##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 20-F
  o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (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, 2005
 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: 000-51242
 CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
   
   
  
 
    
  
 
  
   
    o þ
  o þ
  þ o
  o o þ
  o þ
  o þ




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##### 



TABLE OF CONTENTS
 INTRODUCTIONPART IItem 1. Identity of Directors, Senior Management and AdvisersItem 2. Offer Statistics and Expected TimetableItem 3. Key InformationItem 4. Information on the CompanyItem 4A. Unresolved Staff CommentsItem 5. Operating and Financial Review and ProspectsItem 6. Directors, Senior Management and EmployeesItem 7. Major Shareholder and Related Party TransactionsItem 8. Financial InformationItem 9. The Offer and ListingItem 10. Additional InformationItem 11. Quantitative and Qualitative Disclosures About Market RiskItem 12. Description of Securities Other than Equity SecuritiesPART IIItem 13. Defaults, Dividend Arrearages and DelinquenciesItem 14. Material Modifications to the Rights of Security Holders and Use of ProceedsItem 15. Controls and ProceduresItem 16.A. Audit Committee Financial ExpertItem 16.B. Code of EthicsItem 16.C. Principal Accountant Fees and ServicesItem 16.D. Exemptions from the Listing Standards for Audit CommitteesItem 16.E. Purchases of Equity Securities by the Issuer and Affiliated PurchasersPART IIIItem 17. Financial StatementsItem 18. Financial StatementsItem 19. ExhibitsEX-4.11 SERIES A PREFERRED SHARE PURCHASE AND SALE AGREEMENTEX-4.12 CONTRACT FOR PURCHASE OF BUILDINGEX-4.13 CONTRACT FOR PURCHASE OF BUILDINGEX-8.1 SUBSIDIARIES OF THE REGISTRANTEX-12.1 CERTIFICATION BY THE CEO PURSUANT TO SECTION 302EX-12.2 CERTIFICATION BY THE CFO PURSUANT TO SECTION 302EX-13.1 CERTIFICATION BY THE CEO PURSUANT TO SECTION 906EX-13.2 CERTIFICATION BY THE CFO PURSUANT TO SECTION 906EX-15.1 CONSENT OF CONYERS DILL & PEARMANEX-15.2 CONSENT OF GUANTAO LAW FIRM
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INTRODUCTION
  §
    
    we, us, our company, our, and TechFaith refer to China Techfaith Wireless
Communication Technology Limited and its subsidiaries;§
    
    shares or ordinary shares refers to our ordinary shares, ADSs refers to our
American depositary shares, each of which represents 15 ordinary shares, and ADRs
refers to the American depositary receipts that evidence our ADSs;§
    
    China or PRC refers to the Peoples Republic of China, and solely for the
purpose of this annual report, excludes Taiwan, Hong Kong and Macau; and§
    
    RMB refers to Renminbi, the legal currency of China, and $, dollars, US$ and
U.S. dollars refer to the legal currency of the United States.
    FORWARD-LOOKING INFORMATION
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
    
    our limited operating history as a mobile handset design and software solution
provider;
    
    our ability to effectively manage our growth;
    
    possible decrease in demand for design services by mobile handset brand owners;
    
    our ability to acquire and retain additional international mobile handset brand
owners as our customers;
    
    our ability to design new mobile handset models and provide software solutions in a
timely and cost-efficient manner to meet our customers demands; and
    
    other risks outlined in this annual report on Form 20-F.
  
 PART I
 
 Item 1. Identity of Directors, Senior Management and Advisers
  
 Item 2. Offer Statistics and Expected Timetable
  
 Item 3. Key Information
 Selected Financial Data
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For the Period From July26, 2002 to December 31,
    
    
    For the Year Ended December 31,2002
    
    
    2003
    
    
    2004
    
    
    2005(In thousands, except share, per share and per ADS data)Consolidated Statement of
Operations DataNet revenues
    
    $
    
    
    
    $
    9,677
    
    
    $
    46,560
    
    
    $
    90,110Gross profit
    
    
    
    
    
    
    7,046
    
    
    
    26,676
    
    
    
    55,049Operating expenses
    
    
    (6
    )
    
    
    (2,130
    )
    
    
    (7,971
    )
    
    
    (14,290
    )(Loss) income from operations
    
    
    (6
    )
    
    
    4,916
    
    
    
