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EX-32.1 - EXHIBIT 32.1 - SKY DIGITAL STORES CORP.ex321.htm
EX-32.2 - EXHIBIT 32.2 - SKY DIGITAL STORES CORP.ex322.htm
EX-31.1 - EXHIBIT 31.1 - SKY DIGITAL STORES CORP.ex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2011
or
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
Commission File Number: 000-52293

SKY DIGITAL STORES CORP.
(Exact name of registrant as specified in its charter)

Nevada
 
83-0463005
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

8/F, South Block, Resources Tech Building,
1 Song Ping Shan Road, High-tech Industrial Park,
Nanshan District, Shenzhen, P.R.C. 518057
(Address of principal executive offices) (Zip Code)

86 755 82718088
(Registrant’s telephone number, including area code)

____________________________
 (Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [  ]  No [  ]

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.

Large accelerated filer
[  ]
 
Accelerated filer
[  ]
Non-accelerated filer
[  ]
(Do not check if a smaller reporting company)
Smaller reporting company
[X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 Yes [ ]  No [ X ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [  ]  No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 24,586,737 shares of common stock are issued and outstanding as of November 17, 2011.
 
 
 
1

 
 
TABLE OF CONTENTS
 
PART I – FINANCIAL INFORMATION
 
ITEM 1 FINANCIAL STATEMENTS
3
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
32
ITEM 4. CONTROLS AND PROCEDURES
32
PART II – OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS.
33
ITEM 1A. RISK FACTORS
33
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
33
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
33
ITEM 4. (REMOVED AND RESERVED)
33
ITEM 5. OTHER INFORMATION
33
ITEM 6. EXHIBITS
33
SIGNATURES
34
 
 
2

 
 
PART I – FINANCIAL INFORMATION
 
 
Forward Looking Statements
 
This quarterly report contains forward-looking statements that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. 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. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.
 
Our unaudited financial statements are stated in United States Dollars (US$) and are prepared in accordance with United States Generally Accepted Accounting Principles. The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this quarterly report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward looking statements.
 
In this quarterly report, unless otherwise specified, all dollar amounts are expressed in United States dollars. All references to “common shares” refer to the common shares in our capital stock.
 
As used in this quarterly report, the terms "we", "us", "our", and "SKYC" mean SKY Digital Stores Corp., unless the context clearly requires otherwise.
 
ITEM 1 FINANCIAL STATEMENTS.
 

SKY DIGITAL STORES CORP. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As of September 30, 2011

 
3

 


SKY DIGITAL STORES CORP. AND SUBSIDIARIES


TABLE OF CONTENTS

Consolidated Financial Statements
Page
Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010
1
Consolidated Statements of Operations for the Nine and Three Months Ended September 30, 2011 (Unaudited)
2
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 3011 and 2010 (Unaudited)
3
Notes to Consolidated Financial Statements (Unaudited)
4-23
 

 
4

 

SKY DIGITAL STORES CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Stated in US Dollars)
 
 
   
September 30, 2011
   
December 31, 2010
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
Current Assets
           
Cash
  $ 8,463,311     $ 38,216  
Restricted cash
    3,913,282       -  
Accounts receivable
    3,670,505       5,473,803  
Inventories
    2,732,041       859,476  
Trade Deposit
    95,690       589,312  
Prepaid expense - current
    126,922       31,427  
Other receivables
    285,625       18,236  
Deferred tax assets
    32,813       -  
Total Current Assets
  $ 19,320,189     $ 7,010,470  
                 
Property and equipment, net
    461,773       93,130  
Security deposits and other assets
    69,020       -  
Intangible assets, net
    114,673       -  
Prepaid expenses - non current
    160,966       -  
Goodwill
    95,902       -  
Total Non-current Assets
    902,334       93,130  
                 
Total Assets
  $ 20,222,523     $ 7,103,600  
                 
LIABILITIES AND EQUITY
               
Current Liabilities
               
Accounts payable
  $ 5,681,082     $ 1,876,330  
Advance from customers
    33,478       -  
Accrued expenses and other payables
    652,156       270,009  
Short-term bank loan
    3,913,281       -  
Loans from stockholders
    4,685,570       -  
Income tax payable
    62,161       214,054  
Total Current Liabilities
    15,027,728       2,360,393  
                 
Deferred tax liabilities - non-current
    49,479       -  
Deferred rent
    43,156       -  
Total Liabilities
    15,120,363       2,360,393  
                 
Commitments and Contingencies
    -       -  
                 
Stockholders’ Equity
               
Common stock
               
$0.001 par value, 750,000,000 shares authorized; 24,586,090 and 23716,035 shares issued and outstanding as of September 30, 2011 and December 31, 2010
    24,586       23,716  
Additional paid-in capital
    3,974,590       4,090,481  
Subscription receivable
    -       (642 )
Statutory reserve
    310,652       228,458  
Retained earnings (deficits)
    114,229       (50,687 )
Accumulated other comprehensive income
    606,327       451,881  
Total SKYC stockholders’ Equity
    5,030,384       4,743,207  
Non-controlling interest
    71,776       -  
Total Equity
    5,102,160       4,743,207  
Total Liabilities and Stockholders’ Equity
  $ 20,222,523     $ 7,103,600  
 
See accompanying notes to the consolidated financial statements

 
5

 

SKY DIGITAL STORES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Stated in US Dollars)
 
   
For the Nine Months Ended September 30
   
For the three months ended September 30
 
   
2011
   
2010
   
2011
   
2010
 
Sales
  $ 38,066,707     $ 24,628,445     $ 15,844,644     $ 7,123,816  
Cost of goods sold
    (35,368,682 )     (22,088,431 )     (14,823,183 )     (6,421,665 )
Gross Profit
    2,698,025       2,540,014       1,021,461       702,151  
                                 
Commission and franchise income
    90,541       -       55,084       -  
                                 
Operating Expense
                               
General and administrative expenses
    (1,900,373 )     (542,461 )     (935,676 )     (194,529 )
Selling Expense
    (307,734 )     (276,743 )     (68,575 )     (89,261 )
Total Operating Expenses
    (2,208,107 )     (819,204 )     (1,004,251 )     (283,790 )
                                 
Operating income
    580,459       1,720,810       72,294       418,360  
                                 
Other income (expense):
                               
Interest (expense) income, net
    (42,896 )     3,807       (45,114 )     1,811  
Total other income (expense)
    (42,896 )     3,807       (45,114 )     1,811  
                                 
Income before provision for income taxes
    537,563       1,724,617       27,180       420,171  
                                 
Provision for income taxes
    (270,171 )     (357,371 )     (69,213 )     (105,507 )
                                 
Net income (loss)
    267,392       1,367,246       (42,033 )     314,664  
Net income attributable to non-controlling interests
    13,131       -       15,405       -  
Net income (loss) attributable to SKYC shareholders
  $ 254,261     $ 1,367,246     $ (57,438 )   $ 314,664  
Earnings per share
                               
Basic
  $ 0.01     $ 0.06     $ -     $ 0.01  
Diluted
  $ 0.01     $ 0.06     $ -     $ 0.01  
Weighted average shares outstanding
                               
Basic
    24,190,571       23,716,035       24,856,267       23,716,035  
Diluted
    24,190,571       23,716,035       24,856,267       23,716,035  
 
See accompanying notes to the consolidated financial statements

 
6

 

SKY DIGITAL STORES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Stated in US Dollars)

   
For the Nine Months Ended Sep 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net Income
  $ 267,392     $ 1,367,246  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    110,935       15,841  
Stock-based compensation
    48,583       -  
Deferred tax assets
    (32,125 )     62,536  
Changes in operating assets and liabilities:
               
Restricted cash
    (3,853,030 )     -  
Accounts receivable
    2,274,200       (4,286,024 )
Inventories
    (1,258,740 )     55,391  
Trade deposit
    787,378       979,987  
Prepaid expenses
    (249,377 )     900,446  
Security deposits and other receivables
    53,732       (13,007 )
Accounts payable
    3,577,784       1,578,802  
Accrued expenses and other payables
    (207,449 )     165,755  
Income tax payable
    (195,156 )     107,665  
Customer deposit
    32,822       -  
Deferred rent
    42,171       -  
Net cash provided by (used in) operating Activities
  $ 1,399,119     $ 934,638  
                 
Cash flows from investing activities:
               
Purchase of PP&E
    (449,655 )     (108,479 )
Payment for acquisition of Shenzhen Dasen
(net of cash acquired)
    (804,343 )     -  
Net cash used in Investing Activities
    (1,253,998 )     (108,479 )
                 
Cash flows from financing activities:
               
Loan to unrelated parties
    22,285       83,879  
Repayment of unrelated parties loan
    (350,398 )     (1,046,540 )
Loan from stockholders
    4,478,606       -  
Short-term bank loan
    3,853,030       -  
Loan from related party
    153,102       -  
Repayment of stockholder loan
    -       (187,379 )
Net cash provided by (used in) Financing Activities
    8,156,625       (1,150,040 )
                 
Effect of exchange rate changes on cash
    123,349       35,943  
                 
Net increase (decrease) in cash
    8,425,095       (287,938 )
                 
Cash at beginning of period
    38,216       2,144,912  
Cash at end of period
  $ 8,463,311     $ 1,856,976  
Supplemental disclosure of cash flow information
               
Income tax paid in cash
  $ 433,324     $ 249,706  
   
See accompanying notes to the consolidated financial statements
 

 
7

 

SKY DIGITAL STORES CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(STATED IN US DOLLARS)
 
NOTE 1 — ORGANIZATION AND PRINCIPAL ACTIVITIES

SKY Digital Stores, Corp. (the “Company") was incorporated on March 23, 2006 in the state of Nevada under the name Hoopsoft Development Corp. The Company changed its name to SKY Digital Stores, Corp. (Formerly known as Yellowcake Mining Inc.) on March 17, 2011. Hong Kong First Digital Holding Ltd. (“First Digital”) was incorporated in Hongkong on September 30, 2010.

