UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: September 30, 2006
COMMISSION FILE NUMBER: 001-31954
CITY NETWORK, INC.
(Name of Small Business Issuer as Specified in its Charter)
Nevada 88-0467944
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2F-1, No. 16, Jian Ba Road, Chung Ho City
Taipei County 235, Taiwan, ROC
(Address of Principal Executive Offices)
011-886-2-8226-5566
(Telephone Number)
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
As of November 28, 2006, there were 34,967,183 shares of common stock, par value
$0.001 per share, outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X].
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION.............................................. 3
Item 1. Financial Statements........................................... 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 27
Item 3. Controls and Procedures........................................ 31
PART II - OTHER INFORMATION................................................. 32
Item 1. Legal Proceedings.............................................. 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.... 32
Item 3. Defaults Upon Senior Securities................................ 32
Item 4. Submission of Matters to a Vote of Security Holders............ 33
Item 5. Other Information.............................................. 33
Item 6. Exhibits....................................................... 33
SIGNATURES ................................................................. 34
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CITY NETWORK INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2006 December 31, 2005
------------------ -----------------
(Unaudited) (As Adjusted)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 41,429 $ 853,964
Accounts receivable, net 851,702 4,341,218
Inventories 645,282 252,608
Other receivables 1,243,939 234,176
Prepayment 1,105,685 3,451,482
Short-term assets - discountinued operation -- 530,073
----------- -----------
TOTAL CURRENT ASSETS 3,888,037 9,663,521
----------- -----------
PROPERTY, PLANT AND EQUIPMENT 4,085,259 2,243,214
----------- -----------
OTHER ASSETS:
Deposits 123,388 180,915
Cash held for compensating balances -- 1,380,992
Intangible assets 865,679 925,074
Deferred assets 334,585 148,208
Equity in net assets of affilaiated company 728,769 790,842
Other assets - discountinued operation -- 322,664
----------- -----------
TOTAL OTHER ASSETS 2,052,421 3,748,695
----------- -----------
TOTAL ASSETS $10,025,717 $15,655,430
=========== ===========
3
CITY NETWORK INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2006 December 31, 2005
------------------ -----------------
(Unaudited) (As Adjusted)
LIABILITIIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 1,269,906 $ 1,342,037
Convertible note payable, net -- 250,000
Due to related party 1,199,083 1,131,494
Deferred revenue 8,083 3,027,079
Current portion, long-term debt 2,007,499 4,220,230
Short-term liabilities - discountinued operation -- 301,165
------------ ------------
TOTAL CURRENT LIABILITIES 4,484,571 10,272,005
------------ ------------
NON-CURRENT LIABILITIES:
Convertible note payable, net 545,000 --
Long-term debt, net of current portion 3,532,466 572,668
------------ ------------
TOTAL NON-CURRENT LIABILITIES 4,077,466 572,668
TOTAL LIABILITIES 8,562,037 10,844,673
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value, 100,000,000 shares
authorized, 32,967,183 shares issued outstanding
at June 30, 2006 and December 31, 2005 32,967 32,967
Additional paid in capital 6,282,979 6,157,479
Other comprehensive income 435,265 366,384
Accumulated deficit (5,287,531) (1,746,073)
------------ ------------
TOTAL CAPITAL AND RETAINED DEFICIT 1,463,680 4,810,757
Less: cost of treasury stock -- --
------------ ------------
Total Stockholders' Equity 1,463,680 4,810,757
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,025,717 $ 15,655,430
============ ============
4
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- -------------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
(As Adjusted) (As Adjusted)
Sales, net $ 3,916,705 $ 3,784,392 $ 7,095,525 $ 8,677,108
Cost of sales 4,369,434 3,427,726 7,222,052 8,060,736
------------ ------------ ------------ ------------
Gross Profit (452,729) 356,666 (126,527) 616,372
General and administrative expenses 1,046,465 483,047 1,892,877 1,131,776
------------ ------------ ------------ ------------
Income (loss) from operations (1,499,194) (126,381) (2,019,404) (515,404)
------------ ------------ ------------ ------------
Other (Income) Expense
Interest income (19,133) (3,543) (20,317) (5,598)
Rental income 340 (46,575) (61,720) (142,155)
Commission income 544 303 (98,752) (35,488)
(Gain) Loss on currency exchange (68) (1,346) 12,400 11,889
Other income (1,601) (31,938) (117,612) (88,177)
Reserve for bad debt 1,220,630 (5,900) 1,258,171 690,254
Equity in earnings of investee 110,033 15,870 62,072 25,993
Loss on physical inventory (234) -- 42,660 --
Miscellaneous 204,905 (3,704) 210,197 8,953
(Gain) Loss on sale of fixed assets 5 (679) (719) 79301
Interest expense 49,338 22,934 171,296 104,230
------------ ------------ ------------ ------------
Total other (income) expense 1,564,759 (54,578) 1,457,676 649,202
------------ ------------ ------------ ------------
Income (Loss) before income taxes (3,063,953) (71,803) (3,477,080) (1,164,606)
Provision for income taxes -- 161 -- 339
------------ ------------ ------------ ------------
Loss from continuing operation (3,063,953) (71,964) (3,477,080) (1,164,945)
------------ ------------ ------------ ------------
Income (Loss) from discontinued operation 10,983 (25,313) 31,275 (75,938)
Loss on disposal of discontinued operation (95,653) -- (95,653) --
------------ ------------ ------------ ------------
Net loss $ (3,148,623) $ (97,277) $ (3,541,458) $ (1,240,883)
============ ============ ============ ============
Income (Loss) per share - basic and diluted $ (0.11) $ -- $ (0.12) $ (0.04)
============ ============ ============ ============
Continuing operationgs - basic and diluted $ (0.11) $ -- $ (0.12) $ (0.04)
============ ============ ============ ============
Discontinued operation - basic and diluted $ -- $ -- $ -- $ --
============ ============ ============ ============
Weighted average number of shares
Basic 28,521,728 27,925,720 28,521,728 27,925,720
Diluted 28,521,728 27,925,720 28,521,728 27,925,720
5
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
---------------------------------
2006 2005
----------- -----------
(As Ajusted)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $(3,541,458) $(1,316,821)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 143,084 134,330
Equity in earnings of investee 62,072 25,993
Bad debt 1,258,171 --
(Gain) Losses on disposal of fixed assets (720) 79,301
Loss on physical inventory 42,660 --
Loss (Gain) on foreign currency exchange -- 11,889
(Income) Loss from discontinued operation (31,275) 75,938
Loss on disposal of discontinued operation 95,653 --
Decrease (Increase) in receivables 2,273,493 196,964
Decrease (Increase) in other receivables (995,120) (127,674)
Decrease (Increase) in inventory (445,297) (163,945)
Decrease (Increase) in construction in progress -- (234,760)
Decrease (Increase) in prepayment and other current assets 1,937,705 (1,685,953)
Increase (Decrease) in accounts payable and accrued expenses 419,506 (1,944,445)
(Decrease) Increase in deferred revenue -- 2,879,030
(Decrease) Increase in other liabilities (3,102,747) (109,090)
Cash provided by (used in) operating activities - discontinued operation 525,788 333,789
----------- -----------
Total Adjustments 2,182,973 (528,633)
----------- -----------
Net cash provided by (used in) operating activities (1,358,485) (1,845,454)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from disposal of investment 200,000 --
Proceeds from disposal of property, plant and equipment 42,608 397,222
Purchase on investment -- --
Purchases of property, plant and equipment (1,688,671) (193,310)
Decrease (Increase) in deposit 57,452 23,443
Increase in short-term investments -- --
Payment on deferred assets (150,253) --
Decrease in other assets 1,400,047 --
Cash used in operating activities - discontinued operation (327,116) (1,434,988)
----------- -----------
Net cash provided by (used in) investing activities (465,933) (1,207,633)
----------- -----------
6
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
---------------------------------
2006 2005
----------- -----------
(As Adjusted)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings $ 3,871,909 $ 6,545,154
Payment on notes payable (6,101,032) (5,773,762)
