total of 806,408 shares were issued to the former
stockholders of World Orient.
Purchase
Right
On
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”)
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management agreed to purchase an aggregate of
5,090,315 shares of our common stock at a per share purchase price of $0.6907
(the “Purchase Right”). The purchase price for the shares was paid in
full on May 25, 2009. Each of the stockholders and warrantholders of
the Company prior to the Share Exchange agreed to cancel 0.3317 shares of common
stock and warrants to purchase 0.5328 shares of common stock held by each of
them for each one (1) share of common stock purchased by the ZST Management
pursuant to the Purchase Right (the “Share and Warrant
Cancellation”). Pursuant to the Share and Warrant Cancellation, an
aggregate of 1,688,532 shares of common stock and warrants to purchase 2,712,283
shares of common stock held by certain of our stockholders and warrantholders
prior to the Share Exchange were cancelled.
Private
Placement
On May 5,
2009, we completed the final closing in a series of five closings beginning
January 9, 2009 of a private placement transaction (the “Private
Placement”). Pursuant to subscription agreements entered into with
the investors, we sold an aggregate of 1,263,723 shares of Series A Convertible
Preferred Stock at $3.94 per share. As a result, we received gross
proceeds in the amount of approximately $4.98 million. In connection
with the initial closing of the Private Placement, the Company issued a
promissory note in the principal amount of $170,000, bearing no interest (the
“Note”), to WestPark Capital Financial Services, LLC, the parent company of the
placement agent for the Private Placement, WestPark Capital, Inc.
(“WestPark”). The principal was due and payable by the Company on or before
the earlier of (a) thirty (30) days from the date of issuance of the Note or (b)
upon the receipt by the Company of at least $4 million in the Private
Placement. The Company repaid the Note in full on January 23, 2009
using the proceeds from the second closing of the Private
Placement.
29
Restructuring
Our BVI
subsidiary, World Orient, its wholly-owned BVI subsidiary, Global Asia, and
Global Asia’s wholly-owned Hong Kong subsidiary, Everfair, were owned by non-PRC
individuals. Everfair obtained all the equity interests of Zhengzhou ZST further
to an Equity Purchase Agreement dated October 10, 2008 (the “Equity Purchase
Agreement”) by and among Everfair, Zhong Bo, our Chief Executive Officer and
Chairman of the Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST
Management”). The Equity Purchase Agreement received approval by the Zhengzhou
Municipal Bureau of Commerce on November 10, 2008 and Zhengzhou ZST filed all
required applications and received all appropriate SAFE approvals from the Henan
branch of SAFE.
Upon the
consummation of the Purchase Right and Share and Warrant Cancellation, our Chief
Executive Officer and Chairman of the Board, Zhong Bo, beneficially owned
approximately 59.87% of our outstanding common stock (after giving effect to the
Series A Conversion).
Public
Offering
In
October 2009, we completed a public offering consisting of 3,125,000 shares of
our common stock. Rodman & Renshaw, LLC and WestPark Capital,
Inc. (together, the “Underwriters”) acted as co-underwriters in the public
offering. Our shares of common stock were sold to the public at a
price of $8.00 per share, for gross proceeds of appoximately $25
million. Compensation for the Underwriters’ services included
discounts and commissions of $1,875,000, a $250,000 non-accountable expense
allowance, roadshow expenses of approximately $10,000, and legal counsel fees
(excluding blue sky fees) of $40,000. The Underwriters also received
warrants to purchase an aggregate of 156,250 shares of our common stock at an
exercise price of $10.00 per share. The warrants, which have a term
of five years, are not exercisable until at least one year from the date of
issuance. The warrants also carry registration rights.
Critical
Accounting Policies and Estimates
The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets and liabilities. On an on-going basis, we
evaluate our estimates including the allowance for doubtful accounts, the
salability and recoverability of inventory, income taxes and contingencies. We
base our estimates on historical experience and on other assumptions that we
believes to be reasonable under the circumstances, the results of which form our
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
We cannot
predict what future laws and regulations might be passed that could have a
material effect on our results of operations. We assess the impact of
significant changes in laws and regulations on a regular basis and update the
assumptions and estimates used to prepare our financial statements when we deem
it necessary.
Revenue
recognition. The Company recognizes product sales revenue when the
significant risks and rewards of ownership have been transferred pursuant to PRC
law, including such factors as when persuasive evidence of an arrangement
exists, delivery has occurred, the sales price is fixed or determinable, sales
and value-added tax laws have been complied with, and collectability is
reasonably assured. The Company generally recognizes revenue when its products
are shipped.
The IPTV
device sales contracts include a one-year quality assurance warranty for
defects. According to the sales contract terms, customers are able to hold back
10% of the total contract balance payable to the Company for one year. This
deferred payment obligation is not contingent on resale of the product. In
accordance with SFAS FASB No. 48, "Revenue Recognition When Right of Return
Exists", the Company records the holdback as revenue at the time of sale when
its products are shipped to customers. Costs related to quality assurance
fulfillment are mainly the costs of materials used for repair or replacement of
damaged or defective products and are expensed as incurred. As the costs
associated with such assurance were immaterial in monetary terms, no assurance
liability is accrued for all periods. The Company incurred quality
assurance costs of nil and nil for the nine months ended September 30, 2009 and
2008, respectively. These costs incurred represent 0% and 0% of 2009
and 2008 IPTV box sales, respectively. In the event of defective
product returns, the Company has the right to seek replacement of such returned
units from its supplier.
Revenues
from fixed-price construction contracts are recognized on the completed-contract
method. This method is used because most of the construction and engineering
contracts are completed within six months or less and financial position and
results of operations do not vary significantly from those which would result
from using the percentage-of-completion method. A contract is considered
complete when all costs have been incurred and the installation is operating
according to specifications or has been accepted by the customer.
Contract
costs include all direct material and labor costs and those indirect costs
related to contract performance, such as indirect labor, suppliers, tools,
repairs, and depreciation costs. General and administrative costs are charged to
expenses as incurred. Provisions for estimated losses on uncompleted contracts
are made in the period in which such losses are determined. Claims are included
in revenues when received.
30
Allowance for
doubtful accounts. In estimating the collectability of accounts
receivable we analyze historical write-offs, changes in our internal credit
policies and customer concentrations when evaluating the adequacy of our
allowance for doubtful accounts periodically. Differences may result in the
amount and timing of expenses for any period if we make different judgments or
uses difference estimates. Our accounts receivable represent a significant
portion of our current assets and total assets. Our realization on accounts
receivable, expressed in terms of United States dollars may be affected by
fluctuations in currency rates since the customer’s currency is frequently a
currency other than United States dollars.
Inventories.
Inventories comprise raw materials and finished goods are stated at the lower of
cost or net realizable value, using the first-in first-out (“FIFO”) method.
Substantially all inventory costs are determined using the weighted average
basis. Costs of finished goods include direct labor, direct materials, and
production overhead before the goods are ready for sale. We evaluate the need
for reserves associated with obsolete, slow-moving and non-salable inventory by
reviewing net realizable values on a periodic basis. Inventory costs do not
exceed net realizable value.
Taxation.
The Company is registered in the PRC and has no tax advantages granted by the
local government for corporate income taxes and sales taxes because it is a
domestic corporation. On March 16, 2007, the National People’s Congress of China
enacted a new Enterprise Income Tax (“EIT”) law, under which foreign invested
enterprises and domestic companies will be subject to a uniform rate of 25%. The
new law became effective on January 1, 2008. The new standard EIT rate of 25%
replaces the 33% rate applicable to both foreign invested enterprises and
domestic companies, except for high-tech companies that pay a reduced rate of
15%, subject to government verification of high-tech status every three years.
Companies established before March 16, 2007 continue to enjoy a tax holiday
treatment approved by the local government for a grace period of either five
years or until the tax holiday term is completed, whichever is
sooner.
Recently
Adopted Accounting Pronouncements
In
June 2009, the Financial Accounting Standards Board (FASB) issued a
standard that established the FASB Accounting Standards Codification (ASC)
and amended the hierarchy of generally accepted accounting principles (ASC)
and amended the hierarchy of generally accepted accounting principles (GAAP)
such that the ASC became the single source of authoritative nongovernmental U.S.
GAAP. The ASC did not change current U.S. GAAP, but was intended to
simplify user access to all authoritative U.S. GAAP by providing all the
authoritative literature related to a particular topic in one place. All
previously existing accounting standard documents were superseded and all other
accounting literature not included in the ASC is considered non-authoritative.
New accounting standards issued subsequent to June 30, 2009 are
communicated by the FASB through Accounting Standards Updates (ASUs). The
Company adopted the ASC on July 1, 2009. This standard did not have an
impact on the Company’s consolidated results of operations or financial
condition. However, throughout the notes to the consolidated financial
statements references that were previously made to various former authoritative
U.S. GAAP pronouncements have been changed to coincide with the appropriate
section of the ASC.
In
September 2006, the FASB issued an accounting standard codified in ASC
820, Fair Value Measurements
and Disclosures. This standard established a single definition of fair
value and a framework for measuring fair value, set out a fair value hierarchy
to be used to classify the source of information used in fair value
measurements, and required disclosures of assets and liabilities measured at
fair value based on their level in the hierarchy. This standard applies under
other accounting standards that require or permit fair value measurements. One
of the amendments deferred the effective date for one year relative to
nonfinancial assets and liabilities that are measured at fair value, but are
recognized or disclosed at fair value on a nonrecurring basis. This deferral
applied to such items as nonfinancial assets and liabilities initially measured
at fair value in a business combination (but not measured at fair value in
subsequent periods) or nonfinancial long-lived asset groups measured at fair
value for an impairment assessment. The adoption of the fair value
measurement standard did not have a material impact on the Company’s
consolidated results of operations or financial condition.
In
December 2007, the FASB issued and, in April 2009, amended a new
business combinations standard codified within ASC 805, which changed the
accounting for business acquisitions. Accounting for business combinations under
this standard requires the acquiring entity in a business combination to
recognize all (and only) the assets acquired and liabilities assumed in the
transaction and establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed in a business
combination. Certain provisions of this standard impact the determination of
acquisition-date fair value of consideration paid in a business combination
(including contingent consideration); exclude transaction costs from
acquisition accounting; and change accounting practices for acquisition-related
restructuring costs, in-process research and development, indemnification
assets, and tax benefits. The Company adopted the standard for business
combinations for its business combination during the period ended March 31,
2009.
In
April 2009, the FASB issued an accounting standard, which provides guidance
on (1) estimating the fair value of an asset or liability when the volume
and level of activity for the asset or liability have significantly declined and
(2) identifying transactions that are not orderly. The standard also
amended certain disclosure provisions for fair value measurements and
disclosures in ASC 820 to require, among other things, disclosures in interim
periods of the inputs and valuation techniques used to measure fair value as
well as disclosure of the hierarchy of the source of underlying fair value
information on a disaggregated basis by specific major category of investment.
The standard was effective prospectively beginning April 1, 2009. The
adoption of this standard did not have a material impact on the Company’s
consolidated results of operations or financial condition.
31
In
April 2009, the FASB issued an accounting standard which modifies the
requirements for recognizing other-than-temporarily impaired debt securities and
changes the existing impairment model for such securities. The standard also
requires additional disclosures for both annual and interim periods with respect
to both debt and equity securities. Under the standard, impairment of debt
securities will be considered other-than-temporary if an entity (1) intends
to sell the security, (2) more likely than not will be required to sell the
security before recovering its cost, or (3) does not expect to recover the
security’s entire amortized cost basis (even if the entity does not intend to
sell). The standard further indicates that, depending on which of the above
factor(s) causes the impairment to be considered other-than-temporary,
(1) the entire shortfall of the security’s fair value versus its amortized
cost basis or (2) only the credit loss portion would be recognized in
earnings while the remaining shortfall (if any) would be recorded in other
comprehensive income. The standard requires entities to initially apply its
provisions to previously other-than-temporarily impaired debt securities
existing as of the date of initial adoption by making a cumulative-effect
adjustment to the opening balance of retained earnings in the period of
adoption. The cumulative-effect adjustment potentially reclassifies the
noncredit portion of a previously other-than-temporarily impaired debt security
held as of the date of initial adoption from retained earnings to accumulated
other comprehensive income. The adoption of this standard did not have a
material impact on the Company’s consolidated results of operations or financial
condition.
In
April 2009, the FASB issued an accounting standard regarding interim
disclosures about fair value of financial instruments. The standard essentially
expands the disclosure about fair value of financial instruments that were
previously required only annually to also be required for interim period
reporting. In addition, the standard requires certain additional disclosures
regarding the methods and significant assumptions used to estimate the fair
value of financial instruments. The adoption of this standard did not have a
material impact on the Company’s consolidated results of operations or financial
condition.
In
May 2009, the FASB issued a new accounting standard regarding subsequent
events. This standard incorporates into authoritative accounting literature
certain guidance that already existed within generally accepted auditing
standards, with the requirements concerning recognition and disclosure of
subsequent events remaining essentially unchanged. This guidance addresses
events which occur after the balance sheet date but before the issuance of
financial statements. Under the new standard, as under previous practice,
an entity must record the effects of subsequent events that provide evidence
about conditions that existed at the balance sheet date and must disclose but
not record the effects of subsequent events which provide evidence
about conditions that did not exist at the balance sheet date. This
standard added an additional required disclosure relative to the date through
which subsequent events have been evaluated and whether that is the date on
which the financial statements were issued. For the Company , this standard
was effective beginning April 1, 2009.
In
June 2009, the FASB issued a new standard regarding the accounting for
transfers of financial assets amending the existing guidance on transfers of
financial assets to, among other things, eliminate the qualifying
special-purpose entity concept, include a new unit of account definition that
must be met for transfers of portions of financial assets to be eligible for
sale accounting, clarify and change the derecognition criteria for a transfer to
be accounted for as a sale, and require significant additional disclosure. The
standard is effective for new transfers of financial assets beginning
January 1, 2010. The adoption of this standard is not expected to have a
material impact on the Company’s consolidated results of operations or financial
condition.
In
June 2009, the FASB issued an accounting standard that revised the
consolidation guidance for variable-interest entities. The modifications include
the elimination of the exemption for qualifying special purpose entities, a new
approach for determining who should consolidate a variable-interest entity, and
changes to when it is necessary to reassess who should consolidate a
variable-interest entity. The standard is effective January 1, 2010. The
Company is currently evaluating the impact of this standard, but would not
expect it to have a material impact on the Company’s consolidated results of
operations or financial condition.
In
August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair
Value, which provides additional guidance on how companies should measure
liabilities at fair value under ASC 820. The ASU clarifies that the quoted price
for an identical liability should be used. However, if such information is not
available, a entity may use, the quoted price of an identical liability when
traded as an asset, quoted prices for similar liabilities or similar liabilities
traded as assets, or another valuation technique (such as the market or income
approach). The ASU also indicates that the fair value of a liability is not
adjusted to reflect the impact of contractual restrictions that prevent its
transfer and indicates circumstances in which quoted prices for an identical
liability or quoted price for an identical liability traded as an asset may be
considered level 1 fair value. This ASU is effective October 1, 2009. The
Company is currently evaluating the impact of this standard, but would not
expect it to have a material impact on the Company’s consolidated results of
operations or financial condition.
In
September 2009, the FASB issued ASU No. 2009-12, Investments in Certain Entities
That Calculate Net Asset Value per Share (or Its Equivalent) , that
amends ASC 820 to provide guidance on measuring the fair value of certain
alternative investments such as hedge funds, private equity funds and venture
capital funds. The ASU indicates that, under certain circumstance, the fair
value of such investments may be determined using net asset value (NAV) as a
practical expedient, unless it is probable the investment will be sold at
something other than NAV. In those situations, the practical expedient cannot be
used and disclosure of the remaining actions necessary to complete the sale is
required. The ASU also requires additional disclosures of the attributes of all
investments within the scope of the new guidance, regardless of whether an
entity used the practical expedient to measure the fair value of any of its
investments. This ASU is effective October 1, 2009. The Company is
currently evaluating the impact of this standard, but would not expect it to
have a material impact on the Company’s consolidated results of operations or
financial condition.
32
In
October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue
Arrangements—a consensus of the FASB Emerging
Issues Task Force , that provides amendments to the criteria for
separating consideration in multiple-deliverable arrangements. As a result of
these amendments, multiple-deliverable revenue arrangements will be separated in
more circumstances than under existing U.S. GAAP. The ASU does this by
establishing a selling price hierarchy for determining the selling price of a
deliverable. The selling price used for each deliverable will be based on
vendor-specific objective evidence if available, third-party evidence if
vendor-specific objective evidence is not available, or estimated selling price
if neither vendor-specific objective evidence nor third-party evidence is
available. A vendor will be required to determine its best estimate of selling
price in a manner that is consistent with that used to determine the price to
sell the deliverable on a standalone basis. This ASU also eliminates the
residual method of allocation and will require that arrangement consideration be
allocated at the inception of the arrangement to all deliverables using the
relative selling price method, which allocates any discount in the overall
arrangement proportionally to each deliverable based on its relative selling
price. Expanded disclosures of qualitative and quantitative information
regarding application of the multiple-deliverable revenue arrangement guidance
are also required under the ASU. The ASU does not apply to arrangements for
which industry specific allocation and measurement guidance exists, such as
long-term construction contracts and software transactions. The ASU
is effective beginning January 1, 2011. The Company is currently evaluating
the impact of this standard on the Company’s consolidated results
of operations and financial condition.
In
October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That
Include Software Elements—a consensus of the FASB Emerging
Issues Task Force , that reduces the types of transactions that fall
within the current scope of software revenue recognition guidance. Existing
software revenue recognition guidance requires that its provisions be applied to
an entire arrangement when the sale of any products or services containing or
utilizing software when the software is considered more than incidental to
the product or service. As a result of the amendments included in ASU
No. 2009-14, many tangible products and services that rely on software will
be accounted for under the multiple-element arrangements revenue recognition
guidance rather than under the software revenue recognition guidance. Under the
ASU, the following components would be excluded from the scope of software
revenue recognition guidance: the tangible element of the product,
software products bundled with tangible products where the software components
and non-software components function together to deliver the product’s essential
functionality, and undelivered components that relate to software that is
essential to the tangible product’s functionality. The ASU also provides
guidance on how to allocate transaction consideration when an arrangement
contains both deliverables within the scope of software revenue guidance
(software deliverables) and deliverables not within the scope of that guidance
(non-software deliverables). The ASU is effective beginning January 1,
2011. The Company is currently evaluating the impact of this standard on the
Company’s consolidated results of operations and financial
condition.
33
Results
of Operations
Nine
Months Ended September 30, 2009 and 2008
Revenues
consist of sales of our set-top and digital networking products and revenues
recorded under network installation projects. Revenues from product
sales were $70,067,184 for the nine months ended September 30, 2009, an increase
of $29,079,855, or 71%, compared to $40,987,329 for the same period in
2008. The increase in revenues is primarily a result of the increase in
sales of our IPTV set-top boxes, as well as continued demand for our digital
networking products.
Cost of
goods sold, which include raw material, labor and amounts due to contract
manufacturers, was $58,773,620 for the nine months ended September 30, 2009, an
increase of $25,210,491, or 75%, compared to $33,563,129 for the same period in
2008. This increase in cost of sales was caused by an increase in
sales and was consistent with the increase in revenues. As a
percentage of revenues, cost of sales for the nine months ended September 30,
2009 and 2008 were 84% and 82%, respectively.
Gross
profit for nine months ended September 30, 2009 was $11,293,564, or 16% of
revenues, compared to $7,424,200, or 18% of revenues, for the comparable period
in 2008. Management considers gross profit to be a key performance
indicator in managing our business. Gross profit margins are a factor
of cost of sales, product mix and product demand.
Selling
expenses, which mainly include marketing, shipping, insurance, wage and other
expenses, were $35,334 for the nine months ended September 30, 2009, a decrease
of $71,901, or 67%, compared to $107,235 for the same period in
2008. The decrease was due to the changes in sales contract terms and
arrangement of delivery, which provided that finished goods are shipped directly
from the manufacturer to the customers.
Research
and development expenses were approximately $109,068 for the nine months ended
September 30, 2009 compared to nil for the same period in
2008. The increase was due to the Company’s increased research and
development efforts in connection with its GPS product
line. Furthermore, the Company no longer receives reimbursement for
its research and development expenses from the local government.
Other
general and administrative expenses, which include wages, benefits, utilities,
consulting, turnover taxes, professional fees and other expenses, were $725,054
for the nine months ended September 30, 2009, an increase of $110,991, or 18%,
compared to $614,063 for the same period in 2008. The increase was
due to the Company’s expanded operations and revenue base. On the
going forward basis, we expect our general and administrative expenses to
increase as a result of professional fees incurred as a result of being a
publicly reporting company in the United States.
Interest
expenses for interest-bearing debts for the nine months ended September 30, 2009
was $140,693, decrease of $120,461, or 46%, compared to $261,154 in
2008. The decrease is mainly the result of lower outstanding
debt.
For the
nine months ended September 30, 2009, we recorded a provision for income taxes
of $2,593,724, compared to $1,565,994 for the same period in
2008. The tax rate for the year ended December 31, 2009 was
25%. Our income tax rate for the year ended December 31, 2008 was
25%.
Years
Ended December 31, 2008 and 2007
Revenues
consist of sales of our set-top and digital networking products and revenues
recorded under network installation projects. Revenues from sales, service and
construction were $55.4 million for the year ended December 31, 2008, an
increase of $26.7 million, or 93%, compared to $28.7 million for the same period
in 2007. The increase in revenue was attributed mainly to the increased demand
for our set-top and digital networking products, which we believe is a result of
our market expansion efforts as well as price increases of some of our products.
We believe the increases in sales revenue and volume are a result of our
emphasis on brand promotion and utilizing our sales channels to continually
increase our market share. Regional TV broadcast stations are upgrading their
broadcast systems to the digital network, and as a result, every household is
required to upgrade their IPTV set-top boxes. In 2008, the regional government
provided incentives for TV broadcast stations to expand their broadcast coverage
to suburban areas, which will result in an increase of new subscribers of
digital networks for the next two years.
Furthermore,
demand for our set-top products increased during the year ended December 31,
2008 due to various governmental regulations and policies. The State
Administration of Radio & Television required the use of digital
broadcasting and television in every province and city and IPTV set-top boxes
transmits the analog signals to digital signals. In addition, digital network
broadcast providers began to upgrade their set-top boxes for their subscribers.
Consequently, the demand for our IPTV set-top boxes increased significantly. The
central government also launched several policies to boost domestic demand of
various consumer products, such as automobiles and electronics, especially in
the farming provinces, in order to cope with the financial crisis that occurred
during the year ended December 31, 2008. The central government set an allowance
rate of 13% of the product price in order to stimulate the purchase of such
products, which led to the increase in sales of IPTV set-top boxes as
well.
34
Cost of
goods sold, which include raw material, labor and amounts due to contract
manufacturers, was $45.6 million for the year ended December 31, 2008, an
increase of $22.4 million, or 97%, compared to $23.2 million for the same period
in 2007. This increase in cost of sales was caused by an increase in sales and
was consistent with the increase in revenues. As a percentage of revenues, cost
of sales for the year ended December 31, 2008 and 2007 were 82% and 81%,
respectively.
Gross
profit for year ended December 31, 2008 was $9.8 million, or 18% of revenues,
compared to $5.5 million, or 19% of revenues, for the comparable period in 2007.
Management considers gross profit to be a key performance indicator in managing
our business. Gross profit margins are a factor of cost of sales, product mix
and product demand.
Selling
expenses, which mainly include marketing, shipping, insurance, wage and other
expenses, were $146,459 for the year ended December 31, 2008, an increase of
$143,872, or 5,561%, compared to $2,587 for the same period in 2007. The
increase was primarily due to increased shipping costs. In order to expand the
business of the IPTV set-up boxes, the Company offered favorable shipping terms
to attract customers.
Other
general and administrative expenses, which include wage, benefit, utility,
consulting, turnover taxes, professional fees and other expenses, were
$1,005,975 for the year ended December 31, 2008, an increase of $290,910, or
41%, compared to $715,064 for the same period in 2007. The increase was
primarily a result of an increase in office expenses. We expect our general and
administrative expenses to increase as a result of professional fees incurred as
a result of being a publicly reporting company in the United
States.
For the
years ended December 31, 2008 and 2007, we invested approximately $10,419
and $88,864, respectively, in research and development. However, we
received a reimbursement from the local government for all of our research and
development expenses for the year ended December 31, 2008, and therefore
research and development expenses net of reimbursement was nil.
Interest
expenses for interest-bearing debts for the year ended December 31, 2008 was
$338,742, an increase of $142,419, or 73%, compared to $196,323 in 2007. The
increase is mainly the result of increased bank debt.
For the
year ended December 31, 2008, we recorded a provision for income taxes of $2.1
million, compared to $1.5 million for the same period in 2007. The tax rate for
the year ended December 31, 2007 was 33%. Our income tax rate for the year ended
December 31, 2008 was 25%.
Years
Ended December 31, 2007 and 2006
Revenues
were $28.7 million for the year ended December 31, 2007, an increase of $23
million, or 404%, compared to $5.7 million for the year ended December 31, 2006.
The increase in revenue was attributed mainly due to the increased demand for
our products, which we believe is a result of market expansion efforts and the
introduction of our IPTV set-top boxes into the market at the end of the year
ended December 31, 2007.
Cost of
goods sold was $23.2 million for the year ended December 31, 2007, an increase
of $18.7 million, or 416%, compared to $4.5 million for the year ended December
31, 2006. The increase was primarily a result of the increase in sales and was
consistent with the increase in the net revenue. As a percentage of the net
revenue, cost of sales for the years ended December 31, 2007 and 2006 were 81%
and 79%, respectively. The increase as a percentage of revenues was due to the
increased purchase price of our products.
Gross
profit for the year ended December 31, 2007 was $5.5 million, or 19% of
revenues, compared to $1.2 million, or 21% of revenues, for the year ended
December 31, 2006. The decrease in our gross profit margin for the year ended
December 31, 2007 as a percentage of revenues was primarily due to the increased
purchase price of our products and no corresponding increase in the sales price
of our products.
Selling
expenses were $2,587 for the year ended December 31, 2007, a drop of $16,794, or
87%, compared to $19,381 for the year ended December 31, 2006. The decrease in
selling expenses was attributable to a decrease in wages of sales
persons.
Other
general and administrative expenses were $715,064 for the year ended December
31, 2007, an increase of $484,728, or 210%, compared to $230,337 for the year
ended December 31, 2006. The increase is mainly due to increased personnel
salaries as the Company was hiring new employees for the expansion of new
products.
For the
years ended December 31, 2007 and 2006, we invested approximately $88,864 and
$48, respectively, in research and development. The increase was mainly due to
increased personnel costs dedicated toward the development of new and additional
products.
Interest
expenses for interest-bearing debts for the year ended December 31, 2007 was
$196,323, an increase of $184,707 or 1,590%, compared to $11,616 in 2006. The
increase is mainly the result of increased bank debt.
For the
year ended December 31, 2007, we recorded a provision for income taxes of
$1,515,478, compared to $314,577 for the same period in 2006. The tax rate for
the year ended December 31, 2007 was 33%. Our income tax rate for the year ended
December 21, 2006 was 33%.
35
Liquidity
and Capital Resources
We had
cash and cash equivalents of $1,394,458 as of September 30, 2009, as compared to
$1,134,954 as of December 31, 2008, $1,125,804 as of December 31, 2007 and
$1,183,665 as of December 31, 2006.
We had
working capital of approximately $21,362,069, $8,948,772 and $2,505,155 as at
September 30, 2009, December 31, 2008 and 2007, respectively. The increase of
working capital was largely caused by the increase in accounts
receivable.
Also in
connection with the Share Exchange, we paid $350,000 to WestPark and $125,000 to
a third party unaffiliated with the Company, SRKP 18 or WestPark.
Our trade
receivables has been an increasingly significant portion of our current assets,
representing $25,634,262, $12,322,099 and $9,419,029, or 80%, 71% and 56% of
current assets, as of September 30, 2009 and as of December 31, 2008 and 2007,
respectively. As our sales volume increases, trade receivables
increase accordingly. If customers responsible for a significant amount of
accounts receivable were to become insolvent or otherwise unable to pay for our
products, or to make payments in a timely manner, our liquidity and results of
operations could be materially adversely affected. An economic or
industry downturn could materially adversely affect the servicing of these
accounts receivable, which could result in longer payment cycles, increased
collections costs and defaults in excess of management’s
expectations. A significant deterioration in our ability to collect
on accounts receivable could affect our cash flow and working capital position
and could also impact the cost or availability of financing available to
us.
We
provide our major customers with payment terms ranging from 30 to 90
days. We typically offer certain of our customers 30 to 90 days
credit terms for payment. Allowance for doubtful accounts is based on our
assessment of the collectability of specific customer accounts, the aging of
accounts receivable, our history of bad debts, and the general condition of the
industry. If a major customer’s credit worthiness deteriorates, or
our customers’ actual defaults exceed historical experience, our estimates could
change and impact our reported results. We have not experienced any
significant amount of bad debt since the inception of our
operation.
As of
September 30, 2009, inventories amounted to $1,494,599, compared to $775,185 as
of December 31, 2008. The increase is due to the increase of sales,
the increase of inventory turnover, and the increase in the Company’s inventory
of GPS products. As of December 31, 2008, inventories amounted to
$775,185, compared to $5,488,794 as of December 31, 2007 and $2,622,909 as of
December 31, 2006.. The decrease is due to the fact that we no longer
manufacture our products and instead outsource the manufacturing of our
products.
As of
September 30, 2009, accounts payable and accrued liabilities amounted to
$8,371,440, compared to $1,771,272 as of December 31, 2008. The
increase in accounts payable and accrued liabilities is due to inventory
purchases unpaid prior to the end of the period. As of December 31,
2008, accounts payable and accrued liabilities amounted to $1,771,272, compared
to $3,249,012 as of December 31, 2007 and $5,500,238 as of December 31,
2006. The decrease is due to a shortened payment duration.
As of
September 30, 2009, various taxes payable amounted to $331,749, compared to
$188,539 as of December 31, 2008. As of December 31, 2008, various
taxes payable amounted to $188,539, compared to $490,977 as of December 31, 2007
and $21,220 as of December 31, 2006. The increase in various taxes
payable is due to the rise of sales. The decrease in various taxes
payable from 2007 to 2008 is due to the decrease of our corporate income tax
rate from 33% to 25%.
As of
September 30, 2009, wages payable amounted to $63,750, compared to $59,501 as of
December 31, 2008. As of December 31, 2008, wages payable amounted to
$59,501, compared to $23,890 as of December 31, 2007 and $7,775 as of December
31, 2006. The increase in wages payable is due to increased personnel
costs.
As of
September 30, 2009, corporate taxes payable amounted to $434,388, compared to
nil at December 31, 2008. As of December 31, 2008, corporate taxes
payable amounted to nil, compared to nil as of December 31, 2007 and nil as of
December 31, 2006. The increase in corporate taxes payable is due to
an increase of unpaid corporate taxes.
As of May
5, 2009, we received gross proceeds of approximately $4.98 million, and net
proceeds of approximately $3.86 million, in a private placement transaction (the
“Private Placement”). Pursuant to subscription agreements entered into with the
investors, we sold an aggregate of 1,263,723 shares of Series A Convertible
Preferred Stock at $3.94 per share. In connection with the initial closing of
the Private Placement, the Company issued a promissory note in the principal
amount of $170,000, bearing no interest (the “Note”), to WestPark Capital
Financial Services, LLC, the parent company of WestPark. The principal was due
and payable by the Company on or before the earlier of (a) thirty (30) days from
the date of issuance of the Note or (b) upon the receipt by the Company of at
least $4 million in the Private Placement. The Company repaid the Note in full
on January 23, 2009 using the proceeds from the second closing of the Private
Placement.
For its
services as placement agent, WestPark was paid a commission of 12% of the gross
proceeds from the Private Placement plus a 4% non-accountable expense allowance.
No other consideration was paid to WestPark or to SRKP 18 in connection with the
Share Exchange or Private Placement.
36
We agreed
to file a registration statement covering the common stock underlying the Series
A Convertible Preferred Stock sold in the Private Placement and to pay for all
costs related to the registration of the shares. The registration statement
covering such shares was declared effective by the Securities and Exchange
Commission in October 2009. We have used the proceeds from the Private
Placement to provide working capital for research and development, to perform
upgrades to the technology used in our existing products, and to improve our
marketing strategies and efforts to capture new customers and expand our market
size. In addition, we are currently developing technologies for GPS devices as a
new product line for the Company, which will be marketed in the year
2010.
In
October 2009, we completed a public offering consisting of 3,125,000 shares of
our common stock. Rodman & Renshaw, LLC and WestPark Capital, Inc.