On May 5, 2011, the Company completed the acquisition of First Digital, a company that is in the business of designing, manufacturing and selling of mobile communication and digital products, by means of a share exchange. Pursuant to the terms of the Exchange Agreement, the Company acquired all of the outstanding shares (the “Shares”) of First Digital from the First Digital’s Stockholders; and First Digital’s Stockholders transferred and contributed all of their Shares to the Company. In exchange, the Company issued to the First Digital’s Stockholders, their designees or assigns, an aggregate of 23,716,035 shares (the “Shares Component”) or 97.56% of the shares of common stock of the Company issued and outstanding after the Closing (the “Share Exchange”), at $0.20 per share. The parties understand and acknowledge that such exchange is based upon an acquisition value of First Digital at $4,743,207, which is agreed and acceptable by all parties. As a result of the Share Exchange, First Digital became our wholly owned subsidiary and its subsidiaries business became our main operational business.  Consequently, the Share Exchange has caused the Company to cease to be a shell company.  

The Share Exchange Transaction described above is being accounted for as a reverse acquisition and recapitalization of First Digital because, prior to the transactions, the Company was a non-operating public shell and, subsequent to the transactions, the stockholders of First Digital own a majority of the outstanding common stock of the Company and exercise significant influence over the operating and financial policies of the consolidated entity. Pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"), the merger or acquisition of a private operating company into a non-operating public shell with nominal net assets is considered a capital transaction.

First Digtial operates through its wholly owned subsidiaries, Shenzhen Donxon Mobile Communication Technology Co., Ltd. (“Donxon”) and Shenzhen Xing Tian Kong Digital Company Limited (“Xingtiankong”).
Donxon was incorporated in the People’s Republic of China (the “PRC”) on April 9, 2003. First Digital acquired all $4,112,913 (RMB 30,000,000) of registered Capital of Donxon on September 30, 2010. On February 28, 2011, First Digital formed Xingtiankong in the city of Shenzhen under the laws of the PRC with registered capital of $151,704 (RMB 1,000,000).  First Digital owns 100% of the issued and outstanding capital stock of Donxon and Xingtiankong.

On April 7, 2011, Xingtiankong acquired all of the registered capital of Shenzhen Dasen Communication Technology Company Limited (“Shenzhen Dasen”) with total consideration of $1,237,816. Shenzhen Dasen was incorporated in the city of Shenzhen under the laws of PRC on November 26, 2007. Xiantiankong owns 100% of the issued and outstanding capital stock of Shenzhen Dasen.  Shenzhen Dasen is the holder of 70% of the issued and outstanding capital of Foshan Dasen Communication Chain Service Company Limited, a company incorporated in PRC on January 19, 2007. Shenzhen Dasen was established on November 26, 2007 in Shenzhen, PRC. It engages in the retail business of selling mobile communication products and accessories in PRC and operates the retailing business through its retail website (http://www.dasen.com.cn/) and three branch chain stores located within Guangdong Province.

On August 1, 2011, the Company has incorporated a subsidiary, Xinyang City Donxon Mobile Communication Technology Company Limited, in Henan Province (“Xinyang Donxon”). Xinyang Donxon will perform as a logistics center and a customer service, training and manufacturing facility for the Company.
 
 
8

 

In July and August, 2011, the Company entered into franchising management agreements with multiple independently owned retailing stores throughout Guangdong province, PRC. According to the agreement entered into, the Company will provide branding, product sourcing and management training to the store management and charge a fixed management fee each month and an annual variable management fee based on the audited net income of each store.

The Company’s business is mainly operated by Donxon and Shenzhen Dasen, engaged in the business of designing, manufacturing and selling of mobile communications and digital products and retailing stores in the PRC.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation

The accompanying unaudited consolidated financial statements include the financial statements of the Company and its 100% owned subsidiaries First Digital, Donxon, Xingtiankong and Xinyang Donxon. Pursuant to the Share Exchange Agreement entered into on May 5, 2011, stockholders of First Digital became the majority stockholders of the Company. Based on the Application of ASC 805-40-45, the Company needs to retroactively adjust this transaction to the financial statements of earlier periods presented in the accompanying consolidated financial statements. The financial statements of Shenzhen Dasen are only included from the acquisition date of April 7, 2011. The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”).  All intercompany transactions and accounts have been eliminated in consolidation. This basis of accounting differs from that used in the statutory accounts of the Company, which are prepared in accordance with the “Accounting Principle of China” (“PRC GAAP”).

The unaudited interim consolidated financial statements of the Group as of September 30, 2011, and for the nine months ended September 30, 2011 and 2010, included herein, have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in the financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited interim consolidated financial statements reflect all adjustments that in the opinion of management are necessary to present fairly the financial position, results of operations, cash flows, and stockholders’ equity for the interim periods presented. All adjustments are of a normal recurring nature, unless otherwise disclosed. The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Foreign Currency Translation and Transactions

The accompanying consolidated financial statements are presented in U.S. dollars (“USD”). First Digital’s functional currency is Hong Kong Dollar (“HKD”). Donxon, Xingtiankong and Xinyang Donxon’s functional currency is Chinese Yuan Renminbi (“RMB”). The consolidated financial statements are translated into USD in accordance with the Codification ASC 830, Foreign Currency Matters.  All assets and liabilities were translated at the current exchange rate, at respective balance sheet dates, stockholders’ equity is translated at the historical rates and income statement items are translated at the average exchange rate for the reporting periods.  The resulting translation adjustments are reported as other comprehensive income and accumulated other comprehensive income in stockholders’ equity in accordance with the Codification ASC 220, Comprehensive Income.

Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.  There were no material transaction gains or losses in the periods presented.

Cash flow from the Company’s operations included in the statement of cash flow is calculated based upon the functional currency using the average translation rate. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with arithmetical changes in the corresponding balances on the consolidated balance sheet. No presentation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
 
 
9

 

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Company since it has not engaged in any significant transactions that are subject to the restrictions.

The exchange rates used to translate amounts in RMB into USD for the purposes of preparing the consolidated financial statements were as follows:

   
September 30,
   
December 31,
   
September 30,
 
   
2011
   
2010
   
2010
 
Period end RMB : USD exchange rate
    6.3885       6.5918       6.6781  
Averag  RMB : USD exchange rate
    6.4884       6.7605       6.7983  
Period end HKD : USD exchange rate
    7.7929       7.7822       7.7575  
Average HKD : USD exchange rate
    7.7856       7.7682       7.7704  
 
Use of Estimates

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods presented. Actual results could differ from these estimates.  Significant items subject to such estimates and assumptions include the recoverability of the carrying amounts of recorded assets and liabilities, estimated useful life of property and equipment, inventory obsolesce and the allowance for doubtful accounts.

Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, the estimated liability would be accrued in the Company’s financial statements.
 
If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
 
Cash

Cash includes cash on hand and deposits in PRC and Hong Kong banks which are unrestricted as to withdrawal or use.  Management believes that these major financial institutions are of high credit quality.

Restricted cash

Restricted cash is related to deposits required by bank for banker’s acceptance notes. The balance of restricted cash was $3,913,282 and $0 as of September 30, 2011 and December 31, 2010, respectively.
 
 
10

 

Accounts Receivable

Accounts receivable are recognized and carried at original invoice amounts less allowance for any uncollectible amounts. The Company provides an allowance for doubtful accounts equal to the estimated losses that will be incurred in the collection of all receivables. Historically, the Company has not recorded any allowances as all such amounts are deemed collectible.  Accordingly, the Company didn’t record any allowance for doubtful accounts as of September 30, 2011 and December 31, 2010.

Inventories

Donxon inventories which consist of raw materials and finished goods are stated at the lower of cost and market.  Cost is determined using the First in, First out method. Costs of finished goods are composed of direct materials, direct labor and an attributable portion of manufacturing overhead based on normal operating capacity. Dasen inventory is all finished product purchased for resale. Management regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if valuation allowance is required.

Trade Deposit

Advance payments for purchases of raw materials are included in “Trade Deposit” and represent cash deposits paid to vendors for future purchases. The Company is required to make advance payments to certain suppliers. Advance payments are unsecured and non-interest bearing.