Payment of loan from related party -- (6,293)
Loan from related party 406,920 710,815
Proceeds from long-term debts 3,025,514 125,000
----------- -----------
Net cash provided by (used in) financing activities 1,203,311 1,600,914
----------- -----------
Effect of exchange rate change on cash (194,011) 268,055
Net change in cash and cash equivalents (815,158) (1,184,118)
----------- -----------
Cash and cash equivalents at beginning of year 853,964 2,007,970
Cash and cash equivalents at beginning of year - discontinued operation 2,623 2,674
----------- -----------
Cash and cash equivalents at end of year $ 41,429 $ 826,526
=========== ===========
Components of cash and cash equivalents, end of period
From discontinued operation $ -- $ 1,093
From continuing operations 41,429 825,433
Supplemental cash flows disclosures:
Income tax payments $ -- $ 178
=========== ===========
Interest payments $ 146,506 $ 99,859
=========== ===========
7
CITY NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
September 30, 2006 December 31, 2005
------------------ -----------------
(Unaudited) (As Adjusted)
Common stock, number of shares
Balance at beginning of period 32,967,183 27,500,000
Common stock issued -- 5,467,183
------------ ------------
Balance at end of period 32,967,183 32,967,183
------------ ------------
Treasury stock, number of shares
Balance at beginning of period 4,445,455 --
Treasury stock acquired -- 4,445,455
------------ ------------
Balance at end of period 4,445,455 4,445,455
------------ ------------
Common stock, par value $.001
Balance at beginning of period $ 32,967 $ 27,500
Common stock issued -- 5,467
------------ ------------
Balance at end of period 32,967 32,967
------------ ------------
Additional paid in capital
Balance at beginning of period 6,157,479 5,937,946
Issuance of stock -- 219,533
Deemed interest due to warrants issued related to convertible notes 125,500 --
------------ ------------
Balance at end of period 6,282,979 6,157,479
------------ ------------
Other comprehensive income
Balance at beginning of period 366,384 142,453
Foreign currency translation 68,881 223,931
------------ ------------
Balance at end of period 435,265 366,384
------------ ------------
Retained earnings (deficits)
Balance at beginning of period (1,746,073) (712,383)
Net income (loss) (3,541,458) (1,033,690)
------------ ------------
Balance at end of period (5,287,531) (1,746,073)
------------ ------------
Less: Cost of treasury stock 0 0
------------ ------------
Total stockholders' equity at end of period $ 1,463,680 $ 4,810,757
============ ============
8
CITY NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE A - ORGANIZATION
City Network, Inc., formerly Investment Agents, Inc., was incorporated on
August 8, 1996 under the laws of the State of Nevada. City Network
Technology, Inc., formerly Gelcrest Investments Limited, was incorporated
under the laws of the British Virgin Islands on March 1, 2002. City
Network, Inc. -Taiwan, formerly City Engineering, Inc., was incorporated
under the laws of Republic of China on September 6, 1994. City Network,
Inc. owns 100% of the capital stock of City Network Technology, Inc., and
City Network Technology, Inc. owns 100% of the capital stock of City
Network, Inc. - Taiwan. Collectively the three corporations are referred to
herein as the "Company".
The Company designs, manufactures and markets a comprehensive line of
broadband communication and wireless Internet access products and
solutions. Also, the broadband communication product line includes VOIP,
GUI-based remote management and routing technology software packages for
simplified setup, extensive network management and global network
connectivity capabilities, home PNA and xDSL broadband access equipment,
ADSL/VDSL ACCESS DEVICES, HPNA ACCESS DEVICES, FTTB (Fiber to the Building)
and FTTH (Fiber to the Home), PCMCIA cards and USB adapters. The other
wireless Internet access solutions are used in both individual and
corporate.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying financial statements have been prepared by City Network,
Inc., pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC") Form 10-QSB and Item 310 of Regulation S-B and
generally accepted accounting principles for interim financial reporting.
These financial statements are unaudited and, in the opinion of management,
include all adjustments (consisting of normal recurring adjustments and
accruals) necessary for a fair presentation of the statement of financial
position, operations, and cash flows for the periods presented. Operating
results for the nine months ended September 30, 2006 and 2005 are not
necessarily indicative of the results that may be expected for the year
ended December 31, 2006, or any future period, due to seasonal and other
factors. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting policies have been omitted in accordance with the rules and
regulations of the SEC. These financial statements should be read in
conjunction with the audited consolidated financial statements and
accompanying notes, included in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 2005.
9
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
DISCONTINUED OPERATION
On August 31, 2006, the Company sold its 100% interest in City
Construction, Inc by entered into an agreement with two individuals (the
Buyer). The Company sold its 100% interest in City Construction to the
buyer for $200,000. The assets sold consisted primarily of cash, trade
accounts receivable, short-term investments, construction-in-progress, and
other current assets. The buyer also assumed all the outstanding debts of
City Construction. The control of City Construction has been officially
taken over by the Buyer based on the fact that the full amount of
consideration of $200,000 has been received by the Company, the application
of changing ownership signed by both parties has been filed with a relevant
government agency, and the share certificate of City Construction has been
surrendered to the Buyer.
Under the provisions of SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (FAS 144), the financial results of City
Construction are classified as discontinued operations in the accompanying
Consolidated Statements of Earnings for all periods presented.
Operating results of the discontinued operations which excluded loss on
disposal were as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2006 2005 2006 2005
---------- --------- ---------- ----------
Net sales $ 269,408 $ -- $1,042,642 $ --
Total revenues 269,408 -- 1,042,642 --
Pretax income 10,983 (25,313) 31,275 (75,938)
As of December 31, 2005, assets and liabilities of the Company's
discontinued operations were classified as held for sales in the
accompanying Consolidated Balance Sheet under the following captions:
Short-term assets- discontinued operation, Long-term assets- discontinued
operation, short-term liabilities- discontinued operation, and Long-term
liabilities- discontinued operation. The discontinued assets and
liabilities at December 31, 2005 were composed of as follows:
10
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
DISCONTINUED OPERATION (Continued)
December 31,
2005
--------
Short-term assets -- discontinued operation
Cash $ 2,623
Trade receivables 29,892
Other receivables 7,128
Construction in progress 441,891
Prepayment 48,539
--------
Total 530,073
Other assets -- discontinued operation
Deposits 322,664
--------
Total assets -- discontinued operation $852,737
========
Short-term liabilities -- discontinued operation
Accounts payable and accrued expense $129,830
Deferred revenue 171,335
--------
Total liabilities $301,165
========
The Company assessed the loss on disposal of discontinued operation as
follows:
Carrying value of investment in City Construction
at August 30, 2006 $295,653
Proceeds expected to receive 200,000
--------
Disposal expense 0
--------
Loss on disposal of discontinued operation $ 95,653
========
11
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
REVENUE RECOGNITION
Revenue from sales of products to customers is recognized upon shipment or
when title passes to customers based on the terms of the sales, and is
recorded net of returns, discounts and allowances. Service income is
recognized as the related services are provided pursuant to the terms of
the service agreement.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of City Network,
Inc., and its wholly owned subsidiaries City Network Technology, Inc. and
its wholly owned subsidiaries, City Network, Inc. - Taiwan, collectively
referred to within as the Company. All material intercompany accounts,
transactions and profits have been eliminated in consolidation.
