QXM Qiao Xing Mobile Communication Co., Ltd. Ordinary Shares

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 20-F

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

OR

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

For the fiscal year ended: December 31, 2009

OR

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

OR

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

Date of event requiring this shell company report                     

For the transition period from                      to                     

Commission file number: 1-33430

QIAO XING MOBILE COMMUNICATION CO., LTD.

(Exact name of Registrant as specified in its charter)

British Virgin Islands
(Jurisdiction of Incorporation or Organization)

10th Floor CEC Building, 6 Zhongguancun South Street, Beijing 100086, People’s Republic of China
(Address of Principal Executive Offices)

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

Title of each class		Exchange on which registered
Ordinary Shares, without par value		New York Stock Exchange, Inc.

Securities registered or to be registered pursuant to Section 12(g) of the Act: None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

Number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2009:
52,684,901 Ordinary Shares, without par value

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

Yes o		No þ

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

Yes o		No þ

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

Yes þ		No o

Indicate by check mark whether the registrant 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 o		No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

U.S. GAAP þ

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

Other o

Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 o		Item 18 þ

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

Yes o		No þ

 

 

TABLE OF CONTENTS

INTRODUCTION			1
FORWARD-LOOKING STATEMENTS			2
PART I
Item 1. Identity of Directors, Senior Management and Advisers			3
Item 2. Offer Statistics and Expected Timetable			3
Item 3. Key Information			3
Item 4. Information on the Company		19
Item 4A. Unresolved Staff Comments		31
Item 5. Operating and Financial Review and Prospects		31
Item 6. Directors, Senior Management and Employees		46
Item 7. Major Shareholders and Related Party Transactions		52
Item 8. Financial Information		54
Item 9. The Offer and Listing		55
Item 10. Additional Information		55
Item 11. Quantitative and Qualitative Disclosures About Market Risk		59
Item 12. Description of Securities Other than Equity Securities		60
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies		61
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds		61
Item 15T. Controls and Procedures		61
Item 16A. Audit Committee Financial Expert		61
Item 16B. Code of Ethics		61
Item 16C. Principal Accountant Fees and Services		62
Item 16D. Exemptions from The Listing Standards for Audit Committees		62
Item 16E. Purchases of Equity Securities by The Issuer and Affiliated Purchasers		62
Item 16F. Change in Registrant’s Certifying Accountant		62
Item 16G. Corporate Governance		63
PART III
Item 17. Financial Statements		64
Item 18. Financial Statements		64
Item 19. Exhibits		64
EX-8.1 SUBSIDIARIES OF THE REGISTRANT
EX-12.1 CERTIFICATION OF CEO
EX-12.2 CERTIFICATION OF CFO
EX-13.1 CERTIFICATION OF CFO AND CEO
EX-15.1 CONSENT OF CROWE HORWATH LLP, DATED JUNE 30, 2010
EX-15.2 CONSENT OF KPMG, DATED JUNE 30, 2010
EX-15.3 LETTER OF KPMG TO THE SECURITIES AND EXCHANGE COMMISSION, DATED JUNE 30, 2010

INTRODUCTION

This annual report on Form 20-F includes our audited consolidated financial statements as of December 31, 2008 and 2009, and for the years ended December 31, 2007, 2008 and 2009.

We and certain selling shareholders of our company completed the initial public offering of 13,333,334 ordinary shares of nil par value on May 8, 2007. On May 3, 2007, we listed our ordinary shares on the New York Stock Exchange, or NYSE, under the symbol “QXM.”

Unless otherwise indicated, references in this annual report to:

•		“3G” are to the third generation of telecommunication hardware standards and general technology for mobile networking that provides increased bandwidth and allows a mobile device user to access a wide variety of services, such as multimedia;
•		“CECT” are to CEC Telecom Co., Ltd., our principal operating subsidiary in China;
•		“China” or the “PRC” are to the People’s Republic of China, excluding, for the purpose of this annual report only, Taiwan and the special administrative regions of Hong Kong and Macau;
•		“CDMA” are to Code Division Multiple Access, a method for transmitting simultaneous encoded signals over a shared portion of the spectrum. The foremost application of CDMA is digital cellular phone technology;
•		“EDGE” are to Enhanced Data GSM Environment, a faster version of the GSM wireless service designed to deliver data at rates up to 384 Kbps;
•		“EMS” are to electronic manufacturing services, a general term used to describe the services provided by companies that design, test, manufacture, distribute and provide return and repair services for electronic components and assemblies for original equipment manufacturers;
•		“GSM” are to Global System for Mobile Communications, a digital cellular phone technology based on time division multiple access;
•		“GPS” are to Global Positioning System, a global navigation satellite system often used for navigation purposes;
•		“MIIT” are to China Ministry of Industry and Information Technology;
•		“RMB” and “Renminbi” are to the legal currency of China;
•		“SIM” are to Subscriber Identity Module, the smart card used in cellular phones to securely store the key that is used to identify the mobile phone service subscriber;
•		“SMT” are to Surface Mount Technology, a space saving technique whereby special leadless components are soldered onto the surface of a printed circuit board;
•		“TD-SCDMA” are to Time Division-Synchronous Code Division Multiple Access, a 3G wireless standard that supports data transmission at speeds up to 2 Mbps. The standard combines time division multiple access with an adaptive, synchronous-mode code division multiple access component;
•		“US$,” “$,” and “U.S. dollars” are to the legal currency of the United States;
•		“WCDMA” are to Wideband Code Division Multiple Access, a 3G wireless standard which utilizes one 5 MHz channel for both voice and data, initially offering data speeds up to 384 Kbps; and
•		“We,” “us,” “our company” and “our” are to Qiao Xing Mobile Communication Co., Ltd., its predecessor entities and its consolidated subsidiaries, unless the context indicates otherwise.

Unless otherwise indicated, all historical share information and per-share information contained in this annual report has been retroactively adjusted to reflect a 40-for-one share split that became effective on April 13, 2007.

FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that relate to our current expectations and views of future events. The forward-looking statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995 and relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under “Item 3. Key Information—D. Risk factors,” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, these forward-looking statements can be identified by words or phrases such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “is/are likely to,” “may,” “plan,” “potential,” “will” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

•		our expectations regarding the market for mobile handsets;
•		our expectations regarding the continued growth of the mobile communications industry;
•		our expectations with respect to advancements in our technologies;
•		our beliefs regarding the competitiveness of our mobile handset products;
•		our expectations regarding our manufacturing capacity;
•		our expectations with respect to revenue growth and our ability to achieve profitability;
•		our future business development, results of operations and financial condition; and
•		competition from other manufacturers of mobile handsets.

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report and the documents that we filed as exhibits in this annual report completely and with the understanding that our actual future results may be materially different from what we expect.

PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

The following selected consolidated statement of operations data and selected consolidated cash flow data for the years ended December 31, 2007, 2008 and 2009 and the selected consolidated balance sheet data as of December 31, 2008 and 2009 are derived from our audited consolidated financial statements included elsewhere in this annual report, and are qualified by reference to, and should be read in conjunction with, our audited consolidated financial statements and related notes. We adopted authoritative guidance regarding accounting for non-controlling interests in our consolidated financial statements on January 1, 2009, and retrospectively reclassified certain comparative figures for prior periods to conform to the presentation in 2009. See note 2(v) to our audited consolidated financial statements included elsewhere in this annual report for detailed information. Accordingly, the selected consolidated statement of operations data and the selected consolidated cash flow data for the year ended December 31, 2005, the period from January 1, 2006 to November 30, 2006, and the period from November 30, 2006 to December 31, 2006, and the selected consolidated balance sheet data as of December 31, 2005, 2006 and November 30, 2006 have been derived from our unaudited consolidated financial statements. Our consolidated financial statements are prepared and presented in accordance with United States generally accepted accounting principles, or U.S. GAAP. Our historical results do not necessarily indicate the results that may be expected for any future periods.

Due to the impact of push-down accounting adjustments resulting from our parent company’s purchase of the remaining 20% equity interest in our company on November 30, 2006, as more fully described in “Item 5. Operating and financial review and prospects—Financial impact of our corporate history,” our 2006 consolidated financial data are presented by two separate periods: (1) the “old basis” period from January 1, 2006 through November 30, 2006 and (2) the “new basis” period from November 30, 2006 through December 31, 2006.

		(Old Basis)									(New Basis)
						January 1,					November
		Year ended				2006 to					30, 2006 to
Consolidated statement of operations data		December				November					December				Year ended December 31,
(Amounts in thousands, except per share data)		31, 2005				30, 2006					31, 2006				2007				2008				2009
		(RMB)				(RMB)					(RMB)				(RMB)				(RMB)				(RMB)				($)
Revenues			1,864,125				2,281,198					256,013				3,141,094				2,153,873				1,632,912				239,223
Gross profit			337,747				437,871					37,131				885,250				866,777				251,317				36,818
In-process research and development			—				—					(41,739	)			—				—				—				—
Amortization of other intangible assets			(11,880	)			(10,890	)				(4,288	)			(32,280	)			(11,727	)			(4,733	)			(693	)
Impairment of assets held for sale			—				—					—				—				—				(5,957	)			(873	)
Impairment of other intangible assets			—				—					—				—				(26,235	)			(13,600	)			(1,992	)
Operating income (loss)			273,890				379,917					(13,934	)			729,017				608,791				7,406				1,086
Interest expense			(32,332	)			(27,115	)				(2,213	)			(47,034	)			(165,506	)			(326,512	)			(47,834	)
Gain (loss) on remeasurement of embedded derivatives			—				—					—				—				144,939				(87,935	)			(12,883	)
Loss on remeasurement of warrant liability			—				—					—				—				—				(7,219	)			(1,058	)
(Loss) gain on extinguishment of convertible debts			—				—					—				—				(10,634	)			159,326				23,341
Gain on disposal of subsidiaries			10,307				—					—				—				2,269				—				—
Impairment of investment at cost			—				—					—				—				—				(2,803	)			(41	)
Income (loss) before income tax expense and extraordinary items			251,518				371,607					(13,435	)			711,251				595,422				(238,357	)			(34,919	)
Income tax expense			(16,719	)			(55,991	)				(4,251	)			(113,377	)			(155,717	)			(11,632	)			(1,704	)
Income (loss) before extraordinary items			234,799				315,616					(17,686	)			597,874				439,705				(249,989	)			(36,623	)
Extraordinary items: Gains on acquisitions of additional equity interests in CECT, net of nil tax			48,157				17,796					—				28,689				—				—				—
Net income (loss) (1)			282,956				333,412					(17,686	)			626,563				439,705				(249,989	)			(36,623	)
Net income attributable to noncontrolling interests			(52,349	)			(27,260	)				(1,799	)			(33,074	)			(15,901	)			(380	)			(56	)
Net income (loss) attributable to holders of ordinary shares			230,607				306,152					(19,485	)			593,489				423,804				(250,369	)			(36,679	)
Earnings (loss) per share before extraordinary gains (2)
— Basic			4.56				7.21					(0.49	)			11.69				7.52				(5.21	)			(0.76	)
— Diluted			4.56				7.21					(0.49	)			11.69				6.99				(5.21	)			(0.76	)
Earnings (loss) per share (1)(2)
— Basic			5.77				7.65					(0.49	)			12.28				7.52				(5.21	)			(0.76	)
— Diluted			5.77				7.65					(0.49	)			12.28				6.99				(5.21	)			(0.76	)
Weighted average number of shares outstanding
— Basic			40,000				40,000					40,000				48,322				49,216				48,034				48,034
— Diluted			40,000				40,000					40,000				48,322				56,386				48,034				48,034

		(Old Basis)									(New Basis)
Consolidated balance sheet data		December				November					December 31,
(Amounts in thousands)		31, 2005				30, 2006					2006				2007				2008				2009
		(RMB)				(RMB)					(RMB)				(RMB)				(RMB)				(RMB)				($)
Cash			379,377				713,099					762,086				2,729,982				2,907,148				3,129,070				458,411
Accounts receivable, net			513,035				407,610					546,893				418,564				462,282				114,689				16,802
Prepayments to suppliers			232,189				145,652					232,008				155,993				363,907				181,550				26,597
Total current assets			1,678,800				1,684,197					1,893,910				3,601,182				4,177,000				3,989,431				584,455
Total assets			1,798,408				1,985,147					2,336,152				3,994,102				4,522,920				4,136,593				606,014
Short-term borrowings			639,972				610,314					602,790				983,904				983,950				884,708				129,610
Accounts payable			312,806				177,609					165,326				107,990				52,047				60,751				8,900
Embedded derivative liability			—				—					—				—				124,130				39,978				5,857
Convertible notes			—				—					—				—				206,211				112,162				16,432
Total current liabilities			1,156,072				1,026,702					1,207,228				1,239,764				1,515,747				1,211,067				177,421
Total liabilities			1,161,491				1,030,413					1,218,968				1,245,325				1,516,067				1,233,697				180,737
Total shareholders’ equity			569,963				879,637					1,040,288				2,670,542				2,914,788				2,810,451				411,734

		(Old Basis)									(New Basis)
						January 1,					November
		Year ended				2006 to					30, 2006 to
Consolidated cash flow data		December				November					December				Year ended December 31,
(Amounts in thousands)		31, 2005				30, 2006					31, 2006				2007				2008				2009
		(RMB)				(RMB)					(RMB)				(RMB)				(RMB)				(RMB)				($)
Net cash provided by (used in) operating activities			110,970				513,378					(215,111	)			855,524				110,106				602,369				88,248
Net cash provided by (used in) investing activities			18,386				(249,317	)				63,431				23,016				(57,663	)			(58,529	)			(8,575	)
Net cash provided by (used in) financing activities			168,413				69,661					200,667				1,117,327				143,738				(321,981	)			(47,170	)

		Year ended December 31,
Other selected operating data (3)		2005				2006				2007				2008				2009
Mobile handsets shipped (in thousands of units)			1,730				2,262				3,816				2,714				2,123
Average mobile handset selling price (RMB) (4)			1,012				1,094				816				788				735

		(Old Basis)									(New Basis)
						January 1,					November
		Year ended				2006 to					30, 2006 to
		December				November					December				Year ended December 31,
(Amounts in thousands)		31, 2005				30, 2006					31, 2006				2007				2008				2009
		(RMB)				(RMB)					(RMB)				(RMB)				(RMB)				(RMB)				($)
(Reduction in net income by) / increase in net loss by			(24,017	)			(1,147	)				1				(1,056	)			—				—				—
Reduction in basic and diluted earnings per share by (2)			(0.61	)			(0.02	)				—				(0.02	)			—				—				—

We publish our financial statements in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars were made at the noon buying rate in the City of New York for cable transfers in Renminbi per U.S. dollar as published by the Federal Reserve Board of the United States as of December 31, 2009, which was RMB6.8259 to $1.00. No representation is made that the Renminbi amounts referred to in this annual report could have been or could be converted into U.S. dollars at any particular rate or at all.

On June 18, 2010, the certified exchange rate was RMB6.8267 to $1.00.

The following table sets forth information regarding the certified exchange rates in Renminbi and U.S. dollars for the periods indicated.

		Renminbi per U.S. dollar certified exchange rate
		Period end				Average (1)				Low				High
2005			8.0702				8.1826				8.0702				8.2765
2006			7.8041				7.9579				7.8041				8.0702
2007			7.2946				7.5806				7.2946				7.8127
2008			6.8225				6.9193				6.7800				7.2946
2009			6.8259				6.8295				6.8176				6.8470
December			6.8259				6.8275				6.8244				6.8299
2010
January			6.8268				6.8269				6.8258				6.8295
February			6.8258				6.8285				6.8258				6.8330
March			6.8258				6.8262				6.8254				6.8270
April			6.8247				6.8256				6.8229				6.8275
May			6.8305				6.8275				6.8245				6.8310
June (through June 18, 2010)			6.8267				6.8298				6.8267				6.8323

B. Capitalization and Indebtedness

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

Risks Related to Our Business

Any recurrence of the global financial crisis and economic downturn similar to that occurred in 2008 and early 2009 could materially and adversely affect our business, financial condition, results of operation and prospects.

The global financial markets experienced periods of extreme volatility and disruption in 2008 and early 2009. The global financial crisis, concerns over inflation or deflation, energy costs, geopolitical risks, and the availability and cost of financing contributed to the unprecedented levels of market volatility and adversely affected the expectations for the continuous growth of the global economy, the capital market and the consumer industry. These factors, combined with others, resulted in a severe global economic downturn and also a slowdown in the PRC economy. This change in the macro-economic conditions had an adverse impact on our business and operations by causing a decrease in the number handset mobile we sold in 2009. Although the global and PRC economies have shown signs of recovery from the second half of 2009, any recurrence of the global financial crisis as a result of the recent market volatility arising from the concerns over certain European countries may adversely affect the growth of the PRC economy, which could adversely affect our business, financial condition, results of operations and prospects.

Evaluating our business and prospects may be difficult and our past results may not be indicative of our future performance.

Our business had grown and evolved rapidly from 2003 to 2007. However, primarily due to the global economic downturn and increasing competition in the Chinese mobile handset market, there was a decrease in our revenue, operating income and net income in 2008 and 2009.