(together, the “Underwriters”) acted as co-underwriters in the public offering.
Our shares of common stock were sold to the public at a price of $8.00 per
share, for gross proceeds of appoximately $25 million. Compensation for the
Underwriters’ services included discounts and commissions of $1,875,000, a
$250,000 non-accountable expense allowance, roadshow expenses of approximately
$10,000, and legal counsel fees (excluding blue sky fees) of $40,000. The
Underwriters also received warrants to purchase an aggregate of 156,250 shares
of our common stock at an exercise price of $10.00 per share. The warrants,
which have a term of five years, are not exercisable until at least one year
from the date of issuance. The warrants also carry registration
rights.
We are
required to contribute a portion of our employees’ total salaries to the Chinese
government’s social insurance funds, including pension insurance, medical
insurance, unemployment insurance, and job injuries insurance, and maternity
insurance, in accordance with relevant regulations. Total contributions to the
funds are $14,767 for the nine months ended September 30, 2009 and 6,487,
$130,549 and $396 for the years ended December 31, 2008, 2007 and 2006,
respectively. We expect that the amount of our contribution to the
government’s social insurance funds will increase in the future as we expand our
workforce and operations and commence contributions to an employee housing
fund.
The
ability of Zhengzhou ZST to pay dividends may be restricted due to the foreign
exchange control policies and availability of cash balance. A majority of our
revenue being earned and currency received are denominated in RMB, which is
subject to the exchange control regulation in China, and, as a result, we may be
unable to distribute any dividends outside of China due to PRC exchange control
regulations that restrict our ability to convert RMB into US Dollars.
Accordingly, Zhengzhou ZST’s funds may not be readily available to us to satisfy
obligations which have been incurred outside the PRC, which could adversely
affect our business and prospects or our ability to meet our cash
obligations.
Net cash
used in operating activities was $125,921 for the nine months ended September
30, 2009, compared to net cash provided by operating activities of $5,383,579
for the nine months ended September 30, 2008. The change was due to a
decrease in inventory and an increase in accounts receivable. Net cash
provided by operating activities was $3.3 million for the year ended December
31, 2008, compared to net cash used in operating activities of $7.6 million for
the year ended December 31, 2007. The increase was primarily due to an increase
of account payables and a decrease in inventory.
Net cash
used in investing activities amounted to approximately $969,692 for the nine
months ended September 30, 2009, compared to net cash provided by investing
activities of nil for the nine months ended September 30, 2008. The
change was due to the purchase of property and equipment and intangible
assets. Net cash provided by investing activities amounted to nil for
the year ended December 31, 2008, compared to net cash used by investing
activities of $1,035,188 for the year ended December 31, 2007. The change was
due to a new acquisition in 2007.
Net cash
provided by financing activities amounted to $1,057,235 for the nine months
ended September 30, 2009, compared to net cash used in financing activities of
$5,821,285 for the nine months ended September 30, 2008. The change
was a result of sales of Series A Convertible Preferred Stock in the Private
Placement in 2009. Net cash used by financing activities amounted to
$3.5 million for the year ended December 31, 2008, compared to net cash provided
by financing activities of $6.2 million for the year ended December 31, 2007.
The decrease was primarily a result of a decrease in bank loans and dividends
paid in 2008.
Historically,
we have financed our operations through the issuance and sale of equity
securities, specifically through proceeds from private placements of our
securities, and payments from our customers. Based upon our present
plans, we believe that cash on hand, cash flow from operations, funds available
to use through low-cost domestic financing as well as cash through our recent
public offering financing, we will be sufficient to fund our capital needs for
the next 12 months. Our ability to maintain sufficient liquidity
depends partially on our ability to achieve anticipated levels of revenue, while
continuing to control costs. If we did not have sufficient available
cash, we would have to seek additional debt or equity financing through other
external sources, which may not be available on acceptable terms, or at
all. Failure to maintain financing arrangements on acceptable terms
would have a material adverse effect on our business, results of operations and
financial condition.
Our
ability to maintain sufficient liquidity depends partially on our ability to
achieve anticipated levels of revenue, while continuing to control
costs. If we did not have sufficient available cash, we would have to
seek additional debt or equity financing through other external sources, which
may not be available on acceptable terms, or at all. Failure to
maintain financing arrangements on acceptable terms would have a material
adverse effect on our business, results of operations and financial
condition.
We are
currently developing a new product, a GPS device, which will be available for
sale in the market by the year 2010. We are also expanding our customer base to
obtain new customers in return for sales revenue growth. We believe that our
efforts to develop new products and expand our customer base will increase our
future cash flows. We also plan to obtain additional cash from financings and/or
loans from banks to fund our business operations and to provide additional
working capital. However, there is no assurance that such financing will be
obtained. We expect to continue to raise capital in the future, but cannot
guarantee that such financing activities will be sufficient to fund our current
and future projects and our ability to meet our cash and working capital
needs.
37
Off-Balance
Sheet Arrangements
None.
Change
in Accountants
On April
20, 2009, we dismissed AJ. Robbins, PC (“AJ Robbins”) as its independent
registered public accounting firm following the change in control of the Company
upon the consummation of the Share Exchange. We engaged AJ Robbins to audit our
financial statements for the year ended December 31, 2008. The decision to
change accountants was approved and ratified by our Board of Directors. The
report of AJ Robbins on our financial statements for the fiscal year ended
December 31, 2008 did not contain any adverse opinion or disclaimer of opinion
and was not qualified or modified as to uncertainty, audit scope, or accounting
principle, except for an explanatory paragraph relative to our ability to
continue as a going concern. Additionally, during our two most recent fiscal
years and any subsequent interim period, there were no disagreements with AJ
Robbins on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure.
While AJ
Robbins was engaged by us, there were no disagreements with AJ Robbins on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure with respect to us, which disagreements if not
resolved to the satisfaction of AJ Robbins would have caused it to make
reference to the subject matter of the disagreements in connection with its
report on our financial statements for the fiscal year ended December 31,
2008.
We
engaged Kempisty & Company Certified Public Accountants, P.C. (“Kempisty”)
as our independent registered public accounting firm as of April 20, 2009.
Kempisty served as the independent registered certified public accountants for
World Orient Universal Limited, our wholly-owned subsidiary, for the fiscal year
ended December 31, 2008. During our fiscal years ended December 31, 2008 and
2007 and through April 20, 2009, neither our Company, nor anyone acting on our
behalf, consulted with Kempisty regarding the application of accounting
principles to a specific completed or proposed transaction or the type of audit
opinion that might be rendered on our financial statements, and no written
report or oral advice was provided that Kempisty concluded was an important
factor considered by us in reaching a decision as to any such accounting,
auditing or financial reporting issue.
38
DESCRIPTION
OF BUSINESS
Overview
As used
in this prospectus, unless otherwise indicated, the terms “we,” “our,” “us,”
“Company” and “ZST” refer to ZST Digital Networks, Inc., a Delaware corporation,
formerly known as SRKP 18, Inc. (“SRKP 18”).
We were
incorporated in the State of Delaware on December 7, 2006. We were originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation.
On
December 11, 2008, we entered into a share exchange agreement, as amended on
January 9, 2009 (the “Exchange Agreement”), with World Orient and its
stockholders, pursuant to which the stockholders would transfer all of the
issued and outstanding shares of World Orient to the Company in exchange for
806,408 shares of our common stock (the “Share Exchange”). On January 9, 2009,
we closed the Share Exchange pursuant to which we became the 100% parent of
World Orient and assumed the operations of World Orient and its subsidiaries,
including Zhengzhou ZST. We also changed our name from SRKP 18, Inc. to ZST
Digital Networks, Inc.
We
conduct our business through our subsidiaries, which include our wholly-owned
subsidiary, World Orient, World Orient’s wholly-owned subsidiary, Global Asia,
Global Asia’s wholly-owned subsidiary, Everfair, and Everfair’s wholly-owned
subsidiary, Zhengzhou ZST. Zhengzhou ZST and Everfair were founded in 1996 and
2007, respectively, and are based in Zhengzhou, China and Hong Kong,
respectively. Global Asia and World Orient were founded in August 2008 in the
British Virgin Islands. Control among the various entities is due to stock
ownership.
The
corporate structure of the Company is illustrated as follows:
“China”
or “PRC” refers to the People’s Republic of China. “RMB” or “Renminbi” refers to
the legal currency of China and “$” or “U.S. Dollars” refers to the legal
currency of the United States.
39
Our
Company
We are
principally engaged in supplying digital and optical network equipment to cable
system operators in the Henan Province of China. The Company has developed a
line of internet protocol television (“IPTV”) set-top boxes that are used to
provide bundled cable television, Internet and telephone services to residential
and commercial customers. The Company has assisted in the installation and
construction of over 400 local cable networks covering more than 90 municipal
districts, counties, townships, and enterprises. The Company’s services and
products have been recognized with various certifications, including “integrated
computer information system qualification class III” issued by the Ministry of
Industry Information, “communication user cable construction enterprise
qualification” issued by the Henan Province Administration of Communication,
“Henan Province Security Technology Prevention Engineering Qualification Class
III”, a certificate of “ISO9001:2000 Quality System Authentication”, and “Double
High” certification, high-tech product and high-tech enterprise issued by the
Henan Province government.
At
present, our main clients are broadcasting TV bureaus and cable network
operators serving various cities and counties. We have over 30 main customers,
including the broadcasting TV bureaus and cable network operators of the cities
of Nanyang, Mengzhou, Xuchang, Pingdingshan, Kaifeng, Zhoukou and Gongyi, and
the counties of Yuanyang, Luoning, Neihuang, Yinyang, Xixia, Kaifeng, Nanzhao,
and Gushi.
A map
highlighting our range of service within China is below (the yellow shaded areas
indicate our potential market and target customers and the red and green shaded
areas indicate our current market):
A map
highlighting our range of service within the Henan Province is
below:
In the
near future, we plan to joint venture with cable network operators to provide
bundled television programming, Internet and telephone services to residential
customers in cities and counties located in the Henan Province of
China.
Industry
Over the
past ten years, technological advancements in the electronics industry have
greatly expanded the capabilities of cable TV devices and cable systems. Cable
network devices include amplifiers, optical receivers, IPTV set-top boxes and
other related products. The popularity of these devices benefits from reductions
in cost, size and weight, and improvements in functionality and
reliability.
China’s
consumer market for cable TV devices and electronics has been growing; due in
part to the country’s rapid growing electronic industry. Economic growth in
China has led to greater levels of personal disposable income and increased
spending among China’s expanding middle-class consumer base. Notwithstanding
China’s economic growth, China’s economic output and consumption rates are still
relatively low on a per capita basis compared to developed countries. As China’s
economy develops, we believe that disposable income and consumer spending levels
will continue to become closer to that of developed countries like the United
States.
China’s
market share of cable TV devices and electronics is expected to increase,
especially with the analog to digital conversion taking place over the next
several years. According to the Report of the State Administrative of Movie and
Television, as of 2008, there were over 350 million families who own television
sets and over 160 million families who subscribed to cable TV service in China
with 1,050 million and 480 million viewers respectively. This subscriber market
is growing at approximately 10% to 15% CAGR. Owing to the extensive use of cable
TV and the explosive growth of internet and broadband applications in China, the
market for delivery of Internet service through cable modem or set-top box
appears extremely promising in China in the near future.
40
Henan
Province has a total population of 130 million, or 25 million households,
residing in 118 counties, with over 2,500 villages and more than 10,000
administrative villages. Of the 30 counties in the Henan Province serviced by
the Company, according to the Report of the State Administrative of Movie and
Television, there were approximately 2.7 million cable TV subscribers (i.e.
households) in 2008, which accounted for 10.8% of the population in the Henan
Province, and this market is expected to have a 10%-20% annual increase of
subscribers in the near future. There are approximately 22.3 million households
which are already wired for cable in the province and which are potential cable
television subscribers. The Henan Department of Movies and Television
Broadcasting (“HDMTB”) has approved the extension of cable networks to counties
and villages, with the purpose of bringing digital TV broadcasting and broadband
services to the residents of Henan Province.
China has
a number of benefits in the manufacture of electronic devices, which are
expected to drive this growth:
|
●
|
Low
Costs. China
continues to have a significant low cost of labor as well as easy access
to raw materials and land.
|
|
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|
Proximity to
Electronics Supply Chain. Electronics manufacturing in
general continues to shift to China, giving China-based manufacturers a
further cost and cycle time
advantage.
|
|
●
|
Proximity to
End-Markets. China
has focused in recent years on building its research, development and
engineering skill base in all aspects of higher end manufacturing,
including electronic
devices.
|
Competitive
Strengths
Experienced
Management Team
Our
senior management team has extensive business and industry experience, including
an understanding of changing market trends, consumer needs and technologies,
which gives us the ability to capitalize on the opportunities resulting from
these market changes. Our Chief Executive Officer, Zhong Bo, has over 15 years
of experience in the design and installation of cable television systems, which
we believe has been a key factor in our ability to establish long-lasting and
valuable business relationships in the cable television industry. Other members
of our senior management team also have significant experience with respect to
key aspects of our operations, including research and development, product
design, and sales and marketing.
Design
Capabilities and Manufacturing Oversight
We employ
a rigorous and systematic approach to product design and manufacturing
oversight. We employ a senior design team with members educated by top colleges
in China, with an average of 8 to 10 years of experience. Our design team
develops and tracks new concepts and ideas from a variety of sources, including
direct customer feedback, trade shows, domestic research institutions and our
key core suppliers. We can rapidly modify our design function to accommodate new
customer requests, designs and specifications. We subcontract all manufacturing
on a turnkey basis, with our suppliers delivering fully assembled and tested
products based on our proprietary designs. Our contract manufacturers are
located in Hang Zhou, Shen Zhen and Zheng Zhou, China. We also achieve quality
control over products manufactured under our contract manufacturing arrangements
by sending our technicians on site to supervise the production and testing of
our products. The use of this model allows us to focus substantially all of our
resources on determining customer requirements and on the design, development
and support of our products.
Well-Established
Distribution Channels
We sell
our products through a well-established network of distributors and resellers
which allows us to access the customer markets of the Henan Province as well as
other markets in China. We have distributors throughout Henan, and in other key
provinces in China. We attended various trade fairs for electronic products,
including China Hi-tech Fair (Shenzhen), Canton Fair, Hong Kong Electronics Fair
and International CES Las Vegas to promote our products.
41
Our
Strategy
Our goal
is to be a domestic leader in the development and manufacturer of cable
television systems devices and related electronic products through the following
strategies:
Enhance Brand Awareness. We
believe that continuing to strengthen our brand will be critical to increasing
demand for, and achieving widespread acceptance of, our cable TV network devices
and electronics. We believe a strong brand offers a competitive advantage and so
we intend to devote additional resources to strategic marketing promotion in an
effort to increase brand awareness and product recognition and heighten consumer
loyalty. We aim to develop the brand “ZST” into a both domestically and
internationally recognizable one.
Expand Sales Network and
Distribution Channels. We continue to seek additional penetration into
existing markets as well as commencing sales in additional domestic markets. We
intend to expand our sales and customer service networks of agents and dealers
in China and into new markets. We also intend to develop relationships with a
broader set of wholesalers, distributors and resellers, all in order to expand
the market availability of our products. We expect that these relationships will
allow us to diversify our customer base and increase the availability and
exposure of our products.
Offer Comprehensive Network
Infrastructure Solutions. Our expertise in the design and installation of
cable television systems has afforded us the ability to offer customized
telecommunications systems for a variety of customers. For example, we offer a
customer the ability to deliver a fully integrated video programming solution,
customized set-top boxes and network design and management. We intend to devote
additional resources towards expanding this segment of our
business.
Pursue Strategic Partnerships, Joint
Ventures and Acquisitions. We intend to selectively pursue partnerships,
joint ventures and strategic acquisition opportunities that we believe may allow
us to increase our existing market share, expand into new markets, broaden our
portfolio of products and intellectual property, and strengthen our
relationships with our customers. For example, we plan to joint venture with
cable network operators and target selected acquisitions that will allow us the
ability to provide bundled television programming, internet and telephone
services to residential customers in cities and counties located in the Henan
Province.
We are
currently in the process of establishing a partnership with China Unicom, a
wireless network provider, in connection with the Company’s development and sale
of its GPS tracking units. In March 2009, the Company entered into
a network access right agreement with the Henan Subsidiary of China
Unicom that allows the Company to use the China Unicom wireless network for
providing GPS location and tracking services to third parties.
Upon completion of this offering, the Company intends to negotiate a
reseller agreement with the Henan Subsidiary of China Unicom whereby GPS
tracking units supplied by the Company would be sold in the Henan Subsidiary of
China Unicom retail stores, with the Company receiving a share of subscriber
revenue collected by the Henan Subsidiary of China Unicom.
Act on the Set-top Box Replacement
Cycle. The broader adoption of high definition televisions by consumers
will require more advanced compression (e.g., MPEG-4) and security technologies
within set-top boxes. This may launch a replacement cycle, particularly among
direct-to-home and cable providers with substantial bases of legacy equipment,
which may create additional market opportunities for us.
Products
We
currently offer a range of branded cable television devices and related
networking products including set-top boxes, optical receivers, optical
transmitters and cable transmission amplifiers.
Set-top
Boxes and Related Products
Our line
of internet protocol television (“IPTV”) set-top boxes integrate Internet,
multi-media, and communication technologies, provides residential customers with
high definition digital multi-media service, and provides extensive freedom to
choose video programs offered by the network video providers on broadband IP
network. These devices allow consumers who subscribe to television service from
multi-channel video distributors to access encrypted digital video and audio
content and make use of a variety of interactive applications. These
applications include an on-screen interactive program guide, pay-per-view
offerings, games and shopping and parental control.
In
addition to the functionality of a basic digital set-top box, these devices
enable subscribers to pause, stop, reverse, fast forward, record and replay live
or recorded digital television content using a built-in hard drive capable of
storing up to 200 hours of content. They also include the ability to support
video-on-demand services. Our devices also enable subscribers to access the
enhanced picture quality and sound of high-definition content, in addition to
the functionality of a standard-definition digital set-top box. In addition, our
line of IPTV devices can also deliver customized multi-media service functions
according to user configurations, and delivers performance and additional value
to customers through network and applications software upgrades.
In
addition to set-top boxes we also design and develop related products such as
power supplies, remote controls and other devices and
accessories.
42
Digital
Network Equipment
We offer
a line of fiber-optic receivers and transmitters, cable transmission amplifiers
and other network products which provide the flexibility, speed and clarity
necessary in communications systems. Our optical receivers, amplifiers and power
supply products have been recognized by the Ministry of Broadcasting and TV and
the Henan Municipality Bureau of Broadcasting and TV. We have implemented
stringent quality control systems covering each phase of production, from the
purchase of raw materials through oversight of each step in the manufacturing
process. Quality and reliability is monitored in accordance with the
requirements of ISO 9001 systems. We have also passed stringent quality reviews
and our products meet digital electronic product standards in China, the United
States and Europe.
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●
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Optical
Receivers. Our
optical receivers convert a fiber-optic transmission into digital RF
signals that are amplified and distributed through a 750 – 1000MHz optical
cable system.
|
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Optical
Transmitters. We
have developed a range of optical transmitters, including the 1310nm and
1550nm series products, used in the transmission of cable system front
optical fiber signal.
|
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|
Cable
Transmission Amplifiers. Our main bus amplifier and end
user amplifier products are used to improve the signal quality in cable
networks.
|
Net
revenues for each of our revenue segments as a percentage of net revenues is set
forth below:
|
Nine Months
Ended September 30,
|
Year Ended December 31,
|
||||||||||||||
2009
|
2008
|
2007
|
2006
|
|||||||||||||
Products
|
|
|||||||||||||||
IPTVs
(1)
|
58 | % | 56 | % | 40 | % | — | |||||||||
Optical
devices (2)
|
18 | % | 22 | % | 26 | % | 28 | % | ||||||||
Cable
devices (3)
|
3 | % | 3 | % | 6 | % | 3 | % | ||||||||
Others
(4)
|
21 | % | 15 | % | 28 | % | 67 | % | ||||||||
Subtotal
|
100 | % | 96 | % | 100 | % | 98 | % | ||||||||
Technical
Support
|
— | 2 | % | — | — | |||||||||||
Construction
|
— | 2 | % | — | — | |||||||||||
Total
|
100 | % | 100 | % | 100 | % | 100 | % |
(1)
Includes IPTV set-top boxes.
(2)
Includes optical transmitters, optical workstations, optical receivers and
optical power meters.
(3)
Includes power supply cables, optical cables and pigtails
(4)
Includes security and monitoring devices, which include coding and decoding
devices, digital cameras and matrix exchanges, and network products, which
include welding machines, optical digital audio machines and audio and video
distributors.
Monitoring
and Cable Services
We offer
security and monitoring services which involves the installation of monitoring
systems in buildings, including the design and implementation of various
devices, such as coding and decoding devices, digital cameras and matrix
exchanges. We also offer cable services and provides networking thoughout
buildings with proper devices and components, such as welding machines, optical
digital audio machines, and audio and video distributors.
We offer
our monitoring and cable services to its customers in order to satisfy its
customers needs in connection with its main products - its cable TV and IPTV
equipment. Both services contributed to approximately 8% and 28%, respectively
of our total revenue in the nine months ended September 30,
2009.
43
GPS
Services
In March
2009, the Company entered into a network access right agreement with
the Henan Subsidiary of China Unicom that allows the Company to use the
China Unicom wireless network for providing GPS location and tracking services
to third parties. The Company has developed personal and vehicle tracking
systems, and has staffed a 24/7 call center to handle subscriber queries and
emergency calls. Currently, the system has approximately 400 test users
and receives about 20 subscriber calls per day.
In the
near future, the Company intends to negotiate a reseller agreement with the
Henan Subsidiary of China Unicom whereby GPS tracking units supplied by the
Company would be sold in the Henan Subsidiary of China Unicom retail stores,
with the Company receiving a share of subscriber revenue collected by the Henan
Subsidiary of China Unicom.
Manufacturing
and Suppliers
Manufacturing
Our
manufacturing operations consist of the procurement and inspection of raw
materials and components, final system quality control testing and packaging. We
subcontract all manufacturing on a turnkey basis, with our suppliers delivering
fully assembled and tested products based on our proprietary designs. The use of
this model allows us to focus substantially all of our resources on determining
customer requirements and on the design, development and support of our
products. This model also allows us to have significantly reduced capital
requirements. The assembled products are then delivered to our facilities for
final system quality control testing against product specifications and product
configuration, including software installation.
We
subcontract our manufacturing to a number of manufacturers. Our manufacturers
were selected based on the breadth of available technology, quality,
manufacturing capacity and support for design tools that we use. None of our
products are currently manufactured by more than one supplier. However, in the
event one of our suppliers notifies us that it intends to cease manufacturing a
product, we expect that we will have an adequate opportunity to order sufficient
quantities of the affected products so that shipments to customers will not be
adversely affected while we qualify a new manufacturer.
For the
foreseeable future, we intend to continue to rely on our contract manufacturers
for substantially all of our manufacturing and assembly and the substantial
portion of our test requirements. All of our contract manufacturers produce
products for other companies. We do not have long-term manufacturing agreements
with any of our contract manufacturers. Our contract manufacturers are not
obligated to supply products to us for any specific period, in any specific
quantity or at any specific price, except as may be provided in a particular
purchase order that has been accepted by one of our contract
manufacturers.
We
generally place orders approximately 3 to 4 weeks in advance of expected
delivery. We work closely with our contract manufacturers to manage costs and
delivery times, and we have never experienced material delays in the delivery of
our products from our contract manufacturers. However, we have only a limited
ability to react to fluctuations in demand for our products, which could cause
us to have an excess or a shortage of inventory of a particular
product.
Suppliers
We have
established long-term partnership relationships with our main raw material
suppliers. The raw materials used in our product include LCDs, ICs, flash
memories, WiFi modules, GPS modules, capacitors, resistors, switches, connectors
and batteries. We purchase such materials to satisfy our customers’
requirements. For special products and large orders, we typically quote our
prices and delivery of goods ahead of time after receiving the
orders.
Currently,
our primary suppliers of raw materials are located in South Korea, Taiwan,
United States, and China. Three suppliers, Hangzhou Jingbao Electronic Ltd.,
Farway Electronics Factory and Henan Hui-ke Electronics Co., Ltd., are our
largest suppliers of components for our products, each of which accounted for
more than 10% of our purchases of components for our products for fiscal year
ended December 31, 2008 and 2007. In addition, Henan Hui-ke Electronics Co.,
Ltd., Shenzhen Jiuzhou Technology Co., Ltd. and Hangzhou Jingbao Co., Ltd. each
accounted for more than 10% of our purchases of components for our products for
the nine months ended September 30, 2009. We believe that the raw
materials and components used in manufacturing our products are available from
enough sources to be able to satisfy our needs. Presently, our relationships
with our current suppliers are generally good and we expect that our suppliers
will be able to meet the anticipated demand for our products in the
future.
At times,
the pricing and availability of raw materials can be volatile, attributable to
numerous factors beyond our control, including general economic conditions,
currency exchange rates, industry cycles, production levels or a supplier’s
tight supply. To the extent that we experience cost increases we may seek to
pass such cost increases on to our customers, but cannot provide any assurance
that we will be able to do so successfully or that our business, results of
operations and financial condition would not be adversely affected by increased
volatility of the cost and availability of raw materials.
44
Quality
Control
We
consider quality control an important element of our business practices. We have
stringent quality control systems that are implemented by various
Company-trained staff members to ensure quality control over the production
process, from the purchase of raw materials through oversight of each stage of
the manufacturing process. Our quality control department executes the following
functions:
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testing samples of raw materials
from suppliers;
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implementing sampling systems and
sample files;
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setting internal controls and
regulations for the testing of finished products;
and
|
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articulating the responsibilities
of quality control staff.
|
We also
achieve quality control over products manufactured under our contract
manufacturing arrangements by sending our technicians on site to supervise the
production and testing of our products.
Sales
and Marketing
We have a
broad sales network throughout China. Our sales network spans throughout the
Henan Province and in several major provincial-level and municipal cities in
China. Our distribution network includes exclusive provincial and regional
distributors, resellers and brand-name counters.
We are
highly dependent upon sales of our products to certain of our customers. During
our fiscal year ended December 31, 2008, two customers, Neihuang Radio &
Television Bureau and Kaifeng Radio & Television Bureau, each accounted for
approximately 10% of our net revenues. During the fiscal year ended December 31,
2007, three customers, Nanyang Radio & Television Bureau, Mengzhou Radio
& Television Bureau and Xuchang Radio & Television Bureau, accounted for
approximately 16%, 14% and 13%, respectively, of our net revenues. During the
fiscal year ended December 31, 2006, five customers, Kaifeng Radio &
Television Bureau, Xinye Radio & Television Bureau, Xuchang Radio &
Television Bureau, Huaxian Radio & Television Bureau and Nanyang Radio &
Television Bureau, accounted for approximately 24%, 24%, 19%, 13% and 10%,
respectively, of our net revenues. No other customer accounted for greater than
5% of our net revenues during these periods. All purchases of our products by
customers are made through purchase orders and we do not have long-term
contracts with any of our customers. The loss of any customers to which we sell
a significant amount of our products, or from which we receive significant
portion of orders, or any material adverse change in the financial condition of
such customers could negatively affect our revenues and decrease our
earnings.
The focus
of our marketing plan is print advertising and participation in tradeshows and
exhibitions. With a targeted approach, our print advertisements appear regularly
in popular consumer and industry publications and trade journals. To better
showcase our diverse products to potential customers, we regularly exhibit at
leading trade shows and exhibitions. Our dynamic, state-of-the-art trade show
exhibits are developed internally to showcase our latest product
offerings.
Research
and Development
Companies
in our industry are under pressure to develop new designs and product
innovations to support changing consumer tastes and regulatory requirements. To
date, we have engaged in modest research and development activities and much of
our expenditures on research and debvelopment have been reimbursed by the local
government. We believe that the engineering and technical expertise of our
management and key personnel has allowed us to efficiently and timely identify
and bring new products to market for our customers. However, we believe
that substantial addtitional research and development activities are important
to allowing us to offer technologically-advanced products to serve a broader
array of customers. We expect that our research and development budget will
substantially increase as the scope of our operations expands and as we have
access to additional working capital to fund these activities.
We focus
our product design efforts on both improving our existing products and
developing new products. In an effort to enhance our product quality, reduce
costs and keep up with emerging product trends, we work with our key customers
to identify emerging product trends and implement new solutions intended to meet
the current and future needs of the markets we serve.
For the
years ended December 31, 2008, 2007 and 2006, we have invested approximately
$10,419, $88,864 and $48, respectively, in research and
development. However, the Company received a reimbursement from the
local government for all of its research and development expenses for the year
ended December 31, 2008, and therefore research and development expenses net of
reimbursement was nil. For the nine months ended September 30, 2009, we have
invested $109,068 in research and development and we expect that our research
and development budget will substantially increase in the balance of 2009 and
thereafter.
45
Acquisitions
To
supplement our internal growth, we intend to pursue a targeted acquisition
strategy that will seek acquisition candidates that fulfill one or more of the
following objectives:
|
●
|
increase our penetration of
existing markets;
|
|
●
|
expand into new
markets;
|
|
●
|
increase our service
offerings;
|
|
●
|
add customers and cash flow to
our existing network services business;
and
|
|
●
|
enhance our ability to sell and
delivery value-added
services.
|
We
initially intend to focus our acquisition efforts on cable system providers and
enhanced service providers and on interconnect companies in the Henan Province
that sell, install and maintain data and voice networks for customers. Our
initial goal is to be a vertically integrated service provider, providing
bundled television programming, internet and telephone services to residential
customers in cities and counties located in the Henan Province.
Competition
The
market for set-top boxes and digital networking products is highly competitive,
especially with respect to pricing and the introduction of new products and
features. Our products compete primarily on the basis of:
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●
|
reliability;
|
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●
|
brand
recognition;
|
|
●
|
quality;
|
|
●
|
price;
|
|
●
|
design;
and
|
|
●
|
quality service and support to
retailers and our customers.
|
Currently,
there are many significant competitors in the set-top box business including
several established companies who have sold set-top boxes to major cable
operators for many years. These competitors include companies such as Motorola,
Cisco Systems, and Pace. In addition, a number of rapidly growing companies have
recently entered the market, many of them with set-top box offerings similar to
our existing set-top box products. We also expect additional competition in the
future from new and existing companies who do not currently compete in the
market for set-top boxes. As the set-top box business evolves, our current and
potential competitors may establish cooperative relationships among themselves
or with third parties, including software and hardware companies that could
acquire significant market share, which could adversely affect our business. We
also face competition from set-top boxes that have been internally developed by
digital video providers.
In recent
years, we and many of our competitors, have regularly lowered prices, and we
expect these pricing pressures to continue. If these pricing pressures are not
mitigated by increases in volume, cost reductions from our supplier or changes
in product mix, our revenues and profits could be substantially reduced. As
compared to us, many of our competitors have:
|
●
|
significantly longer operating
histories;
|
|
●
|
significantly greater managerial,
financial, marketing, technical and other competitive resources;
and
|
|
●
|
greater brand
recognition.
|
As a
result, our competitors may be able to:
|
●
|
adapt more quickly to new or
emerging technologies and changes in customer
requirements;
|
|
●
|
devote greater resources to the
promotion and sale of their products and services;
and
|
46
|
●
|
respond more effectively to
pricing pressures.
|
Intellectual
Property
We rely
on a combination of patent and trade secret protection and other unpatented
proprietary information to protect our intellectual property rights and to
maintain and enhance our competitiveness in the portable electronic product
industry. Our Chief Executive Officer, Mr. Zhong Bo, has legal ownership of one
patent in China. This patent is applied in the operations of our Company and Mr.
Zhong has granted the Company a license to use such patent.
Some of
our products are also designed to include software or other intellectual
property licensed from third parties. While it may be necessary in the future to
seek or renew licenses relating to various aspects of our products and business
methods, based on past experience and industry practice we believe that such
licenses generally could be obtained on commercially reasonable terms. However,
there is no guarantee that such licenses could be obtained at all. Because of
technological changes in the portable electronics industry, current extensive
patent coverage and the rapid rate of issuance of new patents, it is possible
certain components of our products may unknowingly infringe existing patents or
intellectual property rights of others.
We have
implemented enhanced file management procedures at the Company in an effort to
protect our proprietary rights; however, there can be no assurance that our
patents and other proprietary rights will not be challenged, invalidated, or
circumvented, that others will not assert intellectual property rights to
technologies that are relevant to us, or that our rights will give us a
competitive advantage. In addition, the laws of some foreign countries may not
protect our proprietary rights to the same extent as the laws of the
China.
We have
one registered trademark in China, with an expiration date of December
2011.