FINANCIAL STATEMENT PRESENTATION
Certain changes to the 2005 financial statements have been made to conform
to the 2006 financial statement format.
RISKS AND UNCERTAINTIES
The Company is subject to substantial risks from, among other things,
intense competition from the providers of broadband products, services and
the telecommunication industry in general, other risks associated with
financing, liquidity requirements, rapidly changing customer requirements,
limited operating history, and the volatility of public markets.
CONTINGENCIES
Certain conditions may exist as of the date the financial statements are
issued, which may result in a loss to the Company but which will only be
resolved when one or more future events occur or fail to occur. The
Company's management and legal counsel assess such contingent liabilities,
and such assessment inherently involves an exercise of judgment. In
assessing loss contingencies related to legal proceedings that are pending
against the Company or unasserted claims that may result in such
proceedings, the Company's legal counsel evaluates the perceived merits of
any legal proceedings or unasserted claims as well as the perceived merits
of the amount of relief sought or expected to be sought.
If the assessment of a contingency indicates that it is probable that a
material loss has been incurred and the amount of the liability can be
estimated, then the estimated liability would be accrued in the Company's
financial statements. If the assessment indicates that a potential material
loss contingency is not probable but is reasonably possible, or is probable
but cannot be estimated, then the nature of the contingent liability,
together with an estimate of the range of possible loss if determinable and
material would be disclosed.
Loss contingencies considered to be remote by management are generally not
disclosed unless they involve guarantees, in which case the guarantee would
be disclosed.
12
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates. Significant estimates include collectibility of accounts
receivable, accounts payable, sales returns and recoverability of long-term
assets.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company has made an allowance for doubtful accounts for trade
receivables based on a combination of write-off history, aging analysis,
and any specific known troubled accounts.
FIXED ASSETS
Property and equipment are stated at cost less accumulated depreciation.
Expenditures for major additions and improvements are capitalized and minor
replacements, maintenance and repairs are charged to expense as incurred.
Depreciation is provided on the straight-line method over the estimated
useful lives of the assets, or the remaining term of the lease, as follows:
Furniture and Fixtures 5 years
Equipment 5 years
Computer Hardware and Software 3 years
Building and Improvements 50 years
INTANGIBLE ASSETS
Effective July 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." The
adoption of SFAS No. 142 required an initial impairment assessment
involving a comparison of the fair value of trademarks, patents and other
intangible assets to current carrying value. No impairment loss was
recognized for the nine months period ended September 30, 2006. Trademarks
and other intangible assets determined to have indefinite useful lives are
not amortized. The Company tests such trademarks and other intangible
assets with indefinite useful lives for impairment annually, or more
frequently if events or circumstances indicate that an asset might be
impaired. Trademarks and other intangible assets determined to have
definite lives are amortized over their useful lives or the life of the
trademark and other intangible asset, whichever is less.
EXCHANGE GAIN (LOSS)
As of September 30, 2006 and 2005, the transactions of City Network, Inc. -
Taiwan and City Construction were denominated in a foreign currency and are
recorded in New Taiwan Dollars ("NTD"), at the rates of exchange in effect
when the transactions occur. Exchange gains and losses are recognized for
the different foreign exchange rates applied when the foreign currency
assets and liabilities are settled.
13
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
TRANSLATION ADJUSTMENT
The accounts of City Network, Inc.- Taiwan was maintained, and its
financial statements were expressed, in New Taiwan Dollars (NTD). Such
financial statements were translated into U.S. Dollars (USD) in accordance
SFAS No. 52, "Foreign Currency Translation", with the NTD as the functional
currency. According to the Statement, all assets and liabilities were
translated at the current exchange rate, stockholder's equity are
translated at the historical rates and income statement items are
translated at the weighted average exchange rate for the period. The
resulting translation adjustments are reported under other comprehensive
income in accordance with SFAS No. 130, "Reporting Comprehensive Income" as
a component of shareholders' equity.
As of September 30, 2006 and December 31, 2005 the exchange rates between
NTD and the USD were NTD$1=USD$0.03023 and NTD$1=USD$0.03044, respectively.
The weighted-average rates of exchange between NTD and USD were
NTD$1=USD$0.03086 and NTD$1=USD$0.03117 for the period (year) ended
September 30, 2006 and December 31, 2005, respectively. Total translation
adjustment recognized as of September 30, 2006 and December 31, 2005 is
$435,265 and $366,384, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Our Company measures its financial assets and liabilities in accordance
with generally accepted accounting principles. For certain of the Company's
financial instruments, including accounts receivable (trade and related
party), notes receivable and accounts payable (trade and related party),
and accrued expenses, the carrying amounts approximate fair value due to
their short maturities. The amounts owed for long-term debt and revolving
credit facility also approximate fair value because interest rates and
terms offered to the Company are at current market rates.
STATEMENT OF CASH FLOWS
In accordance with SFAS No. 95, "Statement of Cash Flows", cash flows from
the Company's operations are based upon the local currencies. As a result,
amounts related to assets and liabilities reported on the statement of cash
flows will not necessarily agree with changes in the corresponding balances
on the balance sheet.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk are accounts receivable and other receivables
arising from its normal business activities. The Company has a diversified
customer base. The Company controls credit risk related to accounts
receivable through credit approvals, credit limits and monitoring
procedures. The Company routinely assesses the financial strength of its
customers and, based upon factors surrounding the credit risk, establishes
an allowance, if required, for un-collectible accounts and, as a
consequence, believes that its accounts receivable credit risk exposure
beyond such allowance is limited.
INVENTORY
Inventory is valued at the lower of cost or market. Cost is determined on
the weighted average method. As of September 30, 2006, inventory consisted
only of finished goods.
14
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
PRODUCT WARRANTIES
The Company estimates its warranty costs based on historical warranty claim
experience and applies this estimate to the revenue stream for products
under warranty. Future costs for warranties applicable to revenue
recognized in the current period are charged to cost of revenue. The
warranty accrual is reviewed quarterly to verify that it properly reflects
the remaining obligation based on anticipated expenditures over the balance
of the obligation period. Adjustments are made when accrual warranty claim
experience differs from estimate.
LONG-TERM EQUITY INVESTMENTS
Long-term equity investments are accounted for by the equity method when
the Company and its subsidiaries owns 20% or more of the investee's voting
shares, or less than 20% of investee's voting shares but is able to
exercise significant influence over the investee's operation and financial
polices, but not more then 50%. All other long-term equity investments are
accounted for by either the lower-of-cost-or-market method or cost method.