We may continue to experience decreases in our revenue, operating income and net income and may not be able to achieve a similar growth rate in future periods as we did from 2003 to 2007 and our historical operating results therefore may not provide a meaningful basis for evaluating our business, financial performance and prospects. Moreover, our business model, technology and ability to achieve satisfactory manufacturing results at higher volumes are unproven. Therefore, you should not rely on our past results or our historical rate of growth as an indication of our future performance.

If we cannot keep pace with market changes and produce mobile handsets with new technologies and features in a timely and cost-efficient manner to meet our customers’ requirements and preferences, the growth and success of our business will be materially adversely affected.

The mobile handset market in China is characterized by changing consumer preferences with respect to style and functionality, increasing demand for new and advanced technologies and features, rapid product obsolescence and price erosion, evolving industry standards, intense competition and wide fluctuations in product supply and demand. If we cannot keep pace with market changes and produce new mobile handsets in a timely and cost-efficient manner to meet our customers’ requirements and preferences, the growth and success of our business will be materially adversely affected.

From time to time, we or our competitors may announce new products, product enhancements or technologies that may replace or shorten the life cycles of our products or cause mobile phone users to defer purchasing our existing products. Shorter product cycles may require us to invest more in developing and designing new products and to introduce new products more rapidly, which may increase our costs of product development and decrease our margins and profitability. In addition, we may not be able to make such additional investments and any additional investments we make in new product development and introductions may not be successful.

Even if we are able to continually develop and introduce new products, they may not gain market acceptance. Market acceptance of our products will depend on various factors including:

•		the perceived advantages of our new products over existing competing products;
•		our ability to attract mobile handset users who are currently using products of our competitors;
•		product cost relative to performance; and
•		the level of customer service available to support new products.

Market acceptance of our products can also be affected by the telecommunication services provided by mobile telecommunications operators in China. For example, on May 24, 2008, the MIIT, the National Development and Reform Commission, or the NDRC, and the Ministry of Finance jointly issued an announcement to promote innovation in homegrown telecommunications technology and the restructuring of the operations in the telecommunications industry. In January 2009, the MIIT issued 3G licenses to China Mobile (TD-SCDMA), China Unicom (CDMA2000) and China Telecom (WCDMA). The development of 3G wireless telecommunication services and subsequent new technologies could materially impact the sales of our existing and future products. In addition, the operation of inexpensive limited mobility telecommunication services or other competitive services, such as personal handyphone system, in China may also have a material adverse effect on the sales of our mobile handsets.

Therefore, commercial acceptance by customers of new products including any 3G mobile handset we offer may not occur at the rate or level we expect, and we may not be able to successfully adapt existing products to effectively and economically meet customer demand, thus impairing the return from our investments. In addition, a very small portion of our mobile handset models represented a disproportionately large percentage of our handset unit sales and revenue in the past several years and these product leaders served as important drivers for our overall growth. However, we may not be able to replicate such “hit” models on a regular basis, if at all, in future periods. If our existing or new products fail to achieve market acceptance for any reason, our business and growth prospects could be materially adversely affected. We may also be required under applicable accounting standards to recognize a charge for the impairment of assets to the extent our existing products become uncompetitive or obsolete, or if any new products fail to achieve commercial acceptance. Any such charge may have a material adverse effect on our results of operations.

Competition in our industry is intense. Our failure to maintain or improve our market position and respond successfully to changes in the competitive landscape may have a material adverse impact on our business and results of operations.

The mobile handset manufacturing industry in China is intensely competitive. Industry participants compete with each other mainly on the basis of the breadth and depth of their product portfolios, price, operational and manufacturing efficiency, technical performance, product features, quality, customer support and brand recognition. We are facing significant competition from a number of competitors, including domestic mobile handset producers such as Bird Ningbo Co., Ltd., Konka Group Co., Ltd., Beijing Tianyu Communication Equipment Co. Ltd., Gionee Communication Co., Ltd. and Haier (Qingdao) Telecom Co., Ltd. and a number of large multinational mobile handset producers, such as Nokia Corporation, Motorola, Inc., Samsung Electronics Co., Ltd., Sony Ericsson Mobile Communications (China) Co. Ltd., and LG Electronics (China) Ltd. Many of our competitors have longer operating histories, greater name recognition, significantly larger market shares, access to larger customer bases and significantly greater economies of scale and financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. Some of these competitors have used, and we expect will continue to use, more aggressive pricing strategies, greater amounts of incentives and subsidies for distributors, retailers and customers, more successful design approaches and more advanced technologies. In addition, some competitors have chosen to focus on building products based on commercially available components, which may enable them to introduce these products faster and with lower levels of research and development spending than us. Furthermore, consolidation among the industry participants in China may potentially result in stronger competitors that are better able to compete as end-to-end suppliers as well as competitors who are more specialized in particular areas and geographic markets. This could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our operating results significantly depend on our ability to compete in this market environment, in particular on our ability to adapt to political, economic or regulatory changes, to introduce new products to the market and to continuously enhance the functionality while reducing the cost of new and existing products. If we fail to maintain or increase our market share and scale compared to our competitors, our cost advantage may be eroded, which could materially adversely affect our competitive position and our results of operations, particularly our profitability.

In addition, we also face competition from unlicensed mobile handset manufacturers in China that make mobile handsets without the requisite governmental approvals and licenses. We believe that these manufacturers are able to keep their production costs low primarily as a result of tax avoidance and non-payment of various fees that are required for all licensed products. Despite recent government action against many of these unlicensed manufacturers, we believe that such mobile handsets still account for a significant portion of all mobile handsets sold in China. If the government is not successful in preventing these unlicensed mobile handset manufacturers from producing and selling their mobile handsets, our market share and our results of operations could be materially adversely affected.

As a result of developments in our industry, we also expect to face new competition from companies in related industries, such as consumer electronics manufacturers. Additionally, we face increasing competition from mobile telecommunication operators that are increasingly offering mobile devices under their own brands. If we cannot respond successfully to these competitive developments, our business and results of operations may be materially adversely affected.

Our sales, results of operations and reputation could be materially adversely affected if we fail to efficiently manage our manufacturing operations without interruption, or fail to ensure that our products meet the expectations of our distributors and our end-user customers and are delivered on time.

The operation of our business requires successful coordination of several sequential and complex manufacturing processes, the disruption of any of which could interrupt our revenue generation and have a material and adverse effect on our relationships with our distributors and end-user customers, our brand name, and our financial performance. Our manufacturing operations involve raw material and component sourcing from third parties, internal assembly processes and distribution processes. These operations are modified on a regular basis in an effort to improve manufacturing and distribution efficiency and flexibility. We may experience difficulties in coordinating our supplies of components and raw materials to meet the demand for our products, increasing or decreasing production at our facilities, adopting new manufacturing processes, finding a timely way to develop the best technical solutions for new products, or achieving manufacturing efficiency and flexibility. We may experience delays in adjusting or upgrading production at our facilities when we introduce new models, delays in expanding manufacturing capacity, failure in our manufacturing processes or failure by our business partners to adequately perform the services we have outsourced to them, which in turn may have a material adverse effect on our sales and results of operations. In addition, a failure or an interruption could occur at any stage of our product development, manufacturing and delivery processes, resulting in products not meeting the expectations of our distributors and our customers, or being delivered late, which could have a material adverse effect on our sales, results of operations and reputation.

Our operations could be materially adversely affected if we fail to manage effectively our relationships with, or lose the services of, our third-party manufacturers or other third-party service providers.

We rely on the manufacturing services provided by third-party manufacturers, including EMS providers, to manufacture a significant portion of our mobile handset products. In 2007, 2008 and 2009, we outsourced to third-party EMS providers, 85.6%, 73.7% and 90.2%, respectively, of the total mobile handsets we shipped. Reliance on third-party manufacturers involves a number of risks, including the lack of control over the manufacturing process and the potential absence or unavailability of adequate capacity. If any of our third-party manufacturers cannot or will not manufacture our products in required volumes on a cost-effective basis, in a timely manner, at a sufficient level of quality, or at all, we will need to secure additional manufacturing capacity. Even if this additional capacity is available at commercially acceptable terms, the qualification process could be lengthy and could cause interruptions in product shipments, which may result in a decrease in our sales. In many cases, some of our competitors also utilize the same contract manufacturers, and we could be blocked from acquiring the needed components or increasing capacity if they have purchased capacity ahead of us. The unexpected loss of any of our third-party manufacturers could be disruptive to our business.

We rely on independent mobile handset designers in China for certain software and hardware designs used in our production. If these or other mobile handset designers terminate their business relationships with us, or are otherwise unable to provide us with designs suitable for our products, or if we fail to enhance our in-house research and development activities to compensate for our inability to obtain designs suitable for our products from these handset designers, our business and our results of operations could be materially adversely affected.

We outsource certain software and hardware designs used in producing our products, such as high-end handset main boards, to independent mobile handset designers in China. If these mobile handset designers terminate their business relationships with us, or are otherwise unable to provide us with designs suitable for our products, or if we fail to increase our in-house research and development activities to compensate for our inability to obtain designs suitable for our products from these handset designers, our business and our results of operations could be materially adversely affected.

Our results of operations, particularly our profitability, may be materially adversely affected if we do not successfully manage price erosion and are not able to manage costs related to our products and operations.

Price erosion is a characteristic of the mobile handset industry, and the products offered by us are also subject to natural price erosion over time. If we are not able to lower our costs at the same rate or faster than this price erosion and introduce new cost-efficient products with higher prices in a timely manner, as well as manage costs related to our products and operations generally, it will have a material adverse effect on our business and results of operations, particularly our profitability.

We rely primarily on our distributors for marketing our products at the provincial and local levels and for after-sales support of our products. Because we have limited influence over our distributors, we cannot be certain that their marketing and after-sale support of our products will be adequate or will not harm our brand and reputation. Moreover, if we fail to timely identify additional or replacement distributors upon the loss of one or more of our distributors, or if we are unable to successfully manage our distribution network, or if we are unable to collect payments from our distributors on a timely basis, our operating results may suffer.

Substantially all of our sales are made to our distributors. As of June 18, 2010, our distribution network included four national distributors, 58 provincial distributors and three TV direct sales distributors. These distributors resell our products to end customers in China either directly or through their own distribution networks principally composed of local distributors and retail outlets. We grant our distributors the right to use our brand name and logo when they market our products within their respective sales territories or channels and when they provide after-sales support to our end-user customers. However, our contractual arrangements with our distributors do not provide us with control over their everyday business activities, and one or more of our distributors may engage in activities that are prohibited under our contractual arrangements with them, that violate PRC laws and regulations governing the mobile handset industry or other PRC laws and regulations generally, or that are otherwise harmful to our business or our reputation in the industry.

Distributors individually accounting for more than 10% of our revenues collectively accounted for 36.1%, 65.1% and 86.4% of our revenues in 2007, 2008 and 2009, respectively. See note 1(c) to our audited consolidated financial statements included elsewhere in this annual report for a list of such distributors. Due to our dependence on distributors for the sale, marketing and after-sales support of our products, any one of the following events may cause material fluctuations or declines in our revenue and have a material adverse effect on our financial condition and results of operations:

•		reduction, delay or cancellation of orders from one or more of our distributors;
•		selection by one or more of our distributors of our competitors’ products;
•		failure to timely identify additional or replacement distributors upon the loss of one or more of our distributors; and
•		failure of any of our distributors to make timely payment for our products.

In addition, we rely on our distributors for marketing activities at the provincial and local levels. This approach may not be effective in building brand recognition at provincial and local levels consistent with our national brand-building efforts. We also outsource to some of our distributors and other third parties our after-sales support to end-user customers. If our after-sales service providers fail to provide adequate, satisfactory and effective after-sales support, our brand image may suffer, and our business and results of operations could be materially adversely affected.

We currently enjoy a number of favorable arrangements with some of our distributors, such as exclusive sales relationships, up-front payment by distributors, and settlement by cash or promissory notes guaranteed by banks. However, the competition for distribution channels is intense in the mobile handset industry in China and many of our competitors are expanding their distribution channels in China. We may not be able to compete successfully against the larger and better funded sales and marketing operations of some of our current or potential competitors, especially if these competitors provide more favorable contractual arrangements for distributors. As a result, we may lose some of our distribution channels to our competitors, which may cause us to lose some or all of our favorable arrangements with these distributors and may even result in the termination of our contractual relationships with some of our distributors. While we do not believe we are substantially dependent upon any individual distributor, finding replacement distributors could be time-consuming and any resulting delay may be disruptive and costly to our business. In addition, we may not be able to successfully manage our distribution channels and the cost of any consolidation or further expansion may exceed the revenue generated from these efforts. The occurrence of any of these factors could result in a significant decrease in the sales volume of our products and therefore materially harm our financial condition and results of operations.

Our distributors often must make a significant commitment of capital to purchase our products, and we provide trade credits to some of our distributors. As a result, any downturn in a distributor’s business that affects the distributor’s ability to pay us could harm our financial condition. Historically, we have not experienced any significant bad debt or collection problems, but such problems may arise in the future. The failure of any of our distributors to make timely payments could require us to write off accounts receivable or increase provisions made against our accounts receivable, either of which could adversely affect our financial condition.

If we fail to source a sufficient quantity of high-quality components used in our products at reasonable costs from our suppliers, our competitive position, reputation and business could suffer. Our dependence on suppliers for certain types of components could jeopardize our production activities and increase our cost of sales.

We do not produce most of the components and raw materials necessary for the production of our mobile handsets and rely on suppliers to provide us with a substantial portion of these components and raw materials. The aggregate costs attributable to our five largest raw materials and components suppliers in 2007, 2008 and 2009 were 70.0%, 72.5% and 88.3%, respectively. We may experience a shortage in the supply of certain components in the future and if any such shortage occurs, our manufacturing capabilities and results of operations could be materially adversely affected. If any supplier is unwilling or unable to provide us with high quality components and raw materials in required quantities and at acceptable costs, we may not be able to find alternative sources on satisfactory terms in a timely manner, or at all. Our inability to find or develop alternative sources if and as required could result in delays or reductions in manufacturing and product shipments. Moreover, these suppliers may delay component or material shipments or supply us with inferior quality components or raw materials that may adversely impact the performance of our mobile handsets. If any of these events occur, our competitive position, reputation and business could suffer.

Some of our products also incorporate imported components. Our imported electronic components and raw materials are subject to a variety of Chinese governmental permit requirements, approval procedures and import duties, and may also, from time to time, be subject to export controls and other legal restrictions imposed by foreign countries. Should the Chinese government refuse to issue the necessary permits or approvals to us or our suppliers, or take any administrative actions to limit imports of certain components, or if we or our suppliers fail to pay any required import duties, or if governmental agencies or laws of foreign countries prevent the timely export of certain components we require to China, we may become subject to penalties and fines or fail to obtain important components for our mobile handsets, and our ability to manufacture and sell our products in China could be adversely affected. In addition, import duties increase the cost of our products and may make them less competitive.

Some components and materials used in our products are currently purchased from a single supplier or a small number of suppliers and our ability to deliver our products according to market demands depends in large part on obtaining timely and adequate supplies of components and materials on competitive terms. Failure by any of our suppliers to meet our needs for components could impact our production targets, limit our sales or increase our costs. While we do not believe we are substantially dependent upon any individual supplier, finding alternative suppliers for these components and materials could be costly and time-consuming. Moreover, if we fail to anticipate customer demand properly, an over- or undersupply of components and production capacity could occur. This factor could limit our ability to supply sufficient products to our customers or could increase our costs. At the same time, we may commit to certain capacity levels or component quantities, which, if unused, will result in charges for unused capacity or scrapping costs.

We maintain inventories of raw materials, components and handsets, and our inventories may become obsolete.

The rapid technological change in our industry, the short product life cycle of our handsets, our limited forecasting experience and processes and the competitive nature of our target markets make forecasting our future sales and operating results difficult. Our expense levels are based, in part, on our expectations regarding future sales. In addition, to enable us to promptly fill orders, we maintain inventories of raw materials, components and handsets. As a result, we have to commit to considerable costs in advance of anticipated sales. Any significant shortfall of sales may result in our maintaining higher levels of inventories of raw materials, components and finished goods than we require, thereby increasing our risk of inventory obsolescence and corresponding inventory write-downs and write-offs. We cannot guarantee that such write-downs will be adequate to cover all losses resulting from inventory obsolescence.

We may require additional capital and we may not be able to obtain it on acceptable terms or at all.

We believe that our current cash and cash flow from operations will be sufficient to meet our present cash needs. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:

•		investors’ perception of, and demand for, securities of China-based mobile handset companies;
•		conditions of the U.S. and other capital markets in which we may seek to raise funds;
•		our future results of operations, financial condition and cash flows;
•		PRC governmental regulation of foreign investment in the telecommunications industry;
•		economic, political and other conditions in China; and
•		PRC governmental policies relating to foreign currency borrowings.

Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could have a material adverse effect on our business, financial condition and results of operations.

Our past brand-sharing practices may result in negative publicity and may even lead to investigations or penalties by relevant PRC regulatory authorities, which could have a material adverse impact on our reputation and business.

Through the first half of 2006, we allowed other mobile handset manufacturers to use our GSM licenses to produce mobile handsets and sell these mobile handsets under our brand name. Although we exerted a certain degree of control over the manufacturing processes of these mobile handsets, we had almost no control over most other aspects of the production and sale of these handsets, including raw materials purchases. As a result, mobile handsets produced under these arrangements by the other manufacturers may not have the same quality as the products made by us and any product quality claims associated with these mobile handsets may result in adverse publicity for us and harm to our reputation in the market, which may result in a decrease in sales of our mobile handsets and materially adversely affect our financial condition and results of operations.