PRC
Government Regulations
Environmental
Regulations
The major
environmental regulations applicable to us include the PRC Environmental
Protection Law, the PRC Law on the Prevention and Control of Water Pollution and
its Implementation Rules, the PRC Law on the Prevention and Control of Air
Pollution and its Implementation Rules, the PRC Law on the Prevention and
Control of Solid Waste Pollution, and the PRC Law on the Prevention and Control
of Noise Pollution.
We have
not been named as a defendant in any legal proceedings alleging violation of
environmental laws. We have no reasonable basis to believe that there is any
threatened claim, action or legal proceedings against us that would have a
material adverse effect on our business, financial condition or results of
operations due to any non-compliance with environmental laws.
Patent
Protection in China
The PRC’s
intellectual property protection regime is consistent with those of other modern
industrialized countries. The PRC has domestic laws for the protection of rights
in copyrights, patents, trademarks and trade secrets. The PRC is also a
signatory to most of the world’s major intellectual property conventions,
including:
|
●
|
Convention establishing the World
Intellectual Property Organization (WIPO Convention) (June 4,
1980);
|
|
●
|
Paris Convention for the
Protection of Industrial Property (March 19,
1985);
|
|
●
|
Patent Cooperation Treaty
(January 1, 1994); and
|
|
●
|
The Agreement on Trade-Related
Aspects of Intellectual Property Rights (TRIPs) (November 11,
2001).
|
Patents
in the PRC are governed by the China Patent Law and its Implementing
Regulations, each of which went into effect in 1985. Amended versions of the
China Patent Law and its Implementing Regulations came into effect in 1992,
1993, 2001 and 2003, respectively. The latest amended version of the China
Patent Law was made on December 7, 2008 and will become effective on October 1,
2009.
The PRC
is signatory to the Paris Convention for the Protection of Industrial Property,
in accordance with which any person who has duly filed an application for a
patent in one signatory country shall enjoy, for the purposes of filing in the
other countries, a right of priority during the period fixed in the convention
(12 months for inventions and utility models, and 6 months for industrial
designs).
47
The
Patent Law covers three kinds of patents, i.e., patents for inventions, utility
models and designs respectively. The Chinese patent system adopts the principle
of first to file. This means that, where more than one person files a patent
application for the same invention, a patent can only be granted to the person
who first filed the application. Consistent with international practice, the PRC
only allows the patenting of inventions or utility models that possess the
characteristics of novelty, inventiveness and practical applicability. For a
design to be patentable, it should not be identical with or similar to any
design which, before the date of filing, has been publicly disclosed in
publications in the country or abroad or has been publicly used in the country,
and should not be in conflict with any prior right of another.
PRC law
provides that anyone wishing to exploit the patent of another must conclude a
written licensing contract with the patent holder and pay the patent holder a
fee. One rather broad exception to this, however, is that, where a party
possesses the means to exploit a patent but cannot obtain a license from the
patent holder on reasonable terms and in reasonable period of time, the PRC
State Intellectual Property Office, or SIPO, is authorized to grant a compulsory
license. A compulsory license can also be granted where a national emergency or
any extraordinary state of affairs occurs or where the public interest so
requires. SIPO, however, has not granted any compulsory license up to now. The
patent holder may appeal such decision within three months from receiving
notification by filing a suit in a people’s court.
PRC law
defines patent infringement as the exploitation of a patent without the
authorization of the patent holder. A patent holder who believes his patent is
being infringed may file a civil suit or file a complaint with a PRC local
Intellectual Property Administrative Authority, which may order the infringer to
stop the infringing acts. Preliminary injunction may be issued by the People’s
Court upon the patentee’s or the interested parties’ request before instituting
any legal proceedings or during the proceedings. Evidence preservation and
property preservation measures are also available both before and during the
litigation. Damages in the case of patent infringement is calculated as either
the loss suffered by the patent holder arising from the infringement or the
benefit gained by the infringer from the infringement. If it is difficult to
ascertain damages in this manner, damages may be reasonably determined in an
amount ranging from one to three times of the license fee under a contractual
license. In the case of false patents, if there is no license fee for
reference, the damages may be reasonably determined in an amount ranging from
RMB 5,000 to RMB 500,000. After October 1, 2009, the range will be increased to
RMB 10,000 to RMB 1,000,000.
Tax
Pursuant
to the Provisional Regulation of China on Value Added Tax and their implementing
rules, all entities and individuals that are engaged in the sale of goods, the
provision of repairs and replacement services and the importation of goods in
China are generally required to pay VAT at a rate of 17.0% of the gross sales
proceeds received, less any deductible VAT already paid or borne by the
taxpayer. Further, when exporting goods, the exporter is entitled to a portion
of or a full refund of the VAT that it has already paid or borne. Our imported
raw materials that are used for manufacturing export products and are deposited
in bonded warehouses are exempt from import VAT.
Foreign
Currency Exchange
Under the
PRC foreign currency exchange regulations applicable to us, the Renminbi is
convertible for current account items, including the distribution of dividends,
interest payments, trade and service-related foreign exchange transactions.
Conversion of Renminbi for capital account items, such as direct investment,
loan, security investment and repatriation of investment, however, is still
subject to the approval of the PRC State Administration of Foreign Exchange, or
SAFE. Foreign-invested enterprises may only buy, sell and/or remit foreign
currencies at those banks authorized to conduct foreign exchange business after
providing valid commercial documents and, in the case of capital account item
transactions, obtaining approval from the SAFE. Capital investments by
foreign-invested enterprises outside of China are also subject to limitations,
which include approvals by the Ministry of Commerce, the SAFE and the State
Reform and Development Commission.
Dividend
Distributions
Under
applicable PRC regulations, foreign-invested enterprises in China may pay
dividends only out of their accumulated profits, if any, determined in
accordance with PRC accounting standards and regulations. In addition, a
foreign-invested enterprise in China are required to set aside at least 10.0% of
their after-tax profit based on PRC accounting standards each year to its
general reserves until the accumulative amount of such reserves reach 50.0% of
its registered capital. These reserves are not distributable as cash dividends.
The board of directors of a foreign-invested enterprise has the discretion to
allocate a portion of its after-tax profits to staff welfare and bonus funds,
which may not be distributed to equity owners except in the event of
liquidation.
Employees
As of the
date of this prospectus, we had approximately 78 employees. All of
our employees are based in China. There are no collective bargaining contracts
covering any of our employees. We believe our relationship with our employees is
satisfactory .
We are
required to contribute a portion of our employees’ total salaries to the Chinese
government’s social insurance funds, including pension insurance, medical
insurance, unemployment insurance, and work-related injury insurance, and
maternity insurance, in accordance with relevant regulations. Total
contributions to the funds are approximately $14,767 for the quarter ended
September 30, 2009 and $6,487 and $130,549 for the years ended December 31, 2008
and 2007, respectively. We expect that the amount of our contribution
to the government’s social insurance funds will increase in the future as we
expand our workforce and operations.
We also
provide housing facilities for our employees. At present, approximately 1% of
our employees live in company-provided housing facilities. Under PRC laws, we
are also required to make contributions to a housing accumulation fund for
employees. Presently, contribution to such housing accumulation fund is
not strictly enforced by the Zhengzhou Municipal Government and
therefore, we provide free housing facilities to all employees who need
accommodation. We may commence contributions to the housing assistance fund in
the future.
48
Effective
January 1, 2008, the PRC introduced a new labor contract law that enhances
rights for the nation's workers, including open-ended work contracts and
severance pay. The legislation requires employers to provide written contracts
to their workers, restricts the use of temporary laborers and makes it harder to
lay off employees. It also requires that employees with fixed-term contracts be
entitled to an indefinite-term contract after a fixed-term contract is renewed
twice. Although the new labor contract law would increase our labor costs, we do
not anticipate there will be any significantly effects on our overall
profitability in the near future since such amount was historically not material
to our operating cost. Management anticipates this may be a step toward
improving candidate retention for skilled workers.
Properties
In China,
only the PRC government and peasant collectives may own land. In 2001, Zhong Bo,
our Chief Executive Officer and Chairman of the Board, acquired a total of
approximately 115 square meters of real estate for approximately RMB Yuan
665,000 (equivalent to approximately USD$97,000) under a land use right grant
from the Zhengzhou State-Owned Land Resource Bureau. Our registered principal
office is located on the property at Building 28, Huzhu Road, Zhongyuan
District, Zhengzhou, China. Mr. Zhong permits the Company to use such property
for free. We have the right to use the real estate until 2069. In the event we
wish to continue to use the real estate after this expiration date, we must
apply for an extension at least one year prior to the land grant’s
expiration.
We also
lease a property, with a floor area of approximately 200 square meters, located
at No. 170 Gongren Road, Zhongyuan District, Zhengzhou, China where we conduct
the same operations as we do at our principal offices. The lease expires on
September 15, 2010 and the annual rent is RMB 50,000, which is approximately
USD$7,300.
On April
24, 2009, the Company entered into a House Lease Agreement for the property
located at 206 Tongbo Street, Boyaxicheng Second Floor, Zhengzhou City, Henan
Province, People’s Republic of China 450007, with a floor area of approximately
945 square meters (the “Lease”). The Lease has a term from May 21, 2009 to April
30, 2011 and the annual rent is RMB 400,000, which is approximately USD$58,485.
The Company entered into the Lease because it required additional space to
conduct its business operations.
We
believe our current facilities will be adequate to meet our operating needs for
the foreseeable future. Should we need additional space, we believe we will be
able to secure additional space at commercially reasonable rates.
Legal
Proceedings
There are
not any material pending legal proceedings to which we are a party or as to
which any of its property is subject, and no such proceedings are known to us to
be threatened or contemplated against us.
49
MANAGEMENT
Executive
Officers, Directors and Key Employees
The
following individuals constitute our board of directors and executive
management:
Name
|
Age
|
Position
|
Term
|
|||
Zhong
Bo
|
58
|
Chairman
of the Board and
Chief
Executive Officer
|
January
9, 2009 thru Present
|
|||
Zhong
Lin
|
28
|
Director
and Chief Operating Officer
|
January
9, 2009 thru Present
|
|||
Yang
Ai Mei
|
58
|
Director
|
January
9, 2009 thru Present
|
|||
Tian
Li Zhi
|
35
|
Director
|
January
9, 2009 thru Present
|
|||
Sheng
Yong
|
46
|
Director
|
January
9, 2009 thru Present
|
|||
Liu
Hui Fang
|
30
|
Director
|
January
9, 2009 thru Present
|
|||
John
Chen
|
32
|
Chief
Financial Officer
|
October
20, 2009 thru Present
|
|||
Xue
Na
|
31
|
Corporate
Secretary, Deputy General Manager and President of the Labor
Union
|
December
11, 2009 thru Present (Corporate Secretary); January 9, 2009 thru Present
(Deputy General Manager and President of the Labor
Union)
|
Zhong Bo
has been chairman of the board of Zhengzhou ZST since 1996. He has also served
as the director of the Henan Association for the Promotion of Non-Governmental
Entrepreneurs since July 1999, as the President of the Federation of Industry
and Commerce (General Chamber of Commerce) since January 2001 and as a committee
member of the Chinese People’s Political Consultative Conference since January
2004. From October 1989 to September 1992, Mr. Zhong served as the manager of
the Zhengzhou and Luoyang Offices of Beijing CEC Video & Audio Technology
Jointly Developed Corporation. From September 1970 to September 1989, Mr. Zhong
served as the technical principal of the Zhumadian Branch of the Wuhan Times
Academy of Sciences. Mr. Zhong obtained a degree in Electronics in September
1989 from the Electronic Engineering Department of Tsinghua University and a
Master’s degree in Business Management in 2003 from Asia International Open
University in Macau.
Zhong Lin
has served as general manager of Zhengzhou ZST since January 2008. Prior to
serving as general manager, Mr. Zhong served as the manager of the system
integration department of Zhengzhou ZST, from April 2005 to December
2007. From 1997 to 2001, Mr. Zhong studied Computer Information Management
at Nanjing University of Science and Technology.
Yang Ai
Mei has served as managing director of Zhengzhou Guangda Textiles Co.,
Ltd., a cotton manufacturing company, since May 1995, where she has worked since
1988. From January 1978 to January 1988, Ms. Yang was the manager of Zhongyuan
Labour Services Company, a company which engages in the sale and trade of
textiles. Ms. Yang received a Bachelor of Economics in the field of Management
in 1975 from Zheng Zhau University.
Tian Li
Zhi has been employed as an attorney for the Henan Image Law Firm since
May 2000. From May 1997 to May 2000, Ms. Tian was a legal consultant for
Zhengzhou Asia Group, a company which manages commercial properties. Ms. Tian
received a law degree in 1997 from Zheng Zhau University.
Sheng Yong
has served as the general manager of Iaoning Unified Biological Energy Sources
Co., Ltd., a biological energy company, since January 2004. From January 1988 to
January 2004, Mr. Sheng was the deputy general manager of Zhengzhou Yinhe
Joint-Stock Co., Ltd., a textile manufacturing company. Mr. Sheng received a
Bachelor of Economics in Management from the Air Force Polities Academy of the
Chinese People’s Liberation Army in 1999.
Liu Hui
Fang has served as finance manager of Henan Zhongfu Container Co., Ltd.,
a company which engages in the production and sale of plastic packaging, since
August 2002. From July 1999 to August 2002, Ms. Liu served as chief accountant
of Zhengzhou Fukang Medical Equipment Co., Ltd., a distributor of medical
equipment. Ms. Liu received a degree in business accounting in 1999 from Henan
Business College. She is also a member of The Chinese Institute of Certified
Public Accountants.
John Chen
previously served as the Vice President, Investment Banking-China Practice of
Brean Murray, Carret & Co., from December 2007 to January
2009. From June 2007 to November 2007, Dr. Chen served as the Senior
Vice President, Investment Banking of Global Hunter Securities
LLC. Dr. Chen served as the Associate Vice President, Business
Development of Paramount BioCapital from March 2006 to December
2006. Prior to that, he was a Clinical Research Fellow, on a one year
fellowship, at the National Cancer Institute from August 2005 to August
2006. Dr. Chen also served as a Biotechnology Associate Analyst at
Friedman, Billings, Ramsey, Inc. from September 2004 to August
2005. Dr. Chen received a M.D./MBA in health management from Tufts
University School of Medicine and Brandeis University, Northeastern University
in 2004 and a B.S. in Biology from the University of California, Irvine in
2000.
50
Xue Na has
served as deputy general manager of Zhengzhou ZST since September 2005 and as
president of the labor union for Zhengzhou ZST since 2003. From January 2002 to
August 2005, Ms. Xue served as the assistant general manager of Zhengzhou ZST
and from July 1997 to December 2001, she held the position of office director of
Zhengzhou ZST. Ms. Xue received her MBA in 2002 from Asia International Open
University (Macau). From 1995 to 1997, Ms. Xue studied public relations at
Zhengzhou Huanghe Science and Technology College.
Except as
noted above, the above persons do not hold any other directorships in any
company with a class of securities registered pursuant to Section 12 of the
Exchange Act or subject to the requirements of Section 15(d) of the Exchange
Act.
Family
Relationships
Zhong Bo
is the father of Zhong Lin.
Involvement
in Certain Legal Proceedings
There
have been no events under any bankruptcy act, no criminal proceedings and no
judgments, injunctions, orders or decrees material to the evaluation of the
ability and integrity of any director, executive officer, promoter or control
person of the Company during the past five years.
There
have been no material proceedings to which any director, officer or affiliate of
the Company, any owner of record or beneficially of more than five percent of
any class of voting securities of the Company, or any associate of any such
director, officer, affiliate of the Company, or security holder is a party
adverse to the Company or any of its subsidiaries or has a material interest
adverse to the Company or any of its subsidiaries.
The
Board of Directors and Committees
Board
Composition
Subject
to certain exceptions, under the listing standards of the NASDAQ Global Market,
a listed company’s board of directors must consist of a majority of independent
directors. Currently, our board of directors has determined that each of the
following non-management directors, Yang Ai Mei, Tian Li Zhi, Sheng Yong and Liu
Hui Fang, is an “independent” director as defined by the listing standards of
the NASDAQ Global Market currently in effect and approved by the SEC and all
applicable rules and regulations of the SEC. All members of the Audit,
Compensation and Nominating Committees satisfy the “independence” standards
applicable to members of each such committee. The board of directors made this
affirmative determination regarding these directors’ independence based on
discussions with the directors and on its review of the directors’ responses to
a standard questionnaire regarding employment and compensation history;
affiliations, family and other relationships; and transactions with the Company.
The board of directors considered relationships and transactions between each
director or any member of his immediate family and the Company and its
subsidiaries and affiliates. The purpose of the board of director’s review with
respect to each director was to determine whether any such relationships or
transactions were inconsistent with a determination that the director is
independent under the NASDAQ Global Market rules.
Audit
Committee
We
established our Audit Committee in February 2009. The Audit Committee consists
of Liu Hui Fang, Yang Ai Mei and Tian Li Zhi, each of whom is an independent
director. Liu Hui Fang, Chairman of the Audit Committee, is an “audit committee
financial expert” as defined under Item 407(d) of Regulation S-K. The purpose of
the Audit Committee is to represent and assist our board of directors in its
general oversight of our accounting and financial reporting processes, audits of
the financial statements and internal control and audit functions. The Audit
Committee’s responsibilities include:
|
•
|
The appointment, replacement,
compensation, and oversight of work of the independent auditor, including
resolution of disagreements between management and the independent auditor
regarding financial reporting, for the purpose of preparing or issuing an
audit report or performing other audit, review or attest
services.
|
|
•
|
Reviewing and discussing with
management and the independent auditor various topics and events that may
have significant financial impact on our Company or that are the subject
of discussions between management and the independent
auditors.
|
The board
of directors has adopted a written charter for the Audit Committee. A copy of
the Audit Committee Charter is posted on our corporate website at: www.shenyangkeji.com.
51
Compensation
Committee
We
established our Compensation Committee in February 2009. The Compensation
Committee consists of Liu Hui Fang and Tian Li Zhi, each of whom is an
independent director. Liu Hui Fang is the Chairman of the Compensation
Committee. The Compensation Committee is responsible for the design, review,
recommendation and approval of compensation arrangements for our directors,
executive officers and key employees, and for the administration of our equity
incentive plans, including the approval of grants under such plans to our
employees, consultants and directors. The Compensation Committee also reviews
and determines compensation of our executive officers, including our Chief
Executive Officer. The board of directors has adopted a written charter for the
Compensation Committee. A copy of the Compensation Committee Charter is posted
on our corporate website at: www.shenyangkeji.com.
Nominating
Committee
We
established our Nominating Committee in February 2009. The Nominating Committee
consists of Tian Li Zhi and Sheng Yong, each of whom is an independent director.
Tian Li Zhi is the Chairman of the Nominating Committee. The Nominating
Committee assists in the selection of director nominees, approves director
nominations to be presented for stockholder approval at our annual general
meeting and fills any vacancies on our board of directors, considers any
nominations of director candidates validly made by stockholders, and reviews and
considers developments in corporate governance practices. The board of directors
has adopted a written charter for the Nominating Committee. A copy of the
Nominating Committee Charter is posted on our corporate website at: www.shenyangkeji.com.
52
EXECUTIVE
COMPENSATION
Summary
Compensation Tables
The
following table sets forth information concerning the compensation for the two
fiscal years ended December 31, 2008 and 2007 of the principal executive
officer, our two most highly compensated officers whose annual compensation
exceeded $100,000, and up to two additional individuals for whom disclosure
would have been required but for the fact that the individual was not serving as
an executive officer of the registrant at the end of the last fiscal year (the
“named executive officers”).
Name and Position
|
Year
|
Salary
|
Bonus
|
All Other
Compensation (1)
|
Total
|
|||||||||||||||
Current
Executive Officers (Post- Share Exchange):
|
|
|||||||||||||||||||
Zhong
Bo (2)
|
||||||||||||||||||||
Chief
Executive Officer and Chairman of the Board
|
2008
|
$ | 6,594 | $ | — | $ | — | $ | 6,594 | |||||||||||
2007
|
6,297 | — | — | 6,297 | ||||||||||||||||
Former
Executive Officers (Prior to Share Exchange):
|
||||||||||||||||||||
Richard
Rappaport (3)
|
||||||||||||||||||||
Former
Chief Executive Officer and Former Director
|
2008
|
$ | — | $ | — | $ | — | $ | — | |||||||||||
2007
|
— | — | — | — |
(1)
|
Relates to automobile, housing
and medical personal
benefits.
|
(2)
|
Mr. Zhong was appointed the
Company’s Chief Executive Officer and Chairman of the Board upon the
closing of the Share Exchange on January 9, 2009. The
compensation Mr. Zhong received in 2007 and 2008 was paid by Zhengzhou
ZST, our wholly-owned subsidiary which we acquired upon the closing of the
Share Exchange on January 9,
2009.
|
(3)
|
Mr. Rappaport resigned from all
positions with the Company upon the closing of the Share Exchange on
January 9, 2009.
|
Outstanding
Equity Awards at 2008 Fiscal Year End
There
were no option exercises or options outstanding in 2008.
Employment
Agreements
We have
entered into an employment agreement with Zhong Bo, our Chief Executive Officer
and Chairman of the Board, which expires in December 2011. Mr. Zhong is paid a
monthly salary of RMB 4,500, which is approximately USD$662. The employment
agreement provides that the parties may terminate the agreement upon mutual
agreement or, under certain conditions, the Company may terminate the
agreement upon one month prior written notice to Mr. Zhong. Mr. Zhong may
terminate his employment immediately under certain circumstances including if
the Company fails to provide certain required labor protection or working
conditions, fails to pay compensation on time and in full, or acts in such a way
to harm Mr. Zhong’s right and interests or threaten his personal safety. The
employment agreement also provides that the Company may terminate such agreement
immediately under certain circumstances including if Mr. Zhong does not satisfy
the conditions for employment during the probation period, materially breaches
the Company’s rules and regulations, or neglects his duties thereby causing
substantial damage to the Company. The employment agreement restricts the
Company’s ability to terminate the employment agreement under certain
circumstances including if Mr. Zhong has proven that he is unable to work due to
a work-related injury, or has contracted an illness or sustained a
non-work-related injury and the prescribed period of medical care has not yet
expired. In addition, the employment agreement provides that under certain
circumstances, Mr. Zhong may have to compensate the Company for economic losses
incurred. Under the employment agreement, Mr. Zhong has an obligation to
maintain commercial secrets of the Company. The employment agreement contains
general provisions for mediation and arbitration in the case of any dispute
arising out of the employment agreement that cannot first be settled by
consultation and negotiation.
On
October 8, 2009, we entered into an employment agreement with Dr. Chen regarding
his employment by the Company as its new Chief Financial Officer effective on
October 20, 2009 (the "Effective Date"). Pursuant to the employment agreement,
Dr. Chen is entitled to a base salary at an annual rate of $150,000. Dr.
Chen was also granted a signing bonus which is calculated as follows:
$410.96 per day multiplied by the number of days between September 25, 2009 and
the Effective Date. The initial term of the employment agreement
will be eighteen (18) months, with automatic one-year
extensions.
53
Upon the
Effective Date, we also granted Dr. Chen options to purchase 25,000 shares of
the common stock of the Company at an exercise price of $8.00 per share (the
“Initial Options”). The Initial Options will be immediately
exercisable but, to the extent they are exercised, will be subject to a
repurchase right of the Company, which will lapse as follows: 50% of
the Initial Options will vest six (6) months after the Effective Date and the
remaining 50% will vest twelve (12) months after the Effective
Date. Upon the 1-year anniversary of the Effective Date, Dr. Chen
will be granted additional options to purchase 12,500 shares of the common stock
of the Company at an exercise price equal to the market price on the grant date
that are not immediately exercisable, and which will vest six (6) months from
the date of grant (the “Subsequent Options”). The Initial
Options and Subsequent Options will expire five (5) years from their respective
grant dates, provided, however, that Dr. Chen remains continuously employed by
the Company during the applicable five-year period.
Director
Compensation
The
Company did not and does not currently have an established policy to provide
compensation to members of its board of directors for their services in that
capacity. The Company intends to develop such a policy in the near
future.
Securities
Authorized for Issuance Under Equity Compensation Plans
As of
December 31, 2008, the Company did not have an equity compensation
plan.
Indemnifications
of Directors and Executive Officers and Limitations of Liability
Under
Section 145 of the General Corporation Law of the State of Delaware, we can
indemnify our directors and officers against liabilities they may incur in such
capacities, including liabilities under the Securities Act. Our certificate of
incorporation provides that, pursuant to Delaware law, our directors shall not
be liable for monetary damages for breach of the directors’ fiduciary duty of
care to us and our stockholders. This provision in the certificate of
incorporation does not eliminate the duty of care, and in appropriate
circumstances equitable remedies such as injunctive or other forms of
non-monetary relief will remain available under Delaware law. In addition, each
director will continue to be subject to liability for breach of the director’s
duty of loyalty to us or our stockholders, for acts or omissions not in good
faith or involving intentional misconduct or knowing violations of the law, for
actions leading to improper personal benefit to the director, and for payment of
dividends or approval of stock repurchases or redemptions that are unlawful
under Delaware law. The provision also does not affect a director’s
responsibilities under any other law, such as the federal securities laws or
state or federal environmental laws.
Our
bylaws provide for the indemnification of our directors to the fullest extent
permitted by the Delaware General Corporation Law. Our bylaws further provide
that our board of directors has discretion to indemnify our officers and other
employees. We are required to advance, prior to the final disposition of any
proceeding, promptly on request, all expenses incurred by any director or
executive officer in connection with that proceeding on receipt of an
undertaking by or on behalf of that director or executive officer to repay those
amounts if it should be determined ultimately that he or she is not entitled to
be indemnified under the bylaws or otherwise. We are not, however, required to
advance any expenses in connection with any proceeding if a determination is
reasonably and promptly made by our board of directors by a majority vote of a
quorum of disinterested board members that (i) the party seeking an advance
acted in bad faith or deliberately breached his or her duty to us or our
stockholders and (ii) as a result of such actions by the party seeking an
advance, it is more likely than not that it will ultimately be determined that
such party is not entitled to indemnification pursuant to the applicable
sections of its bylaws.
We have
been advised that in the opinion of the Securities and Exchange Commission,
insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, or otherwise, such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable. In the
event a claim for indemnification against such liabilities (other than our
payment of expenses incurred or paid by our director, officer or controlling
person in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered, we will, unless in the opinion of our counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by us is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
We may
enter into indemnification agreements with each of our directors and officers
that are, in some cases, broader than the specific indemnification provisions
permitted by Delaware law, and that may provide additional procedural
protection. As of the closing of the Share Exchange, we have not entered into
any indemnification agreements with our directors or officers, but may choose to
do so in the future. Such indemnification agreements may require us, among other
things, to:
|
●
|
indemnify officers and directors
against certain liabilities that may arise because of their status as
officers or directors;
|
|
●
|
advance expenses, as incurred, to
officers and directors in connection with a legal proceeding, subject to
limited exceptions; or
|
|
●
|
obtain directors’ and officers’
insurance.
|
At
present, there is no pending litigation or proceeding involving any of our
directors, officers or employees in which indemnification is sought, nor are we
aware of any threatened litigation that may result in claims for
indemnification.
54
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
Share
Exchange
On
January 9, 2009, we completed the Share Exchange with World Orient and the
former stockholders of World Orient. At the closing, World Orient became our
wholly-owned subsidiary and 100% of the issued and outstanding securities of
World Orient were exchanged for securities of the Company. An aggregate of
806,408 shares of common stock were issued to the stockholders of World Orient.
As of the close of the Share Exchange, the former stockholders of World Orient
owned approximately 22% of our issued and outstanding common stock.
Upon the
closing of the Share Exchange, the Company’s board of directors resigned in full
and appointed Zhong Bo, Zhong Lin, Yang Ai Mei, Tian Li Zhi, Sheng Yong and Liu
Hui Fang to the board of directors of our Company, with Zhong Bo serving as
Chairman. The Company’s board of directors also appointed Zhong Bo as Chief
Executive Officer, Zeng Yun Su as Chief Financial Officer and Corporate
Secretary, Zhong Lin as Chief Operating Officer and Xue Na as Deputy General
Manager and President of the Labor Union, each of whom were executive officers
and/or directors of Zhengzhou ZST. Also in connection with the Share Exchange,
we paid $350,000 to WestPark and $125,000 to a third party unaffiliated with the
Company, SRKP 18 or WestPark.
Purchase
Right and Share and Warrant Cancellation
On
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”)
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management agreed to purchase an aggregate of
5,090,315 shares of our common stock at a per share purchase price of $0.6907
(the “Purchase Right”). The purchase price for the shares was paid in full on
May 25, 2009. Each of the stockholders and warrantholders of the Company prior
to the Share Exchange agreed to cancel 0.3317 shares of common stock and
warrants to purchase 0.5328 shares of common stock held by each of them for each
one (1) share of common stock purchased by the ZST Management pursuant to the
Purchase Right (the “Share and Warrant Cancellation”). Pursuant to the Share and
Warrant Cancellation, an aggregate of 1,688,532 shares of common stock and
warrants to purchase 2,712,283 shares of common stock held by certain of our
stockholders and warrantholders prior to the Share Exchange were
cancelled.
Private
Placement and Underwriting Services
Richard
Rappaport, our President and one of our controlling stockholders prior to the
Share Exchange, indirectly holds a 100% interest in WestPark. Anthony C.
Pintsopoulos, our officer, director and significant stockholder prior to the
Share Exchange, is the Chief Financial Officer of WestPark. Kevin DePrimio and
Jason Stern, each employees of WestPark, are also stockholders of the Company.
Thomas J. Poletti is a former stockholder of the Company and a partner of
K&L Gates LLP, our U.S. legal counsel. Richard Rappaport is the
sole owner of the membership interests of WestPark Capital Financial Services,
LLC. Each of Messrs. Rappaport and Pintsopoulos resigned from all of
their executive and director positions with the Company upon the closing of the
Share Exchange.
WestPark,
the placement agent for our $4.98 million equity financing, received a
commission equal to 12% of the gross proceeds from the financing plus a 4%
non-accountable expense allowance. No other consideration was paid to WestPark
or SRKP 18 in connection with the Share Exchange or Private Placement.
Furthermore, in connection with the initial closing of the Private Placement,
the Company issued a promissory note in the principal amount of $170,000,
bearing no interest (the “Note”), to WestPark Capital Financial Services, LLC,
the parent company of WestPark. The principal was due and payable by us on or
before the earlier of (a) thirty (30) days from the date of issuance of the Note
or (b) upon the receipt by us of at least $4 million in the Private
Placement. We repaid the Note in full on January 23, 2009 using the
proceeds from the second closing of the Private Placement.
In
addition, WestPark acted as a co-underwriter, along with Rodman & Renshaw,
LLC, in our public offering that we closed in October 2009. We sold a
total of 3,125,000 shares of common stock in the public offering at $8.00 per
share, for gross proceeds of approximately $25 million. As
compensation for its services, WestPark received discounts, commissions and
management fees of $348,136, a non-accountable expense allowance of $100,000,
and reimbursement of roadshow expenses of approximately $6,100 and legal counsel
fees (excluding blue sky fees) of $40,000. WestPark also received a
five-year warrant to purchase 62,500 shares of our common stock at an exercise
price of $10.00 per share.
Patent
License Agreement and Patent Transfer
Our Chief
Executive Officer, Zhong Bo, has legal ownership of one patent in China that we
rely on in the operation of our business. On January 9, 2009, we entered into a
patent license agreement with Mr. Zhong for the right to use such patent in the
operation of our business. In addition, we also applied to SIPO for the transfer
of the patent to Zhengzhou ZST and SIPO accepted the application regarding the
patent transfer to Zhengzhou ZST on December 31, 2008. The patent
transfer to Zhengzhou ZST was approved on January 9, 2009. Mr. Zhong did not
receive any additional consideration for the license of the intellectual
property rights to us, other than the execution of the patent license agreement
being a condition to the closing of the Share Exchange.
55
Policy
for Approval of Related Party Transactions
In
February 2009, we established an Audit Committee and adopted an Audit Committee
Charter. The Audit Committee Charter contains our policy for approval
of related party transactions. Our policy is to have our Audit
Committee review and pre-approve any related party transactions and other
matters pertaining to the integrity of management, including potential conflicts
of interest, trading in our securities, or adherence to standards of business
conduct as required by our policies.
Director
Independence
See the
section entitled “Management” beginning on page 50 for a discussion of
board member independence .
56
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Beneficial
ownership is determined in accordance with the rules of the SEC. In computing
the number of shares beneficially owned by a person and the percentage of
ownership of that person, shares of common stock subject to options and warrants
held by that person that are currently exercisable or become exercisable within
60 days of the date of this report are deemed outstanding even if they have not
actually been exercised. Those shares, however, are not deemed outstanding for
the purpose of computing the percentage ownership of any other
person.