For long-term equity investments accounted for under the equity method
related to investee's that are publicly listed companies, unrealized losses
resulting from declines in the market value below cost are recorded as a
separate component of stockholders' equity.
For long-term equity investments in non-listed companies accounted for
under the cost method, investments are stated at original cost. A
write-down of the investment balance to earnings is taken only if it is
determined that there is a permanent decline in the investment's value.
Stock dividends do not result in the recognition of investment income.
For long-term equity investments accounted for by the equity method, the
investment is initially recorded at cost, then reduced by dividends and
increased or decreased by investor's proportionate share of the investee's
net earnings or loss.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with initial
maturities of three months or less to be cash equivalents.
ADVERTISING
Advertising costs are expensed in the year incurred.
15
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for
the current year and deferred taxes on temporary differences between the
amount of taxable income and pretax financial income and between the tax
bases of assets and liabilities and their reported amounts in the financial
statements.
Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period
in which the deferred tax assets and liabilities are expected to be
realized or settled as prescribed in SFAS No. 109, "Accounting for Income
Taxes". As changes in tax laws or rates are enacted, deferred tax assets
and liabilities are adjusted through the provision for income taxes.
DEFERRED OFFERING COSTS AND DISCOUNT TO CONVERTIBLE NOTES
The Company accounts for offering cost incurred in the private placements
as deferred expense and amortizes it over the economic life of these
convertible notes. In accordance with APB No. 14, the Company accounts for
the fair value of warrants and beneficial conversion feature resulting from
issuing convertible notes as discount to these convertible notes and
amortizes the discount over the economic life of these convertible notes.
EARNINGS PER SHARE
The Company uses SFAS No. 128, "Earnings Per Share", for calculating the
basic and diluted earnings (loss) per share. Basic earnings (loss) per
share are computed by dividing net income (loss) attributable to common
stockholders by the weighted average number of common shares outstanding.
Diluted earnings per share are computed similar to basic earnings per share
except that the denominator is increased to include common stock
equivalents, if any, as if the potential common shares had been issued.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
On January 1, 2002, the Company adopted SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets". The Company evaluates
long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If the estimated future cash flows (undiscounted and without
interest charges) from the use of an asset were less than the carrying
value, a write-down would be recorded to reduce the related asset to its
estimated fair value. There have been no such impairments to date.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation No. 48, Accounting for
Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with FASB Statement No. 109, Accounting for Income
Taxes. FIN 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. This Interpretation also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. This
16
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
NEW ACCOUNTING PRONOUNCEMENTS (Continued)
Interpretation is effective for fiscal years beginning after December 15,
2006, with earlier adoption permitted. The company is currently evaluating
the provisions of FIN 48.
In September 2006, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 157, Fair Value Measurement, which provides guidance
for applying the definition of fair value to various accounting
pronouncements. SFAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007. The Company is currently
evaluating the provisions of SFAS 157.
In September 2006, the FASB also issued SFAS No. 158, Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans. SFAS 158 amends
SFAS 87, 88, 106, and 132R, and requires employers to recognize the
overfunded or underfunded status of defined benefit postretirement plans as
an asset or liability in its statement of financial position. SFAS No. 158
is effective as of the end of fiscal years ending after December 15, 2006.
SFAS 158 is not applicable to the Company, as it does not have a defined
benefit pension plan.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin 108 ("SAB 108"), Considering the Effect of Prior Year
Misstatements when Quantifying Misstatements in the Current Year Financial
Statements, that addresses how uncorrected errors in previous years should
be considered when quantifying errors in the current year financial
statements. SAB 108 is effective for fiscal years ending November 15, 2006
and, upon adoption, companies are allowed to record the effects as a
cumulative-effect adjustment to retained earnings. The Company will adopt
SAB 108 for its fiscal year ending December 31, 2006 and is assessing what
impact, if any, the adoption of SAB 108 will have on its financial position
and results of operations.
NOTE C - CONCENTRATION
The Company had two major customers during the nine months ended September
30, 2006. Sales to these customers were approximately $4,729,821. Those
customers comprise 67% of the total sales during the nine months ended
September 30, 2006. Included in accounts receivable is approximately
$1,510,549 from these customers as of September 30, 2006.
NOTE D - CASH
The Company maintains its cash balances at various banks in Taiwan. The
balances are insured by the Central Deposit Insurance Corporation (CDIC) up
to approximately $30,230. As of September 30, 2006, there was $0 in
uninsured balances held at these banks.
17
NOTE E - FIXED ASSETS
Fixed assets consist of the following:
September 30, 2006 December 31, 2005
------------------ -----------------
Land $ 3,258,939 $ 1,909,023
Building and improvements 584,180 --
Other equipment 481,374 525,077
----------- -----------
$ 4,324,493 $ 2,434,100
Accumulated depreciation (239,234) (190,886)
----------- -----------
$ 4,085,259 $ 2,243,214
=========== ===========
NOTE F - INTANGIBLE ASSETS
Intangible assets consist of the following:
September 30, 2006 December 31, 2005
------------------ -----------------
Trademarks $ 2,207 $ 2,222
Intangible asset 1,058,050 1,065,400
----------- -----------
$ 1,055,843 $ 1,067,622
Accumulated amortization (190,164) (142,548)
----------- -----------
$ 865,679 $ 925,074
=========== ===========
NOTE G - COMMITMENTS
Operating Leases - The Company leases office facilities under operating
leases that terminate on various dates. Rental expense for these leases
consisted of $24,815 for the nine months ended September 30, 2006. The
Company has future minimum lease obligations as follows:
Twelve-month ended
September 30, Amount
------------- ------
2007 $27,207
-------
Total $27,207
=======
18
NOTE H - LONG-TERM INVESTMENT
On August 31, 2003 the Company purchased approximately twenty-five percent
(25%) of Beijing Putain Hexin Network Technology Co., Ltd for $325,000. On
December 4, 2003 the Company purchased an additional fifteen percent (15%)
for $398,500. Beijing Putain Hexin Network Technology Co., Ltd is not
publicly traded or listed. The Company is using the complete equity method
to record its share of the subsidiary's net income and loss. As of
September 30, 2006, the Company recognized a loss of $62,072 from their
acquisition.
NOTE I - COMPENSATED ABSENCES
Employees earn annual vacation leave at the rate of seven (7) days per year
for the first three years. Upon completion of the third year of employment,
employees earn annual vacation leave at the rate of ten (10) days per year
for years four through five. Upon completion of the fifth year of
employment, employees earn annual vacation leave at the rate of fourteen
(14) days per year for years six through ten. Upon completion of the tenth
year of employment, one (1) additional day for each additional year, until
it reaches thirty (30) days per year. At termination, employees are paid
for any accumulated annual vacation leave. As of September 30, 2006
vacation liability existed in the amount of $0.
NOTE J - INCOME TAXES
Total Federal and State income tax expense for the nine months ended
September 30, 2006 and 2005 were both amounted to $0. For the nine months
ended September 30, 2006 and 2005, there is no difference between the
federal statutory tax rate and the effective tax rate.