In addition, although there are no specific laws and regulations in China governing the brand-sharing practice as described above or similar practices, the MIIT and the State Administration of Industry and Commerce launched certain campaigns in the past aimed at stopping practices they considered inconsistent with acceptable industry practices. Should these relevant regulatory authorities decide that our past brand-sharing practices were unacceptable or contravened existing laws and regulations in China, we may become subject to investigations or penalties. Furthermore, if any new regulation prohibiting brand-sharing is promulgated with retroactive effect, our past brand-sharing practice may be subject to investigation based upon such new regulation, which may result in penalties and may have an adverse effect on us.

Our operating results are difficult to predict and may fluctuate significantly from period to period in the future.

Our operating results are difficult to predict and may fluctuate significantly from period to period based on a number of factors such as the launch of particular best-selling products in a given period, the seasonality of our mobile handset sales, the short life-cycle of any given handset model in China due to rapid technological advances, a possible deterioration of economic conditions in China and potential changes to the regulation of the mobile handset industry in China. These factors are discussed elsewhere in this annual report. As a result, you may not be able to rely on period-to-period comparisons of our operating results as an indication of our future performance. If our revenues for a particular period are lower than we expect, we may be unable to reduce our fixed costs and operating expenses for that period by a corresponding amount, which would negatively impact our operating results for that period relative to our operating results for other periods.

We must develop or otherwise acquire complex, evolving technologies to use in our business and meet market demand. Our failure to develop or otherwise acquire these complex technologies, or to successfully commercialize such technologies as new advanced products that meet customer demand on a timely basis, will have a material adverse effect on our business, our ability to meet our targets and our results of operations.

To succeed in our markets and meet market demand, we must develop or otherwise acquire complex, evolving technologies to use in our business. However, the development and use of new technologies, applications and technology platforms for our mobile handsets involves the commitment of significant amounts of our management’s time, substantial costs and risks both within and outside of our control. This is true whether we develop these technologies internally, acquire or invest in other companies with these technologies or collaborate with third parties on the development of these technologies.

The technologies, functionalities and features on which we choose to focus may not achieve as broad or timely customer acceptance as we expect. This may result from numerous factors, including the availability of more attractive alternatives or a lack of sufficient compatibility with other existing technologies, products and solutions. Additionally, even if we do select the technologies, functionalities and features that customers ultimately want, we or the companies that work with us may not be able to bring them to the market in a timely manner. We may also face difficulties obtaining and providing the technologies preferred by our potential customers, or at prices acceptable to them.

In addition, our products include increasingly complex technologies developed or licensed to us by third parties. We may not be able to obtain or maintain necessary or desirable licenses or permits from third parties, with full rights needed to use them in our business, on commercially acceptable terms at such times as we may seek to use them.

We rely on a number of technologies licensed from third parties and the loss of some or all of these licenses or failure to renew them on a timely basis could interrupt our production and have a material adverse impact on our business.

We rely on a number of technologies licensed from third parties for manufacturing our mobile handsets. For example, we rely on Access China Inc. for certain software supporting wireless application protocol and multimedia messaging service functions. If some or all of such licenses are terminated, or if we fail to renew certain licenses on a timely basis or if we fail to find alternative suppliers, our production of mobile handsets would be disrupted and our business and financial conditions could be materially adversely affected.

We have not applied for patents or registered copyrights for most of our intellectual property and our failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.

Implementation of PRC intellectual property-related laws has historically been lacking, primarily because of ambiguities in PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. We rely primarily on trade secrets and other contractual restrictions to protect our intellectual property. We have not applied for patents or registered copyrights in China for most of our inventions, original works of authorship, developments and improvements relating to the mobile handsets we produce. The actions we have taken to protect our intellectual property rights may not be adequate to provide us with meaningful protection or commercial advantage. As a result, third parties may use the technologies that we have developed and compete with us, which could have a material adverse effect on our business, financial condition and operating results.

In addition, policing unauthorized use of proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights and the outcome of any such litigation may not be in our favor. Given the relative unpredictability of China’s legal system and potential difficulties in enforcing a court judgment in China, there is no guarantee that we would be able to halt the unauthorized use of our intellectual property through litigation in a timely manner. Furthermore, any such litigation may be costly and may divert management attention away from our business and cause us to expend significant resources. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse impact on our business, financial condition and results of operations.

We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely against us, could disrupt our business and subject us to significant liability to third parties, as well as have a material adverse effect on our financial condition and results of operations.

Our success depends, in large part, on our ability to use and develop our technology, know-how and product designs without infringing upon the intellectual property rights of third parties.

Our products include increasingly complex technology and, as the amount of such technologies and the number of parties claiming rights continue to increase, the possibility of alleged infringement and related intellectual property claims against us continues to rise. The holders of patents and other intellectual property rights potentially relevant to our product offerings may be unknown to us, or may otherwise make it difficult for us to acquire a license on commercially acceptable terms. There may also be technologies licensed to and relied on by us that are subject to infringement or other corresponding allegations or claims by others which could damage our ability to rely on such technologies. In addition, although we endeavor to ensure that companies that work with us possess appropriate intellectual property rights or licenses, we cannot fully avoid the risks of intellectual property rights infringement created by suppliers of components used in our products or by companies with which we work in cooperative research and development activities.

Since all technology standards, including those used and relied on by us, include some intellectual property rights, we cannot fully avoid risks of a claim for infringement of such rights due to our reliance on such standards. We believe that the number of third parties declaring their intellectual property to be relevant to these standards, for example, those standards related to 3G mobile communication technologies as well as other advanced mobile communications standards, is increasing, which may increase the likelihood that we will be subject to such claims in the future. While we believe that any such intellectual property rights declared and found to be essential to a given standard carry with them an obligation to be licensed on fair, reasonable and non-discriminatory terms, not all intellectual property owners agree on the meaning of that obligation and, thus, costly and time-consuming litigation over such issues may result in the future.

As we continue to market and sell our products throughout China, and as litigation becomes more common in China, we face a higher risk of becoming subject to claims for intellectual property infringement. While we have not, to date, become subject to these types of claims, it is possible that we may, in the future, become subject to such intellectual property infringement claims. Regardless of whether such claims have merit or are decided in our favor, any such litigation could have a negative impact on our brand, reputation and ability to conduct our business and sell some or all of our products.

Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products in China or other countries. The validity and scope of claims relating to these patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. In addition, the defense of intellectual property claims, including patent infringement suits, and related legal and administrative proceedings can be both costly and time consuming, and may significantly divert the efforts and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceeding to which we may become a party could cause us to:

•		pay damage awards;
•		seek licenses from third parties;
•		pay additional ongoing royalties, which could decrease our profit margins;
•		redesign our products; or
•		be restricted by injunctions,

each of which could effectively prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or limiting their purchase or use of our products, which could have a material adverse effect on our financial condition and results of operations.

It may become more difficult to maintain our quality standards, and problems with product quality or product performance could result in a decrease in customers and revenue, unexpected expenses and loss of market share. Product liability claims against us could result in adverse publicity and potentially significant monetary damages.

Our operating results depend, in part, on our ability to deliver quality products on a timely and cost-effective basis. In the past, we have experienced manufacturing defects as a result of various factors, including defects in component parts and human error in assembly. As mobile handset products become technologically more complex, it may become more difficult to maintain our quality standards. If we experience deterioration in the performance or quality of any of our products, it could result in delays in shipments, cancellations of orders or customer returns and complaints, loss of goodwill, and harm to our brand and reputation. Furthermore, as a result of ongoing technological developments, our products are increasingly used together with hardware or software components that have been developed by third parties and when a problem occurs, it may be difficult to identify the source of the problem. In addition, some components, such as batteries or software applications, may not be fully compatible with our products and may not meet our and our customers’ quality, safety, security or other standards. The use by customers of our products with incompatible or otherwise substandard hardware or software components, while largely outside of our control, could result in malfunctions or defects in our handsets and result in harm to our brand. These problems may lead to a decrease in customers and revenue, harm to our brand, unexpected expenses, loss of market share, the incurrence of significant warranty and repair costs, diversion of the attention of our engineering personnel from our product development efforts, customer relation problems or loss of customers, any one of which could materially adversely affect our business.

In addition, we contract with third parties, such as EMS providers, to use their manufacturing facilities to produce our mobile handsets. We may be unable to exercise the same degree of quality control over these manufacturing facilities as we can over our own facilities. Any product quality problems associated with the products produced by these third parties may also lead to adverse publicity against us, affect our reputation and cause a decrease in sales of our mobile handsets.

As with other mobile handset producers, we are also exposed to risks associated with product liability claims if the use of the mobile handsets we sell results in injury, death or damage to property. We cannot predict at this time whether product liability claims will be brought against us in the future or the effect of any resulting negative publicity on our business. We do not have product liability insurance and have not made provisions for potential product liability claims. Therefore, we may not have adequate resources to satisfy a judgment if a successful claim is brought against us. Moreover, the successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments and incur substantial legal expenses. Even if a product liability claim is not successfully pursued to judgment by a claimant, we may still incur substantial legal expenses defending against such a claim.

Our sales and profitability depend on the continued growth of the mobile telecommunications industry, especially in China, and if the mobile telecommunications industry does not grow as we expect or grows at a slower speed than we expect, our sales and profitability may be materially adversely affected.

We derive substantially all of our revenues from sales of mobile handsets in China. The continued development of our business depends, in large part, on continued growth in the mobile telecommunications industry, especially in China, in terms of the number of existing mobile subscribers who upgrade or replace their existing mobile handsets, the number of new subscribers and increased usage. Although China’s wireless telecommunication industry has grown rapidly in the past, it may not continue to grow at the same growth rate in the future or at all.

Furthermore, our sales and profitability are also affected by the extent to which there is increasing demand for, and development of, value-added services, leading to opportunities for us to successfully market mobile handsets that feature those services. To a certain extent, we are dependent on third-party mobile telecommunication operators to successfully introduce these value-added services that encourage end users to upgrade or replace their mobile handsets. For instance, mobile telecommunication operators in China have upgraded their networks to offer 3G wireless telecommunication services, which we believe will lead to increased demand for enhanced wireless value-added services and, therefore, increased demand for mobile handsets with more advanced technologies in China. Therefore, if mobile telecommunication operators are not successful in their attempts to introduce new services, increase the number of subscribers, stimulate increased usage and drive replacement sales, our business and results of operations could be materially adversely affected.

These developments in our industry are, to a large extent, outside of our control and any reduced demand for wireless voice and data services, any other downturn or other adverse changes in China’s wireless telecommunication industry could severely harm our business.

Changes in the regulatory environment for telecommunications systems and services, especially in China, could negatively impact our business.

The telecommunications industry in China is heavily regulated and regulatory changes may affect both our customers and us. For example, changes in regulations that impose more stringent standards for the production of mobile handsets could adversely affect our business. Similarly, tariff regulations that affect the pricing of new services offered by mobile telecommunication operators could also affect their ability to invest in network infrastructure, which in turn could affect the sales of our mobile handsets. License fees, environmental, health and safety, privacy and other regulatory changes may increase costs and restrict operations of mobile telecommunication network operators and service providers. The indirect impact of such changes could affect our business adversely even though the specific regulations may not directly apply to our products or us.

MIIT has broad discretion and authority to regulate all aspects of the telecommunication and information technology industry in China, including managing spectrum bandwidths, setting mobile handset specifications and standards, approving the adoption of new technologies such as 3G, and drafting laws and regulations related to the electronics and telecommunication industries. MIIT also determines the forms and types of services that may be offered by telecommunication companies to the public, the rates that are charged to subscribers for those services and the content of material available in China over wireless services, including Internet content. In addition, China’s telecommunication regulatory framework is still at a relatively early stage of development, and prone to directional shifts and major structural changes. The PRC government is in the process of drafting a national telecommunication law, which may include new legislation governing the mobile handset industry. If MIIT sets standards with which our company is unable to comply or which would render our products uncompetitive, our ability to sell products could be severely limited, resulting in substantial harm to our operations.

Any environmental claims or failure to comply with any present or future environmental regulations may require us to spend additional funds and may materially adversely affect our financial condition and results of operations.

We are subject to environmental, health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. We believe that we are in compliance with all material environmental, health and safety laws and regulations related to our products, operations and business activities. Although we have not suffered material environmental claims in the past, the failure to comply with any present or future regulations could result in the assessment of damages or imposition of fines against us, suspension of production or a cessation of our operations. New regulations could also require us to acquire costly equipment or to incur other significant expenses. Any failure by us to control the use of, or to adequately restrict the discharge of, hazardous substances could subject us to potentially significant monetary damages and fines or suspension of our business operations, which could materially adversely affect our financial condition and results of operations.

We do not carry any business interruption insurance or third-party liability insurance for our manufacturing facilities.

We currently have one main handset manufacturing facility located in Huizhou City, Guangdong Province, China. Operation of manufacturing facilities involves many risks, including equipment failures, natural disasters, industrial accidents, power outages, labor disturbances and other business interruptions. We do not carry any business interruption insurance or third-party liability insurance for our manufacturing facilities to cover claims in respect of personal injury or property or environmental damage arising from accidents on our property or relating to our operations. Therefore, our existing insurance coverage may not be sufficient to cover all risks associated with our business. As a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.

Labor laws in the PRC may adversely affect our results of operations.

On June 29, 2007, the PRC government promulgated the Labor Contract Law of the PRC, or the Labor Contract Law, which became effective on January 1, 2008, and its implementary rules effective on September 18, 2008. The Labor Contract Law imposes greater liabilities on employers and significantly impacts the cost of an employer’s decision to reduce its workforce. Further, it requires certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce, the Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous to our business or in a timely and cost effective manner, thus materially and adversely affecting our financial condition and results of operations.

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

On March 16, 2007, the National People’s Congress of the PRC passed the PRC Enterprise Income Tax Law, which law took effect as of January 1, 2008. Under the new PRC Enterprise Income Tax Law, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in the PRC to its foreign investor who is a non-resident enterprise are subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a reduced rate of withholding tax. The British Virgin Islands, where we are incorporated, does not have such a tax treaty with the PRC. If we are considered a non-resident enterprise, this new 10% withholding tax imposed on our dividend income received from CECT would reduce our net income and have an adverse effect on our operating results.

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

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

We depend on our key personnel, and our business and growth may be severely disrupted if we lose their services. We may also have difficulty attracting and retaining qualified management and research and development personnel.

Our future success depends substantially on the continued services of our key personnel. In particular, we are highly dependent on Mr. Zhi Yang Wu, our chairman, and Dr. David Li, our chief executive officer. We rely on their experience in the mobile handset manufacturing industry, similar business operations and sales and marketing and on their relationships with our shareholders, customers and suppliers. If we lose the services of one or more of these key personnel, we may not be able to replace them readily, if at all, with suitable or qualified candidates, and may incur additional expenses to recruit and retain new officers, which could severely disrupt our business and growth. We do not maintain key-man life insurance for any of our key personnel. If one or more of our key personnel is unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all.

In addition, if any of these key personnel joins a competitor or forms a competing company, we may lose some of our customers. We have entered into employment agreements with each of these key personnel, which contain confidentiality and non-competition provisions. However, if any disputes arise between these key personnel and us, it is not clear, in light of uncertainties associated with the PRC legal system, what the court decisions will be and the extent to which these court decisions could be enforced in China, where all of these key personnel reside and hold some of their assets. See “—Risks related to doing business in China—Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.” Furthermore, as we expect to continue to expand our operations and develop new products, we will need to continue attracting and retaining experienced management and key research and development personnel.

Competition for management and research and development personnel in the mobile handset market in China is intense, and the availability of suitable and qualified candidates is limited. In particular, we compete to attract and retain qualified research and development personnel with other mobile handset manufacturers, universities and research institutions. Competition for these individuals could cause us to offer higher compensation and other benefits in order to attract and retain them, which could have a material adverse effect on our financial condition and results of operations. We may also be unable to attract or retain the personnel necessary to achieve our business objectives, and any failure in this regard could severely disrupt our business and growth.

Fluctuations in exchange rates could adversely affect our business.

Because substantially all of our earnings are denominated in Renminbi, any appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our balance sheet position and financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. In addition, fluctuations in the exchange rate between the U.S. dollar and the Renminbi would affect the relative purchasing power of our U.S. dollar denominated cash assets and the Renminbi value of our U.S. dollar denominated bank borrowings. Fluctuations in the exchange rate will also affect the relative value of any dividend we may issue that will be exchanged into U.S. dollars and the earnings from and value of any U.S. dollar-denominated investments we make in the future.

Since July 2005, the Renminbi has no longer been pegged to the U.S. dollar. Although currently the Renminbi exchange rate versus the U.S. dollar is restricted to a rise or fall of no more than 0.3% per day and the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future the PRC authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market.

Only limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies.

We believe that we were a passive foreign investment company for U.S. federal income tax purposes for our taxable year that ended December 31, 2009 and we may continue to be a passive foreign investment company in the current and future taxable years, which could result in adverse U.S. federal income tax consequences to U.S. investors.