Property and Equipment
 
Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations.  Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:
 
 
Years
Machinery and equipment
5 years
Office equipment
3-5 years
Leasehold improvements
2 years
Vehicle
3 years
 
Impairment of Long-Lived Assets
 
Long-lived assets, including property, plant and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. As of September 30, 2011 and December 31, 2010, there was no impairment of long-lived assets.

Intangible Assets

Intangible assets are amortized using the straight-line method over their estimated period of benefit. Evaluation of the recoverability of intangible assets is made annually to take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. No impairments of intangible assets have been identified during any of the periods presented.
 
 
11

 

In conjunction the acquisition of Shenzhen Dasen on April 7, 2011, the Company capitalized $107,281 of identifiable intangible assets. The identifiable intangible assets consist primarily of trade name and customer relationships. Trade name and customer relationship is to be amortized over 15 years, their estimated useful life.

The Company recorded amortization expenses for intangible assets of $4,039 and $2,104 for the nine and three months ended September 30, 2011.

Goodwill and Indefinite-Lived Intangible Assets
 
The Company tests goodwill and impairment annually by comparing the fair value of each of the Company’s reporting units to the respective carrying value of the reporting units. Additionally, the Company may perform tests between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit below its carrying amount. The carrying value of each reporting unit is determined by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units. Goodwill is considered impaired if the carrying amount of the net assets exceeds the fair value of the reporting unit. Impairment, if any, would be recorded in operating income and could significantly adversely affect net income and earnings per share. Shenzhen Dasen is the only reporting unit that carries goodwill subject to impairment test. Shenzhen Dasen was acquired by the Company on April 7, 2011. No impairment indicators occurred subsequent to the acquisition.
 
Revenue Recognition

Effective April 7, 2011, the Company had two types of revenue streams from its two lines of businesses, namely (i) design, manufacturing and sale of mobile phones and digital products (Donxon), (ii) retailing stores (Shenzhen Dasen).

The Company records revenues when all of the following criteria have been met:

Persuasive evidence of an arrangement exists. The Company generally relies upon sales contracts or agreements, and customer purchase orders, to determine the existence of an arrangement;

Sales price is fixed or determinable. The Company assesses whether the sales price is fixed or determinable based on the payment terms and whether the sales price is subject to refund or adjustment;

Delivery has occurred. The Company uses shipping terms and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. The Company’s customary shipping terms are FOB destination point;

Collectability is reasonably assured. The Company assesses collectability based on creditworthiness of customers as determined by our credit checks and their payment histories. The Company records accounts receivable net of allowance for doubtful accounts and estimated customer returns.

Commission income

The Company receives commissions from sale of digital products for third parties. The Company does not charge customers differently from the prices provided by third parties. The Company has no discretion on the digital product prices or the applicable commission rates as they are dictated by the third parties. Commissions from selling of digital products are recognized after phone cards are sold to retail customers. The Company presents revenues from such transactions on a net basis in the statements of income as the Company, generally, does not assume inventory risks and has no obligations for cancelled phone cards.

Income from franchising stores

The Company entered into agreement with multiple independently owned retailing stores throughout Guangdong province, PRC in the third quarter of this year. According to the agreement entered into by the both parties, the Company is entitled to a management fee from these franchising stores. The management fee will be a fixed fee each month and a variable management fee based on audited net income of each store. The company recognizes fixed management fee each month. The Company will book variable management fee income based on estimated net income, if any, of each store.
 
 
12

 

The Company’s revenue is principally derived from sale of mobile phone and digital products to wholesalers and retail stores in the PRC.

The Company provides one-year warranty to its customers that its products will meet the functionality standards agreed to in each sales arrangement. The Company expenses all warranty expenses at the earlier of the time their existence is known or as expenses incurred. For the nine months ended September 30, 2011 and 2010, warranty expenses have been minimal and no warranty reserve was considered necessary. The Company believes the existence of the product warranty in a sales contract does not constitute a deliverable in the arrangement and thus there is no need to apply FASB ASC Topic 605-25 separation and allocation model for a multiple deliverable arrangement. FASB ASC Topic 450 specifically addresses the accounting for standard warranties and neither SAB 104 nor FASB ASC Topic 605-25 supersedes FASB ASC Topic 450.

Income Tax

The Company has adopted the provisions of ASC subtopic 740-10 (“ASC 740-10”), Income taxes: Overall (Pre-Codification: FIN 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109). ASC 740-10 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognizing, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company applies the provisions of ASC 740-10, Accounting For Uncertainty In Income Taxes, which provides clarification related to the process associated with accounting for uncertain tax positions recognized in its combined financial statements. ASC 740-10 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. ASC 740-10 also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements.

Comprehensive Income

Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. For the Company, comprehensive income for the periods presented includes net income and foreign currency translation adjustments.
 
   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Comprehensive income
                       
Net income (loss)
  $ 267,392     $ 1,367,246     $ (42,033 )   $ 314,664  
Foreign currency translation adjustment
    154,446       170,808       52,952       89,822  
Comprehensive income
  $ 421,838     $ 1,538,054     $ 10,919     $ 404,487  
                                 
Comprehensive income attributable to the non-controlling interest
    13,131       -       15,405       -  
Comprehensive income attributable to the SKYC stockholders
  $ 408,707     $ 1,538,054     $ (4,486 )   $ 404,487  

Advertising Expense

The Company expenses all advertising expenses as incurred. Advertising expenses included in selling expenses were $27,308 and $63,422 for the nine months period September 30, 2011 and 2010, respectively. Advertising expenses included in selling expenses were $6,282 and $62,285 for the three months period September 30, 2011 and 2010, respectively.
 
Shipping and Handling

All shipping and handling costs are expensed as incurred and included in selling expenses. Total shipping and handling expenses were $146,871 and $142,014 for the nine months ended September 30, 2011 and 2010, respectively. Total shipping and handling expenses were $36,821 and $44,835 for the three months ended September 30, 2011 and 2010, respectively.

Research and Development Cost

Research and development costs are expensed in the period when they are incurred.
 
 
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Statutory Reserves

Pursuant to the applicable laws in the PRC, Donxon makes appropriations to two non-distributable reserve funds, the statutory surplus reserve and the statutory public welfare reserve.  The appropriations are based on after-tax net earnings as determined in accordance with the PRC generally accepted accounting principles, after offsetting any prior years’ losses. Appropriation to the statutory surplus reserve is based on an amount at least equal to 10% of after-tax net earnings until the reserve is equal to 50% of the entity's registered capital. Donxon’s registered capital is $4,113,555 as of September 30,
2011.  Appropriation to the statutory public welfare fund is based on 5% to 10% of after-tax net earnings and is not mandatory. The statutory public welfare reserve is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable, other than in liquidation.

Donxon does not make appropriations to the discretionary surplus reserve fund.  As of September 30, 2011 and December 31, 2010, Donxon had appropriated $310,652 and $228,458 statutory surplus reserve fund, respectively.

Shenzhen Dasen did not make appropriations to the statutory surplus reserve fund as of September 30, 2011 due to operating losses incurred in the prior periods.

Value-added-tax

In the PRC, value-added-tax (“VAT”) at a rate of 17% of invoiced amount is collected on behalf of the PRC tax authorities. Revenue is recorded net of VAT. VAT collected from customers is offset against VAT paid for purchases and is recorded as a liability on the consolidated balance sheet until paid.

Concentration of Credit Risk
 
Financial instruments that potentially subject the Company to concentrations of credit risk are cash and accounts receivable arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions.  The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.
 
As of September 30, 2010 and December 31, 2010, the Company’s cash was with banks in the PRC and Hongkong, where there is currently no rule or regulation mandated on obligatory insurance of bank accounts.

For the nine months ended September 30, 2011, four customers accounted for 24%, 16%, 15% and 13% of the Company’s sales. For the nine months ended September 30, 2010, no customer accounted for more than 10% of the Company’s sales. For the nine months ended September 30, 2011, four vendors provided 18%, 17%, 17% and 14% of the Company’s total purchases, respectively.  For the nine months ended September 30, 2010, three vendors accounted for 24%, 15% and 14% of the Company’s total purchases, respectively.

For the three months ended September 30, 2011, five customers accounted for 38%, 20%, 18%, 14% and 10% of the Company’s sales. For the three months ended September 30, 2010, no customer accounted for more than 10% of the Company’s sales. For the three months ended September 30, 2011, three vendors provided 21% and 15% and 14% of the Company’s total purchases, respectively.  For the three months ended September 30, 2010, three vendors accounted for 20% and 16% and 13% of the Company’s total purchases, respectively.

Economic and Political Risks

The Company’s operations are conducted primarily in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
 
 
14

 

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

The Company has categorized its assets and liabilities at fair value based upon the fair value hierarchy specified by FASB ASC 820.

The levels of fair value hierarchy are as follows:

i.  
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.

ii.  
Level 2 inputs utilize other-than-quoted prices that are observable, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

iii.  
Level 3 inputs are unobservable and are typically based on our own assumptions, including situations where there is little, if any, market activity.

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties.  As of September 30, 2011 and December 31, 2010, the carrying amounts of financial assets and liabilities, such as cash, accounts receivable, accounts payable, and other payables, approximate their fair values because of the short maturity of these instruments and market rates of interest available to the Company.