The
following table sets forth certain information with respect to beneficial
ownership of our common stock based on issued and outstanding shares of common
stock, by:
•
|
Each
person known to be the beneficial owner of 5% or more of the outstanding
common stock of our Company;
|
•
|
Each
named executive officer;
|
•
|
Each
director; and
|
•
|
All
of the executive officers and directors as a
group.
|
The
number of shares of our common stock outstanding as of the date of this
prospectus is 11,650,442, which excludes 156,250 shares of common stock that are
issuable upon the exercise of outstanding warrants. Unless otherwise indicated,
the persons and entities named in the table have sole voting and sole investment
power with respect to the shares set forth opposite the stockholder’s name,
subject to community property laws, where applicable. Unless otherwise
indicated, the address of each stockholder listed in the table is c/o ZST
Digital Networks, Inc., 206 Tongbo Street, Boyaxicheng Second Floor, Zhengzhou
City, Henan Province, People’s Republic of China 450007.
Name and Address of
Beneficial Owner
|
Title
|
Amount and
Nature of
Beneficial
Ownership
|
Percent of
Class
Beneficially
Owned (1)
|
|||||||
Directors
and Executive Officers:
|
||||||||||
Zhong
Bo
|
Chairman
of the Board of Directors and Chief Executive Officer
|
5,002,251
|
(2)
|
42.93
|
%
|
|||||
Zhong
Lin
|
Director
and Chief Operating Officer
|
—
|
—
|
|||||||
Yang
Ai Mei
|
Director
|
—
|
—
|
|||||||
Tian
Li Zhi
|
Director
|
—
|
—
|
|||||||
Sheng
Yong
|
Director
|
—
|
—
|
|||||||
Liu
Hui Fang
|
Director
|
—
|
—
|
|||||||
All
Officers and Directors as a Group (total of eight (8)
persons)
|
|
5,002,251
|
42.93
|
%
|
||||||
5%
Stockholders:
|
|
|||||||||
Richard
Rappaport
1900
Avenue of the Stars,
Suite
310
Los
Angeles, CA 90067
|
|
908,748
|
(3)
|
7.80
|
%
|
(1)
|
Based on 11,650,442 shares of
common stock issued and outstanding as of the date of this
prospectus.
|
(2)
|
Includes 4,559,393 shares of
common stock owned by Mr. Zhong. Also includes 442,858 shares of common
stock owned by Mr. Zhong’s wife, Wu Dexiu. Mr. Zhong may be deemed the
beneficial owner of these securities since he has voting and investment
control over the securities.
|
(3)
|
Includes 218,399 shares of common
stock owned by Mr. Rappaport. Also includes 61,425 shares of common stock
owned by each of the Amanda Rappaport Trust and the Kailey
Rappaport Trust as well as 567,499 shares of common stock owned by
WestPark Capital Financial Services, LLC. Mr. Rappaport, as Trustee of the
Rappaport Trusts and Chief Executive Officer and Chairman of WestPark
Capital Financial Services, LLC, may be deemed the indirect beneficial
owner of these securities since he has sole voting and investment control
over the
securities.
|
57
DESCRIPTION
OF SECURITIES
Common
Stock
We are
authorized to issue 100,000,000 shares of common stock, $0.0001 par value per
share, of which 11,650,442 shares are issued and outstanding. Each outstanding
share of common stock is entitled to one vote, either in person or by proxy, on
all matters that may be voted upon by their holders at meetings of the
stockholders.
Holders
of our common stock:
(i)
|
have equal ratable rights to
dividends from funds legally available therefore, if declared by our board
of directors;
|
(ii)
|
are entitled to share ratably in
all of the Company’s assets available for distribution to holders of
common stock upon our liquidation, dissolution or winding
up;
|
(iii)
|
do not have preemptive,
subscription or conversion rights or redemption or sinking fund
provisions; and
|
(iv)
|
are entitled to one
non-cumulative vote per share on all matters on which stockholders may
vote at all meetings of our
stockholders.
|
The
holders of shares of our common stock do not have cumulative voting rights,
which means that the holders of more than fifty percent (50%) of outstanding
shares voting for the election of directors can elect all of our directors if
they so choose and, in such event, the holders of the remaining shares will not
be able to elect any of our directors.
Preferred
Stock
We may
issue up to 10,000,000 shares of our preferred stock, $0.0001 par value per
share, from time to time in one or more series. We are authorized to issue
3,750,000 shares of Series A Convertible Preferred Stock, $0.0001 par value per
share. Upon completion of the closing of the Private Placement, we issued
1,263,723 shares of our Series A Convertible Preferred Stock. As of
the date of this prospectus, none of our shares of Series A Convertible
Preferred Stock are issued and outstanding. Our board of directors,
without further approval of our stockholders, is authorized to fix the dividend
rights and terms, conversion rights, voting rights, redemption rights,
liquidation preferences and other rights and restrictions relating to any
series. Issuances of shares of preferred stock, while providing flexibility in
connection with possible financings, acquisitions and other corporate purposes,
could, among other things, adversely affect the voting power of the holders of
our common stock and prior series of preferred stock then
outstanding.
Each
share of the Series A Convertible Preferred Stock is convertible into shares of
common stock at a conversion price equal to the purchase price of such shares.
However, if the Company at any time prior to the first trading day on which its
common stock is quoted on the NYSE Amex, the NASDAQ Capital Market, the NASDAQ
Global Market or the New York Stock Exchange (each a “Trading Market”) sells or
issues any shares of common stock in one or a series of transactions at an
effective price less than such conversion price where the aggregate gross
proceeds to the Company are at least $1.0 million, then the aforementioned
conversion price shall be reduced to such effective price. Each share of Series
A Convertible Preferred Stock shall automatically convert into shares of common
stock if (i) the closing price of the Company’s common stock on the Trading
Market for any 10 consecutive trading day period exceeds $8.00 per share, and
(ii) the shares of common stock underlying the Series A Convertible Preferred
Stock are subject to an effective registration statement. As of the date of this
prospectus, the conversion price of the Series A Convertible Preferred Stock is
equal to $3.94 per share.
If the
Company pays a stock dividend on its shares of common stock, subdivides
outstanding shares of common stock into a larger number of shares, combines,
through a reverse stock split, outstanding shares of its common stock into a
smaller number of shares or issues, in the event of a reclassification of shares
of the common stock, any shares of its capital stock, then the conversion price
of the Series A Convertible Preferred Stock will be adjusted as follows: the
conversion price will be multiplied by a fraction, of which (i) the numerator
will be the number of shares of common stock outstanding immediately before one
of the events described above and (ii) the denominator will be the number of
shares of common stock outstanding immediately after such event.
Holders
of the Series A Convertible Preferred Stock have the right to one vote per share
of common stock issuable upon conversion of the shares underlying any shares of
Series A Convertible Preferred Stock outstanding as of the record date for
purposes of determining which holders have the right to vote with respect to any
matters brought to a vote before the Company’s holders of common
stock.
In the
event of any liquidation, dissolution or winding up of the Company, the holders
of the Series A Convertible Preferred Stock shall receive $3.94 per share of
Series A Convertible Preferred Stock and are entitled to receive in preference
to the holders of common stock an amount per share of $3.94 plus any accrued but
unpaid dividends. If the Company’s assets are insufficient to pay the above
amounts in full, then all of its assets will be ratably distributed among the
holders of the Series A Convertible Preferred Stock in accordance with the
respective amounts that would be payable on such shares if all amounts payable
were paid in full.
58
There are
no additional specific dividend rights or redemption rights of holders of the
Series A Convertible Preferred Stock.
If any
shares of the Company’s Series A Convertible Preferred Stock are redeemed or
converted, those shares will resume the status of authorized but unissued shares
of preferred stock and will no longer be designated as Series A Convertible
Preferred Stock.
As long
as any shares of Series A Convertible Preferred Stock are outstanding, the
Company cannot alter or adversely change the powers, preference or rights given
to the Series A Convertible Preferred Stock holders, without the affirmative
vote of those holders.
Warrants
Prior to
the Purchase Right and Share and Warrant Cancellation, our stockholders held
warrants to purchase an aggregate of 2,882,912 shares of our common stock, and
an aggregate of 2,712,283 warrants were cancelled in conjunction with the
Purchase Right and Share and Warrant Cancellation. The remaining
170,629 warrants, with an exercise price of $0.0002462 per share, were exercised
in full in November 2009.
We issued
warrants to the Underwriters as partial compensation for underwriting services
in connection with our public offering in October 2009. The
Underwriters may purchase up to 156,250 shares of common stock at an exercise
price of $10.00 per share under the warrants, which have a term of five
years.
Market
Price of the Company’s Common Stock
The
shares of our common stock commenced trading on the NASDAQ Global Market in
October 2009, prior to which there was no market for our
securities. The price of our common stock will likely fluctuate. The
stock market in general has experienced extreme stock price fluctuations in the
past few years. In some cases, these fluctuations have been unrelated to the
operating performance of the affected companies. Many companies have experienced
dramatic volatility in the market prices of their common stock. We believe that
a number of factors, both within and outside our control, could cause the price
of our common stock to fluctuate, perhaps substantially. Factors such as the
following could have a significant adverse impact on the market price of our
common stock:
•
|
Our
ability to obtain additional financing and, if available, the terms and
conditions of the financing;
|
•
|
Our
financial position and results of
operations;
|
•
|
Concern
as to, or other evidence of, the reliability and safety of our products
and services or our competitors’ products and
services;
|
•
|
Announcements
of innovations or new products or services by us or our
competitors;
|
•
|
U.S.
federal and state governmental regulatory actions and the impact of such
requirements on our business;
|
•
|
The
development of litigation against
us;
|
•
|
Period-to-period
fluctuations in our operating
results;
|
•
|
Changes
in estimates of our performance by any securities
analysts;
|
•
|
The
issuance of new equity securities pursuant to a future offering or
acquisition;
|
•
|
Changes
in interest rates;
|
•
|
Competitive
developments, including announcements by competitors of new products or
services or significant contracts, acquisitions, strategic partnerships,
joint ventures or capital
commitments;
|
•
|
Investor
perceptions of us; and
|
•
|
General
economic and other national
conditions.
|
59
Delaware
Anti-Takeover Law and Charter and Bylaw Provisions
We are
subject to Section 203 of the Delaware General Corporation Law. This provision
generally prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder for a period of three years
following the date the stockholder became an interested stockholder,
unless:
•
|
prior
to such date, the board of directors approved either the business
combination or the transaction that resulted in the stockholder becoming
an interested stockholder;
|
•
|
upon
consummation of the transaction that resulted in the stockholder becoming
an interested stockholder, the interested stockholder owned at least 85%
of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned by persons who are directors and
also officers and by employee stock plans in which employee participants
do not have the right to determine confidentially whether shares held
subject to the plan will be tendered in a tender or exchange offer;
or
|
•
|
on
or subsequent to such date, the business combination is approved by the
board of directors and authorized at an annual meeting or special meeting
of stockholders and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by
the interested stockholder.
|
Section
203 defines a business combination to include:
•
|
any
merger or consolidation involving the corporation and the interested
stockholder;
|
•
|
any
sale, transfer, pledge or other disposition of 10% or more of the assets
of the corporation involving the interested
stockholder;
|
•
|
subject
to certain exceptions, any transaction that results in the issuance or
transfer by the corporation of any stock of the corporation to the
interested stockholder;
|
•
|
any
transaction involving the corporation that has the effect of increasing
the proportionate share of the stock of any class or series of the
corporation beneficially owned by the interested stockholder;
or
|
•
|
the
receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
|
In
general, Section 203 defines an “interested stockholder” as any entity or person
beneficially owning 15% or more of the outstanding voting stock of a
corporation, or an affiliate or associate of the corporation and was the owner
of 15% or more of the outstanding voting stock of a corporation at any time
within three years prior to the time of determination of interested stockholder
status; and any entity or person affiliated with or controlling or controlled by
such entity or person.
Our
certificate of incorporation and bylaws contain provisions that could have the
effect of discouraging potential acquisition proposals or making a tender offer
or delaying or preventing a change in control of our Company, including changes
a stockholder might consider favorable. In particular, our certificate of
incorporation and bylaws, as applicable, among other things, will:
•
|
provide
our board of directors with the ability to alter its bylaws without
stockholder approval;
|
•
|
provide
for an advance notice procedure with regard to the nomination of
candidates for election as directors and with regard to business to be
brought before a meeting of stockholders;
and
|
•
|
provide
that vacancies on our board of directors may be filled by a majority of
directors in office, although less than a
quorum.
|
Such
provisions may have the effect of discouraging a third-party from acquiring us,
even if doing so would be beneficial to our stockholders. These provisions are
intended to enhance the likelihood of continuity and stability in the
composition of our board of directors and in the policies formulated by them,
and to discourage some types of transactions that may involve an actual or
threatened change in control of our Company. These provisions are designed to
reduce our vulnerability to an unsolicited acquisition proposal and to
discourage some tactics that may be used in proxy fights. We believe that the
benefits of increased protection of our potential ability to negotiate with the
proponent of an unfriendly or unsolicited proposal to acquire or restructure our
Company outweigh the disadvantages of discouraging such proposals because, among
other things, negotiation of such proposals could result in an improvement of
their terms.
However,
these provisions could have the effect of discouraging others from making tender
offers for our shares that could result from actual or rumored takeover
attempts. These provisions also may have the effect of preventing changes in our
management.
60
Transfer
Agent
The
transfer agent and registrar for our common stock is Corporate Stock Transfer,
Inc.
Listing
Our
shares of common stock are traded on the NASDAQ Global Market under the ticker
symbol “ZSTN.”
61
SHARES
ELIGIBLE FOR FUTURE SALE
Prior to
October 20, 2009, the date that our shares of common stock were listed on the
NASDAQ Global Market for trading, there has been no public market for our common
stock. Future sales of substantial amounts of our common stock in the public
market could adversely affect market prices. We have outstanding an
aggregate of 11,650,442 shares of common stock as of the date of this
prospectus. We completed registration of 3,125,000 shares that we offered to the
public on October 2009 and we registered for resale 1,542,323 shares of common
stock that are owned by our stockholders. All of these shares will be
freely tradable without restriction or further registration under the Securities
Act, except that any shares purchased by our “affiliates,” as that term is
defined in Rule 144 of the Securities Act, may generally only be sold in
compliance with the limitations of Rule 144 described below.
All other
outstanding shares not sold in this offering will be deemed “restricted
securities” as defined under Rule 144. Restricted securities may be sold in the
public market only if registered or if they qualify for an exemption from
registration under Rule 144 promulgated under the Securities Act, which rules
are summarized below. Our stockholders will not be eligible to utilize Rule 144
until January 15, 2010, at the earliest, which is 12 months from the date we
filed our Form 10 information, as required under Rule 144. Subject to the
lock-up agreements described below and the provisions of Rules 144, additional
shares will be available for sale in the public market as follows:
Approximate
Number of
Shares Eligible
for
Future Sale
|
Date
|
|
4,667,323
|
Freely
tradable shares that have been registered with the Securities and Exchange
Commission. Consists of 3,125,000 shares of common stock that we
sold in a public offering in October 2009 and 1,542,323 shares of common
stock held by our stockholders that we registered for resale, subject to
lock-up restrictions. However, stockholders holding an
aggregate of 1,147,530 shares of common stock have agreed that they
will not sell any of such securities until six (6) months after our common
stock begins to be listed or quoted on either the New York Stock Exchange,
NYSE Amex, NASDAQ Global Market, NASDAQ Capital Market or the OTC Bulletin
Board and holders of the remaining 394,793 shares agreed that they
will not sell any of such securities until 90 days after our common stock
begins to be listed or quoted on either the New York Stock Exchange, NYSE
Amex, NASDAQ Global Market, NASDAQ Capital Market or the OTC Bulletin
Board, when one-twelfth of their shares will be released from the lock-up
restrictions, and after which their shares will automatically be released
from the lock-up restrictions every 30 days in eleven equal installments
.
|
|
1,086,400
|
These
shares will be freely tradable after the Securities and Exchange
Commission declares effective the registration statement of which this
prospectus is a part. However, the selling stockholders holding
an aggregate of 1,086,400 shares of common stock have agreed with the
Underwriters that they will not sell any of such securities until six (6)
months after our common stock begins to be listed or quoted on either the
New York Stock Exchange, NYSE Amex, NASDAQ Global Market, NASDAQ Capital
Market or the OTC Bulletin Board without the prior written consent of the
Underwriters.
|
|
806,408
|
On
January 15, 2010, which is twelve months after the filing of a current
report on Form 8-K reporting the closing of the Share Exchange, these
shares, which were issued in connection with the Share Exchange, may be
sold under and subject to Rule 144. However, holders of 81,250 of these
shares have agreed with the Underwriters not to directly or indirectly
sell, offer, contract or grant any option to sell, pledge, transfer
(excluding intra-family transfers, transfers to a trust for estate
planning purposes or to beneficiaries of officers, directors and
stockholders upon their death), or otherwise dispose of or enter into any
transaction which may result in the disposition of any shares of our
common stock or securities convertible into, exchangeable or exercisable
for any shares of our common stock, without the prior written consent of
the Underwriters, for a period of 24 months after October 20,
2009. Holders of remaining 725,158 of these shares have agreed
to the same transfer restrictions as described above, except that such
restrictions shall be released on such dates and amounts as
follows: (i) 121,876 shares on the date that is six months
after our common stock begins to be listed or quoted on either the New
York Stock Exchange, NYSE Amex, NASDAQ Global Market, NASDAQ Capital
Market or the OTC Bulletin Board, (ii) 121,876 shares on the date that is
twelve months after such date of listing or quotation; (iii) 353,438
shares on the date that is two years after such date of listing or
quotation, and (iv) 127,968 shares shall be released from the restrictions
as determined by WestPark, in its sole discretion.
|
|
5,090,315
|
On
January 15, 2010, which is twelve months after the filing of a current
report on Form 8-K reporting the closing of the Share Exchange, these
shares, which were issued in connection with the Purchase Right, may be
sold under and subject to Rule 144. However, all of the holders of these
shares have agreed with the Underwriters not to directly or indirectly
sell, offer, contract or grant any option to sell, pledge, transfer
(excluding intra-family transfers, transfers to a trust for estate
planning purposes or to beneficiaries of officers, directors and
stockholders upon their death), or otherwise dispose of or enter into any
transaction which may result in the disposition of any shares of our
common stock or securities convertible into, exchangeable or exercisable
for any shares of our common stock, without the prior written consent of
the Underwriters, for a period of 24 months after October 20,
2009.
|
62
Rule
144
In
general, under Rule 144 a person, or persons whose shares are aggregated, who is
not deemed to have been one of our affiliates at any time during the three
months preceding a sale and who has beneficially owned shares of our common
stock for at least six months, including the holding period of any prior owner,
except if the prior owner was one of our affiliates, would be entitled to sell
all of their shares, provided the availability of current public information
about the Company during the six months following satisfaction of the six-month
holding period requirement.
Affiliates
that have held restricted securities for at least six months to sell such
restricted securities in accordance with the traditional conditions of Rule 144,
including the public information requirement, the volume limitations, manner of
sale provisions and notice requirements. In particular, an affiliate who has
beneficially owned shares of our common stock for at least six months would be
entitled to sell within any three-month period a number of shares that does not
exceed 1% of the number of shares of our common stock then outstanding, which
will equal approximately 116,504 as of the date of this
prospectus.
Any
substantial sale of common stock pursuant to any resale registration statement
or Rule 144 may have an adverse effect on the market price of our common stock
by creating an excessive supply. Subject to lock-up agreements with
the Underwriters, all of the restricted shares may not be sold until January 15,
2010, which is 12 months after the filing of a current report on Form 8-K
reporting the closing of the Share Exchange.
Lock-Up
Agreements and Registration
The
investors in our private placement, in which we sold 1,263,723 shares of Series
A Convertible Preferred Stock, entered into a lock-up agreement pursuant to
which holders holding an aggregate of 868,930 shares agreed not
to sell their shares until six (6) months after our common stock began to be
listed on the NASDAQ Global Market and holders of the remaining 394,793
shares agreed that they will not sell any of such securities until 90 days after
our common stock began to be listed on the NASDAQ Global Market, when
one-twelfth of their shares will be released from the lock-up restrictions, and
after which their shares will automatically be released from the lock-up
restrictions every 30 days in eleven equal installments. We
registered the shares of common stock underlying the Series A Convertible
Preferred Stock sold in the Private Placement in October
2009. Subject to the lock-up agreements, the shares became freely
tradable after October 20, 2009.
We also
registered with the Private Placement shares in October 2009, 243,774 shares of
common stock and 34,826 shares of common stock underlying the warrants held by
certain of our stockholders immediately prior to the Share
Exchange. Such stockholders also entered into a lock-up agreement
pursuant to which they agreed not to sell their shares until six (6) months
after our common stock began to be listed on the NASDAQ Global
Market. Subject to the lock-up agreements, the shares became freely
tradable after October 20, 2009.
We are
registering in the registration statement of which this prospectus is a part
1,086,400 shares of common stock held by stockholders of the Company prior to
the Share Exchange who are affiliates of WestPark. The stockholders
entered into a lock-up agreement pursuant to which they agreed not to sell
their shares until six (6) months after our common stock began to be listed on
the NASDAQ Global Market. Subject to the lock-up agreements, the
shares will become freely tradable upon effectiveness of the registration
statement.
We have
agreed with the Underwriters that we will not, without the prior consent of the
Underwriters, directly or indirectly sell, offer, contract or grant any option
to sell, pledge, transfer, or otherwise dispose of or enter into any transaction
which may result in the disposition of any shares of our common stock or
securities convertible into, exchangeable or exercisable for any shares of our
common stock (excluding the exercise of certain warrants and/or options
currently outstanding and exercisable) for a period of 24 months after the date
of our prospectus dated October 20, 2009.
In
addition, each of our executive officers and directors, in addition to all of
the stockholders that received shares issued in the Share Exchange or pursuant
to the Purchase Right, holding an aggregate of 5,171,565 shares of common
stock, have agreed with the Underwriters not to directly or indirectly sell,
offer, contract or grant any option to sell, pledge, transfer (excluding
intra-family transfers, transfers to a trust for estate planning purposes or to
beneficiaries of officers, directors and stockholders upon their death), or
otherwise dispose of or enter into any transaction which may result in the
disposition of any shares of our common stock or securities convertible into,
exchangeable or exercisable for any shares of our common stock, without the
prior written consent of the Underwriters, for a period of 24 months after the
date of our prospectus dated October 20, 2009. Holders of 725,158 shares
of common stock have agreed with the Underwriters to be bound to the same
transfer restrictions described above, except that such restrictions shall be
released on such dates and amounts as follows: (i) 121,876 shares on
the date that is six months after our common stock began to be listed on the
NASDAQ Global Market, (ii) 121,876 shares on the date that is twelve months
after such date of listing; (iii) 353,438 shares on the date that is two years
after such date of listing, and (iv) 127,968 shares shall be released from the
restrictions as determined by WestPark, in its sole discretion.
63
We have
been advised by the Underwriters that they have no present intention and there
are no agreements or understandings, explicit or tacit, relating to the early
release of any locked-up shares. The Underwriters may, however, consent to an
early release from the lock-up period if, in its opinion, the market for the
common stock would not be adversely impacted by sales. The release of any
lock-up would be considered on a case-by-case basis. Factors that the
Underwriters may consider in deciding whether to release shares from the lock-up
restriction include the length of time before the lock-up expires, the number of
shares involved, the reason for the requested release, market conditions, the
trading price of our securities, historical trading volumes of our securities
and whether the person seeking the release is an officer, director or affiliate
of us.
64
SELLING
STOCKHOLDERS
The
following table provides, as of the date of this prospectus, information
regarding the beneficial ownership of our common stock held by each of the
selling stockholders, including:
•
|
the
number of shares owned by each stockholder prior to this
offering;
|
•
|
the
percentage owned by each stockholder prior to completion of the
offering;
|
•
|
the
total number of shares that are to be offered for each
stockholder;
|
•
|
the
total number of shares that will be owned by each stockholder upon
completion of the offering; and
|
•
|
the
percentage owned by each stockholder upon completion of the
offering.
|
On
January 9, 2009, we closed a share exchange transaction (“Share Exchange”)
pursuant to which we issued an aggregate of 806,408 shares of our common stock
in exchange for all of the issued and outstanding securities of World
Orient. Pursuant to the terms of the Share Exchange, we agreed to
register the 1,194,380 shares of common stock and the 170,629 shares of common
stock underlying the warrants held by our stockholders immediately prior to the
Share Exchange. Of those shares, 243,774 shares of common stock and 34,826
shares of common stock underlying warrants were previously registered and
1,086,400 shares of common stock, which includes 135,794 shares that were issued
to the stockholders pursuant to cashless exercise of 135,803 warrants, are
included in this prospectus.
Name of Selling
Stockholder
|
Number of
Shares of
Common
Stock
Beneficially
Owned Prior
to Offering
|
Percentage of
Shares of
Common
Stock
Beneficially
Owned Prior
to the
Offering
(1)
|
Number of
Shares of
Common
Stock
Registered
for Sale
Hereby
|
Number of
Shares of
Common
Stock
Beneficially
Owned After
Completion
of the
Offering
(2)
|
Percentage of
Shares of
Common Stock
Beneficially
Owned After
Completion
of the
Offering
(1)
|
|||||||||||||||
Richard
Rappaport
|
908,748
|
(3)
|
7.80
|
%
|
908,748
|
—
|
—
|
|||||||||||||
WestPark
Financial Services, LLC
|
567,499
|
(4)
|
4.87
|
%
|
567,499
|
—
|
—
|
|||||||||||||
Anthony
Pintsopoulos
|
136,500
|
(5)
|
1.17
|
%
|
136,500
|
—
|
—
|
|||||||||||||
Amanda
Rappaport Trust
|
61,425
|
(6)
|
*
|
61,425
|
—
|
—
|
||||||||||||||
Kailey
Rappaport Trust
|
61,425
|
(7)
|
*
|
61,425
|
—
|
—
|
||||||||||||||
Kevin
DePrimio
|
47,775
|
(8)
|
*
|
47,775
|
—
|
—
|
||||||||||||||
Jason
Stern
|
27,300
|
(9)
|
*
|
27,300
|
—
|
—
|
||||||||||||||
Total
|
*
|
Indicates less than
1.0%.
|
(1)
|
Based on 11,650,442 shares of
common stock outstanding as of the date of this
prospectus. The number of shares of our
common stock outstanding excludes 156,250 shares of common stock that are
issuable upon the exercise of outstanding warrants, except that in computing the number of
shares beneficially owned by a person and the percentage of ownership of
that person, shares of common stock subject to the warrants held by that
person that are currently exercisable or become exercisable within 60 days
of the date of this prospectus are
deemed outstanding even if they have not actually been exercised. Those
shares, however, are not deemed outstanding for the purpose of computing
the percentage ownership of any other
person.
|
(2)
|
Represents the amount of shares
that will be held by the selling stockholders after completion of this
offering based on the assumption that all shares registered for sale
hereby will be sold. However, the selling stockholders may offer all, some
or none of the shares pursuant to this prospectus, and to our knowledge
there are currently no agreements, arrangements or understandings with
respect to the sale of any of the shares that may be held by the selling
stockholders after completion of this
offering.
|
65
(3)
|
Includes
218,399 shares of common stock owned by Mr. Rappaport. Also includes
61,425 shares of common stock owned by each of the Amanda
Rappaport Trust and the Kailey Rappaport Trust as well as the shares of
common stock owned by WestPark Capital Financial Services, LLC.
Mr. Rappaport, as Trustee of the Rappaport Trusts and Chief Executive
Officer and Chairman of WestPark Capital Financial Services, LLC, may be
deemed the indirect beneficial owner of these securities since he has sole
voting and investment control over the
securities.
|
|
Mr.
Rappaport is Chief Executive Officer of WestPark Capital, Inc., a
registered Financial Industry Regulatory Authority (“FINRA”) member. For
purposes of this offering, Mr. Rappaport may be considered an underwriter.
Mr. Rappaport acquired these securities in the ordinary course of business
and that at the time of the acquisition of these securities, he had no
agreements or understandings, directly or indirectly, with any person to
distribute these securities. Mr. Rappaport is Trustee of the
Amanda Rappaport Trust and Kailey Rappaport Trust, and the father of the
beneficiaries of the foregoing trusts, which are also selling stockholders
in this prospectus. Mr. Rappaport is also the Chief Executive
Officer of WestPark Capital, Inc. and the sole owner of the membership
interests in WestPark Capital Financial Services, LLC, which are also
selling stockholders in this prospectus. WestPark Capital
Financial Services, LLC is the parent company of WestPark Capital,
Inc. Mr. Rappaport may be deemed the indirect beneficial owner
of the securities owned by the foregoing parties. Assuming such
beneficial ownership, Mr. Rappaport would beneficially own a total of
908,748 shares of common stock, which would constitute approximately 7.80%
of our outstanding stock.
|
(4)
|
Richard
Rappaport, as sole membership owner, has voting and investment control
over the shares owned by this entity. WestPark Capital
Financial Services, LLC is the parent company of WestPark Capital,
Inc.
|
(5)
|
Mr.
Pintsopoulos is Chief Financial Officer of WestPark Capital, Inc. For
purposes of this offering, Mr. Pintsopoulos may be considered an
underwriter. Mr. Pintsopoulos acquired these securities in the
ordinary course of business and that at the time of the acquisition of
these securities, he had no agreements or understandings, directly or
indirectly, with any person to distribute these
securities.
|
(6)
|
Richard
Rappaport, as trustee, has voting and investment control over the shares
owned by this entity.
|
(7)
|
Richard
Rappaport, as trustee, has voting and investment control over the shares
owned by this entity.
|
(8)
|
Mr.
DePrimio is the Vice President of Corporate Finance of WestPark Capital,
Inc. For purposes of this offering, Mr. DePrimio may be considered an
underwriter. Mr. DePrimio acquired these securities in the ordinary course
of business and that at the time of the acquisition of these securities,
he had no agreements or understandings, directly or indirectly, with any
person to distribute these
securities.
|
(9)
|
Mr.
Stern is an employee of WestPark Capital, Inc. For purposes of this
offering, Mr. Stern may be considered an underwriter. Mr. Stern acquired
these securities in the ordinary course of business and that at the time
of the acquisition of these securities, he had no agreements or
understandings, directly or indirectly, with any person to distribute
these securities
|
Except as
described in this Selling Stockholders section, none of the selling
stockholders, to our knowledge, has had a material relationship with our company
other than as a shareholder at any time within the past three
years.
·
|
On
January 14, 2009, in connection with the Purchase Right, we entered into a
Share and Warrant Cancellation Agreement and Registration Rights Agreement
with each of the persons and entities that held shares of our common stock
after the closing of the Share Exchange, which closed on January 9,
2009. These stockholders included WestPark Capital Financial
Services, LLC, Richard Rappaport, Anthony Pintsopoulos, Amanda Rappaport
Trust, Kailey Rappaport Trust, Kevin DePrimio, and Jason Stern, each of
whom and which are named as selling stockholders in this
prospectus. Pursuant to the cancellation agreement, the
stockholders agreed to cancel an aggregate of 1,688,532 shares held by
them such that there were 1,194,380 shares of common stock outstanding
after the Share and Warrant Cancellation. The stockholders also
agreed to cancel an aggregate of 2,712,283 warrants such that the
stockholders held an aggregate of 170,629 warrants after the Share and
Warrant Cancellation. Pursuant to the registration rights
agreement, we agreed to register the shares of common stock held by the
stockholders and the shares of common stock that each stockholder could
acquire upon the exercise of the outstanding warrants, after taking into
account the cancellation agreement. Of those shares, 243,774 shares
of common stock and 34,826 shares of common stock underlying warrants were
previously registered and 1,086,400 shares of common stock, which includes
135,794 shares that were issued to the stockholders pursuant to cashless
exercise of 135,803 warrants, are included in this
prospectus.
|
66
|
·
|
In
connection with the Private Placement we closed in May 2009, we paid
WestPark, as placement agent, a commission equal to 12% of the gross
proceeds from the financing plus a 4% non-accountable expense
allowance. No other consideration was paid to WestPark in
connection with the Share Exchange. In addition, WestPark acted
as a co-underwriter in our public offering that we closed in October
2009. We sold a total of 3,125,000 shares of common stock in
the public offering at $8.00 per share, for gross proceeds of
approximately $25 million. Compensation for WestPark’s services
included discounts, commissions and management fees of $348,136, a
non-accountable expense allowance of $100,000, and reimbursement of
roadshow expenses of approximately of $6,100 and legal counsel fees
(excluding blue sky fees) of $40,000. WestPark also received a
five-year warrant to purchase 62,500 shares of our common stock at an
exercise price of $10.00 per share.
|
|
·
|
Richard
Rappaport, one of our controlling stockholders prior to the Share
Exchange, indirectly holds a 100% interest in WestPark, the placement
agent for the Private Placement that closed in May 2009 and the
underwriter of our public offering in October 2009. Mr.