We believe that we were a passive foreign investment company, or a PFIC, for U.S. federal income tax purposes for our taxable year that ended December 31, 2009 under the asset test for the determination of a PFIC as described below. We may continue to be a PFIC in the current and future taxable years unless (i) we significantly reduce the amount of cash we hold or (ii) our market capitalization increases significantly. Such classification could result in adverse U.S. federal income tax consequences to U.S. investors. We must make a separate determination each year as to whether we are a passive foreign investment company.

Specifically, we would be a passive foreign investment company for a taxable year if (i) at least 75% of our gross income is passive income during the taxable year or (ii) at least 50% of the average quarterly value of our assets during the taxable year is derived from assets that produce, or that are held for the production of, passive income.

In applying the asset test described above, the value of our assets will generally be deemed to be equal to the sum of the aggregate value of our outstanding equity plus our liabilities. For purposes of the asset test, our goodwill, which is generally measured as the sum of the aggregate value of outstanding equity plus liabilities, less the value of known assets, should be treated as a non-passive asset. Therefore, a decrease in the market price of our ordinary shares and associated decrease in the value of our goodwill would cause a reduction in the value of our non-passive assets for purposes of the asset test. If there is such a reduction in goodwill and the value of our non-passive assets, the percentage of the value of our assets that is attributable to passive assets may increase, and if such percentage, based on an average of the quarterly values during a taxable year, exceeds 50%, we will be a PFIC for such taxable year. Accordingly, fluctuations in the market price of our ordinary shares may result in us being a PFIC for any year. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we have on hand.

If we are a PFIC for any taxable year, dividends paid by us in that year or the following taxable year will not be eligible for the reduced rate of taxation applicable to non-corporate U.S. investors, including individuals. Additionally, absent a special election, U.S. investors may be subject to additional U.S. federal income taxes on gain recognized with respect to the ordinary shares and on certain distributions, plus an interest charge.

For a detailed discussion of the PFIC rules, see “Item 10. Additional information—E. Taxation—U.S. Federal Income Taxation—Passive foreign investment company.” We urge investors to consult their own tax advisors with respect to the U.S. federal income tax consequences of their investment.

If we fail to maintain an effective system of internal control over financial reporting, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected. In addition, investor confidence and the market price of our ordinary shares may be adversely impacted if we or our independent registered public accounting firm conclude that our internal control over financial reporting is not effective, in accordance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Upon the closing of the initial public offering of our ordinary shares in May 2007, we became a public company in the United States that is subject to the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act requires that we include a report from management on our internal control over financial reporting in this annual report on Form 20-F. In addition, our independent registered public accounting firm must report on the effectiveness of our internal control over financial reporting beginning with our annual report for the fiscal year ending on or after June 15, 2010. We identified a material weakness relating to the adoption and application of a new accounting standard — Emerging Issues Task Issue 07-5, “Determining Whether an Instrument is Indexed to an Entity’s own Stock,” with respect to our assessment of the effectiveness of the Company’s internal control over financial reporting for certain voluntary reporting interim periods in 2009. As of December 31, 2009, we have successfully remediated such material weakness by implementing this accounting standard for our financial statements for the year ended December 31, 2009 and have improved processes and controls with respect to voluntary interim reporting. Our management has concluded that our internal controls over financial reporting were effective as of December 31, 2009. Such management report on internal control over financial reporting was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission, or the SEC. If, in the future, our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which our internal control over financial reporting is documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules or regulations differently than we do, then they may issue an adverse opinion. Any of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our reporting processes, which could adversely impact the market price of our ordinary shares. Our reporting obligations as a public company place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

Effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ordinary shares. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in the effort to comply with Section 404 of the Sarbanes-Oxley Act.

Compliance with new rules and regulations applicable to companies publicly listed in the United States is costly and complex and any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us and cause the market price of our ordinary shares to decrease.

In addition to Section 404, the Sarbanes-Oxley Act also mandates, among other things, that companies adopt new corporate governance measures, imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members, and imposes increased civil and criminal penalties for companies, their chief executive officers, chief financial officers and directors for securities law violations. For example, in response to the Sarbanes-Oxley Act, the New York Stock Exchange has adopted additional comprehensive rules and regulations relating to corporate governance. After the initial public offering of our ordinary shares in May 2007, these new laws, rules and regulations increased the scope, complexity and cost of our corporate governance and future reporting and disclosure practices. Our current and future compliance efforts will continue to require significant management attention. It has also become more difficult and more expensive for companies such as ours to obtain director and officer liability insurance, and we may be required to accept reduced coverage and to incur substantially higher costs to obtain coverage. Further, our board members, chief executive officer and chief financial officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers to fill critical positions within our company. Any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us, cause the market price of our ordinary shares to decrease or even result in the delisting of our ordinary shares from the New York Stock Exchange.

Risks Related to our Relationship with XING

Our parent company has substantial control over us, and one of the existing shareholders of our parent company has substantial control over our parent company and us. The interests of our parent company and its controlling shareholder/shareholders may not be aligned with the interests of our other shareholders.

Our parent company, Qiao Xing Universal Resources, Inc., or Xing, a public company listed on the Nasdaq Global Market, currently owns approximately 60.7% of our outstanding share capital. Accordingly, Xing, as our controlling shareholder, has substantial control over our business, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. Xing’s ultimate major shareholder is Mr. Rui Lin Wu, the chief executive officer and chairman of Xing and vice chairman of our company, who owned an aggregate of 34.7% equity interest in Xing as of May 31, 2010. In addition, Mr. Zhi Jian Wu Li, brother of our chairman and son of our vice chairman, also owned a 7.4% equity interest in Xing through Qiao Xing Trust and Wu Holdings Ltd. as of May 31, 2010. Accordingly, Mr. Rui Lin Wu, who has a controlling influence in determining the outcome of any corporate transaction or other matter submitted to the shareholders for approval at our parent company, also has substantial control over our business.

Without the consents of Xing, Mr. Rui Lin Wu and the other shareholders of Xing, we could be prevented from entering into transactions that could be beneficial to us. The interests of Xing, Mr. Rui Lin Wu and the other shareholders of Xing may differ from the interests of our other shareholders. Xing, Mr. Rui Lin Wu and the other shareholders of Xing may take actions that could have a material adverse impact on us, such as influencing the way we allocate our resources, restricting our entry into certain kinds of businesses and preventing us from pursuing certain business opportunities that may be beneficial and profitable to us and our other shareholders. In addition, this concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ordinary shares. These actions may be taken even if they are opposed by our other shareholders.

As a “controlled company,” we are exempt from certain NYSE corporate governance requirements, which may result in our independent directors not having as much influence as they would if we were not a controlled company.

We are a “controlled company” as defined under Section 303A of the New York Stock Exchange Listed Company Manual, or the NYSE Manual, because one of our shareholders holds more than 50% of our voting power. As a result, for so long as we remain a controlled company as defined under that rule, we are exempt from, and our shareholders generally are not provided with the benefits of, some of the NYSE corporate governance requirements, including that:

•		our compensation committee must be composed entirely of independent directors; and
•		our nomination committee must be composed entirely of independent directors.

Relying on this exemption, Mr. Zhi Yang Wu, who does not satisfy the “independence” requirements of Section 303A of the NYSE Manual, serves as a member of our nominating and corporate governance committee and compensation committee.

Risks Related to Doing Business in China

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially adversely affect our competitive position.

We conduct substantially all of our operations and generate most of our revenues in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:

•		the higher level of government involvement;
•		the early stage of development of the market-oriented sector of the economy;
•		the rapid growth rate;
•		the higher level of control over foreign exchange; and
•		the allocation of resources.

While the PRC economy has grown significantly since the late 1970s, the growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over the telecommunications industry, capital investments or changes in tax regulations that are applicable to us.

The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways. For example, efforts by the PRC government to manage the pace of growth of the PRC economy could result in decreased capital expenditure by mobile telecommunication network operators, which in turn could reduce demand for our products.

Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of mobile communications investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our business and prospects. In particular, any adverse change in the PRC government’s policies towards the mobile communications industry may have a material adverse effect on our business.

Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

We conduct substantially all of our business through our operating subsidiary in the PRC, CECT, which is a foreign-invested enterprise in China. CECT is generally subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

We rely principally on dividends and other distributions on equity paid by our operating subsidiary to fund our cash and financing requirements, but such dividends and other distributions are subject to restrictions under PRC law. Limitations on the ability of our operating subsidiary to pay dividends or other distributions to us could have a material adverse effect on our ability to grow, make investments or acquisitions, pay dividends to you, and otherwise fund and conduct our business.

We are a holding company and conduct substantially all of our business through our operating subsidiary, CECT, which is a limited liability company established in China. We rely on dividends paid by CECT for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities organized in China is subject to limitations. In particular, regulations in the PRC currently permit payment of dividends by CECT to us only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. CECT is also required to set aside no less than 10% of its after-tax net income each year as reserve funds unless such reserve funds, after making up losses of preceding years, have reached 50% of the registered capital, and these reserves are not distributable as dividends. Moreover, if CECT incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitations on the ability of CECT to pay dividends or other distributions to us could have a material adverse effect on our ability to grow, make investments or acquisitions, pay dividends to you, and otherwise fund or conduct our business.

Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

Most of our revenues and expenses are denominated in Renminbi. Under PRC law, the Renminbi is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, CECT may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenues will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize revenues generated in Renminbi to fund our business activities outside China that are denominated in foreign currencies.

Foreign exchange transactions by CECT under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if CECT borrows foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance CECT by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the NDRC, the Ministry of Commerce, or MOFCOM, or their respective local counterparts. These limitations could affect the ability of CECT to obtain foreign exchange through debt or equity financing.

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

In October 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 75, which took effect on November 1, 2005. In May 2007, SAFE issued the Notice of the State Administration of Foreign Exchange on Operating Procedures Concerning Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 106. Notice 75 and Notice 106 require PRC residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside of China, referred to as an “offshore special purpose company,” for the purpose of acquiring any assets of or equity interest in PRC companies and raising fund from overseas. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch, with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. If any PRC shareholder of any offshore special purpose company fails to make the required SAFE registration and amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore special purpose company. The PRC residents who have already incorporated or gained control of offshore entities that had completed onshore investments in the PRC before Notice 75 took effect must register with the relevant local SAFE branch on or before March 31, 2006. In addition, such PRC residents are required to repatriate into the PRC all of their dividend profits or capital gains from their shareholdings in the offshore entity within 180 days of their receipt of such profits or gains. Moreover, failure to comply with the SAFE registration and amendment requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

A number of terms and provisions in Notice 75 and Notice 106 remain unclear. Because of uncertainty over how the Notice 75 and Notice 106 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with the Notice 75 and Notice 106 by our or our parent company’s PRC resident beneficial holders. In addition, such PRC residents may not always be able to complete the necessary registration procedures required by the Notice 75 and Notice 106. We also have little control over either our present or prospective direct or indirect shareholders or the outcome of such registration procedures. A failure by our or our parent company’s PRC resident beneficial holders or future PRC resident shareholders to comply with the Notice 75 and Notice 106, if SAFE requires it, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiary’s ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

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

We face risks related to health epidemics and other outbreaks.

Adverse public health epidemics or pandemics could disrupt business and the economies of the PRC and other countries where we do business. From December 2002 to June 2003, China and other countries experienced an outbreak of a highly contagious form of atypical pneumonia now known as severe acute respiratory syndrome, or SARS. On July 5, 2003, the World Health Organization declared that the SARS outbreak had been contained. However, a number of isolated new cases of SARS were subsequently reported, most recently in central China in April 2004. During May and June of 2003, many businesses in China were closed by the PRC government to prevent transmission of SARS. Some countries, including China, have encountered incidents of the H5N1 strain of avian influenza from 2003. From April 2009 to present, the U.S. and certain other countries and regions, including China, reported the occurrence of H1N1 influenza. We are unable to predict the effect, if any, that any health epidemics may have on our business. In particular, any future outbreak of SARS, avian influenza, H1N1 influenza or other similar adverse public developments may, among other things, significantly disrupt our business, including limiting our ability to travel or ship our products within or outside China and forcing us to temporarily close our manufacturing facilities. Furthermore, an outbreak may severely restrict the level of economic activity in affected areas, which may in turn materially adversely affect our financial condition and results of operations. We have not adopted any written preventive measures or contingency plans to combat any outbreak of H1N1 influenza, avian influenza, SARS or any other epidemic.

Risks Related to Investment in our Shares

The market price for our ordinary shares may be highly volatile.

The trading price of our ordinary shares has been and may continue to be subject to wide fluctuations. During the period from May 3, 2007, the first day on which our ordinary shares were listed on the NYSE, until June 18, 2010, the trading prices of our ordinary shares ranged from $1.32 to $15.48 per ordinary shares and the closing sale price on June 18, 2010 was $2.70 per ordinary share. The market price for our ordinary shares may continue to be volatile and subject to wide fluctuations in response to factors including the following:

•		announcements of technological or competitive developments;
•		regulatory developments in our target markets affecting us, our customers or our competitors;
•		announcements regarding intellectual property infringement litigation involving us or other mobile handset manufacturers or the issuance of patents to us or our competitors;
•		actual or anticipated fluctuations in our quarterly operating results;
•		changes in financial estimates by securities research analysts;
•		changes in the economic performance or market valuations of other mobile handset companies;
•		additions or departures of our directors, executive officers and key research personnel; and
•		release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares.

In addition, securities markets may from time to time experience significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may have a material adverse effect on the market price of our ordinary shares. In particular, changes in the market price of the shares of our parent company, Xing, may result in changes to the market price of our ordinary shares, even if the underlying reasons for the changes in the share price of Xing do not directly relate to our business. In addition, the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price and trading volumes for our ordinary shares. Some of these companies have experienced significant volatility, including significant price declines after their initial public offerings. The trading performances of these companies’ securities at the time of or after their offerings may affect the overall investor sentiment towards PRC companies listed in the United States and consequently may impact the trading performance of our ordinary shares.

Substantial future sales or perceived sales of our ordinary shares in the public market could cause the price of our ordinary shares to decline.

Sales of our ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ordinary shares to decline. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. If any existing shareholder or shareholders sell a substantial amount of our ordinary shares, the prevailing market price for our ordinary shares could be adversely affected.

In addition, we may issue additional ordinary shares for future acquisitions. If we pay for our future acquisitions in whole or in part with additionally issued ordinary shares, your ownership interests in our company would be diluted and this, in turn, could have a material adverse effect on the price of our ordinary shares.

Our articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares.

Our amended and restated articles of association limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ordinary shares may fall and the voting and other rights of the holders of our ordinary shares may be materially adversely affected.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under the U.S. Securities Act of 1933, as amended, or the Securities Act or an exemption from the registration requirements is available. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, in the event we conduct any rights offerings in the future, you may be unable to participate in such offerings and may experience dilution in your holdings.

Certain judgments obtained against us by our shareholders may not be enforceable.

We are a company incorporated under the laws of the British Virgin Islands. We conduct our operations in China and substantially all of our assets are located in China. In addition, our directors and executive officers, and some of the experts named in this annual report, reside within China, and most of the assets of these persons are located within China. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the British Virgin Islands and of the PRC may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

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

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

Furthermore, our directors have the power to take certain actions without shareholder approval which would require shareholder approval under the laws of most U.S. jurisdictions.

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

We are a British Virgin Islands company incorporated on January 31, 2002. We became a wholly owned subsidiary of Xing in November 2006 when Xing acquired the remaining 20% equity interest in our company that was held by Galbo Enterprise Limited. Immediately prior to the listing of our ordinary shares on the NYSE on May 3, 2007, DKR SoundShore Oasis Holding Fund Ltd. and CEDAR DKR Holding Fund Ltd., the holders of senior convertible notes issued by Xing in June 2006, exchanged all of their notes for 7,800,000 of our ordinary shares that were owned by Xing. See “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions—Arrangements in Connection with the Senior Convertible Notes Issued by Xing.” Immediately subsequent to the exchange, we were 80.50% held by Xing, 17.55% held by DKR SoundShore Oasis Holding Fund Ltd. and 1.95% held by CEDAR DKR Holding Fund Ltd. Xing is a British Virgin Islands company whose ordinary shares have been listed on the Nasdaq Global Market (Nasdaq: XING) since February 1999. Our chairman and vice chairman, Messrs. Zhi Yang Wu and Rui Lin Wu, are also executive officers and directors of Xing. Upon the completion of the initial public offering of our ordinary shares on May 8, 2007, Xing owned approximately 61.3% of our outstanding share capital and continues to exercise control over our company, including the ability to select a majority of the directors and to influence the outcome of decisions requiring shareholder approval.

On May 15, 2008, we entered into and completed the transactions contemplated by a Securities Purchase Agreement (the “SPA”) with DKR SoundShore Oasis Holding Fund Ltd. and CEDAR DKR Holding Fund Ltd. (the “Investors”) pursuant to which we issued, and the Investors purchased, an aggregate of $70,000,000 of our 4.0% senior convertible notes (the “Notes”) that came with 1,648,721 common stock purchase warrants. The consideration paid by the Investors comprised a combination of 6,966,666 ordinary shares that were owned by the Investors, valued at approximately $48,349,000, and cash of $21,651,000. All ordinary shares submitted by the Investors in exchange for the Notes were cancelled. In addition, we also issued to our placement agent 942,127 common stock purchase warrants (collectively with the warrants issued to the Investors, the “Warrants”) at terms identical to those issued to the Investors.