Segment Reporting

ASC 280, “Disclosure about Segments of an Enterprise and Related Information”, requires disclosure of reportable segments used by management for making operating decisions and assessing performance.  Reportable segments are categorized by products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. ASC 280 has no effect on the Company’s consolidated financial statements as all of the Company’s operations are conducted in one industry segment.
 
Dividends

Dividends may be declared and paid out of legally available funds at the discretion of our Board of Directors. We do not anticipate or contemplate paying dividends in the foreseeable future. We currently intend to utilize all available funds to develop our business. We can give no assurances that we will ever have excess funds available to pay dividends.

Earnings Per share

The Company reports earnings per share in accordance with the provisions of FASB ASC 260.10, "Earnings Per Share”. FASB ASC 260.10 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury method.

As of September 30, 2011, there are no potentially dilutive securities outstanding.
 
 
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Recent Accounting Pronouncements

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends ASC 820 to require a number of additional disclosures regarding (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15,
2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not expect that the adoption of ASU 2010-06 will have a material impact on its consolidated financial statements.

In April 2010, the FASB issued an authoritative pronouncement on milestone method of revenue recognition. The scope of this pronouncement is limited to arrangements that include milestones relating to research or development deliverables. The pronouncement specifies guidance that must be met for a vendor to recognize consideration that is contingent upon achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. The guidance applies to milestones in arrangements within the scope of this consensus regardless of whether the arrangement is determined to have single or multiple deliverables or units of accounting. The pronouncement will be effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early application is permitted. Companies can apply this guidance prospectively to milestones achieved after adoption. However, retrospective application to all prior periods is also permitted. The Company does not believe the adoption this standard would have materially affected the Company’s consolidated financial statements.

In December 2010, the FASB issued an update which addresses the disclosure of supplementary pro forma information for business combinations. The update requires public entities to disclose pro forma information for business combinations that occurred in the current reporting period, including revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. Amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company has adopted this update and applied the disclosure requirements in connection with the acquisition of Shenzhen Dasen (See Note 12).

In December 2010, the FASB issued ASU No. 2010-28 (“ASU 2010-28”), Intangibles — Goodwill and Other (“ASC 350”): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The objective of this standard is to address questions about entities with reporting units with zero or negative carrying amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. The amendments in this standard modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements.

In June 2011, the FASB issued guidance which eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders' equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance is not expected to have a material impact on the consolidated financial statements.
 
 
16

 

Management does not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, would have a material impact on the Company’s consolidated financial statements.

NOTE 3 — INVENTORIES

As of September 30, 2011 and December 31, 2010, Inventories consist of the following at:

   
September 30,
   
December 31,
 
   
2011
   
2010
 
             
Raw materials
  $ 582,346     $ 859,476  
Finished goods
    2,149,696       -  
    $ 2,732,041     $ 859,476  

NOTE 4 — TRADE DEPOSIT

The Company advances cash as deposits to certain vendors for the purchase of materials. As of September 30, 2011 and December 31, 2010, trade deposits amounted to $95,690 and $589,312, respectively.

NOTE 5 — PREPAID EXPENSES

In order to sell self-brand mobile phone in the PRC market, Donxon prepaid inspection fees and mold fees to acquire Telecom Network permits in China for all types of phone. The amortization period of prepaid expenses is one year. As of September 30, 2011 and December 31, 2010, prepayment for inspection fees and mold fees amounted to $22,568 and $31,427, respectively.

On April 8, 2011, Xingtiankong entered into the Amended Share Exchange Agreement with stockholders of Shenzhen Dasen. As part of the agreement, Xingtingkong hired Guan Yinyan, one of Shenzhen Dasen stockholders as its Business Consultant for three years. Xingtiankong will pay Mr. Guan $309,454 as total compensation for his three-year service. As of September 30, 2011, current and non-current prepaid expenses amounted to $104,354 and $160,966, respectively.

NOTE 6 — PROPERTY AND EQUIPMENT

Property and equipment consist of the following at:
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Machinery and equipment
  $ 154,236     $ 80,714  
Office equipment
    145,867       41,431  
Leasehold improvements
    241,987       -  
Vehicle
    63,113       -  
      605,203       122,145  
Less: Accumulated depreciation
    (143,430 )     (29,015 )
    $ 461,773     $ 93,130  
 
 
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Total depreciation expense for the nine months ended September 30, 2011 and 2010 amounted to $107,013 and $15,841, respectively. Total depreciation expense for the three months ended September 30, 2011 and 2010 amounted to $93,233 and $5,838, respectively.

NOTE 7 — ACCRUED EXPENSES AND OTHER PAYABLES

Accrued expenses and other payables consist of the following at:
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Accrued expenses and other payables
  $ 625,669     $ 109,276  
Value-added tax payable
    26,487       160,733  
    $ 652,156     $ 270,009  
 
NOTE 8 — SHORT-TERM BANK LOAN

On June 28, 2011, Donxon entered into a short-term bank loan with Shenzhen Development Bank for $3,913,281 with a 6.31% annual interest rate. Pursuant to the Loan Agreement, interest expense is payable every month. The full amount of the loan will be repaid on June 27, 2012.  The loan was funded in July, 2011.

NOTE 9 — LOAN FROM STOCKHOLDERS

On February 18, 2010, a lender who was an unrelated party, loaned Yellowcake Mining Inc. a total of $125,000 pursuant to a promissory note requiring interest at 10% per annum and payable on demand.
 
In December 2010, a stockholder of First Digital purchased the loan from the lender for $134,000 which included the principal and accrued but unpaid interest.
 
Stockholders advanced funds to the Company for working capital purposes. The loans from stockholders are unsecured and bear no interest. The amount of loans from stockholders was $4,685,570 as of September 30, 2011. The full amounts of the loans will be due in 2012.
 
NOTE 10 — LEASE COMMITMENTS

The Company leases offices from third parties under operating leases.  For the nine months ended September 30, 2011 and 2010, the Company has rental expenses in the amount of $208,702 and $71,536, respectively. For the three months ended September 30, 2011 and 2010, the Company has rental expenses in the amount of $86,335 and $19,943, respectively. Under the lease agreements, the Company is committed to pay approximately $68,031, $278,796 and $46,688 in years 2011, 2012 and 2013, respectively.
 
 
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NOTE 11 — STOCKHOLDERS’ EQUITY

On April 6, 2011, the Company effected a 1:200 reverse split of the Company’s issued and outstanding shares of common stock, decreasing the number of outstanding shares from 115,335,576 to 578,031 as of December 31, 2010. These statements have been adjusted to reflect this reverse split.

On May 5, 2011, the Company completed the acquisition of First Digital. In the Exchange, the Company issued to First Digital’s stockholders, their designees or assigns, an aggregate of 23,716,035 shares.
 
On May 5, 2011, the Company issued 15,000 shares common stock at $1.65 to Sichenzia Ross Friedman Ference LLP for total consideration of $24,750 for the legal services provided to the Company in connection with the Share Exchange.
 
On June 13, 2011, the Company issued 3,333 shares common stock at $2.5 per share to KCSA Strategic Communications for total consideration of $8,332 for public relationship services provided to the Company.
 
In July and August, 2011, the Company appointed Mr. Bin Wang and Dr. Christos Vlachos as independent directors. Pursuant to the terms of their appointments. Mr. Bin Wang shall receive 100,000 shares of the common stock of the Company per annum for his service. Dr. Christos Vlachos shall receive such number of shares of the common stock of the Company, whose value equal to $60,000 per annum for his service. The value of the shares will be an average of closing price for the five trading days prior to the issuance of the shares. As of September 30, 2011, the Company has not issued any shares to Mr, Bin Wang and Dr, Christos Vlachos.
 
NOTE 12 — ACQUISITION
 
On April 7, 2011, Xingtiankong acquired all of the registered capital of Shenzhen Dasen Communication Technology Company Limited (“Shenzhen Dasen”) with total consideration of $1,252,251 (the “Acquisition”). Shenzhen Dasen was incorporated in the city of Shenzhen under the laws of PRC on November 26, 2007. Upon consummation of the Acquisition, Xiantiankong owns 100% of the issued and outstanding capital stock of Shenzhen Dasen and 70% of the issued and outstanding capital of Foshan Dasen Communication Chain Service Company Limited, a subsidiary of Shenzhen Dasen incorporated in PRC on January 19, 2007. Shenzhen Dasen engages in the retail business of selling mobile communication products and accessories in PRC and operates the retailing business through its retail website (http://www.dasen.com.cn/) and three branch chain stores located within Guangdong Province.

On April 8, 2011(the “Closing Date”), the Company through its subsidiary Xingtiankong, entered the amended Share Exchange Agreement with Shenzhen Dasen, and its registered equity owners. As part of the agreement, Xingtiankong hired Yinyan Guan, one of Shenzhen Dasen stockholders as its Business Consultant for three years, and will pay Mr. Guan $309,454 as total compensation for his three-year service.