    18,705
    
    
    
    40,759Net income
    
    $
    1
    
    
    $
    4,956
    
    
    $
    18,244
    
    
    $
    41,385Net income per share3⁄4 Basic
    
    $
    
    
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.073⁄4 Diluted
    
    $
    
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.07Net income per ADS3⁄4 Basic
    
    $
    
    
    
    $
    0.31
    
    
    $
    0.55
    
    
    $
    1.033⁄4 Diluted
    
    $
    
    
    
    $
    0.31
    
    
    $
    0.52
    
    
    $
    1.00Shares used in per share
computation3⁄4 Basic
    
    
    
    
    
    
    242,465,753
    
    
    
    500,000,000
    
    
    
    604,011,0093⁄4 Diluted
    
    
    
    
    
    
    243,074,581
    
    
    
    551,823,942
    
    
    
    626,626,671
 As of December 31,2002
    
    
    2003
    
    
    2004
    
    
    2005(In thousands)Consolidated Balance Sheet DataCash and cash equivalents
    
    $
    11
    
    
    $
    7,699
    
    
    $
    35,086
    
    
    $
    137,207Accounts receivable
    
    
    
    
    
    $
    5,230
    
    
    $
    7,760
    
    
    $
    34,060Inventories
    
    
    
    
    
    $
    732
    
    
    $
    5,030
    
    
    $
    4,974Total assets
    
    $
    3,618
    
    
    $
    23,911
    
    
    $
    67,542
    
    
    $
    194,163Total current liabilities
    
    $
    1,201
    
    
    $
    8,324
    
    
    $
    23,869
    
    
    $
    15,335Total shareholders equity
    
    $
    2,417
    
    
    $
    9,824
    
    
    $
    28,090
    
    
    $
    175,853Number of ordinary shares issued
    
    
    
    
    
    
    500,000,000
    
    
    
    500,000,000
    
    
    
    658,183,409Total liabilities and
shareholders equity
    
    $
    3,618
    
    
    $
    23,911
    
    
    $
    67,542
    
    
    $
    194,163
 Capitalization and Indebtedness
  Reasons for the Offer and Use of Proceeds
  Risk Factors
 Risks Related to Our Business
 Our limited operating history makes evaluating our business and prospects difficult.
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§
    
    manage our growth effectively;§
    
    maintain our profitability and margin;§
    
    acquire and retain customers;§
    
    attract, train and retain qualified personnel;§
    
    maintain adequate control of our costs and expenses;§
    
    keep up with evolving industry standards and market developments; or§
    
    respond to competitive market conditions.
  If we fail to effectively manage our rapid growth and expansion, our business may be materially and
adversely affected.
  If mobile handset brand owners discontinue or reduce the use of independent mobile handset design
houses, our business will be materially and adversely affected.
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If we fail to retain existing or attract additional international mobile handset brand owners as
customers, our business will be materially affected and the growth of our business impaired.
  If our customers fail to achieve success in their business, our mobile handset solution business
could be adversely affected.
  Defects in our designs could result in a loss of customers and claims against us.
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We are subject to product liability or product recall exposure and have limited insurance coverage.
  We may experience earnings or margin declines or even net losses in the future.
  If we cannot keep up with industry standards and design new mobile handset models in a timely and
cost-efficient manner to meet our customers demand, the growth and success of our business will be
materially and adversely affected.
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We rely on a limited number of customers for a significant portion of our net revenues, and if a
large customer fails to place additional orders with us, or if we fail to attract additional major
customers, our results of operations and financial condition could be materially and adversely
affected.
   The mobile handset design market in China is highly competitive, and we cannot assure you that we
will be able to compete successfully against our competitors.
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If we lose our license for CDMA technology, we may not be able to obtain alternative licenses in a
timely manner.
   We are subject to risks from customers claims for refund and liquidated damages.
  We have not registered copyrights for our product designs and other intellectual property.
  We may not be able to prevent others from unauthorized use of our intellectual property, which
could harm our business and competitive position.
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We may face intellectual property infringement and other claims that could be time-consuming and
costly to defend and result in our loss of significant rights.
   Our business depends substantially on the continuing efforts of our senior executives, and our
business may be severely disrupted if we lose their services.
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If we are unable to attract, train and retain skilled engineers, our business may be materially and
adversely affected.
  We experience fluctuations in quarterly operating results.
  Future acquisitions may have an adverse effect on our ability to manage our business.
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We have limited business insurance coverage in China.
  If we grant employee stock options and/or other share incentives, our net income could be adversely
affected.
  -
 Failure to achieve and maintain effective internal controls could have a material and adverse
effect on the trading price of our ADSs.
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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
services and materially and adversely affect our competitive position.
  Our business benefits from certain tax incentives, and changes to these tax incentives could
adversely affect our operating results.
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Our subsidiaries in China are subject to restrictions on dividend payments, making other payments
to us or any other affiliated company and borrowing or allocating tax losses among our
subsidiaries.
  Fluctuations in exchange rates could result in foreign currency exchange losses.
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Restrictions on currency exchange may limit our ability to receive and use our revenues
effectively.
  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
inject capital into our PRC subsidiary, limit our subsidiarys ability to distribute profits to us,
or otherwise adversely affect us.
   Uncertainties with respect to the PRC legal system could adversely affect us.
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We face risks related to health epidemics and other outbreaks of contagious diseases, including
avian influenza, or avian flu, and SARS.
  Risks Related to Shares and ADSs
 The future sales by our existing shareholders of a substantial number of our ADSs in the public
market could adversely affect the price of our ADSs.
   The market price for our ADSs has been and may continue to be volatile.
  §
    