Rappaport was our President and Director from our inception until the
closing of the Share Exchange in January 2009, upon which he resigned from
all of his executive and director positions with us. Mr.
Rappaport is the Chief Executive Officer of WestPark and sole membership
interest holder in WestPark Capital Financial Services,
LLC.
|
|
·
|
Anthony
C. Pintsopoulos, an officer, director and significant stockholder of ours
prior to the Share Exchange, is the Chief Financial Officer of
WestPark. Mr. Pintsopoulos was our Secretary, Chief Financial
Officer and Director from our inception until the closing of the Share
Exchange in January 2009, upon which he resigned from all of his executive
and director positions with us.
|
|
·
|
WestPark
Capital Financial Services, LLC was one of our principal stockholders
prior to the Share Exchange and is the parent company of
WestPark. WestPark Capital Financial Services, LLC is owned and
controlled by Richard Rappaport. In addition, in connection
with the initial closing of the Private Placement, the Company issued a
promissory note in the principal amount of $170,000, bearing no interest
(the “Note”), to WestPark Capital Financial Services, LLC. The principal
was due and payable by us on or before the earlier of (a) thirty (30) days
from the date of issuance of the Note or (b) upon the receipt by us of at
least $4 million in the Private Placement. We repaid the Note in full on
January 23, 2009 using the proceeds from the second closing of the Private
Placement.
|
67
PLAN
OF DISTRIBUTION
The
selling stockholders of our common stock and any of their pledgees, assignees
and successors-in-interest may, from time to time, sell any or all of their
shares of common stock on any stock exchange, market or trading facility on
which the shares are traded or in private transactions. These sales may be
at fixed or negotiated prices. The selling stockholders may use any one or more
of the following methods when selling shares:
•
|
ordinary
brokerage transactions and transactions in which the broker-dealer
solicits purchasers;
|
•
|
block
trades in which the broker-dealer will attempt to sell the shares as agent
but may position and resell a portion of the block as principal to
facilitate the transaction;
|
•
|
purchases
by a broker-dealer as principal and resale by the broker-dealer for its
account;
|
•
|
an
exchange distribution in accordance with the rules of the applicable
exchange;
|
•
|
privately
negotiated transactions;
|
•
|
settlement
of short sales entered into after the date of this
prospectus;
|
•
|
broker-dealers
may agree with the selling stockholders to sell a specified number of such
shares at a stipulated price per
share;
|
•
|
a
combination of any such methods of
sale;
|
•
|
through
the writing or settlement of options or other hedging transactions,
whether through an options exchange or otherwise;
or
|
•
|
any
other method permitted pursuant to applicable
law.
|
The
selling stockholders may also sell shares under Rule 144 under the Securities
Act, if available, rather than under this prospectus.
Broker-dealers
engaged by the selling stockholders may arrange for other brokers-dealers to
participate in sales. Broker-dealers may receive commissions or discounts from
the selling stockholders (or, if any broker-dealer acts as agent for the
purchaser of shares, from the purchaser) in amounts to be negotiated. Each
selling stockholder does not expect these commissions and discounts relating to
its sales of shares to exceed what is customary in the types of transactions
involved. The maximum commission or discount to be received by any FINRA member
or independent broker-dealer, however, will not be greater than eight percent
(8%) for the sale of any securities being registered hereunder pursuant to Rule
415 of the Securities Act.
In
connection with the sale of our common stock or interests therein, the selling
stockholders may enter into hedging transactions with broker-dealers or other
financial institutions, which may in turn engage in short sales of the common
stock in the course of hedging the positions they assume. The selling
stockholders may also sell shares of our common stock short and deliver these
securities to close out their short positions, or loan or pledge the common
stock to broker-dealers that in turn may sell these securities. The selling
stockholders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities which require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such
transaction).
The
selling stockholders and any broker-dealers or agents that are involved in
selling the shares may be deemed to be “underwriters” within the meaning of the
Securities Act in connection with such sales. In such event, any commissions
received by such broker-dealers or agents and any profit on the resale of the
shares purchased by them may be deemed to be underwriting commissions or
discounts under the Securities Act. Each selling stockholder has informed us
that it does not have any agreement or understanding, directly or indirectly,
with any person to distribute the common stock.
We are
required to pay certain fees and expenses incurred by us incident to the
registration of the shares. We have agreed to indemnify the selling stockholders
against certain losses, claims, damages and liabilities, including liabilities
under the Securities Act.
Because
selling stockholders may be deemed to be “underwriters” within the meaning of
the Securities Act, they will be subject to the prospectus delivery requirements
of the Securities Act. In addition, any securities covered by this prospectus
which qualify for sale pursuant to Rule 144 under the Securities Act may be sold
under Rule 144 rather than under this prospectus. Each selling stockholder has
advised us that they have not entered into any agreements, understandings or
arrangements with any underwriter or broker-dealer regarding the sale of the
resale shares. There is no underwriter or coordinating broker acting in
connection with the proposed sale of the resale shares by the selling
stockholders.
68
We agreed
to keep this prospectus effective until the earlier of (i) the date on which the
shares may be resold by the selling stockholders without registration and
without regard to any volume limitations by reason of Rule 144 under the
Securities Act or any other rule of similar effect or (ii) all of the shares
have been sold pursuant to the prospectus or Rule 144 under the Securities Act
or any other rule of similar effect. The resale shares will be sold only through
registered or licensed brokers or dealers if required under applicable state
securities laws. In addition, in certain states, the resale shares may not be
sold unless they have been registered or qualified for sale in the applicable
state or an exemption from the registration or qualification requirement is
available and is complied with.
Under
applicable rules and regulations under the Exchange Act, any person engaged in
the distribution of the resale shares may not simultaneously engage in market
making activities with respect to our common stock for a period of two (2)
business days prior to the commencement of the distribution. In addition, the
selling stockholders will be subject to applicable provisions of the Exchange
Act and the rules and regulations thereunder, including Regulation M, which may
limit the timing of purchases and sales of shares of our common stock by the
selling stockholders or any other person. We will make copies of this prospectus
available to the selling stockholders and have informed them of the need to
deliver a copy of this prospectus to each purchaser at or prior to the time of
the sale.
69
LEGAL
MATTERS
The
validity of the common stock offered by this prospectus will be passed upon for
us by K&L Gates LLP, Los Angeles, California. Legal matters as to PRC law
will be passed upon for us by Han Kun Law Offices, Beijing, People’s Republic of
China. K&L Gates LLP may rely upon Han Kun Law Offices with respect to
matters governed by PRC law.
EXPERTS
The (i)
consolidated financial statements of ZST Digital Networks, Inc. as of December
31, 2008, 2007, and 2006 and for the years ended December 31, 2008, 2007, and
2006 (ii) and the condensed parent-only balance sheet of ZST Digital Networks,
Inc. as of December 31, 2008 and 2007 and the related condensed parent-only
statements of operations and cash flows for the year ended December 31, 2008 and
the period January 3, 2007 (inception) to December 31, 2007 included in footnote
23 to the Consolidated Financial Statements of ZST Digital Networks, Inc., each
appearing in this prospectus and registration statement have been audited by
Kempisty & Company Certified Public Accountants PC, an independent
registered public accounting firm, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
on the authority of such firm as experts in accounting and
auditing.
ADDITIONAL
INFORMATION
We filed
with the Securities and Exchange Commission a registration statement under the
Securities Act of 1933, as amended, for the shares of common stock in this
offering. This prospectus does not contain all of the information in the
registration statement and the exhibits and schedules that were filed with the
registration statement. For further information with respect to us and our
common stock, we refer you to the registration statement and the exhibits and
schedules that were filed with the registration statement. Statements contained
in this prospectus about the contents of any contract or any other document that
is filed as an exhibit to the registration statement are not necessarily
complete, and we refer you to the full text of the contract or other document
filed as an exhibit to the registration statement. A copy of the registration
statement and the exhibits and schedules that were filed with the registration
statement may be inspected without charge at the Public Reference Room
maintained by the Securities and Exchange Commission at 100 F Street, N.E.
Washington, DC 20549, and copies of all or any part of the registration
statement may be obtained from the Securities and Exchange Commission upon
payment of the prescribed fee. Information regarding the operation of the Public
Reference Room may be obtained by calling the Securities and Exchange Commission
at 1-800-SEC-0330. The Securities and Exchange Commission maintains a website
that contains reports, proxy and information statements, and other information
regarding registrants that file electronically with the SEC. The address of the
website is www.sec.gov
.
We file
periodic reports under the Securities Exchange Act of 1934, as amended,
including annual, quarterly and special reports, and other information with the
Securities and Exchange Commission. These periodic reports, and other
information, are available for inspection and copying at the regional offices,
public reference facilities and website of the Securities and Exchange
Commission referred to above.
70
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
FINANCIAL
STATEMENTS
SEPTEMBER
30, 2009
71
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
INDEX
PAGE
|
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
F-2
- F-3
|
CONSOLIDATED
BALANCE SHEETS
|
F-4
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
F-5
|
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME
|
F-6
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
F-7
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
F-8
- F-32
|
F-1
KEMPISTY
& COMPANY
CERTIFIED
PUBLIC ACCOUNTANTS, P.C.
15
MAIDEN LANE - SUITE 1003 - NEW YORK, NY 10038 - TEL (212) 406-7272 - FAX (212)
513-1930
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
ZST
Digital Networks, Inc. and Subsidiaries
We have
audited the accompanying consolidated balance sheets of ZST Digital Networks,
Inc. and Subsidiaries as of December 31, 2008, 2007 and 2006 and the related
consolidated statements of operations, consolidated cash flows and consolidated
changes in stockholders’ equity and comprehensive income for each of the years
in the three year period ended December 31, 2008. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these 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 at
this time, 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 includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of ZST Digital Networks, Inc.
and Subsidiaries at December 31, 2008, 2007 and 2006 and the results of its
operations and its cash flows for each of the years in the three year period
ended December 31, 2008 in conformity with accounting principles generally
accepted in the in the United States of America.
Kempisty
& Company
Certified
Public Accountants PC
New York,
New York
March 25,
2009, except for footnote 22 dated September 2, 2009
F-2
KEMPISTY
& COMPANY
CERTIFIED
PUBLIC ACCOUNTANTS, P.C.
15
MAIDEN LANE - SUITE 1003 - NEW YORK, NY 10038 - TEL (212) 406-7272 - FAX (212)
513-1930
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
ZST
Digital Networks, Inc. (Formerly SRKP 18, Inc.)
We have
audited the condensed Parent Only balance sheet of ZST Digital Networks, Inc. as
of December 31, 2008 and 2007 and the related condensed Parent Only statements
of operations and cash flows for the year ended December 31, 2008 and the period
January 3, 2007 (inception) to December 31, 2007 included in Footnote 23 to the
Consolidated Financial Statements of ZST Digital Networks, Inc. These
Parent Only condensed financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audit.
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 at
this time, 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 includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our
opinion, the condensed Parent Only financial statements referred to above
present fairly, in all material respects, the financial position of ZST Digital
Networks, Inc. at December 31, 2008 and 2007 and the results of its
operations and its cash flows for the year ended December 31, 2008 and the
period January 3, 2007 (inception) to December 31, 2007 in conformity with
accounting principles generally accepted in the in the United States of
America.
Kempisty
& Company
Certified
Public Accountants PC
New York,
New York
March 25,
2009, except for footnote 22 dated September 2, 2009
F-3
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Consolidated
Balance Sheets
(In U.S.
Dollars)
September 30,
|
September 30,
|
|||||||||||||||||||
2009
|
2008
|
December 31,
|
December 31,
|
December 31,
|
||||||||||||||||
(unaudited)
|
(unaudited)
|
2008
|
2007
|
2006
|
||||||||||||||||
Assets
|
||||||||||||||||||||
Current
assets
|
||||||||||||||||||||
Cash
and cash equivalents
|
$ | 1,394,458 | $ | 846,864 | $ | 1,134,954 | $ | 1,125,804 | $ | 1,183,665 | ||||||||||
Trade
receivables, net (Note 3)
|
25,634,262 | 18,213,473 | 12,322,099 | 9,419,029 | 3,417,763 | |||||||||||||||
Contract
receivable (Note 6)
|
- | 108,315 | - | 101,499 | 94,946 | |||||||||||||||
Employee
advances and short term loans receivable (Note 5)
|
5,280 | 7,944 | 6,307 | 769,855 | 731,645 | |||||||||||||||
Taxes
recoverable
|
- | - | - | - | 6,713 | |||||||||||||||
Inventories
(Note 4)
|
1,494,599 | 391,094 | 775,185 | 5,488,794 | 2,622,909 | |||||||||||||||
Advances
to suppliers (Note 13)
|
3,442,808 | - | 3,024,668 | - | - | |||||||||||||||
Prepaid
expenses and other receivables
|
56,545 | 154,528 | 6,968 | 12,930 | 11,579 | |||||||||||||||
Total
current assets
|
32,027,952 | 19,722,218 | 17,270,181 | 16,917,911 | 8,069,220 | |||||||||||||||
Property
and equipment, net (Note 7)
|
338,585 | 20,930 | 34,148 | 62,521 | 81,048 | |||||||||||||||
Intangible
asset, net (Note 8)
|
613,122 | - | - | - | - | |||||||||||||||
Total
assets
|
$ | 32,979,659 | $ | 19,743,148 | $ | 17,304,329 | $ | 16,980,432 | $ | 8,150,268 | ||||||||||
Liabilities
and Stockholders' Equity
|
||||||||||||||||||||
Current
liabilities
|
||||||||||||||||||||
Accounts
payable – trade
|
$ | 8,141,403 | $ | 7,425,614 | $ | 1,270,096 | $ | 3,026,572 | $ | 5,353,267 | ||||||||||
Customer
deposit
|
- | 1,464 | 1,467 | 36,854 | 3,206 | |||||||||||||||
Billings
in excess of costs on uncompleted projects (Note 10)
|
- | 31,550 | - | 18,635 | 1,943 | |||||||||||||||
Accrued
liabilities and other payable
|
230,037 | 269,128 | 501,176 | 222,440 | 146,971 | |||||||||||||||
Various
taxes payable
|
331,749 | 104,030 | 188,539 | 490,977 | 21,220 | |||||||||||||||
Short-term
loans (Note 9)
|
1,454,244 | 3,916,793 | 3,931,991 | 7,933,436 | 814,621 | |||||||||||||||
Employee
security deposit payable
|
10,312 | 18,954 | 8,911 | 12,281 | 12,831 | |||||||||||||||
Wages
payable
|
63,750 | 50,910 | 59,501 | 23,890 | 7,775 | |||||||||||||||
Dividend
payable
|
- | - | - | 2,624,266 | - | |||||||||||||||
Corporate
tax payable (Note 14)
|
434,388 | 269,223 | - | - | - | |||||||||||||||
Due
to related parties (Note 12)
|
- | 19,885 | 2,359,728 | 23,405 | 19,237 | |||||||||||||||
Total
current liabilities
|
10,665,883 | 12,107,551 | 8,321,409 | 14,412,756 | 6,381,071 | |||||||||||||||
Commitments
and contingencies (Note 15)
|
- | - | - | - | - | |||||||||||||||
Stockholders'
Equity
|
||||||||||||||||||||
Preferred
stock $0.0001 par value, 10,000,000 shares authorized, 6,250,000
shares undesignated, 0 share issued and outstanding at September
30, 2009 and 2008 and December
31, 2008, 2007 and 2006
|
- | - | - | - | - | |||||||||||||||
Preferred
Stock Series A Convertible, $0.0001 par value, 3,750,000 shares
authorized, 1,263,723 shares issued and outstanding at September
30, 2009, and 0 share issued
and outstanding at December 31, 2008, 2007 and 2006. Liquidation
preference and redemption value of $4,976,953 at September 30, 2009
(Note 19)
|
126 | - | - | - | - | |||||||||||||||
Common
stock $0.0001 par value, 100,000,000 shares authorized, 7,091,103
shares issued and outstanding at September 30, 2009, and 5,896,723
shares issued and
outstanding at September 30, 2008 and December 31, 2008, 2007and 2006 (Note
18)
|
709 | 590 | 590 | 590 | 590 | |||||||||||||||
Additional
paid-in capital
|
8,270,475 | 1,466,860 | 1,488,924 | 1,417,855 | 2,203,631 | |||||||||||||||
Accumulated
other comprehensive income
|
39,783 | 574,495 | 590,839 | 423,683 | 138,200 | |||||||||||||||
Statutory
surplus reserve fund (Note 11)
|
1,491,963 | 575,010 | 1,491,963 | 575,010 | 123,126 | |||||||||||||||
Retained
earnings (unrestricted)
|
12,510,720 | 5,025,957 | 5,410,604 | 219,086 | 427,807 | |||||||||||||||
Due
from related parties (Note 12)
|
- | (7,315 | ) | - | (68,548 | ) | (1,124,157 | ) | ||||||||||||
Total
stockholders' equity
|
22,313,776 | 7,635,597 | 8,982,920 | 2,567,676 | 1,769,197 | |||||||||||||||
Total
Liabilities and Stockholders' Equity
|
$ | 32,979,659 | $ | 19,743,148 | $ | 17,304,329 | $ | 16,980,432 | $ | 8,150,268 |
The accompanying notes are an integral
part of these consolidated financial statements.
F-4
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Consolidated
Statements of Operations
(In U.S.
Dollars)
For
the Nine Months Ended
|
||||||||||||||||||||
September
30,
|
For
the Year Ended
|
|||||||||||||||||||
2009
|
2008
|
December
31,
|
||||||||||||||||||
(unaudited)
|
(unaudited)
|
2008
|
2007
|
2006
|
||||||||||||||||
Revenue
|
$ | 70,067,184 | $ | 40,987,329 | $ | 55,430,819 | $ | 28,717,251 | $ | 5,650,246 | ||||||||||
Cost
of goods sold
|
58,773,620 | 33,563,129 | 45,594,243 | 23,221,360 | 4,477,671 | |||||||||||||||
Gross
Profit
|
11,293,564 | 7,424,200 | 9,836,576 | 5,495,891 | 1,172,575 | |||||||||||||||
Operating
Costs and Expenses
|
||||||||||||||||||||
Selling
expenses
|
35,334 | 107,235 | 146,459 | 2,587 | 19,381 | |||||||||||||||
Depreciation
|
27,641 | 33,637 | 20,884 | 43,546 | 42,047 | |||||||||||||||
General
and administrative
|
725,054 | 614,063 | 1,005,975 | 715,064 | 230,337 | |||||||||||||||
Merger
cost
|
566,654 | - | - | - | - | |||||||||||||||
Research
and development
|
109,068 | - | - | 88,864 | 48 | |||||||||||||||
Total
operating costs and expenses
|
1,463,751 | 754,935 | 1,173,318 | 850,061 | 291,813 | |||||||||||||||
Income
from operations
|
9,829,813 | 6,669,265 | 8,663,258 | 4,645,830 | 880,762 | |||||||||||||||
Other
income (expenses)
|
||||||||||||||||||||
Gain
on disposal of assets
|
- | - | (11,295 | ) | (319 | ) | 48,183 | |||||||||||||
Interest
income
|
43,819 | 14,777 | 9,753 | 3,489 | 473 | |||||||||||||||
Interest
expense
|
(140,693 | ) | (261,154 | ) | (338,742 | ) | (196,323 | ) | (11,616 | ) | ||||||||||
Imputed
interest
|
(31,417 | ) | (49,005 | ) | (71,069 | ) | (70,079 | ) | (19,905 | ) | ||||||||||
Sundry
income (expense), net
|
(7,682 | ) | (1,018 | ) | (10,869 | ) | 309 | 55,368 | ||||||||||||
Total
other income (expenses)
|
(135,973 | ) | (296,400 | ) | (422,222 | ) | (262,923 | ) | 72,503 | |||||||||||
Income
before income taxes
|
9,693,840 | 6,372,865 | 8,241,036 | 4,382,907 | 953,265 | |||||||||||||||
Income
taxes (Note 14)
|
(2,593,724 | ) | (1,565,994 | ) | (2,132,565 | ) | (1,515,478 | ) | (314,577 | ) | ||||||||||
Net
income
|
$ | 7,100,116 | $ | 4,806,871 | $ | 6,108,471 | $ | 2,867,429 | $ | 638,688 | ||||||||||
Basic
earnings per share
|
$ | 1.01 | $ | 0.82 | $ | 1.04 | $ | 0.49 | $ | 0.11 | ||||||||||
Weighted
average shares outstanding, basic
|
7,056,103 | 5,896,723 | 5,896,723 | 5,896,723 | 5,896,723 | |||||||||||||||
Diluted
earnings per share
|
$ | 0.86 | $ | 0.82 | $ | 1.04 | $ | 0.49 | $ | 0.11 | ||||||||||
Weighted
average shares outstanding, diluted
|
8,265,403 | 5,896,723 | 5,896,723 | 5,896,723 | 5,896,723 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-5
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Consolidated
Statements of Changes in Stockholders’ Equity and Comprehensive
Income
For the
years ended December 31, 2008, 2007 and 2006 and the nine months ended September
30, 2009 (unaudited)
(In
U.S. Dollars)
Accumulated
|
||||||||||||||||||||||||||||||||||||||||||||
Preferred
Stock
|
Additional
|
Statutory
|
Other
|
Retained
|
Due
from
|
Total
|
||||||||||||||||||||||||||||||||||||||
Series
A
|
Common
Stock
|
Paid-in
|
Reserve
|
Comprehensive
|
Earnings
|
Related
|
Stockholders'
|
Comprehensive
|
||||||||||||||||||||||||||||||||||||
Shares
|
Amount
|
Shares
|
Amount
|
Capital
|
Fund
|
Income
|
(Unrestricted)
|
Parties
|
Equity
|
Income
|
||||||||||||||||||||||||||||||||||
Balance
at December 31, 2005
|
- | $ | - | 5,896,723 | $ | 590 | $ | 2,183,726 | $ | 39,688 | $ | 49,963 | $ | (127,443 | ) | $ | (781,388 | ) | $ | 1,365,136 | ||||||||||||||||||||||||
Imputed
interest allocated
|
- | - | - | - | 19,905 | - | - | - | - | 19,905 | ||||||||||||||||||||||||||||||||||
Allocation
of retained earnings to statutory reserve fund
|
- | - | - | - | - | 83,438 | - | (83,438 | ) | - | - | |||||||||||||||||||||||||||||||||
Due
from related parties
|
- | - | - | - | - | - | - | - | (342,769 | ) | (342,769 | ) | ||||||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | 88,237 | - | - | 88,237 | $ | 88,237 | ||||||||||||||||||||||||||||||||
Net
income for the year
|
- | - | - | - | - | - | - | 638,688 | - | 638,688 | 638,688 | |||||||||||||||||||||||||||||||||
Comprehensive
income
|
- | - | - | - | - | - | - | - | - | - | $ | 726,925 | ||||||||||||||||||||||||||||||||
Balance
at December 31, 2006
|
- | - | 5,896,723 | 590 | 2,203,631 | 123,126 | 138,200 | 427,807 | (1,124,157 | ) | 1,769,197 | |||||||||||||||||||||||||||||||||
Authorized
capital withdrawal by ZST PRC shareholders
|
- | - | - | - | (855,855 | ) | - | - | - | - | (855,855 | ) | ||||||||||||||||||||||||||||||||
Imputed
interest allocated
|
- | - | - | - | 70,079 | - | - | - | - | 70,079 | ||||||||||||||||||||||||||||||||||
Allocation
of retained earnings to statutory reserve fund
|
- | - | - | - | - | 451,884 | - | (451,884 | ) | - | - | |||||||||||||||||||||||||||||||||
Due
from related parties
|
- | - | - | - | - | - | - | - | 1,055,609 | 1,055,609 | ||||||||||||||||||||||||||||||||||
Dividend
declared
|
- | - | - | - | - | - | - | (2,624,266 | ) | - | (2,624,266 | ) | ||||||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | 285,483 | - | - | 285,483 | $ | 285,483 | ||||||||||||||||||||||||||||||||
Net
income for the year
|
- | - | - | - | - | - | - | 2,867,429 | - | 2,867,429 | 2,867,429 | |||||||||||||||||||||||||||||||||
Comprehensive
income
|
- | - | - | - | - | - | - | - | - | - | $ | 3,152,912 | ||||||||||||||||||||||||||||||||
Balance
at December 31, 2007
|
- | - | 5,896,723 | 590 | 1,417,855 | 575,010 | 423,683 | 219,086 | (68,548 | ) | 2,567,676 | |||||||||||||||||||||||||||||||||
Imputed
interest allocated
|
- | - | - | - | 71,069 | - | - | - | - | 71,069 | ||||||||||||||||||||||||||||||||||
Allocation
of retained earnings to statutory reserve fund
|
- | - | - | - | - | 916,953 | - | (916,953 | ) | - | - | |||||||||||||||||||||||||||||||||
Due
from related parties
|
- | - | - | - | - | - | - | - | 68,548 | 68,548 | ||||||||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | 167,156 | - | - | 167,156 | $ | 167,156 | ||||||||||||||||||||||||||||||||
Net
income for the year
|
- | - | - | - | - | - | - | 6,108,471 | - | 6,108,471 | 6,108,471 | |||||||||||||||||||||||||||||||||
Comprehensive
income
|
- | - | - | - | - | - | - | - | - | - | $ | 6,275,627 | ||||||||||||||||||||||||||||||||
Balance
at December 31, 2008
|
- | - | 5,896,723 | 590 | 1,488,924 | 1,491,963 | 590,839 | 5,410,604 | - | 8,982,920 | ||||||||||||||||||||||||||||||||||
Reverse
merger adjustment
|
- | - | 1,194,380 | 119 | 3,216,305 | - | - | - | - | 3,216,424 | ||||||||||||||||||||||||||||||||||
Imputed
interest allocated
|
- | - | - | - | 31,417 | - | - | - | - | 31,417 | ||||||||||||||||||||||||||||||||||
Sale
of 1,263,723 shares of Series A
|
||||||||||||||||||||||||||||||||||||||||||||
Preferred
Stock at $3.94/share
|
1,263,723 | 126 | - | - | 3,533,829 | - | - | - | - | 3,533,955 | ||||||||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | (551,056 | ) | - | - | (551,056 | ) | $ | (551,056 | ) | |||||||||||||||||||||||||||||
Net
income for the nine months ended September 30, 2009
|
- | - | - | - | - | - | - | 7,100,116 | - | 7,100,116 | 7,100,116 | |||||||||||||||||||||||||||||||||
Comprehensive
income
|
- | - | - | - | - | - | - | - | - | - | $ | 6,549,060 | ||||||||||||||||||||||||||||||||
Balance
at September 30, 2009
(unaudited) |
1,263,723 | $ | 126 | 7,091,103 | $ | 709 | $ | 8,270,475 | $ | 1,491,963 | $ | (39,783 | ) | $ | 12,510,720 | $ | - | $ | 22,313,776 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-6
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Consolidated
Statements of Cash Flows
(In U.S.
Dollars)
For
the Nine Months Ended
|
||||||||||||||||||||
September
30,
|
For
the Year Ended
|
|||||||||||||||||||
2009
|
2008
|
December
31,
|
||||||||||||||||||
(unaudited)
|
(unaudited)
|
2008
|
2007
|
2006
|
||||||||||||||||
Cash
Flows From Operating Activities
|
||||||||||||||||||||
Net
income
|
$ | 7,100,116 | $ | 4,806,871 | $ | 6,108,471 | $ | 2,867,429 | $ | 638,688 | ||||||||||
Adjustments
to reconcile net income to net cash provided (used) by operating
activities:
|
||||||||||||||||||||
Imputed
interest
|
31,417 | 49,005 | 71,069 | 70,079 | 19,905 | |||||||||||||||
Depreciation
|
27,641 | 33,637 | 20,884 | 43,546 | 42,047 | |||||||||||||||
Amortization
|
32,250 | - | - | - | - | |||||||||||||||
Gain
on disposal of assets
|
- | - | 11,295 | 319 | (48,183 | ) | ||||||||||||||
Changes
in operating assets and liabilities:
|
||||||||||||||||||||
(Increase)/Decrease
|
||||||||||||||||||||
Account
receivable-trade
|
(13,312,163 | ) | (8,794,444 | ) | (2,903,070 | ) | (6,001,266 | ) | (2,017,173 | ) | ||||||||||
Contract
receivable
|
- | (6,816 | ) | 101,499 | (6,553 | ) | (43,249 | ) | ||||||||||||
Prepaid
expenses and other receivables
|
(49,577 | ) | (141,598 | ) | 5,962 | (1,351 | ) | 13,183 | ||||||||||||
Inventories
|
(719,414 | ) | 5,097,700 | 4,713,609 | (2,865,885 | ) | (1,809,028 | ) | ||||||||||||
Advances
to suppliers
|
(418,140 | ) | - | (3,024,668 | ) | - | - | |||||||||||||
Increase/(Decrease)
|
||||||||||||||||||||
Accounts
payable and accrued liabilities
|
6,600,168 | 4,445,730 | (1,477,740 | ) | (2,251,226 | ) | 4,456,606 | |||||||||||||
Deposits
and other payables
|
(66 | ) | (28,717 | ) | (38,757 | ) | 33,098 | - | ||||||||||||
Billings
in excess of costs on uncompleted projects
|
- | 12,915 | (18,635 | ) | 16,692 | 1,943 | ||||||||||||||
Various
taxes payable and taxes recoverable
|
143,210 | (386,947 | ) | (302,438 | ) | 476,470 | (64,187 | ) | ||||||||||||
Wages
payable
|
4,249 | 27,020 | 35,611 | 16,115 | 7,774 | |||||||||||||||
Corporate
tax payable
|
434,388 | 269,223 | - | - | (93,092 | ) | ||||||||||||||
Net
cash provided (used) by operating activities
|
(125,921 | ) | 5,383,579 | 3,303,092 | (7,602,533 | ) | 1,105,234 | |||||||||||||
Cash
Flows From Investing Activities
|
||||||||||||||||||||
Purchases
of property and equipment
|
(324,726 | ) | - | - | (43,082 | ) | - | |||||||||||||
Purchases
of intangible assets
|
(644,966 | ) | - | - | - | - | ||||||||||||||
Proceeds
from disposal of fixed assets
|
- | - | - | 22,661 | 193,186 | |||||||||||||||
Payment
to ZST PRC shareholders
|
- | - | - | 1,055,609 | (342,769 | ) | ||||||||||||||
Net
cash provided (used) by investing activities
|
(969,692 | ) | - | - | 1,035,188 | (149,583 | ) | |||||||||||||
Cash
Flows From Financing Activities
|
||||||||||||||||||||
(Proceeds
from) repayment of short-term demand loans receivable
|
1,027 | 761,911 | 763,548 | (38,210 | ) | (142,071 | ) | |||||||||||||
Proceeds
from (repayment of) short-term demand loans payable
|
(2,477,747 | ) | (4,016,643 | ) | (4,001,445 | ) | 7,118,815 | 259,771 | ||||||||||||
Net
proceeds from sale of preferred stock
|
3,533,955 | 61,233 | - | - | - | |||||||||||||||
Withdrawal
of authorized capital by ZST PRC shareholders
|
- | - | - | (855,855 | ) | - | ||||||||||||||
Dividend
paid
|
- | (2,624,266 | ) | (2,624,266 | ) | - | - | |||||||||||||
Due
from related parties and affiliated companies
|
- | - | 68,548 | - | - | |||||||||||||||
Due
to related parties and affiliated companies
|
- | (3,520 | ) | 2,336,323 | 4,168 | (237,239 | ) | |||||||||||||
Net
cash provided (used) by financing activities
|
1,057,235 | (5,821,285 | ) | (3,457,292 | ) | 6,228,918 | (119,539 | ) | ||||||||||||
Effect
of exchange rate changes on cash
|
297,882 | 158,766 | 163,350 | 280,566 | 124,725 | |||||||||||||||
Net
increase (decrease) in cash and cash equivalents
|
259,504 | (278,940 | ) | 9,150 | (57,861 | ) | 960,837 | |||||||||||||
Cash
and cash equivalents, beginning of period
|
1,134,954 | 1,125,804 | 1,125,804 | 1,183,665 | 222,828 | |||||||||||||||
Cash
and cash equivalents, end of period
|
$ | 1,394,458 | $ | 846,864 | $ | 1,134,954 | $ | 1,125,804 | $ | 1,183,665 | ||||||||||
Supplemental
disclosure information:
|
||||||||||||||||||||
Interest
expense paid
|
$ | 140,693 | $ | 261,154 | $ | 338,742 | $ | 196,323 | $ | 11,616 | ||||||||||
Income
taxes paid
|
$ | 2,159,336 | $ | 1,296,771 | $ | 2,132,565 | $ | 1,515,478 | $ | 314,577 | ||||||||||
Non
cash investing and financing activities:
|
||||||||||||||||||||
Shares
issued for related parties' debt
|
$ | 2,359,728 | $ | - | $ | - | $ | - | $ | - |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-7
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended Septemner 30, 2009 and 2008 are
unaudited)
NOTE
1 – DESCRIPTION OF BUSINESS AND ORGANIZATION
ZST
Digital Networks, Inc. (“ZST Digital”, formerly SRKP 18, Inc.) was incorporated
in the State of Delaware on December 7, 2006. ZST Digital was originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation. On January 9, 2009, ZST Digital closed a share exchange transaction
(the “Share Exchange”) pursuant to which ZST Digital (i) issued 806,408 shares
of its common stock to acquire 100% equity ownership of World Orient Universal
Limited (“World Orient”), which is the 100% parent of Global Asia Universal
Limited (“Global Asia”), which is the 100% parent of Everfair Technologies
Limited (“Everfair”), which is the 100% parent of Zhengzhou Shenyang Technology
Company Limited (“ZST PRC”), (ii) assumed the operations of World Orient and its
subsidiaries, and (iii) changed ZST Digital’s name from SRKP 18, Inc. to its
current name. Subsequent to the closing of the Share Exchange, on
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the "ZST Management"),
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management agreed to purchase an aggregate of
5,090,315 shares of our common stock at a per share purchase price of $0.6907
(the "Purchase Right") and obtained control of the Company. The
purchase price for the shares was paid in full on May 25, 2009. The
restructuring of the Company is further discussed below.