The Company followed ASC 805 “Business Combination” (formerly SFAS 141R) to account for the Acquisition. The preliminary purchase price allocation for the Acquisition was based upon a preliminary valuation and our estimates and assumptions for the Acquisition are subject to change as we obtain additional information for our estimates during the respective measurement periods.

The fair value of the net assets acquired in the Acquisition was $1,218,220. The cash consideration paid by the Company to the prior stockholders of Shenzhen Dasen was $1,252,251, resulting in the recognition of goodwill in the amount of $95,902.
 
 
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Our preliminary purchase price allocation was as follows.
 
Cash   $ 418,933  
Accounts receivable     509,734  
Inventories     560,489  
Trade deposit     292,191  
Other receivables and other assets     52,231  
Fixed assets     15,785  
Intangible assets     118,788  
Accrued expenses & other payables     (261,511 )
Deferred tax liability     (438,940 )
Net assets acquired     (49,480 )
    $ 1,218,220  
 
Consideration given   $ 1,252,251  
Non-controlling interest     61,872  
Less: Net assets acquired     1,218,220  
Goodwill   $ 95,902  
 
Net deferred tax liabilities of $49,480, resulting from the acquisition, were primarily related to the difference between the book basis and tax basis the inventory fair value step-up and identifiable intangible assets fair value adjustment.

The goodwill of $95,902 arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company and Shenzhen Dasen.

This estimated purchase price allocation is subject to revision based on additional valuation work that is being conducted. The final allocation is pending the receipt of this valuation work and the completion of the Company’s internal review, which is expected during fiscal 2011.

For the period since the acquisition (April 7 – September 30, 2011), Shenzhen Dasen recorded $4,722,829 in revenues and a net gain of approximately $80,362. The following supplemental table presents unaudited consolidated pro forma financial information as if the closing of the acquisition of Shenzhen Dasen had occurred on January 1, 2010 (in thousands, except per share amounts):

   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Revenue
  $ 38,944,556     $ 26,161,411     $ 15,899,728     $ 7,605,715  
Net income attributable to SKYC stockholders
  $ 332,891     $ 1,357,256     $ (57,438 )   $ 355,894  
Net income per share - basic and diluted
  $ 0.01     $ 0.06     $ (0.00 )   $ 0.02  

The unaudited supplemental pro forma financial information should not be considered indicative of the results that would have occurred if the Acquisition had been consummated on January 1, 2010, nor are they indicative of future results.

NOTE 13 — INCOME TAX

First Digital is a company incorporated in Hong Kong and has operations in the PRC, the only tax jurisdiction. First Digital did not earn any income that was derived in Hong Kong for the nine months ended September 30, 2011 and 2010 and therefore was not subject Hong Kong Profit tax. All of the Company’s income is generated in the PRC. Accordingly, its income tax provision is calculated based on the applicable tax rates and existing legislation, interpretations and practices in respect thereof.
 
 
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On March 16, 2007, the PRC promulgated New Enterprise Income Tax Law (the “New Income Tax Law”). The New Taxation Law which became effective on January 1, 2008. Under the New Taxation Law, all enterprises (both domestic enterprises and foreign invested enterprises) have one unified income tax rate of 25%.

On December 6, 2007, the State Council of the PRC issued Implementation Regulations on the New Taxation Law. The New Taxation Law and Implementation Regulations have changed the tax rate from 15% to 18%, 20%, 22%, 24% and 25% for the years ending December 31, 2008, 2009, 2010, 2011, 2012,
respectively, for enterprises in Shenzhen, a “Special Economic Zone” in the PRC. Donxon is located in Shenzhen and is thus entitled to the preferential tax rates for years from 2008 to 2012.

The income tax rate for Shenzhen Dasen is 25%.

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate as:
 
   
Nine Months Ended September 30,
 
   
2011
   
2010
 
U.S. Statutory rate
    34 %     34 %
Foreign income not recognized in the U.S.
    (34 )     (34 )
PRC statutory income tax rate
    24       22  
Net operating loss carry over
    -       (1 )
Other (a)
    26       -  
Effective income tax rate
    50 %     21 %
 
(a)  
The 26% for the nine months ended September 30, 2011 represents expenses incurred by the Company that were not deductible for PRC income tax.
 
Donxon has incurred net operating losses prior to 2009. Net operating loss carried forward, if not utilized, will expire in 20 years after its generation. Management believes that the realization of the benefits from these losses, which generally would generate a deferred tax asset if it can be expected to be utilized in the future, appears more than likely due to the Company’s significantly improved profitability in year 2009 and 2010 for PRC income tax purposes. Accordingly, the Company has provided no valuation allowance on the deferred tax asset benefit. Management will review this valuation allowance periodically and make adjustments as warranted.
 
As of April 7, 2011, Xingtiankong acquired Shenzhen Dasen. Net long-term deferred tax liabilities of $49,480, resulting from the acquisition, were primarily related to the difference between the book basis and tax basis the inventory fair value step-up and identifiable intangible assets fair value adjustment.

A summary of the otherwise deductible (or taxable) current deferred tax items is as follows:
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Current deferred tax assets (liabilities)
           
Deferred rent
  $ 10,357     $ -  
Inventory step-up from Shenzhen acquisition
    21,688       -  
Amortization expenses from identifiable intangible assets in Shenzhen acquisition
    768       -  
Total current deferred tax assets (liabilities)
    32,813       -  
Less: Valuation allowance
    -       -  
    $ 32,813     $ -  
 
 
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Income tax expenses are comprised of the following:
 
   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Current income tax expense
  $ 302,479     $ 357,371     $ 74,061     $ 105,507  
Deferred tax expense (benefit)
    (32,308 )     -       (4,848 )     -  
    $ 270,171     $ 357,371     $ 69,213     $ 105,507  
 
Uncertain tax position
 
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes in its consolidated statements of income. There were no unrecognized tax benefits for the nine months ended September 30, 2011 and 2010. Management does not anticipate any potential future adjustments in the next twelve months which would result in a material change to its tax positions.  As of September 30, 2011 and December 31, 2010, the Company did not accrue any interest and penalties.

NOTE 14 — SEGMENT INFORMITON

Pursuant to ASC 280 we disclose segments on a single entity basis, which in our case is the legal entity. The Company operates as two reportable segments. Substantially all of the Company’s revenues and long-lived assets are in Peoples Republic of China.
 
The Company currently operates and prepares accounting and other financial reports separately to management for six major business organizations (SKY Digital Stores, Corp., Hong Kong First Digital Holding Ltd.(“First Digital”), Shenzhen Donxon Mobile Communication Technology Co., Ltd. (“Donxon”), Shenzhen Xing Tian Kong Digital Company Limited (“Xingtiankong”),  Shenzhen Dasen Communication Technology Company Limited (“Shenzhen Dasen”) and Xinyang City Donxon Mobile Communication Technology Company Limited (“Xinyang Donxon”)).

Our mobile phone manufacturing segment relates to the segment reporting of Donxon and retail store segment relates to Shenzhen Dasen. Management monitors these two segments regularly to make decisions about resources to be allocated to the segments and assess their performance.

The following table presents summarized information by segment:

   
Nine months ended September 30, 2011
   
Nine months ended September 30, 2010
 
   
Mobile phone manufacturing
   
Retail store (a)
   
Total
   
Mobile phone manufacturing
   
Total
 
                               
Revenue
  $ 33,037,198     $ 5,029,509     $ 38,066,707     $ 24,628,445     $ 24,628,445  
Cost of goods
  $ 30,695,597     $ 4,673,085     $ 35,368,682     $ 22,088,431     $ 22,088,431  
Gross profit
  $ 2,341,601     $ 356,424     $ 2,698,025     $ 2,540,014     $ 2,540,014  
Commission and franchise income
  $ -     $ 90,541     $ 90,541     $ -     $ -  
Income from operations
  $ 1,132,482     $ (552,023 )   $ 580,459     $ 1,720,810     $ 1,720,810  
Income tax expenses
  $ 259,559     $ 10,612     $ 270,171     $ 357,371     $ 357,371  
Depreciation & amortization
  $ 99,000     $ 11,935     $ 110,935     $ 15,841     $ 15,841  
Asset expenditures
  $ -     $ -     $ -     $ -     $ -  
Total Assets
  $ 5,965,502     $ 14,257,021     $ 20,222,523     $ 7,578,809     $ 7,578,809  
                                         
(a)Retail store numbers presents periods from April 8 to September 30, 2011
                 
 
 
22

 
 
   
Three months ended September 30, 2011
   
Three months ended September 30, 2010
 
   
Mobile phone manufacturing
   
Retail store
   
Total
   
Mobile phone manufacturing
   
Total
 
                               
Revenue
  $ 11,938,568     $ 3,906,076     $ 15,844,644     $ 7,123,816     $ 7,123,816  
Cost of goods
  $ 11,263,824     $ 3,559,359     $ 14,823,183     $ 6,421,665     $ 6,421,665  
Gross profit
  $ 674,744     $ 346,717     $ 1,021,461     $ 702,151     $ 702,151  
Commission and franchise income
  $ -     $ 55,084     $ 55,084     $ -     $ -  
Income from operations
  $ 237,150     $ (164,856 )   $ 72,294     $ 418,360     $ 418,360  
Income tax expenses
  $ 43,945     $ 25,268     $ 69,213     $ 105,507     $ 105,507  
Depreciation & amortization
  $ 86,085     $ 9,252     $ 95,337     $ 5,838     $ 5,838  
Asset expenditures
  $ 127,095     $ -     $ 127,095     $ -     $ -  
Total Assets
  $ 5,965,502     $ 14,257,021     $ 20,222,523     $ 7,578,809     $ 7,578,809  

NOTE 15 — SUBSEQUENT EVENTS

The Company has evaluated subsequent events for purposes of recognition or disclosure through the date these financial statements were issued.