    actual or anticipated fluctuations in our quarterly operating results;§
    
    changes in financial estimates by securities research analysts;
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§
    
    conditions in the mobile handset market;§
    
    changes in the economic performance or market valuations of other mobile handset
design houses;§
    
    performance of other China-based companies that are quoted on Nasdaq;§
    
    announcements by us or our competitors of new products, acquisitions, strategic
partnerships, joint ventures or capital commitments;§
    
    addition or departure of key personnel; and§
    
    fluctuations of exchange rates between RMB and U.S. dollar.
  We may need additional capital, and the sale of additional ADSs or other equity securities could
result in additional dilution to our shareholders.
  You may face difficulties in protecting your interests, and our ability to protect our rights
through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands
law.
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Your ability to bring an action against us or against our directors and officers, or to enforce a
judgment against us or them, will be limited because we are incorporated in the Cayman Islands,
because we conduct a substantial portion of our operations in China and because the majority of our
directors and officers reside outside of the United States.
  You may not be able to exercise your right to vote.
  Your right to participate in any future rights offerings may be limited, which may cause dilution
to your holdings.
  You may not receive distributions on ordinary shares or any value for them if it is illegal or
impractical to make them available to you.
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You may be subject to limitations on transfer of your ADSs.
  We are controlled by a small group of our existing shareholders, whose interests may differ from
other shareholders.
  We may be classified as a passive foreign investment company, which could result in adverse United
States federal income tax consequences to U.S. holders.
  20




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Item 4. Information on the Company
 History and Development of the Company
     Business Overview
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§
    
    A handset design business unit that provides handset design services;§
    
    A smart phone and pocket PC business unit that sells completed smart phones, pocket
PC and wireless modules; and§
    
    A wireless software and application business unit that designs and provides software
solutions for a wide range of wireless communication platforms.
    Products and Services
 Mobile Handset Design Services.
  §
    
    Mobile Handset Design Services Based on Existing Platforms We design a new model
of mobile handset based on our existing design platform.
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§
    
    Successor Model Design Services We design a successor model of an existing
customers mobile handset previously designed by us to incorporate additional functions
and/or industrial design.§
    
    Mobile Handset Design Services Based on New Platforms We design a new model of
mobile handset based on a new design platform specified by the customer.
   Smart Phones and Pocket PC
 Wireless Software and Application
 Other Products and Services
  23




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Design Process
  Responsibilities of Engineering Teams .
 Industrial Design.
 Mechanical Design.
 Hardware Design.
 Software Design.
 24




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Project Management.
 Quality Assurance.
 Sourcing.
 Production Support.
 Customers
    25




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2004
    
    2005Chinese mobile handset brand owners
    
    - Bird
    
    - Bird- Capitel
    
    - CEC Telecom- CEC Telecom
    
    - Eastcom- Eastcom
    
    - Haier- Haier
    
    - Huawei- Huawei
    
    - Konka- Konka
    
    - Lenovo- Lenovo- SoutecInternational mobile handset brand owners
    
    - Kyocera
    
    - Kyocera- Mitsubishi
    
    - NEC- NEC
    
    - UTStarcom- UTStarcom
     26




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Sales and Marketing
   Technology
     27