The following discussion on the material terms of the transaction should be read in conjunction with, and is qualified in its entirety by, the SPA and the exhibits thereto.

The material terms and conditions of the Notes are summarized as follows:

•		the Notes are unsecured and mature on May 15, 2011;
•		the Notes bear interest at a rate of 4.0% per annum, payable in cash in arrears on a calendar semi-annual basis beginning June 30, 2008;
•		the Notes are convertible at the holders’ option into our ordinary shares at an initial conversion price of $7.43 per ordinary share (which represents a 10% premium to the arithmetic average of the daily volume-weighted average price (“VWAP”) of our ordinary shares during the five trading day period ending on the day immediately prior to the date of execution of the SPA), subject to adjustments as provided for in the Notes;
•		the conversion price for our ordinary shares is subject to reset if the average of the daily VWAP of our ordinary shares for the five consecutive trading days ending on each three-month anniversary of the issuance date of the Notes until maturity (each a “Reset Date”) is less than $6.76. In that event, the conversion price is reset to a price equal to 92.5% of the arithmetic average of the daily VWAP of our common stock for the five trading days ending on the applicable Reset Date. In no event will the conversion price be reset to a price less than $4.05 per share. The conversion price of the Notes was reset to $4.05 per share on November 15, 2008;
•		the Notes cannot be converted if, after giving effect to such conversion, the holders of the Notes (together with their affiliates) would beneficially own in excess of 9.99% of our ordinary shares outstanding immediately after giving effect to the conversion;
•		the Notes require an automatic re-pricing of the conversion price if we make certain sales of our ordinary shares or ordinary share equivalents in a capital-raising transaction at a price below the conversion price;
•		the holders of the Notes can require us to redeem the Notes at any time on or after the 18 month anniversary of the issuance date of the Notes in an amount equal to the sum of (a) the outstanding principal of the Notes, and (b) the accrued and unpaid interest thereon;
•		in the event of a default, change of control and certain other fundamental transactions, the holders of the Notes have the right to require us to redeem all or any portion of the Notes at a price equal to the greater of (i) the amount to be redeemed multiplied by a redemption premium of 125% and (ii) the amount to be redeemed multiplied by the quotient determined by dividing the closing bid price of our ordinary shares on the date immediately preceding such event by the conversion price of the Notes;
•		all principal, interest, late charges and other amounts due under the Notes that are payable in cash shall be settled in U.S. dollars in an amount equal to the applicable U.S. dollar cash payment due under the terms of the Notes multiplied by 6.99 and divided by the exchange rate of one U.S. dollar to Renminbi on the date such payment is due; and
•		we are required under the terms of a Registration Rights Agreement entered into concurrently with the SPA to file with the SEC a registration statement to register the ordinary shares issuable upon the conversion of the Notes and the exercise of the Warrants to permit the resale of such ordinary shares to the public. The registration statement was filed by the Company on June 27, 2008 and was declared effective by the SEC on July 11, 2008.

The material terms and conditions of the Warrants are summarized as follows:

•		each Warrant is exercisable to purchase one ordinary share;
•		the initial exercise price of each Warrant is $8.91 per share, subject to adjustments as provided for in the Warrant;
•		the Warrants are exercisable at any time during a period of five years from May 15, 2008, the date of issuance;
•		the Warrants contain a “cashless exercise” feature if the registration statement covering the shares underlying the Warrants is not available for the resale of the ordinary shares upon the exercise of the Warrants;
•		the Warrants contain certain limitations on the exercise thereof in the event that the holder would beneficially own in excess of 9.99% of our ordinary shares outstanding immediately after giving effect to such exercise; and
•		the Warrants require an automatic re-pricing of the exercise price if we make certain sales of our ordinary shares or ordinary share equivalents in a capital-raising transaction at a price below the exercise price of the Warrants.

On August 19, 2008, the holders of the Notes exercised the option to convert approximately $8,251,000 of the principal amount of the Notes and accrued interest thereon of approximately $46,000 into 1,511,397 ordinary shares of the Company at a conversion price of $5.49 per share.

On March 31, 2009, Xing and Mr. Rui Lin Wu, the chairman of Xing and vice chairman of our company, entered into agreements to purchase our outstanding Notes of approximately $61.7 million from the three holders of the Notes, DKR SoundShore Oasis Holding Fund Ltd., CEDAR DKR Holding Fund Ltd. and Chestnut Fund Ltd. (collectively, the “Sellers”). Under the terms of the agreements, Xing agreed to purchase US$30.0 million of the outstanding Notes for an aggregate purchase price of $24.0 million, payable in three installments to the Sellers on or before the close of business, New York time, on May 1, 2009. Mr. Rui Lin Wu agreed to purchase the remaining Notes for an aggregate purchase price of $26.0 million, payable in full to the Sellers on or before the close of business, New York time, on August 31, 2009. Mr. Rui Lin Wu did not subsequently consummate the purchase transaction. In November 2009, we redeemed the Notes that were purchased by Xing for $30,706,000.

In 2009, certain holders of the Notes exercised the option to converted $16,073,000 of the principal amount of the Notes plus accrued interest thereon of $590,000 into 4,114,286 ordinary shares at a conversion price of $4.05 per share. As of December 31, 2009, the outstanding principal amount of the Notes amounted to approximately $16,432,000.

As a consequence of the above convertible note transactions, the issuance of 565,000 ordinary shares pursuant to the exercise of share options by a director and certain of our employees in January 2008, and the vesting of 960,884 restricted shares in December 2009 and 331,391 restricted shares in April 2010, Xing owned approximately 60.7% of our outstanding share capital as of May 31, 2010.

We conduct substantially all of our business through our operating subsidiary in the PRC, CECT, in which we own a 96.6% equity interest. CECT was formed in 2000 by six PRC companies. We acquired an initial 65% ownership stake in CECT in February 2003 by purchasing equity interests from the initial shareholders, and have increased our ownership position three times. In July 2005, we increased our equity ownership to 90% through a purchase from a minority shareholder of CECT and in July 2006 we further increased our equity ownership to 93.4% through a cash capital injection into CECT in which the other CECT shareholder did not participate. In June 2007, we made another cash capital injection into CECT in which the other CECT shareholder did not participate and increased our equity ownership to 96.6%. The remaining 3.4% equity interest in CECT is currently held by Qiao Xing Group Limited, or Qiao Xing Group, a private company controlled by Messrs. Zhi Yang Wu and Rui Lin Wu, our chairman and vice chairman, respectively. Qiao Xing Group currently does not intend to transfer this 3.4% equity interest in CECT to us or any related party. CECT has a branch located in Huizhou City, Guangdong Province, China.

Set forth below is a chart showing our current corporate structure as of June 18, 2010:

Beijing VEVA Technology Co., Ltd., or BVT, was incorporated in March 2009 and Beijing Yilian Xuntong Technology Co., Ltd., or BYXT, was incorporated in February 2010. Both BVT and BYXT are principally engaged in the sale of mobile phones and accessories in the PRC.

Our principal executive offices are located at 10th Floor CEC Building, 6 Zhongguancun South Street, Beijing 100086, People’s Republic of China. Our telephone number at this address is (86-10) 8219-3728 and our fax number is (86-10) 8219-3722. Our registered office in the British Virgin Islands is at Romasco Place, Wickhams Cay 1, P.O. Box 3140, Road Town, Tortola, British Virgin Islands.

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is www.qxmc.com. The information contained on our website does not constitute a part of this annual report.

B. Business Overview

We are a domestic manufacturer of mobile handsets in China. We manufacture and sell mobile handsets based primarily on the GSM global cellular technologies. We operate our business primarily through CECT, our 96.6% owned subsidiary in China. Our products have been primarily sold under the “CECT” brand name and we launched the “VEVA” brand in May 2008.

We develop, produce and market a wide range of mobile handsets, with increasing focus on differentiated products that generally generate higher profit margins. We sold approximately 2.71 million and 2.12 million handset products in 2008 and 2009, respectively. The average selling price of our handsets was RMB788 in 2008 and RMB735 ($108) in 2009.

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

We currently have one handset manufacturing facility in Huizhou City, Guangdong Province, China. This facility is equipped with three SMT lines and seven assembly and testing lines. We historically outsourced and continue to outsource the manufacturing of a substantial portion of our products to EMS providers. We produced approximately 0.71 million units in our Huizhou facility in 2008 and 0.21 million units in 2009. We sourced approximately 2.04 million units in 2008 and 1.91 million units in 2009 through EMS providers.

Substantially all of our products are sold in China. We sell our products primarily to our national distributors, provincial distributors and TV direct sales distributors. These distributors resell our products to end customers either directly or through their own distribution networks, which are typically composed of local distributors and retail outlets. As of June 18, 2010, our distribution network included four national distributors, 58 provincial distributors and three TV direct sales distributors. In addition, certain of our distributors and other third parties provide repairs and other after-sales services to our end customers through their after-sales service centers located throughout China. In addition, we also resell our VEVA-branded handsets directly to end customers through the website, www.vevago.com and through six VEVA retail stores located in Beijing, China as of June 18, 2010.

PRC Mobile Handset Industry

In recent years, China’s mobile handset market has experienced rapid growth and development. China is the world’s largest wireless telecommunication market in terms of subscribers. We believe that China will continue to play a key role in the development of the global telecommunication industry and remain one of the largest wireless subscriber markets in the world for the foreseeable future.

Moreover, three mobile telecommunication operators in China have been granted 3G licenses in January 2009 by the Chinese government. 3G technology is expected to enable users to transmit larger volumes of data and more sophisticated content, such as streaming media and multi-player games, more quickly. The more extensive use of data transmission, as facilitated by new and upgraded technologies and networks, is expected to lead to increased demand for enhanced wireless value-added services and, therefore, increased demand for mobile phones with more advanced technologies in China.

The mobile phone penetration rate in China is still considerably lower than most of the more developed countries and we believe that it has the potential to increase significantly in the next several years. Historically, the mobile telecommunication subscription and handset demand growth took place in China’s large cities, such as Beijing, Shanghai and Guangzhou. More recently, however, the demand growth is increasingly driven by medium and small cities and rural areas, which still have low penetration rates and benefit from favorable government policies, such as universal service obligations imposed upon mobile telecommunication operators in China, and the increasing affordability of handsets, mainly due to the higher average standard of living across China.

We have observed the following key industry trends and characteristics in the mobile handset industry in China:

Growing affordability of mobile handsets

Living standards in China continue to improve and the cost of wireless network usage and mobile handsets continues to decrease through the development of technology and intensifying competition. Mobile handsets have evolved from luxury products into common electronic consumer goods in China with ownership becoming increasingly affordable. These factors drive both the continued growth of first-time users and replacement demand from existing users.

Continuing growth increasingly driven by replacement demand

In addition to growth from first-time mobile phone users, handset demand growth in China has increasingly been driven by replacement demand and, to a lesser extent, secondary phones. Key factors driving this trend include the increasing affordability of mobile phones and the incessant and rapid improvement in their functionality and usefulness through technological innovations.

Increasing demand for differentiated mobile handsets with more functions and personalized features

As mobile phones have become more sophisticated, Chinese mobile telecommunication operators have begun to make more data and other wireless value-added services available on handsets. Doing so is enabling a growing convergence between wireless communications and traditional media, such as TV, radio and magazines, and new media such as the Internet. The result is that mobile phones are now more than just communication devices and are increasingly being used for a variety of personal, work and entertainment purposes. This convergence has made mobile phones more useful for consumers in China and has increased demand for sophisticated, yet affordable, handsets. Furthermore, we believe consumers in China, particularly younger generations, often view mobile handsets as fashion accessories, preferring customized and distinctive mobile handset products with greater functionality.

As new services and mobile handset functions become available to customers, we believe that more wireless telecommunication subscribers will seek to upgrade their mobile handsets to newer products on a more regular basis.

We believe the future success of mobile handset producers in China will, to a large extent, depend on their ability to offer distinctive products that stand out from those offered by their competitors. Successful products are typically those with distinctive features that are popular with different users. The product life cycle of mobile handsets has been shortened significantly compared to the recent past as new handsets with advanced features and different look and feel are continually being launched in this fast evolving market. To succeed, mobile handset brand owners must constantly and rapidly introduce to the market new handsets with enhanced look and feel and functionality but expect to sell them in lower volumes for each model.

Continual evolution of wireless network technologies

Wireless network technologies have been continually evolving at a rapid pace. Most mobile handsets are currently based on 2G or 2.5G wireless technology. 2.5G technology enables mobile handsets to offer more features, such as Internet access through mobile phones using wireless application protocol technology and multimedia messaging service. Bridging between 2.5G and 3G, 2.75G technology allows data transmission speed of up to 384 Kbps. This enhanced data speed has extended the service scope of current wireless infrastructure before the new 3G networks were deployed. 3G allows a significantly higher data transmission speed at a maximum of 2 to 2.5 Mbps, which enables users to access more features and applications on their mobile phones, such as online mobile gaming and video communication or downloading. In January 2009, MIIT issued 3G licenses to China Mobile (TD-SCDMA), China Unicom (CDMA2000) and China Telecom (WCDMA).

Highly competitive market

Competition in the mobile handset market in China is intense. While international mobile handset brand owners have achieved substantial market share, new Chinese mobile handset brands and handsets are continually being introduced to the market. We believe competition is being fought on multiple fronts such as cost, functionality and industrial design. The market is continuously evolving and the ability to quickly interpret and adapt to trends is a key driver of success.

Increasing presence of mobile telecommunication operators and large electronic retailers in handset distribution

As in international markets, mobile telecommunication operators and large electronics retailers have become increasingly important as distribution channels in recent years. Mobile telecommunication operators are increasingly trying to differentiate themselves by launching customized services, which in turn often require customized handsets that can support these services. Coupled with this, mobile telecommunication operators are buying more handsets as they use handset promotions in order to win and keep customers. Large electronics retail chains, such as GOME Electrical Appliances Holdings Limited and Suning Appliance Co., Ltd., are rapidly expanding throughout China and their proliferation is contributing to the increase in consumer spending on personal electronics.

We cannot assure you that we will benefit from the projections and trends regarding the mobile handset industry set forth in this section.

Our Products

We manufacture and sell a wide variety of mobile handsets that are primarily based on GSM global cellular technologies. We sold approximately 3,816,000, 2,714,000 and 2,123,000 handset products in 2007, 2008 and 2009, respectively. The average selling prices of our handsets were RMB816, RMB788 and RMB735 ($108) in 2007, 2008 and 2009, respectively.

We have devoted significant resources to developing and producing handset products with various features that are targeted at different consumer segments. In 2007, 2008 and 2009, we rolled out 49, 23 and 17 new handset models, respectively. As of December 31, 2009, we offered approximately 47 different handset models to our customers. These products include features such as multimedia functions, touch-screen pads, large LCD screens, ultra-long standby battery, EDGE technology and luxury design with embedded crystals.

The following table sets forth the key features and launch time of our main handset products that are currently available on the market.

				Date of
				commercial
Model		Key features		launch
C6000V		Metal shell; dual camera; 2.8 inch screen		January 2009
VEVA U600		Metal shell; corrosion resistant (alumina coat)		January 2009
VEVA S80		Luxury series with embedded crystals; ultra-long standby battery; dual SIM cards; arc slider design; EDGE technology		April 2009
VEVA V5		Luxury series with embedded crystals; touch lens; ultra-long standby battery; IPTV		April 2009
VEVA S90		Luxury series with embedded crystals; ultra-long standby battery; digital TV; GPS function; multi-touch function		May 2009
VEVA U9		Luxury series with embedded crystals; slider design; FM radio; bluetooth technology		May 2009
VEVA V6		Luxury series with embedded crystals; double-sided cameras; GPS function		May 2009
VEVA U58		Luxury series with embedded crystals; double QVGA screen; dual SIM cards		July 2009

				Date of
				commercial
Model		Key features		launch
VEVA U88		Luxury series with embedded crystals; dual SIM cards; touch screen		July 2009
VEVA W300		Luxury series watch phone with embedded crystals; FM radio; SMS chat		July 2009
VEVA W500		Ceramic casing watch phone; FM radio; SMS chat		July 2009
VEVA U66		Luxury series with embedded crystals; dual SIM cards; LV leather sheath; touch screen		September 2009
T3		3G mobile handsets based on TD-SCDMA technology		September 2009
C3		FM radio; CDMA; ultra-long standby battery		October 2009

Mobile handset models typically have a limited economic life, which is approximately 12 to 15 months for particularly successful handsets and four to six months for most other handsets. Our higher-end and differentiated products that incorporate features which are different from our competitors’ products usually have longer economic lives than our other products. The revenue we derive from a particular model typically declines as the product approaches the end of its economic life. The following table sets forth our five best selling products and product series in terms of sales generated in each of 2007, 2008 and 2009.