The following is a reconciliation of income tax expense:
09/30/06 U.S. State International Total
-------- ---- ----- ------------- -----
Current $ 0 $ 0 $ 0 $ 0
Deferred 0 0 0 0
------ ------ ------ ------
Total $ 0 $ 0 $ 0 $ 0
====== ====== ====== ======
09/30/05 U.S. State International Total
-------- ---- ----- ------------- -----
Current $ 0 $ 0 $ 178 $ 178
Deferred 0 0 0 0
------ ------ ------ ------
Total $ 0 $ 0 $ 178 $ 178
====== ====== ====== ======
19
NOTE J - INCOME TAXES (Continued)
Reconciliation of the differences between the statutory U.S. Federal income
tax rate and the effective rate is as follows:
09/30/06 09/30/05
-------- --------
Federal statutory tax rate 34% 34%
State, net of federal benefit 0% 0%
------ ------
Effective tax rate 34% 34%
====== ======
NOTE K - OTHER COMPREHENSIVE INCOME
Balances of related after-tax components comprising accumulated other
comprehensive income (loss), included in stockholders' equity, at September
30, 2006 and December 31, 2005 are as follows:
Foreign Currency Accumulated Other
Translation Adjustment Comprehensive Income
---------------------- --------------------
Balance at December 31, 2004 $142,453 $142,453
Change for 2005 $223,931 $223,931
-------- --------
Balance at December 31, 2005 $366,384 $366,384
Change for 2006 $ 68,881 $ 68,881
-------- --------
Balance at September 30, 2006 $435,265 $435,265
======== ========
NOTE L - CONVERTIBLE NOTES
On June 30, 2006, the Company sold a $400,000 convertible promissory note
to Cornell Capital Partners, LP. The notes bears interest at 7% per annum
and will mature two years after issuance. A 20% redemption premium on the
principal amount of the Notes is due when they are redeemed, if the closing
bid price of the common stock is less than the Fixed Conversion Price. The
notes are convertible into Common Stock based on at the lower of (a)$0.268
per share or (b) ninety-five percent (95%) of the lowest volume weighted
average price of the Common Stock, as reported by Bloomberg, LP, for the
thirty (30) trading days preceding the conversion. The Company bears
$247,550 of selling expenses. For the nine months ended September 30, 2006,
the amortization of deferred offering cost was $30,944.
In connection with this transaction, the Company issued to Cornell Capital
Partners, LP a five-year warrant to purchase 1,000,000 shares of Common
Stock at an exercises price of $0.001 per share. The Company estimated the
fair value of the warrants attached to the promissory note at $120,000 by
using Black-Scholes option pricing model. In accordance with EITF 00-27,
the Company allocated the fair value of $120,000 to the warrants issued and
the fair value of $280,000 to the convertible notes in accordance with
relative fair value method. Based on the fair value of $280,000, the
Company recognized the beneficial conversion feature of $0 in accordance
20
NOTE L - CONVERTIBLE NOTES (Continued)
with the market price of the Company's common stock on each issuing date.
Consequently, the convertible note of $400,000 had a total discount of
$120,000. As of September 30, 2006, $15,000 of the discount related to
warrant and $0 of discount related to beneficial conversion feature have
been amortized.
On June 30, 2006, the Company amended and reissued the convertible notes
(Original Notes) originally issued to Highgate House Funds, Ltd on August
17, 2005 and December 16, 2005 in the aggregrate principal amount of
$250,000. Each note bears interest at 7% per annum and will mature two
years after issuance.
The above notes are secured by substantially all of the assets of the
Company and its direct and indirect wholly-owned subsidiaries, City
Technology, Inc., City Network, Inc.--Taiwan and City Construction Co.,
Ltd. The Company is currently in default of this security agreement (see
Note M).
NOTE M - CONVERTIBLE NOTES SECURITY AGREEMENT DEFAULT
On June 30, 2006, the Company sold a $400,000 convertible promissory note
to Cornell Capital Partners, LP, and amended and reissued the convertible
notes originally issued to Highgate House Funds, Ltd on August 17, 2005 and
December 16, 2005 in the aggregate principal amount of $250,000 (Note L).
These notes are secured by substantially all of the assets of the Company
and its direct and indirect wholly-owned subsidiaries, City Technology,
Inc., City Network, Inc.--Taiwan and City Construction Co., Ltd. However,
on August 31, 2006, the Company sold its 100% interest in City
Construction, Inc. without consent of the note holders. Based on the
security agreement in connection with the above convertible notes, the note
holders are entitled to receive all distribution with respect to the
pledged property. As of September 30, 2006, and the date of this report, no
such demand has been made.
NOTE N - SHARE-BASED PAYMENTS
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS No. 123R. The Company recognized the share-based
compensation cost based on the grant-date fair value estimated in
accordance with the new provisions of SFAS No. 123R. As of September 30,
2006, the Company had outstanding warrants totaling 1,025,000 with an
exercise price of $0.001 per share.
The fair value for the share-based awards was estimated using the
Black-Scholes option pricing model with the assumptions listed below:
September 30,
-----------------------
2006 2005
---- ----
Expected volatility 47.66 - 81.79% --%
Weighted average volatility 47.66 - 81.79% --%
Expected life (years) 3.0 - 5.0 --
Risk free interest rate 3.55 - 4.69% --%
21
NOTE N - SHARE-BASED PAYMENTS (Continued)
A summary of stock warrants for the nine months ended September 30, 2006 is
presented as follows:
Weighted-
Weighted- Average
Average Remaining Aggregrate
Exercise Contractual Intrinsic
Stock Warrants Shares Price Term (Months) (Values)
-------------- ------ ----- ------------- --------
Outstanding at January 1, 2006 25,000 $ 0.001 19.33
Granted 1,000,000 0.001 60.00
Exercised --
Forfeited or expired --
--------- ------- ------ --------
Outstanding at September 30, 2006 1,025,000 0.001 56.00 $121,975
========= ======= ====== ========
Exercisable at September 30, 2006 1,025,000 $ 0.001 56.00 $121,975
========= ======= ====== ========
NOTE O - DEBT
At September 30, 2006 and December 31, 2005, the Company had notes payable
outstanding in the aggregate amount of $5,539,965 and $ $4,792,898,
respectively. The notes are secured by the Company real properties and time
deposits. Payable as follows:
September 30, 2006 December 31, 2005
------------------ -----------------
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 4.022% per annum, due on interest at 3.838% per annum, due
demand. $ 2,007,499 by October 8, 2006 $ 487,040
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 3.30% per annum, due by interest at 3.838% per annum, due
April 4, 2021 1,541,730 by August 31, 2006 913,200
Note payable to a bank in Taiwan, Note payable to a bank in Taiwan,
interest at 4.200% per annum, due by interest at 5.906% per annum, due
January 24, 2012 1,512,709 by September 28, 2006 232,483
Note payable to a corporation in Note payable to a bank in Taiwan,
Taiwan, no interest, due by February interest at 3.838% per annum, due
10, 2010 478,027 by January 27, 2006 45,660
22
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by February 3, 2006 96,206
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by February 3, 2006 123,693
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by February 17, 2006 233,802
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by February 21, 2006 219,739
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by February 25, 2006 24,352
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by March 3, 2006 69,950
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by March 24, 2006 295,919
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by April 1, 2006 279,553
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by April 21, 2006 435,872
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by April 28, 2006 422,811
Note payable to a bank in Taiwan,
interest at 3.838% per annum, due
by January 17, 2006 339,950
Note payable to a corporation in
Taiwan, no interest, due by
February 10, 2010 572,668
------------- -----------
Total $ 5,539,965 $ 4,792,898
Current portion $ 2,007,499 $ 4,220,230
------------- -----------
Long-term portion $ 3,532,466 $ 572,668
============= ===========
23
NOTE P - RELATED PARTY TRANSACTIONS
Throughout the history of the Company, certain members of the Board of
Directors and general management have made loans to the Company to cover
operating expenses or operating deficiencies:
Alice Chen - As of September 30, 2006, the Company has a non
interest-bearing loan from Alice Chen, a shareholder of the Company, in the
amount of $232,769.