On October 12, 2011, Donxon entered into an acquisition agreement (the “Agreement”) with Vaslink Technology Ltd. (“Vaslink”) and the sole shareholder of Vaslink to acquire Vaslink in consideration for Renminbi 7,500,000 yuan ($1,173,985). Vaslink is a People’s Republic of China company engaged in the research, development, wholesale and retail of computer information technology, communications product, hardware and software in Guangzhou, People’s Republic of China.

Pursuant to the Agreement, the purchase price of Renminbi 7,500,000 yuan ($1,173,985) shall be paid in the Company’s common stock, valued at $1.21 per share. The transfer of all the equity and assets of Vaslink shall be completed within five days after the execution of this Agreement. The payment of the Company’s common stock shall be made within five business days after the completion of the procedures for the equity transfer.

 
23

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this quarterly report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Such condensed consolidated financial statements and information have been prepared to reflect our financial position as of September 30, 2011 and December 31, 2010, together with our results of operations for the three and nine months ended September 30, 2011 and 2010, and cash flows for the nine months ended September 30, 2011 and 2010. Our actual results could differ materially from those discussed in the forward looking statements. Factors that could cause or contribute to such differences include those discussed below and elsewhere in this quarterly report.
Our unaudited financial statements are stated in United States Dollars and are prepared in accordance with Generally Accepted Accounting Principles in the United States of America.
 
Overview
 
We were incorporated in the state of Nevada on March 23, 2006 under the name Hoopsoft Development Corp.  On January 9, 2007, we entered into an agreement and plan of merger with Yellowcake Mining Inc., a Nevada corporation and wholly-owned subsidiary of Hoopsoft Development Corp., incorporated for the sole purpose of effecting the merger.  Pursuant to the terms of the agreement and plan of merger, Yellowcake Mining Inc. merged with and into Hoopsoft Development Corp., with Hoopsoft Development Corp. carrying on as the surviving corporation under the name “Yellowcake Mining Inc.”

On May 5, 2011, we entered into a Share Exchange Agreement (“Exchange Agreement”) by and among SKYC, HongKong First Digital Holding Limited (“FDH”), and the shareholders of FDH (the “FDH Shareholders”). The closing of the transaction (the “Closing”) took place on May 5, 2011 (the “Closing Date”). On the Closing Date, pursuant to the terms of the Exchange Agreement, we acquired all of the outstanding shares (the “Shares”) of FDH from the FDH Shareholders; and FDH Shareholders transferred and contributed all of their Shares to us. In exchange, we issued to the FDH Shareholders, their designees or assigns, an aggregate of 23,716,035 shares (the “Shares Component”) or 97.56% of the shares of common stock of the Company issued and outstanding after the Closing (the “Share Exchange”), at $0.20 per share. The parties understand and acknowledge that such exchange is based upon an acquisition value of FDH at $4,743,207, which is agreed and acceptable by all parties. The acquisition of FDH is treated as a reverse acquisition, and the business of FDH became the business of the Company.
 
SKYC is a mobile internet product and application service provider. We have retail and online e-commerce stores targeting the Chinese consumers. We design and manufacture mobile terminals under the Donxon/EMI brand which are sold through our retail stores and other outlets.

Recent Developments

Consumer acceptance of 3G and Smartphones continues to grow in Q3. We see growing demands of smartphone and associated accessories in our Tier 1 stores in Shenzhen.  For the third quarter of 2011, retail businesses in Tier 2 cities remain steady.  This reaffirms our development plan to tackle new generation of Smartphone consumers with next generation retail stores that focus on promoting a new life style with Smartphones.  We will continue to expand our network in Tier I cities that focuses on top selling models of Smartphones and accessories.  These stores will educate consumers on how to use new mobile terminals to fit their lifestyle.

The experience of new mobile terminals comes from mobile applications.  We are expanding and educating our frontline sales and support staff on mobile applications. This educated sales and support team will be the resident guru for our retail customers. To serve our growth in the new mobile terminal segment, we entered into an agreement to acquire Vaslink Technology Ltd on October 12, 2011.  This acquisition will enhance our technical capabilities in mobile applications in both corporate and retail segments.  We continue to search for merger and acquisition opportunities to expand our core business.
 
 
24

 

Results of Operations

SKYC is a mobile internet products and application service provider.  We operate retail stores under SKYC and Dasen Mobile Communications brands.  In September of 2011, we added 25 franchise stores in Guangdong Province. We plan to expand our retail network through franchises and self-operating stores.  We will focus on smartphones, smart pads and associated accessories.  We work closely with global leading smartphone suppliers to enhance our store design and staff training.
In preparation of the rapid expansion of our retail stores in major cities of China, we established a subsidiary, Xinyang City Donxon Mobile Communication Technology Company Limited (“Xinyang Donxon”), in Henan Province on August 1, 2011. Xinyang Donxon will serve as a logistic center and a customer service, training and manufacturing facility.

Our design and manufacturing business under the Donxon/EMI brand continues to grow steadily.  In spite of the global economic slowdown, revenue growth from our mobile handsets and portable projectors holds double digit growth.  We expect to end 2011 with a 15% revenue growth.
 
Results of operation for the three and nine months ended September30, 2011 compared with the three and six months ended September 30, 2010 (Unaudited)
 
The following tables set forth key components of our results of operations and key components of our revenue for the period indicated.  The discussion following the table is based on these results.

   
For the Nine Months Ended
September 30
   
For the three months ended
September 30
 
   
2011
   
2010
   
2011
   
2010
 
Sales
  $ 38,066,707       24,628,445     $ 15,844,644       7,123,816  
Cost of goods sold
    (35,368,682 )     (22,088,431 )     (14,823,183 )     (6,421,665 )
Gross Profit
    2,698,025       2,540,014       1,021,461       702,151  
                                 
Commission and franchise income
    90,541       -       55,084       -  
                                 
Operating Expense
                               
General and administrative expenses
    (1,900,373 )     (542,461 )     (935,676 )     (194,529 )
Selling Expense
    (307,734 )     (276,743 )     (68,575 )     (89,261 )
Total Operating Expenses
    (2,208,107 )     (819,204 )     (1,004,251 )     (283,790 )
                                 
Operating income
    580,459       1,720,810       72,294       418,360  
                                 
Other income (expense):
                               
Interest (expense) income, net
    (42,896 )     3,807       (45,114 )     1,811  
Total other income (expense)
    (42,896 )     3,807       (45,114 )     1,811  
                                 
Income before provision for income taxes
    537,563       1,724,617       27,180       420,171  
                                 
Provision for income taxes
    (270,171 )     (357,371 )     (69,213 )     (105,507 )
                                 
Net income (loss)
    267,392       1,367,246       (42,033 )     314,664  
 
 
25

 
 
Net Sales / Revenue:
 
For the three and nine months ended September 30, 2011, net sales increased by 122% and 55% to $15.8 million and $38 million respectively. Significant revenue growth is attributable to the expansion of retail store business and sales of leading smartphone models in our franchise network.  Revenue from handset manufacturing business showed sign of steady growth for the three months ended September 30, 2011.  We expect this momentum to continue, and the handset manufacturing business will be on track to delivery 15% year over year growth.
 
Gross profit:
 
Gross profit increased by 45.5% to $1.02 million and increased by 6.22% to $2.70 million for the three and nine months ended September 30, 2011, compared with the same periods in 2010. This increase was due to introduction of leading smartphones in our franchise network.  We expect to improve the gross margin as we open more self-operating stores. Q3 market conditions put pressure on handset manufacturing business. We lowered gross margin to improve revenue growth.
 
Operating Expense:
 
Operating expense for the three and nine months ended September 30, 2011 increased from $283,790 for the three month period in 2010 to $1,004,251 in 2011 and $819,204 for the nine month period  in 2010 to $2.2 million in 2011. The 254% and 170% increase were due to cost associated with the acquisition of Dasen, additional legal and audit expenses required in order to prepare for the reverse merger completed in May 2011 and comply with the SEC regulatory requirements as well as expenses related to digital stores operations integration into the Company. We anticipate improvements in operating expense to revenue ratio as retail business expansion completes in the next 2 years.
 
Net Income:
 
Net Income prior to allocation of amounts attributable to non-controlling interests for the three months ended September 30, 2011 is net loss $42,033 compared with net income of $ 314,664 for the three months ended September 30, 2010 and net income of $267,392 for the nine months ended September 30, 2011 as compared with $1,367,246 during same period in 2010. Net income decreased by 113.4% and 80.4%, respectively due to significant increase in general and administrative expense with listed company structure, added level of management, legal and finance staffing to support development and reporting requirements.
 