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Research and Development
  §
    
    to keep abreast of the advanced technologies in the mobile handset industry;§
    
    to emphasize cost-effectiveness and manufacturability of our designs;§
    
    to develop high quality handsets based on various commonly adopted platforms and to
ensure flexibility on design and production modifications; and§
    
    to make effective use of the technologies licensed from leading global technology
companies.
  Intellectual Property
   28




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Competition
   §
    
    ability to design and integrate many hardware and software functions and features
based on different platforms;§
    
    product quality and reliability;§
    
    cost effectiveness;§
    
    economies of scale;§
    
    ability to rapidly complete a design;§
    
    service and customer support capabilities; and§
    
    customer base and customer loyalty.
   Regulation
  29




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FTA Certification
  CTA Certification
  Tax
   30




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,
 Foreign Currency Exchange
   31




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Dividend Distribution
   Organizational Structure
  
 
 *
    
    Held through intermediary companies incorporated in the British Virgin Islands 32




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§
    
    Techfaith Wireless Communication Technology (Beijing) Limited, or TechFaith China,
which primarily designs GSM-based mobile handsets;§
    
    Techfaith Wireless Communication Technology (Beijing) Limited II, or TechFaith
Beijing, formerly known as Beijing Centel Technology R&D Co., Ltd., which primarily
designs GSM-based mobile handsets;§
    
    Techfaith Wireless Communication Technology (Shanghai) Limited, or TechFaith
Shanghai, formerly known as Leadtech Communication Technology (Shanghai) Limited, which
primarily designs CDMA mobile handsets using technology licensed from QUALCOMM;§
    
    STEP Technologies (Beijing) Co., Ltd., or STEP Technologies, which primarily designs
GSM-based mobile handsets based on a baseband platform licensed from Texas Instruments
and WCDMA mobile handsets using technology licensed from QUALCOMM;§
    
    Techfaith Intelligent Handset Technology (Beijing) Limited, or Techfaith Intelligent
Handset Beijing, which primarily focuses on smart phones and related products; and§
    
    TechFaith Software (China) Limited, or TechSoft, which primarily develops
application software for wireless devices.
  Property, Plants and Equipment
  
 Item 4A. Unresolved Staff Comments
  33




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Item 5. Operating and Financial Review and Prospects
  Operating Results
    34




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Major Factors Affecting Our Results of Operations
 Net Revenues.
  35




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Cost of Revenues.
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Operating Expenses.
 General
and Administrative.
 Research
and Development.
 Selling
and Marketing.
 Income Taxes.
  37




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Critical Accounting Policies
  Revenue Recognition.
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Results of Operations
  For the Year Ended December 31,2003
    
    
    2004
    
    
    2005(In thousands)Consolidated Statement of
Operations DataNet revenues:Design fees
    
    $
    7,947
    
    
    $
    29,495
    
    
    $
    63,020Royalty income
    
    
    1,259
    
    
    
    6,961
    
    
    
    15,651Component products
    
    
    471
    
    
    
    10,104
    
    
    
    11,439Total net revenues
    
    $
    9,677
    
    
    $
    46,560
    
    
    $
    90,110Cost of revenues:Design fees
    
    $
    2,260
    
    
    $
    10,951
    
    
    $
    26,258Royalty income
    
    
    
    
    
    
    725
    
    
    
    Component products
    
    
    371
    
    
    
    8,208
    
    
    
    8,803Total cost of revenues
    
    $
    2,631
    
    
    $
    19,884
    
    
    $
    35,061Gross profit:Design fees
    
    $
    5,687
    
    
    $
    18,544
    
    
    $
    36,762Royalty income
    
    
    1,259
    
    
    
    6,236
    
    
    
    15,651Component products
    
    
    100
    
    
    
    1,896
    
    
    
    2,636Total gross profit
    
    $
    7,046
    
    
    $
    26,676
    
    
    $
    55,049Operating expenses:General and administrative
    
    $
    (968
    )
    
    $
    (4,771
    )
    
    $
    (9,574
    )Research and development
    
    
    (700
    )
    
    
    (2,506
    )
    
    
    (3,447
    )Selling and marketing
    
    
    (39
    )
    