Stella Tseng - As of September 30, 2006, the Company has a non
interest-bearing loan from Stella Tseng, a shareholder of the Company, in
the amount of $966,314.
NOTE Q - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable,
deposits and accounts payable approximate their fair value because of the
short maturity of those instruments.
The carrying amounts of the Company's long-term debt approximate their fair
value because of the short maturity and/or interest rates which are
comparable to those currently available to the Company on obligations with
similar terms.
NOTE R - LEGAL PROCEEDINGS
The Company is party to certain litigation that has arisen in the normal
course of its business and that of its subsidiary.
Hwa-Ching - In August 2004, a customer closed business and did not pay the
remaining balance due to City Network - Taiwan on outstanding receivables
in the amount of NT$27,313,003 or US$837,690. City Network - Taiwan has
filed criminal and civil litigation against the customer for fraud. The
Company has recorded a reserve against this account in the amount of
$660,538. This case is currently ongoing.
In August 2004, City Network Inc.-Taiwan filed a lawsuit against the owner
of Hwa-Ching Co., as well as the following eight individuals in Taiwan,
alleging fraud for closing down Hwa-Ching Co. without payment for the
delivered merchandise. City Network Inc.-Taiwan sought approximately NT$27
million or approximately US$830,000. In January 27 2006, the court reached
a verdict and found three individuals guilty of fraud and another two
individual not guilty. In connection to the litigation against the other
three individuals, the court has not yet reached a verdict.
In December 2004, the Company filed a lawsuit against Tain-Kang Co., a
customer of Hwa-Ching Co. in Taipei District Court claiming damages owed to
Hwa-Ching from Tain-Kang in the amount of approximately NT$5,796,000 or
US$178,169 to cover the outstanding account payable owed by Hwa-Ching to
the Company. In November 2005, Taipei District Court reached the judgment
in favor of defendant. The Company filed appeal to Taiwan High Court.
During the appeal, the Company reduced the claimed amount to NT$3,796,000
or US$116,689 due to Tain-Kang has provided the proof of payments of
NT$2,000,000 in the court. To date, the court has not yet reached a verdict
on this case.
24
NOTE R - LEGAL PROCEEDINGS (Continued)
On October 10, 2004, RPPI International Ltd. (or Rong-Dian), a vendor of
the Company, filed a lawsuit against City Network Inc.-Taiwan in the Taiwan
Taipei district court of Taiwan, in Taipei, Taiwan, alleging breach of
contract for two different purchase agreements that City Network
Inc.-Taiwan entered with them and two third parties. Rong-Dian sought the
aggregate amount of approximately NT$40.2 million or US$1.2 million for the
alleged breaches. One purchase agreement was for an order that City Network
Inc.-Taiwan sold to Hwa-Ching Co. in the amount of approximately NT$27.3
million or US$840,000 and the other purchase agreement was for an order
City Network Inc.-Taiwan sold to a separate customer of the Company in the
amount of approximately NT$12.9 million or US$396,546.
On June 21, 2005, City Network Inc.-Taiwan entered a settlement agreement
with Rong-Dian and on June 29, 2005, the district court lifted the lawsuit
against us. In the June 2005 settlement agreement, City Network Inc.-Taiwan
agreed to pay Rong-Dian a total of approximately NT$40.2 million or US$1.2
million, to cover the full amount City Network Inc.-Taiwan owed under the
two purchase agreements. In August 2005, City Network Inc.-Taiwan paid
Rong-Dian approximately NT$12.9 million or US$390,909 of the total amount
owed upon receipt of such amount from our customer. City Network Inc. -
Taiwan intends to pay the balance of approximately NT$27.3 million or
US$840,000 to Rong-Dian in 54 separate checks, issued and payable by
Tai-Wang Technology Co., Ltd. These checks will be in increments of
NT$500,000 or US$15,370 and payable for 53 consecutive months, beginning on
August 10, 2005 with the last and 54th payment being in the amount of
NT$813,003 or US$24,992 instead of NT$500,000 or US$15,370. As of September
30, 2006, approximately NT$5 million, or approximately US$151,150, has been
paid on this liability.
Pursuant to the June 2005 settlement agreement, City Network Inc.-Taiwan
agreed to pay Rong-Dian the balance of NT$27.3 million in monthly payments.
However, as a result of its relationship with Tai-Wang and the fact that
Tai-Wang is the vendor who introduced City Network Inc.-Taiwan to
Rong-Dian, Tai-Wang assumed the responsibility for the payment of NT$27.3
million or US$827,272 to Rong-Dian. Tai-Wang wrote each monthly check in
advance and thereafter provided all 54 checks to Rong-Dian. Rong-Dian will
cash one check each month until it receives payment of the full NT$27.3
million. However, as Tai-Wang has no written obligation with City Network
Inc.-Taiwan to make each monthly payment, beyond an oral promise to do so,
there is no assurance that each monthly check will be properly cashed by
Rong-Dian. Therefore the Company continues to report the total liability to
Rong-Dian. As each payment is successfully paid by Tai-Wang the Company
will reduce the liability accordingly and recognize other income as the
benefit provided by Tai-Wang.
Additionally, as part of the June 2005 settlement agreement, we secured our
obligation that Tai-Wang would pay Rong-Dian the outstanding balance of
NT$27.3 million or US$827,272 by giving Rong-Dian a first priority mortgage
on certain property including lots 701-4 and 701-6 in Jay-hou-xiao-duan,
Xi-zhi Duan, Xixhi City, Taipei County, Taiwan. The value of the first
priority mortgage on the property is approximately NT$27.3 million or
US$827,272, the aggregate amount owed to Rong-Dian. City Network
Inc.-Taiwan agreed with Rong Dian that this mortgage will expire in 2010.
25
NOTE R - LEGAL PROCEEDINGS (Continued)
Shanghai Bank - On January 24, 2005, Shanghai Commercial and Savings Bank
("Shanghai Bank") filed a lawsuit with the Taipei District Court against
the Company claiming approximately NT$12 million or approximately
US$387,000 for the payment of an unpaid purchase price for goods. The
Company purchased such goods from Chin Shin and Chin Shin assigned the
account receivable to Shanghai Bank. As such, Shanghai Bank sued the
Company for the payment of those goods. However,the Company returned the
said goods because they were defective.
On November 24, 2005, the Company entered a settlement agreement with
Shanghai Bank and the district court lifted the lawsuit against the
Company. In the settlement agreement, the City Network Inc.- Taiwan agreed
to pay Shanghai Bank a total of NT$5,100,000 or US$ 155,244. In December
2005, City Network, Inc.- Taiwan paid Shanghai Bank NT$1,100,000 or
US$33,484. City Network, Inc.- Taiwan intends to pay the balance of
NT$4,000,000 or US$121,760 to Shanghai Bank in 4 separate checks. These
checks will be payable for each 2 months, beginning on February 25, 2006.