LIQUIDITY AND CAPITAL RESOURCES
 
The following table provides certain selected balance sheets comparisons between the nine months ended September 30, 2011 and year ended December 31, 2010:

   
September 30,
2011
   
December 31, 2010
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
Current Assets
           
Cash
  $ 8,463,311     $ 38,216  
Restricted cash
    3,913,282       -  
Accounts receivable
    3,670,505       5,473,803  
Inventories
    2,732,041       859,476  
Trade deposit
    95,690       589,312  
Prepaid expense - current
    126,922       31,427  
Other receivables
    285,625       18,236  
Deferred tax assets
    32,813       -  
Total Current Assets
    19,320,189       7,010,470  
                 
Property and equipment, net
    461,773       93,130  
Security deposits and other assets
    69,020       -  
Intangible assets, net
    114,673       -  
Prepaid expenses - non current
    160,966       -  
Goodwill
    95,902       -  
Total Non-current Assets
    902,334       93,130  
                 
Total Assets
  $ 20,222,523     $ 7,103,600  
                 
LIABILITIES AND EQUITY
               
Current Liabilities
               
Accounts payable
  $ 5,681,082     $ 1,876,330  
Advance from customers
    33,478       -  
Accrued expenses and other payables
    652,156       270,009  
Short-term bank loan
    3,913,281       -  
Loans from shareholder
    4,685,570       -  
Income tax payable
    62,161       214,054  
Total Current Liabilities
    15,027,728       2,360,393  
                 
Deferred tax liabilities - non-current
    49,479       -  
Deferred rent
    43,156       -  
Total Liabilities
  $ 15,120,363     $ 2,360,393  
 
 
26

 
 
Liquidity:
 
As of September 30, 2011, our balance of cash and cash equivalents was $8,463,311, compared to $38,216 as of December 31, 2010. These funds were deposited in financial institutions located in China. The increase of our cash in Q3 of 2011 was due to capital requirement to establish Xinyang Donxon in Henan Province and, preparation to expand the number of stores in Tier I cities. The additional cash was raised through shareholder loans and short-term bank loans. The loans are shown as restricted cash for acceptance notes and not part of increase. Historically, funds received have been expended in the furtherance of growing the business, establishing brand portfolios and used for dividend repayments and the repayment of loans payable. The Company currently generates its cash flow through operations which it believes will be sufficient to sustain current level operations for at least the next twelve months.
 
Capital Resources:
 
Current assets as of September 30, 2011 totaled $19,320,189 an increase of 175.6% compared with December 31, 2010. This increase is primarily due to the establishment of Xinyang Donxon and taking up short term loans from shareholders and financial institution.
 
Current liabilities as of Sep 30, 2011 totaled $15,027,728, reflecting an increase of 537% from $2,360,393 as of December 31, 2010 balance.  This increase is primarily due to short term loans from shareholders and financial institution as well as our increased account payable.
 
Discussion of Cash Flow
 
Comparison of cash flow results for nine months ended September 30, 2011 and 2010 is summarized as follows:

   
Nine Months Ended Sep 30
 
   
2011
   
2010
 
Net cash provided by (used in) operating Activities
  $ 1,399,119     $ 934,638  
Net cash used in Investing Activities
    (8,156,625 )     (108,479 )
Net cash provided by (used in) Financing Activities
    4,303,595       (1,150,040 )
Effect of exchange rate changes on cash
    123,349       35,943  
Change in cash during the period
  $ 8,425,095     $ (287,938 )
 
Operating Activities
 
Net cash provided by operating activities during the nine months ended September 30, 2011 was $1,399,119 which consisted of our net income of $267,392, offset by net changes in operating asset and liabilities, including an increase in restricted cash of $3,853,030,  a decrease in accounts receivable of $2,274,200, an increase in inventory of $1,258,740, a decrease in trade deposits of $ 787,378 and net increase in accounts payable of $3,577,784.
 
 
27

 
 
Investing Activities
 
Net cash used in investing activities for the nine months ended September 30, 2011 was $1,253,998, compared with $108,479 for the nine months ended September 30, 2010. The increase is attributable to the completion of acquisition of Dasen on April 7, 2011, and the construction of new office facility to combine offices in Shenzhen.
 
Financing Activities
 
Net cash provided by financing activities for the nine months ended September 30, 2011 was $8,156,625, including $4,478,606 loans from stockholders and  related party and short team bank loan of $3,853,030 which is restricted.
 
Net cash used in financing activities  for the nine months ended September 30, 2010 was $1,150,040, including loan repayments to stockholders as well as unrelated parties.
 
Critical Accounting Policies
 
Accounts Receivable
 
Accounts receivable are recognized and carried at original invoice amounts less allowance for any uncollectible amounts. The Company provides an allowance for doubtful accounts equal to the estimated losses that will be incurred in the collection of all receivables. Historically, the Company has not recorded any allowances as all such amounts are deemed collectible.  Accordingly, the Company didn’t record any allowance for doubtful accounts as of September 30, 2011 and December 31, 2010.
 
Inventories
 
Donxon inventories which consist of raw materials and finished goods are stated at the lower of cost and market.  Cost is determined using the First in, First out method. Costs of finished goods are composed of direct materials, direct labor and an attributable portion of manufacturing overhead based on normal operating capacity. Dasen inventory is all finished product purchased for resale. Management regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if valuation allowance is required.
 
Trade Deposit
 
Advance payments for purchases of raw materials are included in “Trade Deposit” and represent cash deposits paid to vendors for future purchases. The Company is required to make advance payments to certain suppliers. Advance payments are unsecured and non-interest bearing.
 
 
28

 
 
Impairment of Long-Lived Assets
 
Long-lived assets, including property, plant and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. As of September 30, 2011 and December 31, 2010, there was no impairment of long-lived assets.
 
Intangible Assets
 
Intangible assets are amortized using the straight-line method over their estimated period of benefit. Evaluation of the recoverability of intangible assets is made annually to take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. No impairments of intangible assets have been identified during any of the periods presented.
 
In conjunction the acquisition of Shenzhen Dashen on April 7, 2011, the Company capitalized $107,281 of identifiable intangible assets. The identifiable intangible assets consist primarily of trade name and customer relationships. Trade name and customer relationship is to be amortized over 15 years, their estimated useful life.
 
The Company recorded amortization expenses for intangible assets of $4,039 and $2,104 for the nine and three months ended September 30, 2011.
 
Goodwill and Indefinite-Lived Intangible Assets
 
The Company tests goodwill for impairment annually by comparing the fair value of each of the Company’s reporting units to the respective carrying value of the reporting units. Additionally, the Company may perform tests between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit below its carrying amount. The carrying value of each reporting unit is determined by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units. Goodwill is considered impaired if the carrying amount of the net assets exceeds the fair value of the reporting unit. Impairment, if any, would be recorded in operating income and could significantly adversely affect net income and earnings per share. Shenzhen Dasen is the only reporting unit that carries goodwill subject to impairment test. Shenzhen Dasen was acquired by the Company on April 7, 2011. No impairment indicators occurred subsequent to the acquisition.
 
Revenue Recognition
 
Effective April 7, 2011, the Company had two types of revenue streams from its two lines of businesses, namely (i) design, manufacturing and sale of mobile phones and digital products (Donxon), (ii) retailing stores (Shenzhen Dasen).
 
The Company records revenues when all of the following criteria have been met:
 
  
Persuasive evidence of an arrangement exists. The Company generally relies upon sales contracts or agreements, and customer purchase orders, to determine the existence of an arrangement;
 
  
Sales price is fixed or determinable. The Company assesses whether the sales price is fixed or determinable based on the payment terms and whether the sales price is subject to refund or adjustment;
 
  
Delivery has occurred. The Company uses shipping terms and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. The Company’s customary shipping terms are FOB destination point;
 
  
Collectability is reasonably assured. The Company assesses collectability based on creditworthiness of customers as determined by our credit checks and their payment histories. The Company records accounts receivable net of allowance for doubtful accounts and estimated customer returns.
 
 
29

 
 
Commission income
 
The Company receives commissions from sale of digital products for third parties. The Company does not charge customers differently from the prices provided by third parties. The Company has no discretion on the digital product prices or the applicable commission rates as they are dictated by the third parties. Commissions from selling of digital products are recognized after phone cards are sold to retail customers. The Company presents revenues from such transactions on a net basis in the statements of income as the Company, generally, does not assume inventory risks and has no obligations for cancelled phone cards.
 
Income from franchise stores
 
The Company entered into agreement with multiple independently owned retailing stores throughout Guangdong province, PRC in the third quarter of this year. According to the agreement entered into by the both parties, the Company is entitled to a management fee from these franchise stores. The management fee will be a fixed fee each month and a variable management fee based on audited net income of each store. The company recognizes fixed management fee each month. The Company will book variable management fee income based on estimated net income, if any, of each store.
 