		For the year ended December 31,
		2007												2008												2009
Product		Revenue				Percentage				Rank				Revenue				Percentage				Rank				Revenue				Percentage				Rank
		(RMB)												(RMB)												(RMB)
		(Amounts in thousands, except percentages)
VEVA S90			—				—								—				—								343,150				22.0	%			1
VEVA S80			—				—								—				—								273,775				17.6	%			2
VEVA S50			—				—								—				—								195,020				12.5	%			3
VEVA S70			—				—								—				—								164,861				10.6	%			4
VEVA V6			—				—								—				—								115,509				7.4	%			5
VEVA S60			—				—								633,328				29.6	%			1				—				—
VEVA S70			—				—								262,688				12.3	%			2				—				—
W100			—				—								234,443				11.0	%			3				—				—
C3100			—				—								182,521				8.5	%			4				—				—
VEVA S50			—				—								150,298				7.0	%			5				—				—
C1000			623,495				19.8	%			1				—				—								—				—
C1000+			332,318				10.6	%			2				—				—								—				—
T100			321,903				10.2	%			3				—				—								—				—
C2000			320,147				10.2	%			4				—				—								—				—
C6000			264,099				8.4	%			5				—				—								—				—

Research and Development

The mobile handset industry is characterized by rapid technological developments, frequent launches of new products and services, changes in customer preferences and behavior, and evolving industry standards. In order to maintain our long-term profitability and financial and operating success, we must continually develop new mobile handsets that are attractive to users to replace our existing handsets as they reach the end of their economic lives. The success of our handsets will largely depend on our ability to anticipate and effectively respond to changing consumer tastes and preferences.

We believe that we have strong product development capabilities for mobile handsets. Our research and development team has developed a number of distinctive handset designs and certain product and process technologies used in producing our handsets, including mobile phone application software, user-friendly product interfaces, printed circuit board designs, such as baseband and radio frequency circuit designs, production technology designs and production testing systems, that contribute to our ability to produce differentiated products. We also designed the ultra-long standby batteries used in our products, which are produced by a third-party. In 2007, 2008 and 2009, our total research and development expenses were RMB18.6 million, RMB29.2 million and RMB36.4 million ($5.3 million), respectively. As of December 31, 2009, we employed 133 research and development personnel, which included personnel specialized in industrial design, mechanical design, software and hardware development, project management and quality assurance.

We have strengthened our product development capabilities in recent years. With our accumulated knowledge and experience, we have been able to increasingly shorten our product development cycles. Currently, our product development cycle, from product concept defining to mass production, is typically six to nine months. In 2007, 2008 and 2009, we designed, developed and rolled out 49, 23 and 17 new handset models, respectively.

Our research and development efforts concentrate on developing higher-end and differentiated products. Our research and development expenditures have been, and will continue to be, directed primarily at enhancing our ability to design and develop mobile handsets tailored for the PRC market and differentiated from the products of our competitors. As part of our cost reduction efforts, we also direct part of our research and development resources to increase the percentage of locally sourced raw materials and components used in producing our handsets.

Our in-house handset development teams are based at our two research and development centers in Beijing and Huizhou. Our Beijing research center had 128 research and development personnel as of December 31, 2009 and focuses on developing higher-end and differentiated products. Our Huizhou research center had five research and development employees as of December 31, 2009 and concentrates on developing handsets for the mid-range and economy markets based on existing technologies.

We also outsource certain software and hardware designs used in producing our products, such as high-end handset main boards, to certain independent mobile handset designers in China, such as Leadcore Technology Co., Ltd.

Manufacturing

Manufacturing facilities

Currently, we mainly manufacture our products in an approximately 3,700 square meter manufacturing facility located in Huizhou City, Guangdong Province, China, which commenced operations in September 2004. This facility is located on property we lease from third parties. As of December 31, 2009, our Huizhou facility was equipped with three SMT lines and seven assembly and testing lines, with annual production design capacity of 1.5 million units. Our design capacity represents the maximum output of our existing equipment based on their design specifications. However, there is typically a substantial difference between our design capacity and our actual output due to various factors, including the high number of different models we produce and the time required to adjust the production line and conduct test production for each new model change. We produced approximately 561,000, 714,000 and 207,000 units of our own handsets in 2007, 2008 and 2009, respectively, at our Huizhou facility. As of December 31, 2009, we had an aggregate of 378 manufacturing employees working in this facility.

We also outsource the production of a substantial portion of our products to EMS providers, thereby leveraging their production process technology and capability. Under this arrangement, the EMS providers establish the production lines mainly using their own equipment while we provide product design as well as certain equipment and all components used for the production. Our EMS provider is also obligated to provide after-sales services for products they manufactured for a certain period of time. The production volumes under such arrangements were approximately 3,335,000 units in 2007, 2,040,000 units in 2008 and 1,916,000 units in 2009. Our current EMS providers include Shenzhen Changcheng Co., Ltd, Huizhou Yunlong Co., Ltd., and Shenzhen Zhong Zhi Chuang Co., Ltd.. We believe that our business is not substantially dependent on any individual EMS provider.

In addition, we provide handset processing services to certain handset producers, including a subsidiary of Xing that is not part of our operating group. Under this arrangement, we receive raw materials and components from third parties and process them into handsets or into handset printed circuit boards, or PCB. We produced approximately 1,227,000, 1,106,000 and 803,000 units of handsets and handset PCB under such arrangement in 2007, 2008 and 2009, respectively.

Raw materials and components

Our raw materials and components costs accounted for 92.0% of our total cost of goods sold in 2007, 92.5% in 2008 and 94.7% in 2009. The principal raw materials and components used in the production of our mobile handsets are chipsets, molds, LCD screens, casings, cameras, batteries and keypads.

We source raw materials and components based on price and quality. We believe continuing price negotiations with our suppliers have contributed to our profitability in the past few years. We source chipsets and high-end LCD screens and cameras primarily from overseas suppliers due to the better quality of their products. For example, we source chipsets from MediaTek Inc. and Philips NXP and LCD screens from Truly Semiconductors Ltd. and Foxconn Technology Group. As part of our continuing cost control efforts, we also locally source a significant portion of the raw materials and components used in our manufacturing process, including primarily casing, batteries, cable and low-end LCD screens and cameras. The use of locally sourced raw materials and components also shortens our lead order time and provides us with better access to technical and other support from our suppliers. We also enjoy volume discounts for purchasing certain raw materials and components from our suppliers.

We seek to diversify the supply sources of raw materials and components and to date have not experienced any material disruption of our manufacturing operations due to insufficient supply of raw materials or components. We currently source raw materials and components from more than 100 suppliers. We do not anticipate any significant interruption in the supply of our raw materials and components that would have a material impact on our business in the future. The aggregate costs attributable to our five largest raw materials and components suppliers in 2007, 2008 and 2009 were 70.0%, 72.5% and 88.3%, respectively, of our total purchases during the relevant periods. However, we believe that our business is not substantially dependent on any individual supplier.

We purchase raw materials and components using both forecast orders and purchase orders. To ensure our suppliers will have sufficient time to prepare the components according to our requirements, we typically make a forecast order three or four months before the expected delivery time. The forecast order is not binding on either party. We then make a confirmed purchase order four to eight weeks prior to the delivery time. We separately negotiate the price for each purchase order and typically do not enter into long-term supply contracts.

We maintain different inventory levels of our raw materials, depending on the type of product and lead time required to obtain additional supplies. We seek to maintain reasonable inventory levels that achieve a balance between our efforts to reduce our storage costs and optimize working capital, and the need to ensure that we have access to adequate supplies. As of December 31, 2008 and 2009, we had RMB116.2 million and RMB77.3 million ($11.3 million), respectively, of raw materials in inventory.

Production management

We closely monitor our inventory levels based on sales levels. We typically maintain an aggregate of approximately 30,000 units of inventory of our finished products. We plan our production on a monthly basis based on anticipated demand and make periodic adjustments to our actual production and inventory levels based on actual orders received.

Manufacturing process

The following diagram shows the general production stages for our handsets:

Quality control and certifications

Our quality control procedures include raw material and components quality inspection and testing. In addition, we have established inspection points at key production stages to identify product defects during the production process. Our finished handset products are inspected and tested according to standardized procedures. Moreover, we provide regular training and specific guidelines to our operators to ensure that production processes meet our quality inspection and other quality control procedures.

Our handset manufacturing facility obtained the ISO 9001 quality management system certification in 2000.

Distribution and Marketing

Distribution network

Substantially all of our products were sold to customers in mainland China. We sell our products primarily to our national distributors, provincial distributors and TV direct sales distributors that resell our products to end customers either directly or through their own distribution networks, which are principally composed of local distributors and retail outlets. As of June 18, 2010, our distribution network included four national distributors, 58 provincial distributors and 3 TV direct-sales distributors. In addition, we also retail our VEVA-branded handsets directly to end customers through the website, www.vevago.com and through six VEVA retail stores located in Beijing, China as of June 18, 2010.

We enter into distribution agreements with our national and provincial distributors. Under these agreements, our national distributors are granted the exclusive rights to distribute certain of our products in China. Our provincial distributors are granted the exclusive rights to distribute selected products within their respective territories. Under such exclusive distribution arrangements, no distributor is allowed to sell the same product in the same region with other distributors, which effectively eliminates competition among our distributors. We provide our distributors with product and training guidelines for each of our products and require them to observe these guidelines and provide trainings to employees working at the retail outlets. We regularly monitor and review our distributors’ sales performance and compliance with our guidelines and contract terms. Our distributors engage in self-initiated promotional activities within the scope of guidelines provided by us, and bear the costs associated with such activities.

Sales generated by our five best-performing distributors accounted for approximately 53.0%, 85.1% and 86.4% of our revenue in 2007, 2008 and 2009, respectively, and the best-performing distributor accounted for approximately 12.4%, 52.7% and 19.9% of our revenue in the same periods. Our distribution agreements generally have a term of one year, but in some cases may extend as long as five years for key distributors. However, the best-performing distributors varied and their respective percentages of our revenue fluctuated significantly in each of the above periods. Although we rely on distributors for the sale, marketing and after-sales support of our products, we believe our business is not substantially dependent on any individual distributor.

Marketing

We market our handsets through traditional mass media channels, including television, newspapers, magazines, the Internet and outdoor media, such as billboards. In addition, we also provide guidelines to our distributors for conducting promotional activities at retail outlets, such as offering products at discount prices during holiday seasons.

Pricing

We set the prices of our products based on our development and production costs, the prices of competing products and end-user feedback we collect through our distributors, and review and adjust our product pricing periodically based on these factors. Due to rapidly evolving technology developments that lower our production costs, intense market competition and changes of consumer tastes and preferences, we typically experience gradual price declines during the economic lives of our products.

To avoid pricing competition among our distributors, we set retail price-setting guidelines for our products. Under these guidelines, distributors are permitted to sell our products within a pre-determined range, which provides them with limited flexibility in terms of pricing.

After-Sales Services

We have established uniform replacement and warranty policies for each of our products. Certain of our distributors and other third-parties provide after-sales services for our products, including handset replacements, components replacements and repairs, through after-sales service centers located throughout China. We enter into agreements with those service providers, under which we are obligated to bear the costs of materials used for after-sales services provided during the warranty period. The after-sales service providers bear all other expenses, including cost of materials for services provided after the warranty period has expired as well as labor expenses. We are also responsible for the training of after-sales service personnel.

Intellectual Property and Proprietary Rights

We utilize our internally developed technologies and intellectual property rights to develop, design and manufacture our handset products. Our internally developed technologies and intellectual property rights are an important element of our business operations and a competitive tool for us.

We rely on trade secret protection and confidentiality agreements to protect our proprietary information and know-how. Our management and each of our research and development personnel have entered into a standard annual employment contract, which includes a confidentiality clause and a clause acknowledging that all inventions, designs, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership rights that they may claim in those works. Despite our precautions, it may be possible for third parties to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business—We have not applied for patents or registered copyrights for most of our intellectual property and our failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.”

We have not applied for patents or registered copyrights in China for most of our inventions, original works of authorship, developments and improvements relating to the mobile handsets we produce. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business—We have not applied for patents or registered copyrights for most of our intellectual property and our failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.” Although we believe that, as of today, patents and copyrights have not been essential to maintaining our competitive market position, we intend to assess appropriate occasions in the future for seeking patent and copyright protections for those aspects of our business that provide significant competitive advantages.

In April 2009, we obtained the trademark registration certificate from the China Trademark Office for one trademark relating to our brand name “CECT”. We are currently in the process of applying for the registration of three other trademarks relating to our brand name “CECT” with the China Trademark Office. The registration of these three trademarks was previously applied for by a third party who was not involved in the mobile handset manufacturing industry. We purchased the trademark application rights relating to these three trademarks from the third party through a related party in 2007 but were informed by the China Trademark Office that a third party raised objections related to our applications for the registration of these three trademarks. As a result of the objections, we may not be able to obtain the trademark registration certificates for these three trademarks from the China Trademark Office. See “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions—Transfer of Trademark Application Rights.” In addition, as of December 31, 2009, we had 26 approved trademarks and 14 trademark applications pending with the China Trademark Office.

Technology Licenses and Agreements

In addition to our internally developed technologies and know-how, we also depend on technologies licensed from third parties to design and manufacture our products. For example, we entered into a software license agreement with Mobile Soft Technology (Nanjing) Co., Ltd., or Mobile Soft, on October 28, 2005, under which we were granted the right to use certain software that supports wireless application protocol and multimedia messaging service functions in our handsets for a period of two years. The contract was renewed on March 10, 2008 with Access China Inc., a company that acquired Mobile Soft in 2007, for an additional three years.

We believe that none of the license agreements is critical to our business and that we can identify alternative technologies and technology providers without undue disruption to our business and operations. However, we cannot assure you that the loss of one or more of these licenses will not have a material adverse effect on our business. See “Item 3. Key Information—D. Risk Factors—Risk Related to Our Business—We rely on a number of technologies licensed from third parties and the loss of some or all of these licenses or failure to renew them on a timely basis could interrupt our production and have a material adverse impact on our business.”

Competition

The mobile handset manufacturing industry in China is intensely competitive. Industry participants compete with each other mainly on the basis of the breadth and depth of their product portfolios, price, operational and manufacturing efficiency, technical performance, product features, quality, customer support and brand recognition. We face significant competition from a number of competitors, including domestic mobile handset producers such as Bird Ningbo Co., Ltd., Konka Group Co., Ltd., Beijing Tianyu Communication Equipment Co. Ltd., Gionee Communication Co., Ltd., and Haier (Qingdao) Telecom Co., Ltd. and a number of large multinational mobile handset producers, such as Nokia Corporation, Motorola, Inc., Samsung Electronics Co., Ltd., Sony Ericsson Mobile Communications (China) Co. Ltd., and LG Electronics (China) Ltd. Many of our competitors have longer operating histories, greater name recognition, significantly larger market shares, access to larger customer bases and significantly greater economies of scale and financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. Some of these competitors have used, and we expect will continue to use, more aggressive pricing strategies, greater incentives and subsidies for distributors, retailers and customers, more successful design approaches and more advanced technologies. In addition, some competitors have chosen to focus on building products based on commercially available components, which may enable them to introduce these products faster and with lower levels of research and development spending than us.

International mobile handset makers tend to have established and well-known brands, which we believe Chinese consumers tend to find desirable relative to domestic Chinese brands. Domestic mobile handset manufacturers in China generally compete on style, functionality, price, quality, after-sales service and breadth of products, and are constantly exposed to the risk that competitors may implement new technologies, or may offer lower prices, additional products or services or other incentives that they are not able to offer.

Since we commenced our handset business operations, we have experienced significant price and margin pressures due to intense market competition. However, we have been able to maintain relatively high product margins due to our strategic focus on developing higher-end and differentiated products, which provides us with a competitive advantage over other handset manufacturers. Price competition may become even more intense in the future and we cannot guarantee we will be able to maintain the current level of our profit margins.

In addition, we also face competition from unlicensed mobile handset manufacturers in China that make mobile handsets without the requisite governmental approvals and licenses. However, we believe that these manufacturers are able to keep their production costs low primarily as a result of tax avoidance and non-payment of various fees that are required for all licensed products. Despite recent government actions against many of these unlicensed manufacturers, we believe that such mobile handsets still account for a significant portion of all mobile handsets sold in China. If the PRC government is not successful in preventing these unlicensed mobile handset manufacturers from producing and selling their mobile handsets, our market share and our results of operations could be materially adversely affected.

As a result of developments in our industry, we also expect to face new competition from companies in related industries, such as consumer electronics manufacturers. Additionally, we face increasing competition from mobile telecommunication operators that are increasingly offering mobile devices under their own brands.

Environmental Matters

Our manufacturing facilities are subject to various pollution control regulations with respect to noise and air pollution and the disposal of waste and hazardous materials. We are also subject to periodic inspections by local environmental protection authorities. We believe that we have obtained all requisite environmental permits and approvals to conduct our business.

Employees

As of December 31, 2009, we had 600 full-time employees. The following table sets forth the number of our full-time employees by function as of December 31, 2007, 2008 and 2009, respectively:

		As of December 31,
Functions		2007				2008				2009
Manufacturing and engineering			516				373				378
General and administration			66				66				47
Marketing and sales			44				85				42
Research and development			162				168				133

We offer our employees competitive compensation packages and various training programs, and as a result we have been able to attract and retain qualified personnel. As of December 31, 2009, 47.6% of our employees held university or graduate degrees.

As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including housing, pension, medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. The total amount of contributions we made to employee benefit plans for the years ended December 31, 2007, 2008 and 2009 was approximately RMB1.3 million, RMB4.6 million and RMB6.6 million ($1.0 million), respectively.