As of September 30, 2006, NT$4,100,000 or US $123,943 has been paid on this
liability.
NOTE S - GOING CONCERN
The Company has suffered recurring losses from operations, cash
deficiencies and the inability to meet its maturing obligations without
borrowing from related parties and restructuring debts. These issues may
raise substantial concern about its ability to continue as a going concern.
Management has prepared the following statement to address these and other
concerns:
The Company is currently engaged in discussions with a number of companies
regarding strategic acquisitions or potential financings. Although these
discussions are ongoing, there can be no assurance that any of these
discussions will result in actual acquisitions or a completed financing for
the Company.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Form 10-QSB.
The information in this discussion contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements involve risks and uncertainties, including statements
regarding our capital needs, business strategy and expectations, including but
not limited to the following:
* our ability to raise funds in the future through public or private
financings;
* the timing of our introduction of products or product enhancements;
* our ability to manage costs associated with our product or technology
acquisitions;
* our ability to keep pace with rapidly changing technology, evolving
industry standards and new product and services in our industry;
* customers' acceptance of our product designs;
* our ability to integrate businesses, products and technologies and in
joint ventures and strategic relationships with other companies;
* our business expenses being greater than anticipated due to
competitive factors or unanticipated developments;
* changes in political and economic conditions in the Asian and European
countries where we do business;
* our ability to retain management and key personnel;
* our ability to protect our developed technologies, know-how,
trademarks and related intellectual properties; and
* our ability to comply with the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002.
Any statements contained herein that are not statements of historical facts may
be deemed to be forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as "may", "will", "should",
"expect", "plan", "intend", "anticipate", "believe", estimate", "predict",
"potential" or "continue", the negative of such terms or other comparable
terminology. Actual events or results may differ materially. We disclaim any
obligation to publicly update these statements, or disclose any difference
between its actual results and those reflected in these statements. The
information constitutes forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995.
27
BACKGROUND OF THE COMPANY
City Network, Inc., formerly Investment Agents, Inc., was incorporated on
August 8, 1996 under the laws of the State of Nevada. City Network Technology,
Inc., formerly Gelcrest Investments Limited, was incorporated under the laws of
the British Virgin Islands on March 1, 2002. City Network, Inc. - Taiwan,
formerly City Engineering, Inc., was incorporated under the laws of Republic of
China on September 6, 1994. City Network, Inc. owns 100% of the capital stock of
City Network Technology, Inc., and City Network Technology, Inc. owns 100% of
the capital stock of City Network, Inc. - Taiwan. Collectively, the three
corporations are referred to herein as the "Company".
The Company designs, manufactures and markets a comprehensive line of
broadband communication and wireless Internet access product and solutions.
Also, the broadband communication product line includes VOIP, GUI-based remote
management and routing technology software packages for simplified setup,
extensive network management and global network connectivity capabilities, Home
PNA and xDSL broadband access equipment, ADSL/VDSL ACCESS DEVICES, HPNA ACCESS
DEVICES, FTTB (Fiber to the Building) and FTTH (Fiber to the Home), PCMCIA cards
and USB adapters. The other wireless internet access solutions are used in both
individual and corporate settings.
The Company has also focused on the sales of LCD panels, LCD TVs/ Monitor
and other LCD products, and some the LCD TVs/Monitors got the approved from
customers, will be start the business next year..
On December 16, 2004, the Company changed its fiscal year end from February
28 to December 31.
We have suffered recurring losses from operations, cash deficiencies and
the inability to meet our maturing obligations without borrowing from related
parties and restructuring debts. These issues may raise substantial concern
about our ability to continue as a going concern.
We are currently engaged in discussions with a number of companies
regarding strategic acquisitions or potential financings. Although these
discussions are ongoing, there can be no assurance that any of these discussions
will result in actual acquisitions or a completed financing for us.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial conditions and results of
operations is based upon our financial statements, which have been prepared in
accordance with generally accepted accounting principles in the United States of
America ("GAAP"). The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. See "Summary of Significant Accounting Policies" in the Notes
to Consolidated Financial Statements in Item to this Report for our critical
accounting policies. No significant changes in our critical accounting policies
have occurred since December 31, 2004.
28
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 2005
NET SALES. Net sales for the three months ended September 30, 2006 were
$3,916,705 compared to $3,784,392 for the three months ended September 30, 2005.
The increase in net sales for the three months ended September 30, 2006 was due
to an increase in the sales to Vietnam.
COST OF SALES. Cost of sales for the three months ended September 30, 2006
was $4,369,434 or 111.5% of net sales, as compared to $3,427,726 or 90.6% of net
sales, during the three months ended September 30, 2005. The increase was due to
the increase of net sales. The increase in the cost of sales as a percentage of
revenue was due to decreased sales of higher-margin products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $1,046,465 or 26.7% of net sales, for the three months ended September 30,
2006, as compared to $483,047 or 12.8% of net sales, for the three months ended
September 30, 2005. The increase was due to an increase in consulting fees for
the construction project in Vietnam. The increase in general and administrative
expenses as a percentage of net sales is due to the increase in consulting fees
for a construction project in Vietnam.
LOSS FROM OPERATIONS. Loss from operations for the three months ended
September 30, 2006 was $(1,499,194), compared to loss from operations for the
three months ended September 30, 2005 of $(126,381). The increase in loss from
operations for the three months ended September 30, 2006 compared with loss from
operations for the three months ended September 30, 2005 resulted primarily from
reasons primarily described above.
OTHER (INCOME) EXPENSE. Other (income) expense was $1,564,759 for the three
months ended September 30, 2006, as compared to $(54,578) for the three months
ended September 30, 2005. This change was the reserve for bad debt and late
payment penalty charged by bank.
NET LOSS. Net loss for three months ended September 30, 2006 was
$(3,148,623) compared to net loss of $(97,277) for the three months ended
September 30, 2005. The decrease in net loss was due to the reasons described
above.
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2005
NET SALES. Net sales for the nine months ended September 30, 2006 were
$7,095,525 compared to $8,677,108 for the nine months ended September 30, 2005.
The decrease in net sales for the nine months ended September 30, 2006 was due
to a decrease in demand for our products.
COST OF SALES. Cost of sales for the nine months ended September 30, 2006
was $7,222,052 or 101.8% of net sales, as compared to $8,060,736 or 92.9% of net
sales, during the nine months ended September 30, 2005. The decrease in cost of
sales is associated with the decrease in sales. The increase in the cost of
sales as a percentage of revenue was due to decreased sales of higher-margin
products.
29
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $1,892,877, or 26.7% of net sales, for the nine months ended September 30,
2006, as compared to $1,131,776, or 13.0% of net sales, for the nine months
ended September 30, 2005. The increase was due to an increase in consulting fee
for the construction project in Vietnam. The increase in general and
administrative expenses as a percentage of net sales is due to the increase in
consulting fee for the construction project in Vietnam.