The Company’s revenue is principally derived from sale of mobile phone and digital products to wholesalers and retail stores in the PRC.
 
The Company provides one-year warranty to its customers that its products will meet the functionality standards agreed to in each sales arrangement. The Company expenses all warranty expenses at the earlier of the time their existence is known or as expenses incurred. For the nine months ended September 30, 2011 and 2010, warranty expenses have been minimal and no warranty reserve was considered necessary. The Company believes the existence of the product warranty in a sales contract does not constitute a deliverable in the arrangement and thus there is no need to apply FASB ASC Topic 605-25 separation and allocation model for a multiple deliverable arrangement. FASB ASC Topic 450 specifically addresses the accounting for standard warranties and neither SAB 104 nor FASB ASC Topic 605-25 supersedes FASB ASC Topic 450.
 
Income Tax
 
The Company has adopted the provisions of ASC subtopic 740-10 (“ASC 740-10”), Income taxes: Overall (Pre-Codification: FIN 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109). ASC 740-10 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognizing, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition.
 
The Company applies the provisions of ASC 740-10, Accounting For Uncertainty In Income Taxes, which provides clarification related to the process associated with accounting for uncertain tax positions recognized in its combined financial statements. ASC 740-10 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. ASC 740-10 also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements.
 
Comprehensive Income
 
Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. For the Company, comprehensive income for the periods presented includes net income and foreign currency translation adjustments.
 
Statutory Reserves
 
Pursuant to the applicable laws in the PRC, Donxon makes appropriations to two non-distributable reserve funds, the statutory surplus reserve and the statutory public welfare reserve.  The appropriations are based on after-tax net earnings as determined in accordance with the PRC generally accepted accounting principles, after offsetting any prior years’ losses. Appropriation to the statutory surplus reserve is based on an amount at least equal to 10% of after-tax net earnings until the reserve is equal to 50% of the entity's registered capital. Donxon’s registered capital is $4,113,555 as of September 30, 2011.  Appropriation to the statutory public welfare fund is based on 5% to 10% of after-tax net earnings and is not mandatory. The statutory public welfare reserve is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable, other than in liquidation.
 
 
30

 
 
Donxon does not make appropriations to the discretionary surplus reserve fund.  As of September 30, 2011 and December 31, 2010, Donxon had appropriated $310,652 and $228,458 statutory surplus reserve fund, respectively.
 
Shenzhen Dasen did not make appropriations to the statutory surplus reserve fund as of September 30, 2011 due to operating losses incurred in the prior periods.
 
Recent Account Pronouncements
 
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends ASC 820 to require a number of additional disclosures regarding (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not expect that the adoption of ASU 2010-06 will have a material impact on its consolidated financial statements.

In April 2010, the FASB issued an authoritative pronouncement on milestone method of revenue recognition. The scope of this pronouncement is limited to arrangements that include milestones relating to research or development deliverables. The pronouncement specifies guidance that must be met for a vendor to recognize consideration that is contingent upon achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. The guidance applies to milestones in arrangements within the scope of this consensus regardless of whether the arrangement is determined to have single or multiple deliverables or units of accounting. The pronouncement will be effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early application is permitted. Companies can apply this guidance prospectively to milestones achieved after adoption. However, retrospective application to all prior periods is also permitted. The Company does not believe the adoption this standard would have materially affected the Company’s consolidated financial statements.

In December 2010, the FASB issued an update which addresses the disclosure of supplementary pro forma information for business combinations. The update requires public entities to disclose pro forma information for business combinations that occurred in the current reporting period, including revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. Amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company has adopted this update and applied the disclosure requirements in connection with the acquisition of Shenzhen Dasen (See Note 12).

In December 2010, the FASB issued ASU No. 2010-28 (“ASU 2010-28”), Intangibles — Goodwill and Other (“ASC 350”): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The objective of this standard is to address questions about entities with reporting units with zero or negative carrying amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. The amendments in this standard modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements.

In June 2011, the FASB issued guidance which eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders' equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance is not expected to have a material impact on the consolidated financial statements.

Management does not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, would have a material impact on the Company’s consolidated financial statements.
 
 
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Not Applicable.
 
ITEM 4. CONTROLS AND PROCEDURES.
 
Disclosure Controls and Procedures
 
As required by paragraph (b) of Rules 13a-15 or 15d-15 under the Exchange Act, our management, with the participation of our principal executive and principal financial officer evaluated our company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report on Form 10-Q. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our company's reports filed under the Exchange Act is accumulated and communicated to our principal executive officer and our principal accounting officer, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, management concluded that as of the end of the period covered by this quarterly report on Form 10-Q, these disclosure controls and procedures were not effective.
 
Specifically, our management identified certain matters involving internal control and our operations that it considered to be material weaknesses.  As defined in the Exchange Act, a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant's annual or interim financial statements will not be prevented or detected on a timely basis.  The material weaknesses identified by our management as of September 30, 2011, are described below:
 
·
We did not design, implement, or maintain effective entity-level controls related to our control environment, resulting in the following significant control deficiencies:
 
 
o  
The Code of Business Conduct and Ethics, which was specifically designed for public company applicability, has yet to be formally acknowledged by members of management and the finance department.
 
 
o  
There is an absence of independence and financial expertise on the Board of Directors, and we do not have an Audit Committee or a formalized internal audit function, limiting its ability to provide effective oversight of our management.

·
We used pre-merger finance structure which required certain manual review procedures before consolidated financial statement can be completed and left the management limited time to review.
 
Changes in Internal Control over Financial Reporting
 
During the period ended September 30, 2011, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
 
Plan for Remediation of Material Weaknesses
 
We intend to take appropriate and reasonable steps to make the necessary improvements to remediate our material weaknesses when we are able to do so financially and when the timing is appropriate for our company. We are currently evaluating steps needed to remediate deficiencies
 
Certifications
 
Certifications with respect to disclosure controls and procedures and internal control over financial reporting under Rules 13a-14(a) or 15d-14(a) of the Exchange Act are attached to this quarterly report on Form 10-Q.

 
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PART II – OTHER INFORMATION
 
 
ITEM 1. LEGAL PROCEEDINGS.
 
None.
 
ITEM 1A. RISK FACTORS.
 
Not Applicable.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
None.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
 
None.
 
ITEM 4. (REMOVED AND RESERVED).
 
ITEM 5. OTHER INFORMATION.
 
None.
 
ITEM 6. EXHIBITS.
 
Exhibits required by Item 601 of Regulation S-K:
 
Exhibit
   
Number
 
Description
3.1
 
Articles of Incorporation (attached as an exhibit to our Form SB-2 Registration Statement, filed on September 22, 2006)
3.2
 
Bylaws (attached as an exhibit to our Form SB-2 Registration Statement, filed on September 22, 2006)
3.3
 
Articles of Merger filed with the Secretary of State on January 12, 2007 and which is effective January 23, 2007 (attached as an exhibit to our current report on Form 8-K, filed on January 25, 2007)
3.4
 
Certificate of Change filed with the Secretary of State of Nevada on January 12, 2007 and which is effective January 23, 2007 (attached as an exhibit to our current report on Form 8-K, filed on January 25, 2007)
3.5
 
Amended and Restated Bylaws (attached as an exhibit to our current report on Form 8-K, filed on September 18, 2008)
10.1
 
Share Exchange Agreement by and between the Company, HongKong First Digital Holding Company Limited and the FDH Shareholders, dated May 5, 2011 (attached as an exhibit to our current report on Form 8-K filed on May 6, 2011).
10.2
 
Interest Transfer Agreement between Yinyan Guan and Qingguo Zeng dated April 7, 2011 (attached as an exhibit to our current report on Form 8-K filed on May 6, 2011).
10.3
 
Supplemental Agreement between Yinyan Guan and Qingguo Zeng dated April 8, 2011 (attached as an exhibit to our current report on Form 8-K filed on May 6, 2011).
10.4
 
Consulting Agreement between. Shenzhen Xing Tian Kong Digital Co., Ltd. and Yinyan Guan dated April 8, 2011 (attached as an exhibit to our current report on Form 8-K filed on May 6, 2011).
31.1*
 
Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
 
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
 
Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
 
Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2
 
Nominating Committee Charter (attached as an exhibit to our annual report on Form 10-KSB, filed on November 14, 2007)
EX-101.INS*
 
XBRL INSTANCE DOCUMENT
EX-101.SCH*
 
XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
EX-101.CAL*
 
XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
EX-101.DEF*
 
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
EX-101.LAB*
 
XBRL TAXONOMY EXTENSION LABELS LINKBASE
EX-101.PRE*
 
XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE
 
* Filed herewith.
 
 
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SIGNATURES
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
SKY DIGITAL SOTRES CORP.
 
       
Dated:  November 21, 2011
By:
/s/ Lin Xiangfeng  
   
Lin Xiangfeng
 
   
Chief Executive Officer and Chairman
 
   
(Chief Executive Officer)
 
     
       
 
By:
/s/ Johnny C.W. Chan  
   
Johnny C.W. Chan
 
   
Chief Financial Officer
 
   
 (Principal Financial Officer)
 
    

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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