We adopted our 2007 equity incentive plan in March 2007 to provide an additional means to attract, motivate, retain and reward selected directors, officers, managers, employees and other eligible persons. As of June 18, 2010, options to purchase 1,200,000 of our ordinary shares remained outstanding, 662,782 restricted shares remained unvested, and 5,080,618 ordinary shares remained reserved for issuance under this plan.

We enter into a standard employment agreement with our management and research and development personnel that includes confidentiality and non-competition provisions. These contracts include a covenant that prohibits each of them from engaging in any activities that compete with our business during, and for three years after, the period of their employment with our company. Under current national and local PRC laws and regulations, which vary by jurisdiction, we cannot assure you that the non-competition provisions will be enforceable in all cases.

We believe that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations. Our employees are not covered by any collective bargaining agreement.

Insurance

Qiao Xing Telecommunication Industry Co., Ltd., an independent third party, maintains property insurance for its premises in Huizhou, in which our current handset production facility is located. The aggregate maximum amount covered by this policy is equivalent to approximately RMB130.9 million ($19.2 million). We also maintain property insurance for our automobiles. We do not maintain business interruption insurance, product quality insurance or key-man life insurance. We believe our insurance coverage is customary and standard for companies of comparable size in comparable industries in China. However, we cannot assure you that our existing insurance policies are sufficient to insulate us from all losses and liabilities that we may incur.

Our Principal Facilities

Our corporate headquarters are located in approximately 4,100 square meters of office space in the CECT Building in Beijing for which we have entered into a lease which will expire in December 2010. Our handset manufacturing facility is located on a leased property of approximately 3,700 square meters in Huizhou. We believe that our existing facilities are adequate and suitable to meet our present needs and that additional space can be obtained on commercially reasonable terms to meet our future requirements.

As of June 18, 2010, we operated six VEVA retail stores in Beijing, China. These retail stores are located in approximately 390 square meters of shopping space with lease terms ranging from one to two years.

Regulations

This section sets forth a summary of the most significant regulations or requirements that affect our business activities in China or our shareholders’ right to receive dividends and other distributions from us.

Chinese Regulatory Framework for the Telecommunications Industry

Overview

China’s telecommunications industry, including the mobile handset manufacturing industry, is heavily regulated, primarily through MIIT, which is under the supervision of the State Council. In addition, a number of other government departments, such as the NDRC, also have regulatory authority over various aspects of the telecommunications industry.

The telecommunications industry in China is regulated at both the national and provincial levels. At the national level, MIIT is the primary regulatory authority and, together with other regulatory authorities, such as the NDRC, is responsible for, among other things:

•		Formulating and enforcing industry policies, regulations and technology standards;
•		Granting network access licenses for telecommunications equipment;
•		Supervising the quality and the operation of telecommunications equipment connected to public telecommunication networks; and
•		Together with other relevant regulatory authorities, formulating the macro-planning of mobile telecommunications equipment production.

At the provincial level, provincial telecommunications authorities, together with other relevant regulatory authorities, are responsible for implementing and enforcing the policies and regulations formulated by MIIT, as well as other central government authorities, within their provinces.

The Chinese government is currently in the process of drafting a telecommunications law in order to establish a uniform regulatory framework for the telecommunications industry in China. However, it is not clear when the law will be adopted. Pending the adoption of the telecommunications law, the PRC Telecommunications Regulation issued by the State Council on September 25, 2000, or the Telecommunications Regulation, is currently the main regulation governing the telecommunications industry in China. The Telecommunications Regulation covers all key aspects of telecommunications operations, including, among others, access of telecommunications equipment to networks such as for use in the mobile handset industry.

MIIT license

The PRC government regulates telecommunications equipment manufacturing primarily through requiring network access licenses for telecommunications equipment, under a unified network entry approval and certification system established pursuant to the Notice Regarding the Implementation of Network Entry License System for Mobile Communications Terminal Products, promulgated on May 19, 1994 by the Ministry of Posts and Telecommunications, the predecessor of MIIT.

On May 10, 2001, MIIT promulgated the Administration Measures of the Network Access of Telecommunications Equipment. According to these measures, all telecommunications terminal equipment that is subject to the network entry license system, including mobile handsets, must obtain a network access license issued by MIIT in order for that product to have access to public telecommunications networks and to be sold in China.

To obtain a network access license, a handset manufacturer must submit an application to MIIT, together with a test report issued by a telecommunications equipment testing organization recognized by the General Administration of Quality Supervision, Inspection and Quarantine, or the GAQSIQ, and authorized by MIIT, or a product quality certificate issued by a state-designated certification agency. Handset manufacturers must place a sticker on the licensed handset bearing the mark of the network access license issued by MIIT. Each network access license is valid for three years. Handset manufacturers must submit applications to renew such licenses at least three months before the expiration of the three-year period. In addition, manufacturers must re-apply for such a license if there are any changes in the technology or certain other prescribed particulars of the licensed handset.

MIIT requires handset manufacturers to implement a comprehensive quality control system and provide after-sales services for their licensed products. These requirements apply equally to both domestic and foreign manufacturers and to both equipment produced in China and equipment imported from overseas. The GAQSIQ, in consultation with MIIT, carries out on-the-spot checks to supervise the quality of the licensed telecommunications equipment and publicly announces the results of such spot checks. Any violation of these requirements may result in penalties in the form of a suspension of the network access license, a warning or a fine.

On May 7, 2003, MIIT promulgated the Administration Measures of the Supervision after Licensing on Telecommunications Equipment, regulating the rules of supervision on the quality control systems, quality of the telecommunications equipment and using condition of the access symbol.

In addition, according to the Implementation Rules for Compulsory Certification of Telecommunications Equipment issued by the Certification and Accreditation Administration of the PRC on December 7, 2001 and the Administration of Compulsory Product Certification Provisions issued on December 3, 2001 by the GAQSIQ, starting from May 1, 2002, certain telecommunications terminal products, including wireless terminal products (such as GSM and CDMA handsets) and multimedia terminal products become subject to a mandatory certification program by designated governmental agencies, known as the China Compulsory Certification, or the 3C certificate. A 3C certificate will be issued to terminal products after testing of such products against standards for health and safety, telecommunications network security and radio compatibility. Terminal products without 3C certificates cannot be sold or used in telecommunications networks in China, regardless of whether a network access license has been obtained for such product.

We have obtained 3C certificates and network access licenses for all models of the handsets we manufacture.

NDRC approval

In China, investments in fixed assets are generally subject to the approval of the NDRC (or its predecessor, the State Planning Commission). On December 31, 1998, MIIT and the State Planning Commission jointly issued the Notice of Accelerating the Development of the Mobile Telecommunications Industry. This Notice emphasizes that mobile handset production projects shall be subject to the approval of the State Planning Commission, after MIIT’s examination of such projects. Furthermore, mobile handset production shall be incorporated into the national guidance plan approved annually by the State Planning Commission.

In 2004, the State Council promulgated the Decision of Investment Regime Reform, which provides that certain types of investment projects, including mobile handset production investment projects, shall be verified, instead of being approved, by the NDRC. On February 19, 2005, the NDRC promulgated the Several Regulations on the Verification of Mobile Communication Systems and Terminal Product Investment Projects, which provides that mobile handset manufacturers must first obtain verification from the NDRC, which shall solicit the opinion of MIIT before issuance of such verification.

As a result of the gradually decreasing involvement of regulatory authorities, licenses to manufacture mobile handsets have become increasingly easy for domestic enterprises to obtain. On October 9, 2007, the State Council promulgated the Decision of the Fourth Abolition and Adjustment of the Administrative Approval Items, which abolished the verification requirement for mobile handset production.

We possess all licenses and verifications necessary to conduct our business as a manufacturer and seller of mobile handsets in China under these and all other applicable laws and regulations.

Environmental Regulations

We use, generate and discharge toxic, volatile or otherwise hazardous chemicals and wastes in our research and development and manufacturing activities. As a result, we are subject to a variety of governmental regulations related to the storage, use and disposal of hazardous materials. The major environmental regulations applicable to us include the Environmental Protection Law of the PRC, the Law of the PRC on the Prevention and Control of Water Pollution, Implementation Rules of the Law of the PRC on the Prevention and Control of Water Pollution, the Law of the PRC on the Prevention and Control of Air Pollution, the Law of the PRC on the Prevention and Control of Solid Waste Pollution, and the Law of the PRC on the Prevention and Control of Noise Pollution. We believe we are in compliance with these environmental laws and rules in all material respects.

C. Organizational Structure

See “—A. History and Development of the Company.”

D. Property, Machinery and Equipment

See “—B. Business Overview—Manufacturing—Manufacturing facilities.”

ITEM 4A. UNRESOLVED STAFF COMMENTS

No unresolved comments.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information provided under “Item 3. Key Information—D. Risk factors.”

Overview

We are a domestic manufacturer of mobile handsets in China. We manufacture and sell mobile handsets based primarily on GSM global cellular technologies. We develop, produce and market a wide range of mobile handsets, with increasing focus on differentiated products that generally have higher profit margins. We sell our products primarily to our national distributors, provincial distributors and TV direct sales distributors, which resell our products to end customers in mainland China either directly or through their own distribution networks principally composed of local distributors and retail outlets. In addition, we also retail our VEVA-branded handsets directly to end customers through the website, www.vevago.com and through six VEVA retail stores located in Beijing, China as of June 18, 2010.

We sold approximately 3.82 million, 2.71 million and 2.12 million mobile handsets in 2007, 2008 and 2009, respectively. Our revenues decreased by 31.4% from RMB3,141.1 million in 2007 to RMB2,153.9 million in 2008, and decreased by 24.2% to RMB1,632.9 million ($239.2 million) in 2009. Our earnings before extraordinary items decreased by RMB158.2 million from RMB597.9 million in 2007 to RMB439.7 million in 2008 and we recorded a loss before extraordinary items of RMB250.0 million ($36.6 million) in 2009. Our net income attributable to ordinary shareholders decreased by RMB169.7 million from RMB593.5 million in 2007 to RMB423.8 million in 2008, and our net loss attributable to ordinary shareholders was RMB250.4 million ($36.7 million) in 2009.

Key Factors Affecting Our Financial Performance

We believe the most significant factors affecting our financial performance are:

•		Industry growth;
•		Competition and market position;
•		Product offerings and pricing;
•		Cost management; and
•		Working capital management.

Industry growth

In recent years, China’s mobile handset market has experienced rapid growth and development. We believe that China will continue to play a key role in the development of the global telecommunication industry and remain one of the largest wireless subscriber markets in the world for the foreseeable future.

Moreover, China’s mobile telecommunication operators have upgraded their networks to offer 3G wireless telecommunication services. 3G technology is expected to enable users to transmit larger volumes of data and more sophisticated content, such as streaming media and multi-player games, more quickly. In January 2009, MIIT issued 3G licenses to China Mobile (TD-SCDMA), China Unicom (CDMA2000) and China Telecom (WCDMA). The more extensive use of data transmission, as facilitated by new and upgraded technologies and networks, is expected to lead to increased demand for enhanced wireless value-added services and, therefore, increased demand for mobile phones with more advanced technologies in China.

The mobile phone penetration rate in China is still considerably lower than most of the more developed countries and we believe that it has the potential to increase significantly in the next several years. Historically, the mobile telecommunication subscription and handset demand growth took place in China’s large cities, such as Beijing, Shanghai and Guangzhou. More recently, however, the demand growth is increasingly driven by medium and small cities and rural areas, which still have low penetration rates and benefit from favorable government policies, such as universal service obligations imposed upon mobile telecommunication operators in China, and the increasing affordability of handsets, mainly due to the higher average standard of living across China.

Competition and market position

While China’s mobile handset market is expected to grow significantly, competition is intense. The market has become highly fragmented in recent years as an increasing number of handset producers have entered the market.

We face significant competition from domestic and multinational mobile handset producers. A small number of multinational players have gained significant market share in China based on greater brand name recognition among Chinese consumers. In addition, competition from domestic handset makers has intensified in recent years.

We focus on developing and marketing differentiated products for the Chinese handset market. By leveraging our in-house research and development capabilities and operational cost advantages, we have been able to offer consumers handsets with more attractive features at relatively lower prices. This strategy has allowed us to maintain our market position while avoiding direct competition with mass market competitive products.

Product offerings and pricing

The mobile handset market in China, as well as globally, is characterized by rapidly changing technical standards and increasing demand for handsets with more functions and personalized features and shortening product life cycles. Pricing of mobile handsets depends principally on manufacturing costs, overall market demand, competition and, increasingly, costs associated with licensing fees, royalties and other payments for technology improvements. Increased economies of scale, technology advancements, and intensified market competition among material and component suppliers have led to significant reductions in handset prices. The selling price and corresponding gross profit margin for a particular mobile handset model typically declines over time as it reaches maturity in the product life cycle. The product life cycle for our most successful handsets has been approximately 12 to 15 months and four to six months for other handset products.

Our success depends on our ability to satisfy market demand by continually and successfully introducing new product offerings tailored towards local consumers and changing trends. Historically, we have been able to limit the decline in our average selling prices and reduce the impact on our overall margins by successfully introducing popular new products with increased features and designs. For example, in 2007, we released a series of products with enhanced functions, such as the fingerprint recognition information security phone and the wrist watch phone. In 2008, we released our new VEVA-branded mobile handsets to target the fashion-conscious professional men and women. The VEVA mobile handsets not only took our products’ overall design and functionality to a new level, but also gave value-conscious shoppers an attractive performance-price value proposition. Our ability to continually introduce new product offerings with attractive features has allowed us to achieve higher average selling prices and consistently achieve relatively higher profit margins.

We also expect to continue to incur costs to license third-party technologies used in our products, as well as for royalties and other fees we may be required to pay in order to use 3G or other technologies used in our handset products.

Cost management

We have adopted various measures to control our development and production costs, including utilizing locally sourced raw materials and components, focusing on in-house design and manufacturing and utilizing a limited number of core handset platform designs for developing and producing a wide range of products with varying features. We also achieved greater economies of scale by significantly increasing our total sales while containing the increases in operating expenses such as selling and distribution expenses, and general and administrative expenses.

Working capital management

We believe our success also depends on our ability to effectively manage our inventory levels, trade-related receivables and payables and other working capital needs. We communicate regularly with our distributors to collect timely feedback from end users and through other channels regarding demand for particular products and project our production volumes and inventory levels based on our analysis of this feedback. As a result, this careful monitoring helps us better manage our working capital requirements. However, we depend on timely and accurate market feedback and a good relationship with our distributors to achieve these added efficiencies. Any failure to obtain timely and accurate market feedback or to correctly estimate demand for our products could result in lost sales opportunities, potential inventory related charges or reduced sales prices and gross margins for our products. We also closely monitor the level of trade-related receivables and payables to effectively anticipate and manage working capital needs.

Financial Impact of Our Corporate History

The following sets forth our corporate transactions that have had a significant impact on our statement of operations for the years ended December 31, 2005, 2006, 2007, 2008 and 2009:

•		In 2005, we acquired an additional 25.0% equity interest in CECT for aggregate consideration of RMB75.0 million, including, among other components, the transfer of a 90.0% equity interest in Beijing Jinxin Hengtong Technology Company Limited, or BJHTCL, and a 3.9% equity interest in China Electronics Financial Co., Ltd., both of which were originally held through CECT. This transaction resulted in an extraordinary gain of RMB48.2 million on the acquisition of additional equity interest in CECT and a gain of RMB10.3 million on the disposal of BJHTCL.
•		In July 2006, we made an additional capital contribution of $18.8 million (equivalent to RMB149.6 million) into CECT. As the minority CECT shareholder did not make a corresponding additional capital contribution, our ownership interest in CECT increased by 3.4% to 93.4%. The transaction resulted in an extraordinary gain of RMB17.8 million.
•		In June 2007, we made another capital contribution of $50 million (equivalent to RMB380.4 million) into CECT. As the minority CECT shareholder did not make a corresponding additional capital contribution, our ownership interest in CECT increased by 3.14% to 96.6%. The transaction resulted in an extraordinary gain of RMB28.7 million.
•		In May 2008, we issued the $70,000,000 Notes in exchange for a combination of 6,966,666 of our ordinary shares that were owned by the Investors of the Notes, valued at approximately $48,349,000, and cash of $21,651,000. For the year ended December 31, 2008, the Notes resulted in interest expense of RMB92.9 million, gain on revaluation of the derivative instruments embedded in the Notes of RMB144.9 million and an exchange loss of RMB11.5 million that arose from the revaluation of the Notes. For the year ended December 31, 2009, the Notes resulted in interest expense of RMB276.1 million ($40.5 million), loss on revaluation of the derivative instruments embedded in the Notes of RMB87.9 million ($12.9 million), loss on revaluation of the Warrants of RMB7.2 million ($1.1 million) and an exchange gain of RMB0.4 million ($0.1 million) that arose from the revaluation of the Notes.

•		In August 2008, the holders of the Notes exercised the option to convert $8,251,000 of the principal amount of the Notes and accrued interest thereon of $46,000 into 1,511,397 of our ordinary shares at a conversion price of $5.49 per share, resulting in a loss on extinguishment of the convertible debts of RMB10.6 million ($1.6 million).
•		In November and December 2009, the holders of the Notes exercised the option to require us to redeem $30,706,000 of the principal amount of the Notes and to convert $16,073,000 of the principal amount of the Notes and accrued interest thereon of $590,000 into 4,114,286 of our ordinary shares at a conversion price of $4.05 per share, resulting in a gain on extinguishment of the convertible debts of RMB159.3 million ($23.3 million).