World
Orient was incorporated in British Virgin Islands (“BVI”) on August 12, 2008. As
at December 31, 2008, World Orient had 50,000 capital shares authorized with
$1.00 par value and 50,000 shares issued and outstanding. In November 2008,
World Orient acquired 100% ownership of Global Asia.
Global
Asia was incorporated in BVI on August 12, 2008. As at December 31, 2008, Global
Asia had 50,000 capital shares authorized with $1.00 par value and 50,000 shares
issued and outstanding. In October 2008, Global Asia acquired 100% ownership of
Everfair.
Everfair
is a holding company incorporated in November 26, 2007 in Hong Kong, PRC with
the original sole shareholder Kuk Kok Sun. Everfair had 10,000 capital shares
authorized with 1.00 HKD par value and 10,000 shares issued and outstanding.
Pursuant to a share transfer agreement, Global Asia agreed to paid Kuk Kok Sun
10,000 HKD for the ownership transfer.
In
October 2008, Everfair entered an ownership transfer agreement with the original
owners of ZST PRC. Pursuant to the ownership transfer agreement, Everfair agreed
to pay the original owners 12,000,000 RMB for the ownership transfer within
three months of the approval of a new business license. This transfer was
completed in January 2009 after the closing of the Share Exchange and exercise
of the purchase rights by the shareholders of ZST PRC.
ZST PRC
was established on May 20, 1996 as a private domestic corporation in Zhengzhou,
Henan Province, PRC with an authorized capital of RMB 1.5 million. On April 8,
1999, the Company increased its authorized capital from RMB 1.5 million to RMB 8
million. On July 27, 2004, the Company further increased its authorized capital
to RMB 18 million. On March 15, 2007, the Company decreased its authorized and
invested capital to RMB 11.5 million. In February 2009, ZST PRC increased its
authorized capital to RMB 17 million.
ZST PRC’s
primary revenues were from sales of broadcasting equipment, hi-tech optical
transmission devices, and telecommunication products. ZST PRC is principally
engaged in supplying digital and optical network equipment to cable system
operators in the Henan Province of China. It has developed a line of internet
protocol television (“IPTV”) set-top boxes that are used to provide bundled
cable television, Internet and telephone services to residential and commercial
customers. At present, ZST PRC’s main clients are broadcasting TV bureaus and
cable network operators serving various cities and counties. In the near future,
the Company plans to joint venture with cable network operators to provide
bundled television programming, Internet and telephone services to residential
customers in cities and counties located in the Henan Province of
China.
ZST
Digital and its subsidiaries, World Orient, Global Asia, Everfair, and ZST PRC
shall be collectively referred throughout as the “Company”.
F-8
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
1 – DESCRIPTION OF BUSINESS AND ORGANIZATION (continued)
Pursuant
to PRC rules and regulations relating to mergers of PRC companies with foreign
entities, an offshore company controlled by PRC citizens that intends to merge
with a PRC company will be subject to strict examination by the relevant PRC
foreign exchange authorities. To enable ZST PRC to go public, ZST management
made the following restructuring arrangements: (i) established Everfair as a
Hong Kong holding company owned by a non-PRC citizen and indirectly controlled
the operations of Everfair, (ii) had Everfair enter into an equity transfer
agreement with ZST PRC by paying 12,000,000 RMB to ZST Management, (iii)
established World Orient as a BVI holding company owned by a non PRC-citizen,
(iv) had World Orient and its wholly owned subsidiary Global Asia, its
subsidiary Everfair, and its subsidiary ZST PRC enter into a share exchange
agreement with ZST Digital, (v) concurrently conducted a private investment in a
public company (“PIPE”) financing, and (vi) used proceeds from the PIPE
transaction to pay 12,000,000 RMB to ZST Management pursuant to the ownership
transfer agreement.
Upon
consummation of the Share Exchange and the Purchase Right, ZST Management owns a
majority of the issued and outstanding shares of common stock of the Company and
Zhong Bo was appointed as Chairman of the Board and Chief Executive Officer of
ZST Digital.
For
accounting purposes, this transaction is being accounted for as a reverse
merger. The transaction has been treated as a recapitalization of World Orient
and its subsidiaries, with ZST Digital (the legal acquirer of World Orient and
its subsidiaries including ZST PRC) considered the accounting acquiree and ZST
PRC, the only operating company, and whose management took control of ZST
Digital (the legal acquiree of ZST Digital) is considered the accounting
acquirer. The Company did not recognize goodwill or any intangible
assets in connection with the transaction.
On
October 6, 2009, the Company effected a 1-for-2.461538462 reverse stock split of
the Company’s issued and outstanding shares of common stock (the “Reverse Stock
Split”). The par value and number of authorized shares of the common stock
remained unchanged. All references to number of shares and per share amounts
included in these consolidated financial statements and the accompanying notes
have been adjusted to reflect the Reverse Stock Split
retroactively.
To
summarize the paragraphs above, the organization and ownership structure of the
Company is currently as follows:
F-9
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
Presentation
The
accompanying consolidated financial statements have been prepared by the Company
in accordance with accounting principles generally accepted in the United States
of America (“US GAAP”).
In the
opinion of the management, the consolidated financial statements reflect all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position of the Company as of September 30, 2009
and 2008, and December 31, 2008, 2007, and 2006; and the results of operations
and cash flows for the nine months ended September 30, 2009 and 2008, and the
years then ended December 31, 2008, 2007 and 2006, respectively.
The
Company has evaluated subsequent events through the date that the financial
statements were issued, which was November 15, 2009, the date immediately
preceding the date of the Company’s Quarterly Report on Form 10-Q for the period
ended September 30, 2009.
Basis of
Consolidation
The
consolidated financial statements include the accounts of the Company and its
subsidiaries. All significant inter-company transactions have been eliminated in
consolidation.
Use of
Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting year. Because of the use
of estimates inherent in the financial reporting process, actual results could
differ from those estimates.
Fair Value of Financial
Instruments
The
standard for “Disclosures About Fair Value of Financial Instruments,” defines
financial instruments and requires fair value disclosures of those financial
instruments. On January 1, 2008, the Company adopted the standard “Fair Value
Measurements,” which defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances disclosures
requirements for fair value measures. Current assets and current liabilities
qualified as financial instruments and management believes their carrying
amounts are a reasonable estimate of fair value because of the short period of
time between the origination of such instruments and their expected realization
and if applicable, their current interest rate is equivalent to interest rates
currently available. The three levels are defined as
follow:
|
·
|
Level
1 — inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active
markets.
|
|
·
|
Level
2 — inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the assets or liability, either directly or indirectly, for
substantially the full term of the financial
instruments.
|
|
·
|
Level
3 — inputs to the valuation methodology are unobservable and significant
to the fair value.
|
As of the
balance sheet date, the estimated fair values of the financial instruments were
not materially different from their carrying values as presented due to the
short maturities of these instruments and that the interest rates on the
borrowings approximate those that would have been available for loans of similar
remaining maturity and risk profile at respective period-ends. Determining which
category an asset or liability falls within the hierarchy requires significant
judgment. The Company evaluates the hierarchy disclosures each
quarter.
Cash and Cash
Equivalents
Cash and
cash equivalents include cash on hand, cash on deposit with various financial
institutions in PRC, Hong Kong, and all highly-liquid investments with original
maturities of three months or less at the time of purchase. Banks and
other financial institutions in PRC do not provide insurance for funds held on
deposit.
F-10
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Accounts
Receivable
Accounts
receivable are carried at original invoice amount less an estimate made for
doubtful accounts based on a review of all outstanding amounts on a monthly
basis. The Company analyzes the aging of accounts receivable balances,
historical bad debts, customer concentrations, customer credit-worthiness,
current economic trends and changes in our customer payment terms. Significant
changes in customer concentration or payment terms, deterioration of customer
credit-worthiness or weakening in economic trends could have a significant
impact on the collectability of receivables and our operating results. The
Company has not provided a bad debt allowance based upon its historical
collection experience. There were no bad debts written off during the years
ended December 31, 2008, 2007, and 2006, and the six months September 30, 2009
and 2008, respectively.
According
to the sales contract terms, customers are able to hold back 10% of the total
contract balance payable to the Company for one year. The hold back is carried
at 10% of original invoice as accounts receivable.
Inventories
Inventories,
which are primarily comprised of raw materials and finished goods, are stated at
the lower of cost or net realizable value, using the first-in first-out (FIFO)
method. Cost is determined on the basis of a moving average. The Company
evaluates the need for reserves associated with obsolete, slow-moving and
non-salable inventory by reviewing net realizable values on a periodic
basis.
Property and
Equipment
Property
and equipment are recorded at cost and depreciated using the straight-line
method, with an estimated 5% salvage value of original cost, over the estimated
useful lives of the assets as follows:
Machinery
and equipment
|
5
years
|
|
Electronic
equipment
|
5
years
|
|
Office
equipment
|
5
years
|
|
Automobile
|
5
years
|
|
Other
equipment
|
10
years
|
Expenditures
for repairs and maintenance, which do not improve or extend the expected useful
lives of the assets, are expensed as incurred while major replacements and
improvements are capitalized.
When
property or equipment is retired or disposed of, the cost and accumulated
depreciation are removed from the accounts, with any resulting gains or losses
being included in net income or loss in the year of disposition.
Impairment of Long-Lived
Assets
The
Company accounts for impairment of plant and equipment and amortizable
intangible assets in accordance with the standard of “Accounting for Impairment
of Long-Lived Assets and Long-Lived Assets to be Disposed Of”, which requires
the Company to evaluate a long-lived asset for recoverability when there is
event or circumstance that indicate the carrying value of the asset may not be
recoverable. An impairment loss is recognized when the carrying amount of a
long-lived asset or asset group is not recoverable (when carrying amount exceeds
the gross, undiscounted cash flows from use and disposition) and is measured as
the excess of the carrying amount over the asset’s (or asset group’s) fair
value.
Intangible
Assets
Intangible
assets are recorded at cost and amortized using the straight-line method over
the estimated useful lives of the assets as follows:
Software
|
5
years
|
F-11
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Revenue
Recognition
The
Company recognizes product sales revenue when the significant risks and rewards
of ownership have been transferred pursuant to PRC law, including such factors
as when persuasive evidence of an arrangement exists, delivery has occurred, the
sales price is fixed or determinable, sales and value-added tax laws have been
complied with, and collectability is reasonably assured. The Company generally
recognizes revenue when its products are shipped.
The IPTV
device sales contracts include a one-year quality assurance warranty for
defects. According to the sales contract terms, customers are able to
hold back 10% of the total contract balance payable to the Company for one year.
In accordance with the standard of "Revenue Recognition When Right of Return
Exists", the Company records the holdback as revenue at the time of sale when
its products are shipped to customers because:
(a)
|
The
contract price to the customer is predetermined and fixed at the date of
sale.
|
(b)
|
The
customer is obligated to pay the Company the 10% holdback after one year
and the obligation is not contingent on resale of the
product.
|
(c)
|
The
customer’s obligation to the Company would not be changed in the event of
theft or physical destruction or damage of the product because the Company
entrust the suppliers to ship the products to the customers, therefore the
suppliers bear the liability for products lost or damaged when in transit
to the customers.
|
(d)
|
The
customer acquiring the product for resale has economic substance apart
from that provided by the Company.
|
(e)
|
The
Company does not have significant obligations for future performance to
directly bring about resale of the product by the customer other than
replacement of defective product due to hardware defects in materials and
workmanship.
|
(f)
|
The
amount of future returns can be reasonably
estimated based on the historical returns
experience.
|
The
Company determined that the costs associated with such assurance were immaterial
in monetary terms based on the historical returns experience. The Company has a
return policy where the customers must make a request within 30 days of receipt
to return the products when the products delivered have more than 40% defects or
the products are not delivered on time. As of September 30, 2009, the Company
has not received any returns.
In the
event of defective product returns, the Company has the right to seek
replacement of such returned units from its supplier. Based on the agreement,
the supplier will replace the defective product when the defects are caused by
hardware defects in materials and workmanship during manufacturing process for a
period of one year. The Company incurred quality assurance costs of $199,999,
$63,495, $0, $0 and $0 for the years ended December 31, 2008, 2007 and 2006 and
for the nine months ended September 30, 2009 and 2008,
respectively. These costs incurred represent 0.67%, 0.52%, 0%, 0%, 0%
of years ended December 31, 2008, 2007 and 2006 and nine months ended September
30, 2009 and 2008 IPTV box sales, respectively.
Based on
the facts above, the Company recognizes costs related to the quality assurance
when incurred.
Revenues
from fixed-price construction contracts are recognized on the completed-contract
method. This method is used because most of the construction and engineering
contracts are completed within six months or less and financial position and
results of operations do not vary significantly from those which would result
from using the percentage-of-completion method. A contract is considered
complete when all costs have been incurred and the installation is operating
according to specifications or has been accepted by the customer.
Contract
costs include all direct material and labor costs and those indirect costs
related to contract performance, such as indirect labor, suppliers, tools,
repairs, and depreciation costs. General and administrative costs are charged to
expenses as incurred. Provisions for estimated losses on uncompleted contracts
are made in the period in which such losses are determined. Claims are included
in revenues when received.
Comprehensive
Income
The
Company has adopted the standard of “Reporting
Comprehensive Income”, which establishes standards for reporting and displaying
comprehensive income, its components, and accumulated balances in a full-set of
general-purpose financial statements. Accumulated other comprehensive income
represents the accumulated balance of foreign currency translation
adjustments.
F-12
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Related
Parties
A party
is considered to be related to the Company if the party directly or indirectly
or through one or more intermediaries, controls, is controlled by, or is under
common control with the Company. Related parties also include principal owners
of the Company, its management, members of the immediate families of principal
owners of the Company and its management and other parties with which the
Company may deal if one party controls or can significantly influence the
management or operating policies of the other to an extent that one of the
transacting parties might be prevented from fully pursuing its own separate
interests. A party which can significantly influence the management or operating
policies of the transacting parties or if it has an ownership interest in one of
the transacting parties and can significantly influence the other to an extent
that one or more of the transacting parties might be prevented from fully
pursuing its own separate interests is also a related party.
Income
Taxes
The
Company accounts for income taxes in accordance with the standard of “Accounting
for Income Taxes”, which requires an asset and liability approach for financial
accounting and reporting for income taxes and allows recognition and measurement
of deferred tax assets based upon the likelihood of realization of tax benefits
in future years. Under the asset and liability approach, deferred taxes are
provided for the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. A valuation allowance is provided for
deferred tax assets if it is more likely than not these items will either expire
before the Company is able to realize their benefits, or that future
deductibility is uncertain.
The
Company adopted standard of “Accounting for Uncertainty in Income Taxes,” which
prescribes a comprehensive model for how a company should recognize, measure,
present and disclose in its financial statements uncertain tax positions that
the Company has taken or expects to take on a tax return (including a decision
whether to file or not to file a return in a particular
jurisdiction).
Research and
Development
Research
and development costs are expensed to operations as incurred. The Company spent
$5,000, $88,864, and $48 for the years ended December 31, 2008, 2007 and 2006,
respectively, and $109,068 and nil for the nine months ended September 30, 2009
and 2008, respectively on direct research and development (“R&D”)
efforts.
The
Company received reimbursement from the local government therefore research and
development expenses net of reimbursement was $0 for the year ended December 31,
2008.
Advertising
Costs
The
Company expenses advertising costs as incurred. The Company did not incur any
advertising expenses for the years ended December 31, 2008, 2007 and 2006, and
the nine months ended September 30, 2009 and 2008, respectively.
Foreign Currency
Translation
The
functional currency of ZST PRC is RMB, the functional currencies of World
Orient, Global Asia, and Everfair are HKD, and the functional currency of ZST
Digital is the local currency, RMB. The Company used the RMB as the functional
currency of ZST Digital since RMB is the currency of primary economic
environment. The Company maintains its financial statements using the functional
currency. Monetary assets and liabilities denominated in currencies other than
the functional currency are translated into the functional currency at rates of
exchange prevailing at the balance sheet dates. Transactions denominated in
currencies other than the functional currency are translated into the functional
currency at the exchange rates prevailing at the dates of the transaction.
Exchange gains or losses arising from foreign currency transactions are included
in the determination of net income (loss) for the respective
periods.
F-13
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Foreign Currency Translation
(Continued)
For
financial reporting purposes, the financial statements of each subsidiary, which
are prepared in either RMB or HKD, are translated into the Company’s reporting
currency, USD. Balance sheet accounts are translated using the closing exchange
rate in effect at the balance sheet date and income and expense accounts are
translated using the average exchange rate prevailing during the reporting
period. Adjustments resulting from the translation, if any, are included in
accumulated other comprehensive income (loss) in the owners’
equity.
The
exchange rates used for foreign currency translation were as follows (USD$1 =
RMB):
Period Covered
|
Balance Sheet Date Rates
|
Average Rates
|
||||||
Nine
months ended September 30, 2009
|
6.81756 | 6.82174 | ||||||
Nine
months ended September 30, 2008
|
6.83527 | 6.97496 | ||||||
Year
Ended December 31, 2008
|
6.81731 | 6.93730 | ||||||
Year
Ended December 31, 2007
|
7.29410 | 7.59474 | ||||||
Year
Ended December 31, 2006
|
7.79750 | 7.96369 |
The
exchange rates used for foreign currency translation were as follows (USD$1 =
HKD):
Period Covered
|
Balance Sheet Date Rates
|
Average Rates
|
||||||
Nine
months ended September 30, 2009
|
7.75013 | 7.75193 | ||||||
Nine
months ended September 30, 2008
|
7.76908 | 7.79838 | ||||||
Year
Ended December 31, 2008
|
7.74960 | 7.74960 | ||||||
Year
Ended December 31, 2007
|
7.80214 | 7.70153 |
Recently Issued Accounting
Pronouncements
In
June 2009, the Financial Accounting Standards Board (FASB) issued a
standard that established the FASB Accounting Standards Codification (ASC)
and amended the hierarchy of generally accepted accounting principles (GAAP)
such that the ASC became the single source of authoritative nongovernmental U.S.
GAAP. The ASC did not change current U.S. GAAP, but was intended to simplify
user access to all authoritative U.S. GAAP by providing all the authoritative
literature related to a particular topic in one place. All previously existing
accounting standard documents were superseded and all other accounting
literature not included in the ASC is considered non-authoritative. New
accounting standards issued subsequent to June 30, 2009 are communicated by
the FASB through Accounting Standards Updates (ASUs). The Company adopted the
ASC on July 1, 2009. This standard did not have an impact on our
consolidated results of operations or financial condition. However, throughout
the notes to the consolidated financial statements references that were
previously made to various former authoritative U.S. GAAP pronouncements have
been changed to coincide with the appropriate section of the ASC.
In
September 2006, the FASB issued an accounting standard codified in ASC 820,
Fair Value Measurements and
Disclosures. This standard established a single definition of fair value
and a framework for measuring fair value, set out a fair value hierarchy to be
used to classify the source of information used in fair value measurements, and
required disclosures of assets and liabilities measured at fair value based on
their level in the hierarchy. This standard applies under other accounting
standards that require or permit fair value measurements. One of the amendments
deferred the effective date for one year relative to nonfinancial assets and
liabilities that are measured at fair value, but are recognized or disclosed at
fair value on a nonrecurring basis. This deferral applied to such items as
nonfinancial assets and liabilities initially measured at fair value in a
business combination (but not measured at fair value in subsequent periods) or
nonfinancial long-lived asset groups measured at fair value for an impairment
assessment. The adoption of the fair value measurement standard did not
have a material impact on our consolidated results of operations or financial
condition.
F-14
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recently Issued Accounting
Pronouncements
In
December 2007, the FASB issued and, in April 2009, amended a new
business combinations standard codified within ASC 805, which changed the
accounting for business acquisitions. Accounting for business combinations under
this standard requires the acquiring entity in a business combination to
recognize all (and only) the assets acquired and liabilities assumed in the
transaction and establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed in a business
combination. Certain provisions of this standard impact the determination of
acquisition-date fair value of consideration paid in a business combination
(including contingent consideration); exclude transaction costs from acquisition
accounting; and change accounting practices for acquisition-related
restructuring costs, in-process research and development, indemnification
assets, and tax benefits. We adopted the standard for business combinations for
our business combination during the period ended March 31, 2009.
In
April 2009, the FASB issued an accounting standard which provides guidance
on (1) estimating the fair value of an asset or liability when the volume
and level of activity for the asset or liability have significantly declined and
(2) identifying transactions that are not orderly. The standard also
amended certain disclosure provisions for fair value measurements and
disclosures in ASC 820 to require, among other things, disclosures in interim
periods of the inputs and valuation techniques used to measure fair value as
well as disclosure of the hierarchy of the source of underlying fair value
information on a disaggregated basis by specific major category of investment.
The standard was effective prospectively beginning April 1, 2009. The
adoption of this standard did not have a material impact on our consolidated
results of operations or financial condition.
In
April 2009, the FASB issued an accounting standard which modifies the
requirements for recognizing other-than-temporarily impaired debt securities and
changes the existing impairment model for such securities. The standard also
requires additional disclosures for both annual and interim periods with respect
to both debt and equity securities. Under the standard, impairment of debt
securities will be considered other-than-temporary if an entity (1) intends
to sell the security, (2) more likely than not will be required to sell the
security before recovering its cost, or (3) does not expect to recover the
security’s entire amortized cost basis (even if the entity does not intend to
sell). The standard further indicates that, depending on which of the above
factor(s) causes the impairment to be considered other-than-temporary,
(1) the entire shortfall of the security’s fair value versus its amortized
cost basis or (2) only the credit loss portion would be recognized in
earnings while the remaining shortfall (if any) would be recorded in other
comprehensive income. The standard requires entities to initially apply its
provisions to previously other-than-temporarily impaired debt securities
existing as of the date of initial adoption by making a cumulative-effect
adjustment to the opening balance of retained earnings in the period of
adoption. The cumulative-effect adjustment potentially reclassifies the
noncredit portion of a previously other-than-temporarily impaired debt security
held as of the date of initial adoption from retained earnings to accumulated
other comprehensive income. The adoption of this standard did not have a
material impact on our consolidated results of operations or financial
condition.
In
April 2009, the FASB issued an accounting standard regarding interim
disclosures about fair value of financial instruments. The standard essentially
expands the disclosure about fair value of financial instruments that were
previously required only annually to also be required for interim period
reporting. In addition, the standard requires certain additional disclosures
regarding the methods and significant assumptions used to estimate the fair
value of financial instruments. The adoption of this standard did not have a
material impact on our consolidated results of operations or financial
condition.
In
May 2009, the FASB issued a new accounting standard regarding subsequent
events. This standard incorporates into authoritative accounting literature
certain guidance that already existed within generally accepted auditing
standards, with the requirements concerning recognition and disclosure of
subsequent events remaining essentially unchanged. This guidance addresses
events which occur after the balance sheet date but before the issuance of
financial statements. Under the new standard, as under previous practice, an
entity must record the effects of subsequent events that provide evidence about
conditions that existed at the balance sheet date and must disclose but not
record the effects of subsequent events which provide evidence about conditions
that did not exist at the balance sheet date. This standard added an additional
required disclosure relative to the date through which subsequent events have
been evaluated and whether that is the date on which the financial statements
were issued. For our company,
this standard was effective beginning April 1, 2009.
F-15
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recently Issued Accounting
Pronouncements
In
June 2009, the FASB issued a new standard regarding the accounting for
transfers of financial assets amending the existing guidance on transfers of
financial assets to, among other things, eliminate the qualifying
special-purpose entity concept, include a new unit of account definition that
must be met for transfers of portions of financial assets to be eligible for
sale accounting, clarify and change the derecognition criteria for a transfer to
be accounted for as a sale, and require significant additional disclosure. The
standard is effective for new transfers of financial assets beginning
January 1, 2010. We are currently evaluating the impact of this standard,
but do not expect it to have a material impact on our consolidated results of
operations or financial condition.
In
June 2009, the FASB issued an accounting standard that revised the
consolidation guidance for variable-interest entities. The modifications include
the elimination of the exemption for qualifying special purpose entities, a new
approach for determining who should consolidate a variable-interest entity, and
changes to when it is necessary to reassess who should consolidate a
variable-interest entity. The standard is effective January 1, 2010. We are
currently evaluating the impact of this standard, but do not expect it to have a
material impact on our consolidated results of operations or financial
condition.
In
August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair
Value, which provides additional guidance on how companies should measure
liabilities at fair value under ASC 820. The ASU clarifies that the quoted price
for an identical liability should be used. However, if such information is not
available, a entity may use, the quoted price of an identical liability when
traded as an asset, quoted prices for similar liabilities or similar liabilities
traded as assets, or another valuation technique (such as the market or income
approach). The ASU also indicates that the fair value of a liability is not
adjusted to reflect the impact of contractual restrictions that prevent its
transfer and indicates circumstances in which quoted prices for an identical
liability or quoted price for an identical liability traded as an asset may be
considered level 1 fair value. This ASU is effective October 1, 2009. We
are currently evaluating the impact of this standard, but do not expect it to
have a material impact on our consolidated results of operations or financial
condition.
In
October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue
Arrangements—a consensus of the FASB Emerging Issues Task Force, that
provides amendments to the criteria for separating consideration in
multiple-deliverable arrangements. As a result of these amendments,
multiple-deliverable revenue arrangements will be separated in more
circumstances than under existing U.S. GAAP. The ASU does this by establishing a
selling price hierarchy for determining the selling price of a deliverable. The
selling price used for each deliverable will be based on vendor-specific
objective evidence if available, third-party evidence if vendor-specific
objective evidence is not available, or estimated selling price if neither
vendor-specific objective evidence nor third-party evidence is available. A
vendor will be required to determine its best estimate of selling price in a
manner that is consistent with that used to determine the price to sell the
deliverable on a standalone basis. This ASU also eliminates the residual method
of allocation and will require that arrangement consideration be allocated at
the inception of the arrangement to all deliverables using the relative selling
price method, which allocates any discount in the overall arrangement
proportionally to each deliverable based on its relative selling price. Expanded
disclosures of qualitative and quantitative information regarding application of
the multiple-deliverable revenue arrangement guidance are also required under
the ASU. The ASU does not apply to arrangements for which industry specific
allocation and measurement guidance exists, such as long-term construction
contracts and software transactions. The ASU is effective beginning
January 1, 2011. We are currently evaluating the impact of this standard on
our consolidated results of operations and financial condition.
F-16
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recently Issued Accounting
Pronouncements
In
October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That
Include Software Elements—a consensus of the FASB Emerging Issues Task
Force, that reduces the types of transactions that fall within the
current scope of software revenue recognition guidance. Existing software
revenue recognition guidance requires that its provisions be applied to an
entire arrangement when the sale of any products or services containing or
utilizing software when the software is considered more than incidental to the
product or service. As a result of the amendments included in ASU
No. 2009-14, many tangible products and services that rely on software will
be accounted for under the multiple-element arrangements revenue recognition
guidance rather than under the software revenue recognition guidance. Under the
ASU, the following components would be excluded from the scope of software
revenue recognition guidance: the tangible element of the product,
software products bundled with tangible products where the software components
and non-software components function together to deliver the product’s essential
functionality, and undelivered components that relate to software that is
essential to the tangible product’s functionality. The ASU also provides
guidance on how to allocate transaction consideration when an arrangement
contains both deliverables within the scope of software revenue guidance
(software deliverables) and deliverables not within the scope of that guidance
(non-software deliverables). The ASU is effective beginning January 1,
2011. We are currently evaluating the impact of this standard on our
consolidated results of operations and financial condition.
NOTE
3 – TRADE RECEIVABLES, NET
Trade
receivables consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Trade
receivables
|
$ | 20,622,671 | $ | 13,685,493 | $ | 9,518,706 | $ | 7,982,800 | $ | 3,417,763 | ||||||||||
Trade
receivables-10% hold back
|
5,011,591 | 4,527,980 | 2,803,393 | 1,436,229 | - | |||||||||||||||
Total
|
$ | 25,634,262 | $ | 18,213,473 | $ | 12,322,099 | $ | 9,419,029 | $ | 3,417,763 |
The
Company has not provided a bad debt allowance based upon its historical
collection experience. There were no bad debts written off for the years ended
December 31, 2008, 2007 and 2006, and the nine months ended September 30, 2009
and 2008, respectively and no accounts receivable outstanding in excess of 90
days at September 30, 2009 and 2008 and December 31, 2008, 2007 and
2006.
The aging
of the accounts receivable (in thousands) are as follows:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
1-30
days
|
$ | 12,683 | $ | 7,241 | $ | 3,910 | $ | 4,384 | $ | 1,751 | ||||||||||
31-60
days
|
7,940 | 5,472 | 5,368 | 1,796 | 1,667 | |||||||||||||||
61-90
days
|
- | 972 | 241 | 1,803 | - | |||||||||||||||
Total
|
$ | 20,623 | $ | 13,685 | $ | 9,519 | $ | 7,983 | $ | 3,418 |
The trade
receivables above are collateral for short-term bank loans in the amount of
$1,454,244 and $3,931,991 as of September 30, 2009 and December 31,
2008.
The trade
receivables – 10% hold back are held back by customer that is due one year from
the date of delivery. As of September 30, 2009, there are no delinquent
receivables.
F-17
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
4 – INVENTORIES
Inventory
consists of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Products
for sale
|
$ | 1,494,599 | $ | 391,094 | $ | 775,185 | $ | 5,488,794 | $ | 2,622,909 |
The
Company sold its production lines in 2006 and has operated as a distributor
since that time. There was no reserve for obsolete inventory for all the periods
as the Company has purchased inventory based on customers’ orders.
Since
2008, the Company focuses on sales of IPTV devices and ordered products
according to sales contracts. Thus, the ending balance of inventory
decreased.
NOTE
5 – EMPLOYEE ADVANCES AND SHORT TERM LOANS RECEIVABLE
Employee
advances consist of the following:
September
30,
|
December
31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Employee
advances
|
$ | 5,280 | $ | 7,944 | $ | 6,307 | $ | - | $ | - |
Employee
advances for business operating expenses and were deducted from their monthly
wages.
Short-term
interest-free loans receivable consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Short-term
loans receivable
|
$ | - | $ | - | $ | - | $ | 769,855 | $ | 731,645 |
Short-term
interest-free loans were borrowed by the Company’s customers who were short of
working capitals with terms less than six months in order to maintain customer
relations, and were payable on demand. Since the customers usually have a
long-time business relationship with the Company, the Company did not charge for
any interests. The Company has not experienced any problems of
collections.
NOTE
6 – CONTRACTS RECEIVABLE
Contracts
receivable consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Contracts
receivable
|
$ | - | $ | 108,315 | $ | - | $ | 101,499 | $ | 94,946 |
The
Company started to provide construction services for Henan Siqi Technology
Company in 2005 under separated contracts. The contracts receivables were from
several completed projects. The Company still finished all projects with Henan
Siqi Technology Company and contracts receivables were collected in 2008. There
was no ongoing project at the end of 2008.