LOSS FROM OPERATIONS. Loss from operations for the nine months ended
September 30, 2006 was $(2,019,404), compared to income from operations for the
nine months ended September 30, 2005 of $(515,404). The loss from operations for
the nine months ended September 30, 2006 compared with income from operations
for the nine months ended September 30, 2005 was due to a decrease in sales
without a proportionate decrease in the cost of sales and general and
administrative expenses.
OTHER (INCOME) EXPENSE. Other (income) expense was $1,457,676 for the nine
months ended September 30, 2006, as compared to $649,202 for the nine months
ended September 30, 2005. This change was the result of the reserve for bad debt
and late payment penalty charged by bank.
NET LOSS. Net loss for nine months ended September 30, 2006 was
$(3,541,458) compared to income of $(1,240,883) for the nine months ended
September 30, 2005. The net loss for the nine months ended September 30, 2006
compared with income for the nine months ended September 30, 2005 was due to the
reasons described above.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2006 and December 31, 2005, we had cash and cash
equivalents of $41,429 and $853,964, respectively. Our current assets totaled
$3,888,037 at September 30, 2006 as compared to $9,663,521 at December 31, 2005.
Our total current liabilities were $4,484,571 at September 30, 2006 as compared
to $10,272,005 at December 31, 2005. Working capital at September 30, 2006 was
$(596,534) and $(608,484) at December 31, 2005. For the nine months ended
September 30, 2006, total cash used in operations was $(1,358,485) as compared
to net cash used in operations of $(1,845,454) during the same period in 2005.
Net cash provided by financing activities was $1,203,311, which consisted of
loans, as compared with net cash provided by financing activities of $1,600,914
during the nine months ended September 30, 2005.
WORKING CAPITAL REQUIREMENTS
Our operations and short term financing do not currently meet our cash
needs. We currently are engaged in discussions with a number of companies
regarding strategic acquisitions or investments. Although these discussions are
ongoing, there can be no assurance that any of these discussions will result in
actual acquisitions or investment. Several potential investors have already
shown their interest to invest in our company.
FACTORS THAT INTERRUPT OUR OPERATIONS
Our major risk is incurring a large amount of bad debt. Our short-term and
long-term liquidity may be influenced by uncollected account receivables. If the
amount of bad debt is high, it will severely affect our ability to continue
30
operations. Therefore, we are taking precautions to manage this risk, such as
preparing accounts receivable aging reports each week and collecting the overdue
invoices. We will try to diversify our customer base and control credit risk
related to accounts receivable through credit approvals, credit limits and
monitoring procedures. Although we have already taken these measures, it is
still possible to incur a large amount of bad debt.
Financial instruments that potentially subject us to concentrations of
credit risk are cash, accounts receivable and other receivables arising from its
normal business activities. We place our cash in what we believe to be
credit-worthy financial institutions. We have a diversified customer base, most
of which are related parties. We control credit risk related to accounts
receivable through credit approvals, credit limits and monitoring procedures. We
routinely assess the financial strength of its customers and, based upon factors
surrounding the credit risk, establish an allowance, if required, for
un-collectible accounts and, as a consequence, believe that our accounts
receivable credit risk exposure beyond such allowance is limited.
CAPITAL EXPENDITURES. Total capital expenditures during the nine months
ended September 30, 2006 were $1,688,671 compared to $193,310 for the nine
months ended September 30, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
ITEM 3. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including our Chief Executive Officer and the Chief Financial
Officer, the Company conducted an evaluation of the effectiveness of the design
and operation of its disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
as of the end of the period covered by this report (the "Evaluation Date").
Based on this evaluation, our Chief Executive Officer and the Chief Financial
Officer concluded as of the Evaluation Date that the Company's disclosure
controls and procedures were effective such that the material information
required to be included in our SEC reports is recorded, processed, summarized
and reported within the time periods specified in SEC rules and forms relating
to the Company, including our consolidating subsidiaries, and was made known to
them by others within those entities, particularly during the period when this
report was being prepared.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HWA-CHING CO. AND RELATED LAWSUITS
In April 2004, Hwa-Ching Co. made purchases from City Network Inc.-Taiwan
for products in the aggregate amount of approximately NT$19 million or
US$575,757. In June 2004, Hwa-Ching Co. wrote a check to City Network
Inc.-Taiwan paying for such products and City Network Inc.-Taiwan successfully
cashed this check. Also in June 2004, Hwa-Ching Co. made purchases from City
Network Inc.-Taiwan for additional products in the aggregate amount of
approximately NT$18 million or US$545,454 and paid for such products with a
check that City Network Inc.-Taiwan also successfully cashed.
During June to August 2004, Hwa-Ching Co. requested additional products
from City Network Inc.-Taiwan in the aggregate amount of approximately NT$27
million or US$818,181. City Network Inc.-Taiwan filled these orders with
confidence as Hwa-Ching had paid for the prior orders from April 2004 and June
2004. However, the check, in the amount of approximately NT$27 million or
US$818,181 that Hwa-Ching Co. wrote to City Network, Inc.-Taiwan bounced upon
deposit with the bank. Immediately thereafter, Hwa-Ching Co. closed down with
this remaining account payable balance of approximately NT$27 million or
US$818,181 outstanding and payable to City Network Inc.-Taiwan.
In August 2004, City Network Inc.-Taiwan filed a lawsuit against Yune-Chang
Tsuo, the owner of Hwa-Ching Co., as well as the following eight individuals
including, Yong-Zhang Zhuo, Shu-Tao Lu, Yong-Yi Zhuo, Zhuan-Xuan Dai, Ya-Hui
Qiu, Mei-Zhen Huang, Zong-Ya Wu, Yao-Guo Cen in Taiwan Taipei district court of
Taiwan, in Taipei, Taiwan, alleging fraud for closing down Hwa-Ching Co. without
payment for the delivered merchandise. City Network Inc.-Taiwan sought
approximately NT$27 million or approximately US$900,000 from Yune-Chang Tsuo to
cover the outstanding account payable. To date, the court has not yet reached a
verdict on this case.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
On June 30, 2006, the Company sold a $400,000 convertible promissory note
to Cornell Capital Partners, LP, and amended and reissued the convertible notes
originally issued to Highgate House Funds, Ltd on August 17, 2005 and December
16, 2005 in the aggregate principal amount of $250,000. These notes are secured
by substantially all of the assets of the Company and its direct and indirect
wholly-owned subsidiaries, City Technology, Inc., City Network, Inc.--Taiwan and
City Construction Co., Ltd. However, on August 31, 2006, the Company sold its
100% interest in City Construction, Inc. without consent of the note holders.
Based on the security agreement in connection with the above convertible notes,
the note holders are entitled to receive all distribution with respect to the
pledged property. As of September 30, 2006, and the date of this report, no such
demand has been made.
32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits:
No. Description
--- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith.
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, filed herewith.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350 (Section 906 of the Sarbanes-Oxley Act of 2002), filed
herewith.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350 (Section 906 of the Sarbanes-Oxley Act of 2002), filed
herewith.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITY NETWORK, INC.
Dated: November 29, 2006 By: /s/ Alice Chen
------------------------------------
Alice Chen
Chief Executive Officer
(Principal Executive Officer)
Dated: November 29, 2006 By: /s/ Yun-Yi Tseng
------------------------------------
Yun-Yi Tseng
Chief Financial Officer
(Principal Financial Officer)
34