In addition, on November 30, 2006, Xing obtained 100% ownership of our company when it completed its acquisition of the remaining 20% equity interest in our company from Galbo Enterprise Limited. As more fully described in note 2(a) to our audited consolidated financial statements included elsewhere in this annual report, this acquisition by Xing established a new basis of accounting that resulted from the “push-down” of Xing’s basis to our underlying assets and liabilities, effective November 30, 2006.

Our business grew and evolved rapidly from 2003 to 2007. However, we experienced a decrease in our revenue, operating income and net income during the years ended December 31, 2008 and 2009. We may continue to experience decreases in our revenue, operating income and net income and may not be able to achieve a similar growth rate in future periods as we did from 2003 to 2007 and our historical operating results therefore may not provide a meaningful basis for evaluating our business, financial performance and prospects. Moreover, our business model, technology and ability to achieve satisfactory manufacturing results at higher volumes are unproven. Therefore, you should not rely on our past results or our historical rate of growth as an indication of our future performance.

We operate and manage our business as a single segment. Since we primarily generate our revenue from customers in mainland China, we do not account for our results of operations on a geographic basis. For more details regarding our results of operations, see “—A. Operating results.” For more details regarding our corporate history, see “Item 4. Information on the company—A. History and Development of the Company.”

Revenue

We generate a substantial majority of our revenue from the sale of mobile handsets and related accessories to our distributors. Accessories mainly include components used for after-sales services. We also derive a portion of our revenue from other services, including value-added services and handset processing services.

We report handsets and accessories revenue net of value-added taxes, selling price rebates and price guarantees. Selling price rebates refer to price discounts to distributors when they achieve certain sales volumes. Price guarantees are monetary compensation for distributors when the retail prices of our products fall below certain pre-agreed levels.

		Year ended December 31,
		2007								2008								2009
						Percentage								Percentage												Percentage
(Amounts in thousands, except percentages)		Amount				of revenue				Amount				of revenue				Amount								of revenue
		(RMB)								(RMB)								(RMB)				($)
Revenues:
Handsets and accessories			3,113,756				99.1	%			2,140,346				99.4	%			1,624,270				237,957				99.5	%
Services and others			27,338				0.9	%			13,527				0.6	%			8,642				1,266				0.5	%
Total			3,141,094				100.0	%			2,153,873				100.0	%			1,632,912				239,223				100.0	%

We sold approximately 3.82 million, 2.71 million and 2.12 million handsets in 2007, 2008 and 2009, respectively. The average selling price of our handsets was RMB816 in 2007, RMB788 in 2008 and RMB735 ($108) in 2009. The decrease in average selling price in 2008 was primarily due to the sale of a large volume of ultra-low cost phones, such as the C3100, in the first half of 2008, as well as promotional sales in the fourth quarter of 2008 across the CECT-branded products in response to the economic downturn in China. The decrease in average selling price in 2009 was mainly due to aggressive pricing policy to deal with the increasing competition in the PRC mobile handset market.

Our services mainly include value-added services provided to our end customers, such as ringtone downloading and handset processing services. Our revenue from value-added services was RMB8.1 million, RMB4.2 million and RMB2.2 million ($0.3 million), respectively, in 2007, 2008 and 2009. We provided handset processing services to certain handset producers. Under this arrangement, we receive raw materials and components from third parties and process them into handsets or into handset PCB. Our revenue from handset processing services was RMB19.2 million, RMB9.3 million and RMB6.4 million ($1.0 million), respectively, in 2007, 2008 and 2009.

Cost of Goods Sold and Operating Expenses

The following table sets forth our cost of goods sold and operating expenses and these amounts as percentages of our revenue for the periods indicated.

		Year ended December 31,
		2007								2008								2009
						Percentage								Percentage												Percentage
(Amounts in thousands, except percentages)		Amount				of revenue				Amount				of revenue				Amount								of revenue
		(RMB)								(RMB)								(RMB)				($)
Cost of goods sold			2,255,844				71.8	%			1,287,096				59.8	%			1,381,595				202,405				84.6	%
Operating expenses:
Selling and distribution			36,322				1.2	%			146,551				6.8	%			109,598				16,056				6.7	%
General and administrative			69,032				2.2	%			44,231				2.1	%			73,619				10,785				4.5	%
Research and development			18,599				0.6	%			29,242				1.4	%			36,404				5,333				2.2	%
Amortization of other intangible assets			32,280				1.0	%			11,727				0.5	%			4,733				693				0.3	%
Impairment of assets held for sale			—				—				—				—				5,957				873				0.4	%
Impairment of other intangible assets			—				—				26,235				1.2	%			13,600				1,992				0.8	%
Total operating expenses			156,233				5.0	%			257,986				12.0	%			243,911				35,732				14.9	%

Cost of goods sold

We commenced the manufacturing of our products in our Huizhou facility in September 2004. In addition, we also outsource the production of our products to EMS providers. The following table sets forth the unit sales volume and revenue contribution of the products produced by us and outsourced from EMS providers, respectively, for the periods indicated.

		Year ended December 31,
		2007								2008								2009
		Sales								Sales								Sales
(Amounts in thousands, except units)		volume				Revenue				volume				Revenue				volume				Revenue
		(Unit)				(RMB)				(Unit)				(RMB)				(Unit)				(RMB)
Manufactured in Huizhou facility			549,547				416,707				714,199				389,348				207,248				69,514
Outsourced from EMS providers			3,266,751				2,697,037				1,999,756				1,748,879				1,916,222				1,490,577
Total			3,816,298				3,113,744				2,713,955				2,138,227				2,123,470				1,560,091

The largest items contributing to our cost of goods sold are the cost of raw materials and components used for the manufacturing of our products, including those produced at our Huizhou facility and through outsourcing arrangements with EMS providers. Other items contributing to our cost of goods sold are direct labor, which includes salaries and benefits for personnel directly involved in manufacturing activities, production expenses, which consist of salaries and benefits for indirect labor, depreciation charges, utilities and rental expenses, product design fees paid to third-party designers, shipping costs for products sold, processing fees for handsets outsourced from EMS providers, mold amortization expenses, and after-sales service-related expenses, including related labor costs and materials expenses.

Our cost of goods sold per unit was RMB591, RMB474 and RMB651 ($95), in 2007, 2008 and 2009, respectively. The decrease in cost of goods sold per unit in 2008 was mainly due to the sale of a large volume of ultra-low cost phones, such as the C3100, in the first half of 2008. The increase in cost of goods sold per unit in 2009 was mainly due to the increase in the sales volume of the higher-end VEVA series products, which use more expensive materials.

Operating expenses

Selling and distribution expenses

Our selling and distribution expenses primarily consist of share-based compensation, salaries, benefits and other staff-related expenses for our sales and marketing personnel, office expenses related to sales and marketing activities and advertising and other promotional expenses. Our selling and distribution expenses decreased by RMB37.0 million from RMB146.6 million in 2008 to RMB109.6 million ($16.1 million) in 2009, primarily due to lower airtime costs incurred as a result of the reduced use of TV direct sales as a channel to distribute our products in 2009.

General and administrative expenses

Our general and administrative expenses primarily consisted of share-based compensation, salaries, benefits and other expenses for our administrative personnel, expenses relating to legal, accounting and other professional services, travel and entertainment, depreciation and amortization charges and bad debt provisions.

Our general and administrative expenses in 2009 were RMB73.6 million ($10.8 million), compared to RMB44.2 million in 2008. The increase was primarily due to higher share-based compensation expenses recognized in 2009, which increased from RMB12.2 million in 2008 to RMB31.0 million ($4.5 million) in 2009. The higher share-based compensation expenses in 2009 were primarily due to the grant of restricted shares to a director and various employees in December 2009. In addition, bad debt provision also increased from RMB0.7 million in 2008 to RMB12.4 million in 2009 ($1.8 million).

Research and development expenses

Our research and development expenses primarily consist of share-based compensation, salaries, benefits and other staff-related expenses for our research and development personnel, office expenses and related cost of materials and product testing expenses.

Our research and development expenses increased by RMB7.2 million from RMB29.2 million in 2008 to RMB 36.4 million ($5.3 million) in 2009. The increase was primarily due to an increase in material and software costs, and the write-off of RMB3.2 million ($0.5 million) of costs relating to discontinued development projects in 2009.

Amortization of other intangible assets

Amortization of other intangible assets was RMB32.3 million in 2007, RMB11.7 million in 2008 and RMB4.7 million ($0.7 million) in 2009. Amortization expense decreased in 2008 and 2009 as certain intangible assets had become been fully amortized during 2007, 2008 and 2009.

Impairment of assets held for sale

In November 2009, we entered into an agreement for the sale of a property and the associated land use rights to a third party for a total consideration of RMB163,000 ($23,880). Such transaction was subsequently completed in the second quarter of 2010. As of December 31, 2009, the land and property have been reclassified from non-current assets to current assets as assets held for sale. In addition, an impairment charge of RMB5,957 ($873) was made in 2009 to write down the value of the assets to their fair value which was estimated based on the expected sales proceeds less costs to sell.

Impairment of other intangible assets

As a result of our strategic shift to focus more on our high-end VEVA-branded mobile handsets, we made an impairment charge of RMB26.2 million on our “CECT” brand in the year ended December 31, 2008 and a charge of RMB13.6 million ($2.0 million) in the year ended December 31, 2009. We did not record any impairment charge on other intangible assets during the year ended December 31, 2007.

Share-based compensation expense

We adopted our 2007 equity incentive plan on March 19, 2007 pursuant to which we may issue up to 8,000,000 ordinary shares upon exercise of awards granted under the plan. On March 19, 2007, we granted options to a director and certain employees to purchase 2,716,520 ordinary shares under this plan. These options have an exercise price of $7.50 per share, vest at different dates beginning November 1, 2007 and have terms varying from two to six years from the date of grant. In addition, on March 19, 2007, we also granted an option to a consultant who provided consulting services to us in connection with the initial public offering of our ordinary shares to purchase up to 1,200,000 ordinary shares at an exercise price of $18.00 per share. This option vested on April 1, 2007 and has a term of four years commencing from the grant date. See “Item 6. Directors, Senior Management and Employees—B. Compensation—Equity Incentive Plan.”

In 2009, the amount of share-based compensation expense relating to the options granted to our director and employees in March 19, 2007 were $1.8 million (equivalent to RMB12.1 million), of which 1.2% was charged to selling and distribution expenses, 84.7% to general and administrative expenses and 14.1% to research and development expenses. The share-based compensation relating to the option granted to our consultant, as determined using the Black-Scholes option pricing model, amounted to $1.7 million (equivalent to RMB12.9 million) on March 19, 2007, the option grant date and the date of completion of the relevant consultancy work as agreed to by our management, and was debited to our ordinary share capital as share issuance cost upon the completion of our initial public offering in May 2007.

In December 2009, we granted 1,955,057 restricted shares to a director and various employees and concurrently cancelled 1,744,800 of employee share options that were outstanding under our equity incentive plan. Among the 1,955,057 restricted shares that were granted, 960,884 shares vested immediately while the balance of 994,173 shares vest on various dates ending April 1, 2012. The grant of restricted shares and cancellation of outstanding share options resulted in a modification charge of approximately $6.4 million, which is being recognized over the vesting periods of the restricted shares. The modification charge recognized in 2009 amounted to $3.3 million (RMB22.9 million), of which 0.7% was charged to selling and distribution expenses, 90.9% to general and administrative expenses and 8.4% to research and development expenses. As of December 31, 2009, the total unrecognized stock compensation expense amounted to $7.5 million which is expected to be recognized over a remaining weighted average vesting period of 2.25 years.

Taxation

Taxation in the British Virgin Islands

We are exempt from all provisions of the Income Tax Act of the British Virgin Islands, including with respect to all dividends, interests, rents, royalties, compensation and other amounts payable by us to persons who are not persons resident in the British Virgin Islands. Capital gains realized with respect to any of our shares, debt obligations or other securities by persons who are not persons resident in the British Virgin Islands are also exempt from all provisions of the Income Tax Act of the British Virgin Islands. No estate, inheritance, succession or gift tax rate, duty, levy or other charge is payable by persons who are not persons resident in the British Virgin Islands with respect to any of our shares, debt obligations or other securities.

No stamp duty is payable in the British Virgin Islands on a transfer of shares in a British Virgin Islands business company.

PRC enterprise income tax

Our primary PRC operating subsidiary, CECT, was subject to the PRC Enterprise Income Tax Law Concerning Foreign-Invested Enterprises and Foreign Enterprises. CECT, as a foreign-invested enterprise, was generally subject to enterprise income tax at a statutory rate of 33% (30% national income tax plus 3% local income tax) through 2007 under this law and its related regulations, and 25% effective January 1, 2008 under the new tax law described below. CECT was entitled to preferential enterprise income tax rate at 15% in 2007 as a “high-tech enterprise” formed in the Zhongguancun Science Park high technology zone in Beijing. CECT ceased to be qualified as a “high-tech enterprise” from January 1, 2008 and has been subject to enterprise income tax at a rate of 25% from January 1, 2008.

On March 16, 2007, the National People’s Congress of the PRC passed the PRC Enterprise Income Tax Law, which law took effect on January 1, 2008. In accordance with the new law, a unified enterprise income tax rate of 25% and unified tax deduction standards are applied equally to both domestic-invested enterprises and foreign-invested enterprises such as CECT. In addition, under the prior laws and regulations, dividend payments to foreign investors made by foreign-invested enterprises in the PRC, such as CECT, were exempted from PRC withholding tax. Under the new PRC Enterprise Income Tax Law and the relevant implementing rules, however, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in the PRC to a foreign corporate investor who is a non-resident enterprise are subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a reduced rate of withholding tax. The British Virgin Islands, where we are incorporated, does not have such a tax treaty with the PRC. If we are considered a non-resident enterprise, the 10% withholding tax on dividend income received from CECT would reduce our net income and have an adverse effect on our operating results.

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

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of, among other things, assets, liabilities, revenue and expenses. We base our estimates on our own historical experience and on various other factors that we believe to be relevant under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our financial statements as their application places the most significant demands on our management’s judgment.

Obligations for price guarantees

We report revenue net of estimated obligations for price guarantees. Our obligations under price guarantees, which generally cover a period of between three to four months, are provided based on management’s estimates of future price reductions and the level of unsold inventories held by our customers at the dates of the expected price adjustments. These estimations are made by our management based on their judgment and experience, and any errors could result in our accruing a provision amount that does not correspond with the actual level of claims. Our provision for price guarantees is analyzed as follows:

		Year ended December 31,
(Amounts in thousands)		2007				2008				2009
		(RMB)				(RMB)				(RMB)				($)
Balance at beginning of year			—				—				—				—
Provision — reported as a reduction of revenue			2,943				91				118				17
Utilization			(2,943				(91	)			(118	)			(17	)
Balance at end of year			—				—				—				—

As of December 31, 2007, 2008 and 2009, there were no significant planned price reductions for products sold that were still covered under price guarantees and, accordingly, we had not made any provision for such obligations.

Obligations for product warranties

We guarantee that products will meet the stated functionality as agreed to in each sale arrangement. We provide for the estimated warranty costs under these guarantees based upon historical experience and our estimate of the level of future claims, and accrue for specific items at the time their existence is known and the amounts can be estimated. These various estimations are made by our management based on their judgment and experience, and any errors could result in our accruing a warranty amount that does not correspond with the actual level of warranty claims. Provisions for product warranty costs are included in cost of goods sold in our consolidated statements of operations and are analyzed as follows:

		Year ended December 31,
(Amounts in thousands)		2007				2008				2009
		(RMB)				(RMB)				(RMB)				($)
Balance at beginning of year			6,809				8,097				5,029				737
Provision			14,960				7,485				2,830				415
Utilization			(13,672				(10,553	)			(5,936	)			(870	)
Balance at end of year			8,097				5,029				1,923				282

Warranty costs as a percentage of our handsets and accessories revenue may fluctuate from year to year and does not necessarily correlate directly with the trends of our revenue growth. In any particular period, we may experience higher warranty claims due to the launch of new products and/or variations in our manufacturing processes. We typically experience a lower level of warranty claims as our products and manufacturing processes mature and a higher level of claims on new products and processes. Historically, our actual warranty claims have not been significantly different from our estimates, and our method of making warranty claims estimates and the significant assumptions used in making such estimates have been consistently applied over the past three years.

Collectibility of accounts receivable

The allowance for doubtful accounts is based on our management’s best estimate of the amount of probable credit losses in our existing accounts receivable. An analysis of the allowance for doubtful accounts for the years ended December 31, 2007, 2008 and 2009 is as follows:

		Year ended December 31,
(Amounts in thousands)		2007				2008				2009
		(RMB)				(RMB)				(RMB)				($)
Balance at beginning of year			2,045				5,429				6,043				885
Bad debt expense			3,384				1,277				12,938				1,896
Bad debt recovery			—				(595	)			(540	)			(79	)
Bad debt write-off			—				(68	)			—				—
Balance at end of year			5,429				6,043				18,441				2,702