F-18
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
7 –PROPERTY AND EQUIPMENT, NET
Property
and equipment consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Machinery
and equipment
|
$ | 89,460 | $ | 89,229 | $ | 89,463 | $ | 83,616 | $ | 83,024 | ||||||||||
Electronic
equipment
|
324,926 | - | - | - | - | |||||||||||||||
Office
equipment
|
39,617 | 32,362 | 32,447 | 48,775 | 41,846 | |||||||||||||||
Automobiles
|
101,823 | 101,559 | 101,827 | 95,173 | 97,034 | |||||||||||||||
Accumulated
depreciation
|
(217,241 | ) | (202,220 | ) | (189,589 | ) | (165,043 | ) | (140,856 | ) | ||||||||||
Property
and equipment, net
|
$ | 338,585 | $ | 20,930 | $ | 34,148 | $ | 62,521 | $ | 81,048 |
The
depreciation expenses were $20,884, $43,546, and $42,047 for the years ended
December 31, 2008, 2007 and 2006, respectively, and $27,641 and $33,637 for the
nine months ended September 30, 2009 and 2008, respectively.
NOTE
8 – INTANGIBLE ASSETS, NET
Intangible
assets consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Software
|
$ | 645,392 | $ | - | $ | - | $ | - | $ | - | ||||||||||
Accumulated
amortization
|
(32,270 | ) | - | - | - | - | ||||||||||||||
Total
|
$ | 613,122 | $ | - | $ | - | $ | - | $ | - |
The
amortization expenses were $0, $0, and $0 for the years ended December 31, 2008,
2007 and 2006, respectively, and $32,270 and $0 for the nine months ended
September 30, 2009 and 2008, respectively. The software has not yet been placed
in service, and therefore the Company has not started amortizing the
asset.
NOTE
9 – SHORT-TERM DEMAND LOANS PAYABLE
Since
2005, the Company had several outstanding short-term demand corporation loans
which were used primarily for general working capital purposes. These short-term
unsecured loans were borrowed from long-term relationship customers bearing no
interest. The imputed interests are assessed as an expense to the business
operation and addition to the paid-in capital. The calculation is performed
monthly by annual rate in the rage from 5.58 to7.30% with the reference to the
one-year loan rate from The People’s Bank of China. All the loans have been paid
off as of June 30, 2008.
The
imputed interest on the loans above were $26,487, $0, and $0 for the years ended
December 31, 2008, 2007, and 2006, respectively, and $0 and $26,487 for the nine
months ended September 30, 2009 and 2008, respectively.
The
Company secured one-year bank loans from Bank of Communication and Austria
Central Cooperation Bank. These loans carried at an annual interest rate of
6.7275% for loans from Bank of Communication and 6.6975% for loans from Austria
Central Cooperation Bank Beijing Branch. Both loans are secured by accounts
receivable of the Company.
The
outstanding loans are as follows:
September 30,
|
December 31,
|
|||||||||||||||||||
Bank
Loan:
|
2009
|
2008
|
2008
|
2007
|
2006
|
|||||||||||||||
Bank
of Communication
|
$ | - | $ | - | $ | - | $ | - | $ | 384,750 | ||||||||||
Austria
Central Cooperation Bank
|
1,454,244 | 3,916,793 | 3,931,991 | 6,343,233 | - | |||||||||||||||
$ | 1,454,244 | $ | 3,916,793 | $ | 3,931,991 | $ | 6,343,233 | $ | 384,750 |
F-19
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
9 – SHORT-TERM DEMAND LOANS PAYABLE (continued)
Interest
expense incurred for the above short-term bank loans were $338,742, $196,323,
and $11,616 for the years ended December 31, 2008, 2007, and 2006, respectively,
and $140,693 and $261,154 for the nine months ended September 30, 2009 and 2008,
respectively.
September 30,
|
December 31,
|
|||||||||||||||||||
Corporation
Loan:
|
2009
|
2008
|
2008
|
2007
|
2006
|
|||||||||||||||
Henan
Siqi Technology Company
|
$ | - | $ | - | $ | - | $ | 41,129 | $ | 179,545 | ||||||||||
ZZ
Huashitong Company
|
- | - | - | 1,209,923 | - | |||||||||||||||
Yancity
Television Department
|
- | - | - | 11,792 | 11,030 | |||||||||||||||
Shanghai
Post-communication Equipment
|
- | - | - | 123,387 | 115,422 | |||||||||||||||
Xinhao
Electronic Company
|
- | - | - | 144,473 | - | |||||||||||||||
Tonghua
Tianma Company
|
- | - | - | 54,012 | - | |||||||||||||||
ZZ
Boqing Technology Company
|
- | - | - | 89,772 | ||||||||||||||||
Others
|
- | - | - | 5,487 | 34,102 | |||||||||||||||
$ | - | $ | - | $ | - | $ | 1,590,203 | $ | 429,871 |
The
imputed interests were $36,573, $70,079, and $19,905for the years ended December
31, 2008, 2007, and 2006, respectively, and $0 and $26,487 for the nine months
ended September 30, 2009 and 2008, respectively.
NOTE
10 – COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Billings
on uncompleted contracts
|
$ | - | $ | 207,811 | $ | - | $ | 105,565 | $ | 34,626 | ||||||||||
Costs
incurred on uncompleted contracts
|
- | (176,261 | ) | - | (86,930 | ) | (32,683 | ) | ||||||||||||
Billings
in excess of costs on uncompleted contracts
|
$ | - | $ | 31,550 | $ | - | $ | 18,635 | $ | 1,943 |
The
Company finished two construction projects with Henan Siqi Technology Company in
2008.
NOTE
11 – STATUTORY RESERVES
As
stipulated by the relevant laws and regulations for enterprises operating in
PRC, the subsidiaries of the Company are required to make annual appropriations
to a statutory surplus reserve fund. Specifically, the subsidiaries of the
Company are required to allocate 10% their profits after taxes, as determined in
accordance with the PRC accounting standards applicable to the subsidiaries of
the Company, to a statutory surplus reserve until such reserve reaches 50% of
the registered capital of the subsidiaries of the Company.
F-20
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
12 – RELATED PARTIES TRANSACTIONS
Due to related
parties
For the
year then ended December 31, 2008, the Company had an outstanding payable to Mr.
Zhong, Ms. Sen, Mr. Huang, Ms. Wu, and Ms. Li totaling $2,102,178, $13,759,
$21,152, $211,814 and $10,825, respectively. These amounts are non-secured,
non-interest bearing, and are considered to be short-term within 5 months
starting from October 6, 2008 to March 5, 2009. The notes were converted into
approximately 2,929,097 shares of common stock during the quarter ended March
31, 2009 in accordance with the Purchase Rights at $0.6907 per share. The shares
are reflected as issued and outstanding on the statement of stockholders’ equity
since inception.
Due to
related parties consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Sen,
Hui (shareholder)
|
$ | - | $ | - | $ | 13,759 | $ | - | $ | 7,054 | ||||||||||
Zhong,
Bo (CEO)
|
- | - | 2,102,178 | - | 12,183 | |||||||||||||||
Huang,
Jenkang (Vice President)
|
- | - | 21,152 | - | - | |||||||||||||||
Wu,
Dexio (Warehousing, Ceo's Spouse)
|
- | - | 211,814 | - | - | |||||||||||||||
Li,
Yuting (Executive Secretary to CEO)
|
- | - | 10,825 | - | - | |||||||||||||||
Total
|
$ | - | $ | - | $ | 2,359,728 | $ | - | $ | 19,237 |
The
imputed interests were $34,496, $0, and $0 for the years ended December 31,
2008, 2007, and 2006, respectively, and $31,417 and $22,518 for the nine months
ended September 30, 2009 and 2008, respectively.
Due to affiliated
companies
For the
year then ended December 31, 2007, the Company had an outstanding payable of
$23,405 to Henan Jingbuo Electronics Co., Ltd (“Jingbuo”), Mr. Zhong; Bo holds
98.84% of the ownership. The demand loans were used primarily for general
working capital purposes with non-interest bearing and no fixed repayment
date.
Due to
affiliated companies consist of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Henan
Jingbuo Electronics Co., Ltd.
(Mr. Zhong, Bo owns 98.84%) |
$ | - | $ | 19,885 | $ | - | $ | 23,405 | $ | - |
Due from related
parties
For the
year then ended December 31, 2007 and 2006, the Company had an outstanding
receivable from Shenyang Real Estate (ZZ) Co., Ltd; Mr. Zhong Bo holds 60% of
the ownership. Due to its shortage of working capital, Shenyang Real Estate
borrowed loans from the Company with non-interest bearing and no fixed repayment
date.
For the
year then ended December 31, 2006, the Company had an outstanding receivable
from Shenyang Cables (ZZ) Co., Ltd, Mr. Zhong Lin holds 91.4% of the ownership.
The demand loans were used primarily for general working capital purposes with
non-interest bearing and no fixed repayment date.
For the
year then ended December 31, 2007, the Company had an outstanding receivable
from Henan Jingbuo Electronics Co., Ltd, Mr. Zhong Bo holds 98.84% of the
ownership. The demand loans were used primarily for general working capital
purposes with non-interest bearing and no fixed repayment date.
F-21
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
12 – RELATED PARTIES TRANSACTIONS (continued)
Due from
affiliated companies consists of the following:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Shenyang
Real Estate (ZZ) Co., Ltd.
|
$ | - | $ | - | $ | - | $ | 68,548 | $ | 384,750 | ||||||||||
Henan
Jingbuo Electronics Co., Ltd.
|
- | 7,315 | - | - | 473,929 | |||||||||||||||
Shenyang
Cables (ZZ) Co., Ltd.
|
- | - | - | - | 265,478 | |||||||||||||||
Total
|
$ | - | $ | 7,315 | $ | - | $ | 68,548 | $ | 1,124,157 |
Exchange of related parties’
debt for common stock
Pursuant
to relevant laws and regulations of China and the ownership transfer agreement
with the original owners of ZST PRC, the Company, through its Everfair
subsidiary, agreed to pay approximately $1.7 million (RMB 12,000,000) to acquire
the assets of ZST PRC. As part of the Purchase Rights Agreement the original
owners agreed to use these proceeds to complete the exercise of the Purchase
Rights to purchase the Company’s shares and obtain control of the Company. The
payables were converted into approximately 2,161,218 shares of common stock
during the quarter ended March 31, 2009 in accordance with the Purchase Rights
at $0.6907 per share. The shares are reflected as issued and outstanding on the
statement of stockholders’ equity since inception.
NOTE
13 – ADVANCES
In
accordance with the purchase contracts, the Company is required to make an
advance to its suppliers to purchase the IPTV materials and add on process work.
The advance is applied to the total invoice balance upon satisfaction of the
delivered goods.
NOTE
14 – INCOME TAXES
The
Company is registered in PRC and has no tax advantages granted by local
government for corporate income taxes and sales taxes because it is a domestic
corporation.
Beginning
January 1, 2008, the new Enterprise Income Tax (“EIT”) law has replaced the old
laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”).
The new standard EIT rate of 25% replaces the 33% rate applicable to both DES
and FIEs, except for High Tech companies that pay a reduced rate of 15%, subject
to government verification for Hi-Tech company status in every three years. For
companies established before March 16, 2007 continue to enjoy tax holiday
treatment approved by local government for a grace period of either for the next
5 years or until the tax holiday term is completed, whichever is
sooner.
The
provision for taxes on earnings consisted of:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
PRC
Corporate Income Tax
|
$ | 2,593,724 | $ | 1,565,994 | $ | 2,132,565 | $ | 1,515,478 | $ | 314,577 |
A
reconciliation between the income tax computed at the PRC statutory rate and the
Company’s provision for income taxes is as follows:
September 30,
|
December 31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
PRC
corporate income tax rate
|
25 | % | 25 | % | 25 | % | 33 | % | 33 | % |
The PRC
tax authority conducts periodic and ad hoc tax filing reviews on business
enterprises operating in the PRC after those enterprises have completed their
relevant tax filings, hence the Company’s tax filings may not be
finalized. It is therefore uncertain as to whether the PRC tax
authority may take different views about the Company’s tax filings which may
lead to additional tax liabilities.
F-22
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
15 – COMMITMENTS AND CONTINGENCIES
Office lease
commitments
The
Company has entered into two office lease agreements. The Company’s
commitments for minimum lease payments under these leases for the next five
years and thereafter are as follows as follows:
Year Ending December 31,
|
||||
2010
|
$ | 8,251 | ||
2011
|
- | |||
Thereafter
|
- | |||
$ | 8,251 |
Rent
expense for the nine months ended September 30, 2009 and 2008 were $5,497and
$5,548, respectively, and for the years ended December 31, 2008, 2007 and 2006
were $7,380, $1,646, and $20,847, respectively.
The
Company has entered into new office lease agreement in 2009. The term of the new
lease agreement term is from May 2009 to April 2011. The Company’s commitment
for the lease will be approximately $58,000 a year. The lessor delayed the first
year lease payment and the Company will start to pay from May 2010.
Lack of
insurance
The
Company could be exposed to liabilities or other claims for which the Company
would have no insurance protection. The Company does not currently maintain any
business interruption insurance, products liability insurance, or any other
comprehensive insurance policy except for property insurance policies with
limited coverage. For example, because the Company does not carry products
liability insurance, a failure of any of the products marketed by the Company
may subject it to the risk of product liability claims and litigation arising
from injuries allegedly caused by the improper functioning or design of its
products. The Company cannot assure that it will have enough funds to defend or
pay for liabilities arising out of a products liability claim. To the extent the
Company incurs any product liability or other litigation losses, its expenses
could materially increase substantially. There can be no assurance that the
Company will have sufficient funds to pay for such expenses, which could end its
operations. There can be no guarantee that the Company will be able
to obtain additional insurance coverage in the future, and even if it can obtain
additional coverage, the Company may not carry sufficient insurance coverage to
satisfy potential claims. All investors of the Company could lose their entire
investment should uninsured losses occur.
F-23
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
16 – SEGMENT INFORMATION
The US
GAAP Standard for Disclosures about Segments of an Enterprise and Related
Information requires certain financial and supplementary information to be
disclosed on an annual and interim basis for each reportable segment of an
enterprise. The Company believes that it operates in one business segment
(research, development, production, marketing and sales of electronic products)
and in one geographical segment (China), as all of the Company’s current
operations are carried out in China.
The
Company’s revenues, costs and gross profits were broken into the following
categories:
September 30,
|
December 31,
|
|||||||||||||||||||
Product Sales:
|
2009
|
2008
|
2008
|
2007
|
2006
|
|||||||||||||||
Sales
revenues
|
$ | 70,067,184 | $ | 40,377,727 | $ | 54,200,946 | $ | 28,717,251 | $ | 5,547,875 | ||||||||||
Cost
of sales
|
58,773,620 | 33,529,601 | 45,169,613 | 23,221,360 | 4,462,387 | |||||||||||||||
Gross
Profit
|
$ | 11,293,564 | $ | 6,848,126 | $ | 9,031,333 | $ | 5,495,891 | $ | 1,085,488 | ||||||||||
Gross
Margin
|
16.12 | % | 16.96 | % | 16.66 | % | 19.14 | % | 19.57 | % | ||||||||||
September
30,
|
December
31,
|
|||||||||||||||||||
Technical
Support Revenues:
|
2009
|
2008
|
2008
|
2007
|
2006
|
|||||||||||||||
Sales
revenues
|
$ | - | $ | 609,602 | $ | 612,918 | $ | - | $ | 5,503 | ||||||||||
Service
cost
|
- | 33,528 | 33,710 | - | ||||||||||||||||
Gross
Profit
|
$ | - | $ | 576,074 | $ | 579,208 | $ | - | $ | 5,503 | ||||||||||
Gross
Margin
|
- | 94.50 | % | 94.50 | % | - | 100.00 | % | ||||||||||||
September
30,
|
December
31,
|
|||||||||||||||||||
Construction
Revenues:
|
2009
|
2008
|
2008
|
2007
|
2006
|
|||||||||||||||
Construction
revenues
|
$ | - | $ | - | $ | 616,955 | $ | - | $ | 96,868 | ||||||||||
Construction
costs
|
- | - | 390,920 | - | 15,284 | |||||||||||||||
Gross
Profit
|
$ | - | $ | - | $ | 226,035 | $ | - | $ | 81,584 | ||||||||||
Gross
Margin
|
- | - | 36.64 | % | - | 84.22 | % | |||||||||||||
September
30,
|
December
31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Total
revenues
|
$ | 70,067,184 | $ | 40,987,329 | $ | 55,430,819 | $ | 28,717,251 | $ | 5,650,246 | ||||||||||
Total
cost of sales
|
58,773,620 | 33,563,129 | 45,594,243 | 23,221,360 | 4,477,671 | |||||||||||||||
Gross
Profit
|
$ | 11,293,564 | $ | 7,424,200 | $ | 9,836,576 | $ | 5,495,891 | $ | 1,172,575 | ||||||||||
Gross
Margin
|
16.12 | % | 18.11 | % | 17.75 | % | 19.14 | % | 20.75 | % |
F-24
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
17 – OPERATING RISK
Concentration of credit
risk
The
Company maintains cash balances at various financial institutions in the PRC
that do not provide insurance for amounts on deposit. The Company operates
principally in the PRC and grants credit to its customers. Although the PRC is
economically stable, it is always possible that unanticipated events both
domestically and in foreign countries could disrupt the operations of the
Company or its customers.
Country
risk
The
Company has significant investments in the PRC. The operating results of the
Company may be adversely affected by changes in the political and social
conditions in the PRC and by changes in Chinese government policies with respect
to laws and regulations, anti-inflationary measures, currency conversion,
international remittances and rates and methods of taxation, among other things.
The Company can give no assurance that those changes in political and other
conditions will not result in have a material adverse effect upon the Company’s
business and financial condition.
NOTE
18 – COMMON STOCK
On
January 9, 2009, ZST Digital closed a share exchange transaction (the “Share
Exchange”) pursuant to which ZST Digital (i) issued 806,408 shares of its common
stock to acquire 100% equity ownership of World Orient Universal Limited (“World
Orient”), which is the 100% parent of Global Asia Universal Limited (“Global
Asia”), which is the 100% parent of Everfair Technologies Limited (“Everfair”),
which is a 100% parent of Zhengzhou Shenyang Technology Company Limited (“ZST
PRC”), (ii) assumed the operations of World Orient and its subsidiaries, and
(iii) changed ZST Digital’s name from SRKP 18, Inc. to ZST Digital Networks,
Inc.
Immediately
after the closing of the Share Exchange but prior to the Private Placement, ZST
Digital had outstanding 2,000,788 shares of common stock, no shares of preferred
stock, no options, and warrants to purchase 176,629 shares of common stock at an
exercise price of $0.00024621 per share.
On
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”),
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management purchased an aggregate of 5,090,315 shares
of our common stock at a per share purchase price of $0.6907 (the “Purchase
Right”). The purchase price for the shares was paid in full on May 25,
2009.
Prior to
the closing of the Share Exchange, each of the shareholders and warrantholders
of the Company canceled 0.3317 shares of common stock and warrants to purchase
0.5328 shares of common stock held by each of them for each one (1) share of
common stock purchased by the ZST Management pursuant to the Purchase Right (the
“Share and Warrant Cancellation”). Pursuant to the Share and Warrant
Cancellation, an aggregate of 1,688,533 shares of common stock and warrants to
purchase 2,712,283 shares of common stock held by certain of our stockholders
and warrantholders prior to the Share Exchange were cancelled.
On
October 6, 2009, the Company effected a 1-for-2.461538462 reverse stock split of
the Company’s issued and outstanding shares of common stock (the “Reverse Stock
Split”). The par value and number of authorized shares of the common stock
remained unchanged. All references to number of shares and per share amounts
included in these consolidated financial statements and the accompanying notes
have been adjusted to reflect the Reverse Stock Split
retroactively.
F-25
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
19 – SERIES A CONVERTIBLE PREFERRED STOCK
The
Company is authorized to issue 10,000,000 shares of preferred
stock.
On
January 5, 2009, the Company filed a Certificate of Designations, Preferences
and Rights (the “Certificate”) whereby it designated 3,750,000 shares of its
preferred stock, $0.0001 par value per share, as Series A Convertible Preferred
Stock, (the “Preferred Stock”). Each share of Preferred Stock has a
stated value of $3.94. Each share of Preferred Stock is convertible,
at the option of the holder at any time and from time to time after the original
issue date of the Preferred Stock, into one share of Common Stock, at a
conversion price equal to the per share purchase price, subject to adjustment as
more fully described in the Certificate. Each share of Preferred
Stock has the right to one vote per share of Common Stock issuable upon
conversion of the shares of Preferred Stock.
In 2009,
the Company conducted five closings of a private placement transaction (the
“Private Placement”). As of June 30, 2009, pursuant to subscription agreements
entered into with the investors, the Company sold an aggregate of 1,263,723
shares of Series A Convertible Preferred Stock at $3.94 per share for gross
proceeds of $4,976,953. Each share of Preferred Stock shall be convertible at
the option of the holder thereof, at any time and from time to time from and
after the Original Issue Date into that number of shares of Common Stock
determined by dividing the Stated Value of $3.94 of such share of Preferred
Stock by the Conversion Price of $3.94.
On
January 9, 2009, the Company conducted an initial closing of the Private
Placement. Pursuant to subscription agreements entered into with investors, the
Company sold an aggregate of 445,874 shares of Series A Convertible Preferred
Stock at $3.94 per share. As a result, the Company received gross proceeds in
the amount of $1,750,902. In connection with the initial closing of the Private
Placement, the Company issued a promissory note in the principal amount of
$170,000, bearing no interest, to WestPark Capital Financial Services, LLC, the
parent company of WestPark, the placement agent for the Private Placement (the
“Note”).
On
January 23, 2009, the Company conducted a second closing of the Private
Placement. Pursuant to subscription agreements entered into with investors, the
Company sold an aggregate of 132,264 shares of Series A Convertible Preferred
Stock at $3.94 per share. As a result, the Company received gross proceeds in
the amount of $525,000, of which $170,000 was used to repay the Note in
full.
On
February 13, 2009, the Company conducted a third closing of the Private
Placement. Pursuant to subscription agreements entered into with investors, the
Company sold an aggregate of 332,917 shares of Series A Convertible Preferred
Stock at $3.94 per share. As a result, the Company received gross proceeds in
the amount of $1,310,000.
On April
15, 2009, the Company conducted a fourth closing of the Private Placement.
Pursuant to subscription agreements entered into with investors, the Company
sold an aggregate of 203,924 shares of Series A Convertible Preferred Stock at
$3.94 per share. As a result, the Company received gross proceeds in the amount
of $804,000.
On May 5,
2009, the Company conducted a fifth closing of the Private Placement. Pursuant
to subscription agreements entered into with investors, the Company sold an
aggregate of 148,744 shares of Series A Convertible Preferred Stock at $3.94 per
share. As a result, the Company received gross proceeds in the amount of
$587,051.
In
accordance with the standard of “Beneficial Conversion Feature” codified within
ASC 470, the Series A Convertible Preferred Stock does not have an embedded
beneficial conversion feature (BCF) because the effective conversion price of
such shares equals the fair value of the Company’s common stock. The Company
determined that the fair value of the common stock at $3.94 per share based on
the fact that (1) the common stock is not readily tradable in an open market at
the time of issuance, and (2) the Company has recently sold the convertible
preferred stock that is convertible into common stock at 1:1 ratio for $3.94 per
share in a private placement, therefore the market price of the common stock is
$3.94 per share. However, if in the future the Company has a dilutive issuance
of securities, as defined in the Preferred Stock Certificate of Designation, the
Company must recognize a beneficial conversion if and when a reset of the
conversion price occurs.
F-26
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
19 – SERIES A CONVERTIBLE PREFERRED STOCK (continued)
Value
Allocated to Preferred Stocks:
|
||||
Proceeds
from issuance
|
$ | 4,976,953 | ||
Less
value allocated to warrants
|
- | |||
Value
allocated to preferred stocks
|
$ | 4,976,953 | ||
Market
Value of Shares Issuable Upon Conversion:
|
||||
Shares
issuable upon conversion of the preferred stocks
|
1,263,723 | |||
Market
value of stock on preferred stock issuance date
|
$ | 3.94 | ||
Market
value of shares issuable upon conversion
|
$ | 4,976,953 | ||
Beneficial
Conversion Feature:
|
||||
Market
value of shares issuable upon conversion
|
$ | 4,976,953 | ||
Less
value allocated to preferred stocks
|
4,976,953 | |||
Value
of beneficial conversion feature
|
$ | - |
The
Company evaluated whether or not the Series A Convertible Preferred Stock
contained any embedded conversion features that meet the definition of
derivatives under the “Embedded Derivative” standard codified within ASC 815,
and related interpretations. The standard states that an embedded
derivative instrument shall be separated from the host contract and accounted
for as a derivative instrument pursuant to the statement if and only if all the
following criteria are met:
|
a.
|
The
economic characteristics and risks of the embedded derivative instrument
are not clearly and closely related to the economic characteristic and the
risks to the host contact. (Additional guidance on applying this criterion
to various contracts containing embedded derivative instrument s is
included in Appendix A of this
statement.)
|
|
b.
|
The
contract that embodies both the embedded derivative instrument and the
host contract are not measured at fair value under otherwise applicable
generally accepted accounting principles with changes in fair value
reported in earnings as they occur.
|
|
c.
|
A
separate instrument with the same terms as the embedded derivative
instrument would, pursuant to subtopic 10 of the standard codified within
ASC 815, be a derivative instrument subject to the requirements of this
statement. However, this criterion is not met if the separate instrument
with the same terms as the embedded derivative instrument would be
classified as a liability (or an asset in some circumstance) under the
provisions of the standard codified within ASC 480 but would be classified
in stockholders’ equity absent the provisions in the standard codified
within ASC 480.
|
The
Series A Convertible Preferred Stock has a fixed conversion provision of 1
preferred share for 1 common share and is convertible at the option of the
holder and automatically based upon certain events happening. Based upon the
above requirement of subtopic 15 of ASC 815, it is clear that any potential
embedded derivatives in the Series A Convertible Preferred Stock are clearly and
closely related and do not require bifurcation from the host.
The
Company evaluated whether or not the convertible preferred stock should be
classified as a liability or equity under the standard codified within ASC 480,
“Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity” and EITF Topic D-98 “Classification and Measurement of
Redeemable Securities”. The Company concluded that under EITF Topic D-98,
preferred securities that are redeemable for cash or other assets are to be
classified outside of permanent equity if they are redeemable (i) at a
fixed or determinable price on a fixed or determinable date, (ii) at the
option of the holder, or (iii) upon the occurrence of an event that is not
solely within the control of the issuer. Accordingly, the Company classified the
Series A Preferred Stock as permanent equity since there was no deemed
liquidation events that require one or more class or type of equity security to
be redeemed.
F-27
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
20 – EARNINGS PER SHARE
Basic net
income per share is computed by dividing net income by the weighted-average
number of shares outstanding during the period.
Diluted
net income per share is computed by using the weighted-average number of shares
of common stock outstanding and, when dilutive, potential shares from options
and warrants to purchase common stock, using the treasury stock
method.
The
following table illustrates the computation of basic and dilutive net income per
share and provides a reconciliation of the number of weighted-average basic and
diluted shares outstanding:
September
30,
|
December
31,
|
|||||||||||||||||||
2009
|
2008
|
2008
|
2007
|
2006
|
||||||||||||||||
Net
income
|
$ | 7,100,116 | $ | 4,806,871 | $ | 6,108,471 | $ | 2,867,429 | $ | 638,688 | ||||||||||
Denominator:
|
||||||||||||||||||||
Basic
weighted-average shares outstanding
|
7,056,103 | 5,896,723 | 5,896,723 | 5,896,723 | 5,896,723 | |||||||||||||||
Effect
of convertible preferred stock
|
1,046,796 | - | - | - | - | |||||||||||||||
Effect
of dilutive warrants
|
162,504 | - | - | - | - | |||||||||||||||
Basic
weighted-average shares outstanding
|
$ | 8,265,403 | $ | 5,896,723 | $ | 5,896,723 | $ | 5,896,723 | $ | 5,896,723 | ||||||||||
Net
income per share:
|
||||||||||||||||||||
Basic
|
$ | 1.01 | $ | 0.82 | $ | 1.04 | $ | 0.49 | $ | 0.11 | ||||||||||
Diluted
|
$ | 0.86 | $ | 0.82 | $ | 1.04 | $ | 0.49 | $ | 0.11 |
NOTE
21 – COMMON STOCK WARRANTS
In
January 2007, the Company sold to its original shareholders warrants to purchase
2,882,912 shares of common stock at an exercise price of $0.0001. On January 14,
2009, these shareholders canceled an aggregate of 2,712,283 warrants such that
the shareholders held an aggregate of 170,629 warrants immediately after the
Share Exchange. The warrant has a 5 year term and is not exercisable until at
least one year from the date of Share Exchange.
The
summary of the status of the Company’s outstanding warrant activity for the nine
months ended September 30, 2009 is as follows:
Warrants
|
Average
Exercise Price
|
|||||||
170,629 | $ | 0.0002462 |
NOTE
22 – SUBSEQUENT EVENTS
On
October 6, 2009, the Company effected a 1-for-2.461538462 reverse stock split of
the Company’s issued and outstanding shares of common stock (the “Reverse Stock
Split”). The par value and number of authorized shares of the common stock
remained unchanged. All references to number of shares and per share amounts
included in these consolidated financial statements and the accompanying notes
have been adjusted to reflect the Reverse Stock Split
retroactively.
F-28
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
22 – SUBSEQUENT EVENTS (continued)
On
October 8, 2009, the Company entered into an employment agreement with John
Chen, M.D., regarding his employment by the Company as its new Chief Financial
Officer (the “Employment Agreement”). Dr. Chen’s appointment as Chief
Financial Officer was effective on October 20, 2009 (the “Effective Date”).
Pursuant to the Employment Agreement, Dr. Chen will be entitled to a base salary
at an annual rate of $150,000, as well as reimbursement for the cost of standard
corporate-style healthcare insurance coverage and for home-office and business
travel expenses. Dr. Chen was also granted a signing bonus which is
calculated as follows: $410.96 per day multiplied by the number of days between
September 25, 2009 and the Effective Date. Dr. Chen was granted options to
purchase 25,000 shares of the common stock of the Company at an exercise price
of $8.00 per share and exercisable until October 20, 2014. The options
will be immediately exercisable but, to the extent they are exercised, will be
subject to a repurchase right of the Company which will lapse as follows: 50% of
the options and shares will vest six (6) months after the Effective Date and the
remaining 50% will vest twelve (12) months after the Effective
Date.
On
October 20, 2009, the Company completed a public offering and sold 3,125,000
shares of its common stock at $8.00 per share. The Company granted the
representative of the underwriters a 45-day option to purchase up to an
additional 468,750 shares of common stock at $8.00 per share. The shares of the
Company’s common stock were sold to the public for gross proceeds of
approximately $25 million. The Company also issued warrants to the underwriters
to purchase 312,500 shares of the Company’s common stock at an exercise price of
$10 per share.
On
October 25, 2009, the Company entered into a GPS Device Supply and Terminal
Service Agreement (the “GPS Agreement”) with Xing Yang Security Service Co.,
Ltd. (“Xing Yang”), a provider of personal, logistics, and technology safety
services. Pursuant to the GPS Agreement, the Company will provide GPS hardware
installation and monthly call center services to Xing Yang. Specifically,
the Company will supply and install GPS tracking units in Xing Yang’s armored
trucks and Xing Yang’s trucks will have access to the Company’s call center,
which provides direction, information and emergency support for
subscribers. Pursuant to the GPS Agreement, Xing Yang will pay the Company
RMB 4,000,000 (approximately $590,000) upon entering into the GPS Agreement and
an additional annual service fee up to approximately RMB 500,000 (approximately
$74,000) each year.
NOTE
23 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION
Basis of
Presentation
The
condensed parent company financial statements have been prepared in accordance
with Rule 12-04, Schedule I of Regulation S-X, as the restricted net assets of
the subsidiaries of ZST Digital Networks, Inc. exceed 25% of the consolidated
net assets of ZST Digital Networks, Inc. The ability of our Chinese operating
subsidiaries to pay dividends may be restricted due to the foreign exchange
control policies and availability of cash balances of the Chinese operating
subsidiaries. Because substantially all of our operations are conducted in China
and a substantial majority of our revenues are generated in China, a majority of
our revenue being earned and currency received are denominated in Renminbi
(RMB). RMB is subject to the exchange control regulation in China, and, as a
result, we may be unable to distribute any dividends outside of China due to PRC
exchange control regulations that restrict our ability to convert RMB into US
Dollars.
The
condensed parent company financial statements have been prepared using the same
accounting principles and policies described in the notes to the consolidated
financial statements, with the only exception being that the parent company
accounts for its subsidiaries using the equity method. Refer to the consolidated
financial statements and notes presented above for additional information and
disclosures with respect to these financial statements.
F-29
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
23 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION (continued)
ZST
Digital Networks, Inc.
(Formerly
SRKP 18, Inc.)
Condensed Parent Company
Balance Sheets
(Dollars
In Thousands)
September 30,
|
September 30,
|
December 31,
|
December 31,
|
|||||||||||||
2009
|
2008
|
2008
|
2007
|
|||||||||||||
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
ASSETS
|
||||||||||||||||
Investment
in subsidiaries, at equity in net assets
|
$ | 22,367 | $ | 7,643 | $ | 8,983 | $ | 2,636 | ||||||||
Total
Assets
|
22,367 | 7,643 | 8,983 | 2,636 | ||||||||||||
LIABILITIES AND STOCKHOLDERS'
EQUITY
|
||||||||||||||||
CURRENT
LIABILITIES
|
||||||||||||||||
Accrued
liabilities and other payable
|
52 | - | - | - | ||||||||||||
Total
Current Liabilities
|
52 | - | - | - | ||||||||||||
COMMITMENTS
AND CONTINGENCIES
|
- | - | - | - | ||||||||||||
STOCKHOLDERS’
EQUITY
|
||||||||||||||||
Preferred
stock, $0.0001 par value, 10,000,000 shares authorized, 6,250,000 shares
undesignated, 0 and 0 shares issued and outstanding at
September 30, 2009 and, 2008, and December 31, 2008 and 2007,
respectively.
|
- | - | - | - | ||||||||||||
Preferred
stock Series A Convertible, $0.0001 par value, 3,750,000 shares
authorized, 1,263,723 and 0 shares issued and outstanding at September 30,
2009 and June 38, 2008, and 0 shares issued and outstanding at December
31, 2008, and 2007, respectively. Liquidation preference and redemption
value of $4,976,953 September 30, 2009.
|
1 | - | - | - | ||||||||||||
Common
stock, $0.0001 par value, 100,000,000 shares authorized, 7,091,103 and
5,896,723 shares issued and outstanding at September 30, 2009 and 2008,
and 5,896,723 shares issued and outstanding at December 31, 2008, and
2007, respectively.
|
1 | 1 | 1 | 1 | ||||||||||||
Additional
paid-in capital
|
8,270 | 1,467 | 1,488 | 1,417 | ||||||||||||
Accumulated
other comprehensive income
|
(40 | ) | 574 | 591 | 424 | |||||||||||
Statutory
surplus reserve fund
|
1,492 | 575 | 1,492 | 575 | ||||||||||||
Retained
earnings (unrestricted)
|
12,511 | 5,026 | 5,411 | 219 | ||||||||||||
Total
Stockholders' Equity
|
22,315 | 7,643 | 8,983 | 2,636 | ||||||||||||
Total
Liabilities and Stockholders' Equity
|
$ | 22,367 | $ | 7,643 | $ | 8,983 | $ | 2,636 |
F-30
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
23 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION (continued)
ZST
Digital Networks, Inc.
(Formerly
SRKP 18, Inc.)
Condensed Parent Company
Statements of Operations
(Dollars
In Thousands)
For the period from
|
||||||||||||||||
January 3, 2007
|
||||||||||||||||
For The Nine months ended
|
For the Year Ended
|
(Inception) to
|
||||||||||||||
September 30,
|
December 31,
|
December 31,
|
||||||||||||||
2009
|
2008
|
2008
|
2007
|
|||||||||||||
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Revenue
|
$ | - | $ | - | $ | - | $ | - | ||||||||
Merger
cost
|
555 | - | - | - | ||||||||||||
Other
general and administrative
|
106 | - | - | - | ||||||||||||
Total
Expenses
|
661 | - | - | - | ||||||||||||
Equity
in undistributed income of subsidiaries
|
7,761 | 4,807 | 6,108 | 2,867 | ||||||||||||
Income
before income taxes
|
7,100 | 4,807 | 6,108 | 2,867 | ||||||||||||
Provision
for income tax
|
- | - | - | - | ||||||||||||
Net
income
|
$ | 7,100 | $ | 4,807 | $ | 6,108 | $ | 2,867 |
F-31
ZST
DIGITAL NETWORKS, INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(Amounts
and disclosures for the nine months ended September 30, 2009 and 2008 are
unaudited)
NOTE
23 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION (continued)
ZST
Digital Networks, Inc.
(Formerly
SRKP 18, Inc.)
Condensed Parent Company
Statements of Cash Flows
(Dollars
In Thousands)
For the period from
|
||||||||||||||||
For The Nine months
|
For the
|
January 3, 2007
|
||||||||||||||
ended
|
Year Ended
|
(Inception) to
|
||||||||||||||
September 30,
|
December 31,
|
December 31,
|
||||||||||||||
2009
|
2008
|
2008
|
2007
|
|||||||||||||
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Cash
Flows from Operating Activities
|
||||||||||||||||
Net
income
|
$ | 7,100 | $ | 4,807 | $ | 6,108 | $ | 2,867 | ||||||||
Adjustments
to reconcile net income to net cash provided (used) by operating
activities: Increase in accrued liabilities and other
payable
|
51 | - | - | - | ||||||||||||
Equity
in undistributed income of subsidiaries
|
(7,761 | ) | (4,807 | ) | (6,108 | ) | (2,867 | ) | ||||||||
Net
Cash Provided (Used) by Operating Activities
|
(610 | ) | - | - | - | |||||||||||
Cash
Flows from Investing Activities
|
||||||||||||||||
Capital
contribution to subsidiaries
|
(2,924 | ) | - | - | ||||||||||||
Net
Cash Provided (Used) by Investing Activities
|
(2,924 | ) | - | - | - | |||||||||||
Cash
Flows from Financing Activities
|
||||||||||||||||
Sale
of preferred stocks
|
3,534 | - | - | - | ||||||||||||
Net
Cash Provided (Used) by Investing Activities
|
3,534 | - | - | - | ||||||||||||
Net
Increase in Cash and Cash Equivalents
|
- | - | - | - | ||||||||||||
Cash
and Cash Equivalents, beginning of period
|
- | - | - | - | ||||||||||||
Cash
and Cash Equivalents, end of period
|
$ | - | $ | - | $ | - | $ | - | ||||||||
Supplemental
disclosure information:
|
||||||||||||||||
Non-cash
Investing and Financing activities:
|
||||||||||||||||
Shares
issued for related parties' debt
|
$ | 2,360 | $ | - | $ | - | $ | - |
F-32
PART
II
INFORMATION
NOT REQUIRED IN THE PROSPECTUS
Item
13. Other Expenses of Issuance and Distribution
The
following table sets forth the costs and expenses, other than underwriting
discounts and commissions, if any, payable by the Registrant relating to the
sale of common stock being registered.
Securities
and Exchange Commission registration fee (1)
|
$ | 602.64 | ||
Transfer
Agent Fees (1)
|
500.00 | |||
Accounting
fees and expenses (1)
|
10,000.00 | |||
Legal
fees and expenses (1)
|
20,000.00 | |||
Miscellaneous
(1)
|
897.36 | |||
Total
|
$ | 32,0000.00 |
(1)
|
All amounts are estimates other
than the Commission’s registration
fee.
|
Item
14. Indemnification of Directors and Officers
Under
Section 145 of the General Corporation Law of the State of Delaware, we can
indemnify our directors and officers against liabilities they may incur in such
capacities, including liabilities under the Securities Act. Our certificate of
incorporation provides that, pursuant to Delaware law, our directors shall not
be liable for monetary damages for breach of the directors’ fiduciary duty of
care to us and our stockholders. This provision in the certificate of
incorporation does not eliminate the duty of care, and in appropriate
circumstances equitable remedies such as injunctive or other forms of
non-monetary relief will remain available under Delaware law. In addition, each
director will continue to be subject to liability for breach of the director’s
duty of loyalty to us or our stockholders, for acts or omissions not in good
faith or involving intentional misconduct or knowing violations of the law, for
actions leading to improper personal benefit to the director, and for payment of
dividends or approval of stock repurchases or redemptions that are unlawful
under Delaware law. The provision also does not affect a director’s
responsibilities under any other law, such as the federal securities laws or
state or federal environmental laws.
Our
bylaws provide for the indemnification of our directors to the fullest extent
permitted by the Delaware General Corporation Law. Our bylaws further provide
that our board of directors has discretion to indemnify our officers and other
employees. We are required to advance, prior to the final disposition of any
proceeding, promptly on request, all expenses incurred by any director or
executive officer in connection with that proceeding on receipt of an
undertaking by or on behalf of that director or executive officer to repay those
amounts if it should be determined ultimately that he or she is not entitled to
be indemnified under the bylaws or otherwise. We are not, however, required to
advance any expenses in connection with any proceeding if a determination is
reasonably and promptly made by our board of directors by a majority vote of a
quorum of disinterested board members that (i) the party seeking an advance
acted in bad faith or deliberately breached his or her duty to us or our
stockholders and (ii) as a result of such actions by the party seeking an
advance, it is more likely than not that it will ultimately be determined that
such party is not entitled to indemnification pursuant to the applicable
sections of our bylaws.
We have
been advised that in the opinion of the Securities and Exchange Commission,
insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, or otherwise, such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable. In the
event a claim for indemnification against such liabilities (other than our
payment of expenses incurred or paid by our director, officer or controlling
person in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered, we will, unless in the opinion of our counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by us is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
We may
enter into indemnification agreements with each of our directors and officers
that are, in some cases, broader than the specific indemnification provisions
permitted by Delaware law, and that may provide additional procedural
protection. As of the date of this prospectus, we have not entered into any
indemnification agreements with our directors or officers, but may choose to do
so in the future. Such indemnification agreements may require us, among other
things, to:
|
•
|
indemnify officers and directors
against certain liabilities that may arise because of their status as
officers or directors;
|
|
•
|
advance expenses, as incurred, to
officers and directors in connection with a legal proceeding, subject to
limited exceptions; or
|
|
•
|
obtain directors’ and officers’
insurance.
|
At
present, there is no pending litigation or proceeding involving any of our
directors, officers or employees in which indemnification is sought, nor are we
aware of any threatened litigation that may result in claims for
indemnification.
II-1
Item
15. Recent Sales of Unregistered Securities
On
October 20, 2009, we granted our Chief Financial Officer, John Chen, options to
purchase 25,000 shares of the Company’s common stock at an exercise price of
$8.00 per share in connection with his entering into an employment agreement
with the Company. We sold these options under the exemption from
registration provided by Section 4(2) of the Securities Act and/or Rule 506 of
Regulation D promulgated thereunder.
On May 5,
2009, we completed the final closing in a series of five closings beginning
January 9, 2009 of a private placement transaction in which we received gross
proceeds of approximately $4.98 million (the “Private Placement”). Pursuant to
subscription agreements entered into with the investors, we sold an aggregate of
1,263,723 shares of Series A Convertible Preferred Stock at a price of $3.94 per
share. In connection with the initial closing of the Private Placement, the
Company issued a promissory note in the principal amount of $170,000, bearing no
interest (the “Note”), to WestPark Capital Financial Services, LLC, the parent
company of WestPark. The principal was due and payable by the Company on or
before the earlier of (a) thirty (30) days from the date of issuance of this
Note or (b) upon the receipt by the Company of at least $4 million in the
Private Placement. The Company repaid the Note in full using the proceeds from
the second closing of the Private Placement. The securities were offered and
sold to investors in reliance upon exemptions from registration pursuant to
Section 4(2) under the Securities Act and Rule 506 promulgated thereunder. Each
of the persons and/or entities receiving our securities qualified as an
accredited investor (as defined by Rule 501 under the Securities
Act).
The
placement agent, WestPark, earned a placement fee equal to 12% of the funds
placed in the Private Placement plus a 4% non-accountable expense allowance. No
other consideration was paid to WestPark or SRKP 18 in connection with the Share
Exchange or Private Placement.
On
January 14, 2009, Zhong Bo, our Chief Executive Officer and Chairman of the
Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST Management”)
each entered into a Common Stock Purchase Agreement pursuant to which the
Company issued and the ZST Management agreed to purchase an aggregate of
5,090,315 shares of our common stock at a per share purchase price of $0.6907
(the “Purchase Right”). The purchase price for the shares was paid in full on
May 25, 2009. Each of the stockholders and warrantholders of the Company prior
to the Share Exchange agreed to cancel 0.3317 shares of common stock and
warrants to purchase 0.5328 shares of common stock held by each of them for each
one (1) share of common stock purchased by the ZST Management pursuant to the
Purchase Right (the “Share and Warrant Cancellation”). Pursuant to the Share and
Warrant Cancellation, an aggregate of 1,688,532 shares of common stock and
warrants to purchase 2,712,283 shares of common stock held by certain of our
stockholders and warrantholders prior to the Share Exchange were cancelled. The
shares of common stock were offered and issued in reliance upon an exemption
from registration pursuant to Regulation S of the Securities Act. We complied
with the conditions of Rule 903 as promulgated under the Securities Act
including, but not limited to, the following: (i) each recipient of the shares
is a non-U.S. resident and has not offered or sold their shares in accordance
with the provisions of Regulation S; (ii) an appropriate legend was affixed to
the securities issued in accordance with Regulation S; (iii) each recipient of
the shares has represented that it was not acquiring the securities for the
account or benefit of a U.S. person; and (iv) each recipient of the shares
agreed to resell the securities only in accordance with the provisions of
Regulation S, pursuant to a registration statement under the Securities Act, or
pursuant to an available exemption from registration. We will refuse to register
any transfer of the shares not made in accordance with Regulation S, after
registration, or under an exemption.
On
January 9, 2009, pursuant to the terms of the Share Exchange, we issued 806,408
shares of common stock to the stockholders of World Orient in exchange for all
of the issued and outstanding shares of World Orient. The securities were
offered and issued in reliance upon an exemption from registration pursuant to
Regulation S of the Securities Act. We complied with the conditions of Rule 903
as promulgated under the Securities Act including, but not limited to, the
following: (i) each recipient of the shares is a non-U.S. resident and has not
offered or sold their shares in accordance with the provisions of Regulation S;
(ii) an appropriate legend was affixed to the securities issued in accordance
with Regulation S; (iii) each recipient of the shares has represented that it
was not acquiring the securities for the account or benefit of a U.S. person;
and (iv) each recipient of the shares agreed to resell the securities only in
accordance with the provisions of Regulation S, pursuant to a registration
statement under the Securities Act, or pursuant to an available exemption from
registration. We will refuse to register any transfer of the shares not made in
accordance with Regulation S, after registration, or under an
exemption.
On
January 3, 2007, we issued 2,882,912 shares of common stock for an aggregate
cash consideration of $5,000 and warrants to purchase 2,882,912 shares of common
stock at an exercise price of $0.0001 per share for an aggregate cash
consideration of $2,500. We sold these shares of common stock and warrants under
the exemption from registration provided by Section 4(2) of the Securities Act
and/or Rule 506 of Regulation D promulgated thereunder. Upon the full exercise
of the Purchase Right, the stockholders of the Company prior to the Share
Exchange agreed to the cancellation of an aggregate of 1,688,532 shares of
common stock and warrants to purchase 2,712,283 shares of common stock held by
them.
II-2
Item
16. Exhibits
Exhibit
Index
Exhibit
No.
|
Exhibit Description
|
|
2.1
|
Equity
Purchase Agreement dated October 10, 2008 by and among Zhong Bo, Wu Dexiu,
Huang Jiankang, Sun Hui, Li Yuting and Everfair Technologies, Ltd.
(translated to English) (incorporated by reference from Exhibit 2.1 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
2.2
|
Share
Exchange Agreement dated December 11, 2008 by and among the Registrant,
World Orient Universal Limited and all of the stockholders of World Orient
Universal Limited (incorporated by reference from Exhibit 2.2 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
2.3
|
Amendment
No. 1 to Share Exchange Agreement dated January 9, 2009 by and among the
Registrant, World Orient Universal Limited and all of the stockholders of
World Orient Universal Limited (incorporated by reference from Exhibit 2.3
to the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
3.1
|
Certificate
of Incorporation (incorporated by reference from Exhibit 3.1 to the
Registration Statement on Form 10-SB filed with the Securities and
Exchange Commission on November 26, 2007).
|
|
3.2
|
Bylaws
(incorporated by reference from Exhibit 3.2 to the Registration Statement
on Form 10-SB filed with the Securities and Exchange Commission on
November 26, 2007).
|
|
3.3
|
Certificate
of Designations, Preferences and Rights of Series A Convertible Preferred
Stock as filed with the Office of Secretary of State of Delaware on
January 5, 2009 (incorporated by reference from Exhibit 3.3 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
|
|
3.4
|
Certificate
of Ownership and Merger effecting name change as filed with the Secretary
of State of Delaware on January 9, 2009 (incorporated by reference from
Exhibit 3.4 to the Current Report on Form 8-K filed with the Securities
and Exchange Commission on January 15, 2009).
|
|
3.5
|
Certificate
of Amendment to the Company's Certification of Incorporation effecting
reverse stock split as filed with the Secretary of State of Delaware, on
October 6, 2009 (incorporated by reference from Exhibit 3.1 to the Current
Report on Form 8-K file with the Securities and Exchange Commission on
October 7, 2009).
|
|
4.1
|
Form
of Warrant dated January 3, 2007 (incorporated by reference from Exhibit
4.1 to the Registration Statement on Form 10-SB (File No. 000-52934) filed
with the Securities and Exchange Commission on November 26,
2007).
|
|
5.1
|
Opinion
of K&L Gates LLP.
|
|
10.1
|
Form
of Subscription Agreement (incorporated by reference from Exhibit 10.1 to
the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
10.2
|
Registration
Rights Agreement dated January 9, 2009 by and between the Registrant and
the Stockholders (incorporated by reference from Exhibit 10.2 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
10.3
|
Share
and Warrant Cancellation Agreement dated January 9, 2009 by and between
the Registrant and the Stockholders (incorporated by reference from
Exhibit 10.3 to the Current Report on Form 8-K filed with the Securities
and Exchange Commission on January 15, 2009).
|
|
10.4
|
Promissory
Note dated January 9, 2009 by and between SRKP 18, Inc. and WestPark
Capital, Inc (incorporated by reference from Exhibit 10.4 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
|
|
10.5
|
Form
of 2008 Employment Agreement entered into with executive officers
indicated in Schedule A attached to the Form of Agreement (translated to
English) (incorporated by reference from Exhibit 10.5 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
|
|
10.6
|
Patent
License Agreement dated January 9, 2009 by and between Zhengzhou Shenyang
Technology Company Limited and Zhong Bo (translated to English)
(incorporated by reference from Exhibit 10.6 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on January 15,
2009).
|
|
10.7
|
House
Lease Agreement dated August 29, 2007 by and between Zhengzhou Green City
Advertisement Co., Ltd. and Zhengzhou Shenyang Technology Company Limited
(translated to English) (incorporated by reference from Exhibit 10.7 to
the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
10.8
|
Accounts
Receivable Financing Agreement dated January 4, 2008, as amended, by and
between Zhengzhou Shenyang Technology Company Limited and Raiffeisen
Zentralbank Oesterreich AG Beijing Branch (translated to English)
(incorporated by reference from Exhibit 10.8 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on January 15,
2009).
|
|
10.9
|
Receivable
Pledge Agreement dated January 4, 2008 by and between Zhengzhou Shenyang
Technology Company Limited and Austria Central Cooperation Bank Beijing
Branch (translated to English) (incorporated by reference from Exhibit
10.9 to the Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 15, 2009).
|
|
10.10
|
Form
of Common Stock Purchase Agreement dated January 14, 2009 (incorporated by
reference from Exhibit 10.1 to the Current Report on Form 8-K filed with
the Securities and Exchange Commission on January 21,
2009).
|
II-3
10.11
|
House
Lease Agreement dated April 24, 2009 by and between Zhengzhou Zhong Xing
Real Estate Co., Ltd. and Zhengzhou Shenyang Technology Company Limited
(translated to English) (incorporated by reference from Exhibit 10.1 to
the Quarterly Report on Form 10-Q filed with the Securities and Exchange
Commission on June 12, 2009).
|
|
10.12
|
Value
Added Service Cooperation Agreement dated March 19, 2009 by and between
China Unicom Henan Branch and Zhengzhou Shenyang Technology Company
Limited (translated to English).
|
|
10.13
|
Employment
Agreement dated October 8, 2009 by and between the Registrant and John
Chen, M.D. (incorporated by reference from Exhibit 10.1 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
October 9, 2009).
|
|
10.14
|
Stock
Option Agreement by and between the Registrant and John Chen, M.D.
(incorporated by reference from Exhibit 10.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on October 21,
2009).
|
|
10.15
|
Form
of Stock Purchase Agreement by and between the Registrant and John Chen,
M.D. (incorporated by reference from Exhibit 10.15 to the Registration
Statement on Form S-1/A (File No. 333-160343) filed with the Securities
and Exchange Commission on October 16, 2009).
|
|
10.16
|
GPS
Device Supply and Terminal Service Agreement dated October 25, 2009
(incorporated by reference from Exhibit 10.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on November 10,
2009).
|
|
21.1
|
List
of Subsidiaries (incorporated by reference from Exhibit 21.1 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
|
|
23.1
|
Consent
of Kempisty & Company, Certified Public Accountants,
P.C.
|
|
23.2
|
Consent
of K&L Gates LLP (contained in Exhibit 5.1).
|
|
23.3
|
Consent
of Han Kun Law Offices.
|
|
24.1
|
Power
of Attorney (included on signature
page).
|
II-4
Item
17. Undertakings
The
undersigned registrant hereby undertakes with respect to the securities being
offered and sold in this offering:
The
undersigned Registrant hereby undertakes that to file, during any period in
which offers or sales are being made, a post-effective amendment to this
registration statement:
i. To
include any prospectus required by Section 10(a)(3) of the Securities Act of
1933;
ii. To
reflect in the prospectus any facts or events arising after the effective date
of the registration statement (or the most recent post-effective amendment
thereof) which, individually or in the aggregate, represent a fundamental change
in the information set forth in the registration statement. Notwithstanding the
foregoing, any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated maximum
offering range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate offering price set forth
in the “Calculation of Registration Fee” table in the effective registration
statement;
iii. To
include any material information with respect to the plan of distribution not
previously disclosed in the registration statement or any material change in
such information in registration statement.
That, for
the purpose of determining any liability under the Securities Act of 1933, each
such post-effective amendment shall be deemed to be a new registration statement
relating to the securities offered therein and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
To remove
from registration by means of post-effective amendment any of the securities
being registered which remain unsold at the termination of the
offering.
For
determining liability of the undersigned registrant under the Securities Act to
any purchaser in the initial distribution of the securities, the undersigned
registrant undertakes that in a primary offering of securities of the
undersigned registrant pursuant to this registration statement, regardless of
the underwriting method used to sell the securities to the purchaser, if the
securities are offered or sold to such purchaser by means of any of the
following communications, the undersigned registrant will be a seller to the
purchaser and will be considered to offer or sell such securities to the
purchaser:
i. in any
preliminary prospectus or prospectus of the undersigned registrant relating to
the offering required to be filed pursuant to Rule 424;
ii. any
free writing prospectus relating to the offering prepared by or on behalf of the
undersigned registrant or used or referred to by the undersigned
registrant;
iii. the
portion of any other free writing prospectus relating to the offering containing
material information about the undersigned registrant or its securities provided
by or on behalf of the undersigned registrant; and
iv. any
other communication that is an offer in the offering made by the undersigned
registrant to the purchaser.
Insofar
as indemnification for liabilities arising under the Securities Act of 1933 (the
“Act”) may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable.
In the
event that a claim for indemnification against such liabilities, other than the
payment by the registrant of expenses incurred and paid by a director, officer
or controlling person of the registrant in the successful defense of any action,
suit or proceeding, is asserted by such director, officer or controlling person
in connection with the securities being registered hereby, the registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
For the
purpose of determining liability under the Securities Act to any purchaser, the
undersigned registrant undertakes that each prospectus filed pursuant to Rule
424(b) as part of a registration statement relating to an offering, other than
registration statements relying on Rule 430B or other than prospectuses filed in
reliance on Rule 430A, shall be deemed to be part of and included in the
registration statement as of the date it is first used after effectiveness.
Provided, however, that no statement made in a registration statement or
prospectus that is part of the registration statement or made in a document
incorporated or deemed incorporated by reference into the registration statement
or prospectus that is part of the registration statement will, as to a purchaser
with a time of contract of sale prior to such first use, supersede or modify any
statement that was made in the registration statement or prospectus that was
part of the registration statement or made in any such document immediately
prior to such date of first use.
II-5
SIGNATURES
Pursuant
to the requirements of the Securities Act of 1933, as amended, the Amendment No.
1 to the Registrant has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Zhengzhou, People’s Republic of China, on the 14th day of
January, 2010.
ZST
DIGITAL NETWORKS, INC.
|
||
By:
|
/s/ Zhong Bo
|
|
Name:
|
Zhong
Bo
|
|
Title:
|
Chief
Executive Officer and
|
|
Chairman
of the Board
|
POWER
OF ATTORNEY
KNOW
ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Zhong Bo, as his true and lawful attorney-in-fact and
agent, with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign (1) any and all
amendments to this Form S-1 (including post-effective amendments) and (2) any
registration statement or post-effective amendment thereto to be filed with the
Securities and Exchange Commission pursuant to Rule 462(b) under the Securities
Act of 1933, as amended, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission and any other regulatory authority, granting unto said
attorney-in-fact and agent, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant
to the requirements of the Securities Act of 1933, as amended, this Amendment
No. 1 to the Registration Statement has been signed by the following
persons in the capacities and on the dates indicated:
Signature
|
Title
|
Date
|
||
/s/ Zhong Bo
|
Chief
Executive Officer and Chairman of the Board
|
January
14, 2010
|
||
Zhong
Bo
|
(Principal
Executive Officer)
|
|||
/s/ John Chen
|
|
Chief Financial Officer
|
|
January
14, 2010
|
John
Chen
|
(Principal Financial and Accounting Officer)
|
|||
/s/ Zhong Lin
|
Chief
Operating Officer and Director
|
January
14, 2010
|
||
Zhong
Lin
|
||||
/s/ Yang Ai Mei
|
Director
|
January
14, 2010
|
||
Yang
Ai Mei
|
||||
/s/ Tian Li Zhi
|
Director
|
January
14, 2010
|
||
Tian
Li Zhi
|
||||
/s/ Sheng Yong
|
Director
|
January
14, 2010
|
||
Sheng
Yong
|
||||
/s/ Liu Hui Fang
|
Director
|
January
14, 2010
|
||
Liu
Hui Fang
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II-6
EXHIBIT
INDEX
Exhibit
No.
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Exhibit Description
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2.1
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Equity
Purchase Agreement dated October 10, 2008 by and among Zhong Bo, Wu Dexiu,
Huang Jiankang, Sun Hui, Li Yuting and Everfair Technologies, Ltd.
(translated to English) (incorporated by reference from Exhibit 2.1 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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2.2
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Share
Exchange Agreement dated December 11, 2008 by and among the Registrant,
World Orient Universal Limited and all of the stockholders of World Orient
Universal Limited (incorporated by reference from Exhibit 2.2 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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2.3
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Amendment
No. 1 to Share Exchange Agreement dated January 9, 2009 by and among the
Registrant, World Orient Universal Limited and all of the stockholders of
World Orient Universal Limited (incorporated by reference from Exhibit 2.3
to the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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3.1
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Certificate
of Incorporation (incorporated by reference from Exhibit 3.1 to the
Registration Statement on Form 10-SB filed with the Securities and
Exchange Commission on November 26, 2007).
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3.2
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Bylaws
(incorporated by reference from Exhibit 3.2 to the Registration Statement
on Form 10-SB filed with the Securities and Exchange Commission on
November 26, 2007).
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3.3
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Certificate
of Designations, Preferences and Rights of Series A Convertible Preferred
Stock as filed with the Office of Secretary of State of Delaware on
January 5, 2009 (incorporated by reference from Exhibit 3.3 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
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3.4
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Certificate
of Ownership and Merger effecting name change as filed with the Secretary
of State of Delaware on January 9, 2009 (incorporated by reference from
Exhibit 3.4 to the Current Report on Form 8-K filed with the Securities
and Exchange Commission on January 15, 2009).
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3.5
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Certificate
of Amendment to the Company's Certification of Incorporation effecting
reverse stock split as filed with the Secretary of State of Delaware, on
October 6, 2009 (incorporated by reference from Exhibit 3.1 to the Current
Report on Form 8-K file with the Securities and Exchange Commission on
October 7, 2009).
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4.1
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Form
of Warrant dated January 3, 2007 (incorporated by reference from Exhibit
4.1 to the Registration Statement on Form 10-SB (File No. 000-52934) filed
with the Securities and Exchange Commission on November 26,
2007).
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5.1
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Opinion
of K&L Gates LLP.
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10.1
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Form
of Subscription Agreement (incorporated by reference from Exhibit 10.1 to
the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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10.2
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Registration
Rights Agreement dated January 9, 2009 by and between the Registrant and
the Stockholders (incorporated by reference from Exhibit 10.2 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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10.3
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Share
and Warrant Cancellation Agreement dated January 9, 2009 by and between
the Registrant and the Stockholders (incorporated by reference from
Exhibit 10.3 to the Current Report on Form 8-K filed with the Securities
and Exchange Commission on January 15, 2009).
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10.4
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Promissory
Note dated January 9, 2009 by and between SRKP 18, Inc. and WestPark
Capital, Inc (incorporated by reference from Exhibit 10.4 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
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10.5
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Form
of 2008 Employment Agreement entered into with executive officers
indicated in Schedule A attached to the Form of Agreement (translated to
English) (incorporated by reference from Exhibit 10.5 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
January 15, 2009).
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10.6
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Patent
License Agreement dated January 9, 2009 by and between Zhengzhou Shenyang
Technology Company Limited and Zhong Bo (translated to English)
(incorporated by reference from Exhibit 10.6 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on January 15,
2009).
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10.7
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House
Lease Agreement dated August 29, 2007 by and between Zhengzhou Green City
Advertisement Co., Ltd. and Zhengzhou Shenyang Technology Company Limited
(translated to English) (incorporated by reference from Exhibit 10.7 to
the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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10.8
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Accounts
Receivable Financing Agreement dated January 4, 2008, as amended, by and
between Zhengzhou Shenyang Technology Company Limited and Raiffeisen
Zentralbank Oesterreich AG Beijing Branch (translated to English)
(incorporated by reference from Exhibit 10.8 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on January 15,
2009).
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10.9
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Receivable
Pledge Agreement dated January 4, 2008 by and between Zhengzhou Shenyang
Technology Company Limited and Austria Central Cooperation Bank Beijing
Branch (translated to English) (incorporated by reference from Exhibit
10.9 to the Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 15, 2009).
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10.10
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Form
of Common Stock Purchase Agreement dated January 14, 2009 (incorporated by
reference from Exhibit 10.1 to the Current Report on Form 8-K filed with
the Securities and Exchange Commission on January 21,
2009).
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10.11
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House
Lease Agreement dated April 24, 2009 by and between Zhengzhou Zhong Xing
Real Estate Co., Ltd. and Zhengzhou Shenyang Technology Company Limited
(translated to English) (incorporated by reference from Exhibit 10.1 to
the Quarterly Report on Form 10-Q filed with the Securities and Exchange
Commission on June 12,
2009).
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II-7
10.12
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Value
Added Service Cooperation Agreement dated March 19, 2009 by and between
China Unicom Henan Branch and Zhengzhou Shenyang Technology Company
Limited (translated to English).
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10.13
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Employment
Agreement dated October 8, 2009 by and between the Registrant and John
Chen, M.D. (incorporated by reference from Exhibit 10.1 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
October 9, 2009).
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10.14
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Stock
Option Agreement by and between the Registrant and John Chen, M.D.
(incorporated by reference from Exhibit 10.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on October 21,
2009).
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10.15
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Form
of Stock Purchase Agreement by and between the Registrant and John Chen,
M.D. (incorporated by reference from Exhibit 10.15 to the Registration
Statement on Form S-1/A (File No. 333-160343) filed with the Securities
and Exchange Commission on October 16, 2009).
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10.16
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GPS
Device Supply and Terminal Service Agreement dated October 25, 2009
(incorporated by reference from Exhibit 10.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on November 10,
2009).
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21.1
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List
of Subsidiaries (incorporated by reference from Exhibit 21.1 to the
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2009).
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23.1
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Consent
of Kempisty & Company, Certified Public Accountants,
P.C.
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23.2
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Consent
of K&L Gates LLP (contained in Exhibit 5.1).
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23.3
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Consent
of Han Kun Law Offices.
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24.1
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Power
of Attorney (included on signature
page).
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II-8