    
    (694
    )
    
    
    (1,269
    )Impairment of acquired
intangible assets
    
    
    (423
    )
    
    
    
    
    
    
    Total operating expenses
    
    $
    (2,130
    )
    
    $
    (7,971
    )
    
    $
    (14,290
    )Income from operations
    
    $
    4,916
    
    
    $
    18,705
    
    
    $
    40,759Total other income (loss), net
    
    
    (9
    )
    
    
    (484
    )
    
    
    2,149Income taxes
    
    
    
    
    
    
    
    
    
    
    (54
    )Minority interests
    
    
    49
    
    
    
    23
    
    
    
    (1,469
    )Net income
    
    $
    4,956
    
    
    $
    18,244
    
    
    $
    41,385
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Comparison of the Year Ended December 31, 2004 and the Year Ended December 31, 2005
 Net Revenues
  Design Fees.
 Royalty Income.
 Component Products.
 Cost of Revenues
  Design Fees.
 Royalty Income.
 Component Products.
 Gross Profit
  40




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Design Fees.
 Royalty Income.
 Component Products.
 Operating Expenses
  General and Administrative.
 Research and Development.
 Selling and Marketing.
 Total Other Income (Loss), Net
  Net Income
  41




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Comparison of the Year Ended December 31, 2003 and the Year Ended December 31, 2004
 Net Revenues
  Design Fees.
 Royalty Income.
 Component Products.
 Cost of Revenues
  Design Fees.
 Royalty Income.
 42




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Component Products.
 Gross Profit
  Design Fees.
 Royalty Income.
 Component Products.
 Operating Expenses
  General and Administrative.
 Research and Development.
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Selling and Marketing.
 Impairment of Acquired Intangible Assets.
 Total Other Income (Loss), Net
  Net Income
  Liquidity and Capital Resources
  Year Ended December 31,2003
    
    
    2004
    
    
    2005(In thousands)Net cash provided by operating activities
    
    $
    8,716
    
    
    $
    25,809
    
    
    $
    16,950Net cash used in investing activities
    
    
    (8,395
    )
    
    
    (8,112
    )
    
    
    (5,529
    )Net cash provided by financing activities
    
    
    7,342
    
    
    
    9,700
    
    
    
    89,259Effect of exchange rate changes
    
    
    25
    
    
    
    (10
    )
    
    
    1,441Net increase in cash and cash equivalents
    
    
    7,688
    
    
    
    27,387
    
    
    
    102,121Cash and cash equivalents at beginning of
period
    
    
    11
    
    
    
    7,699
    
    
    
    35,086Cash and cash equivalents at end of period
    
    $
    7,699
    
    
    $
    35,086
    
    
    $
    137,207
  44




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3⁄4 3⁄4
 Operating Activities.
   45




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Investing Activities.
 Financing Activities.
   Research and Development, Patents and Licenses, etc.
 3⁄4
 Trend Information
  46




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Off-Balance Sheet Arrangements
  Contractual Obligations
  Payment Due by PeriodLess Than 1
    
    
    
    
    
    
    
    
    
    
    More Than 5Contractual Obligations
    
    Total
    
    
    Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    Years(In thousands of U.S. dollars)Long-term debt obligations
    
    $
    3⁄4
    
    
    $
    3⁄4
    
    
    $
    3⁄4
    
    
    $
    3⁄4
    
    
    $
    3⁄4Operating lease obligations
    
    
    5,035
    
    
    
    1,787
    
    
    
    2,927
    
    
    
    321
    
    
    
    3⁄4Purchase obligations(1)
    
    
    418
    
    
    
    418
    
    
    
    3⁄4
    
    
    
    3⁄4Investment obligations(2)
    
    
    1,239
    
    
    
    1,239
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4Total
    
    $
    6,692
    
    
    $
    3,444
    
    
    $
    2,927
    
    
    $
    321
    
    
    $
    3⁄4
 
 (1)
    
    Purchase obligations relating to the purchase of plant, machinery and equipment.(2)
    
    Investment obligations relating to contribution as paid-in-capital in a newly established
affiliate.  Quantitative and Qualitative Disclosures about Market Risk
 Interest Rate Risk.
 Foreign Exchange Risk.
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Recent Accounting Pronouncements
 Accounting
for Stock Issued to Employee
 Accounting for Conditional
Asset Retirement Obligations, an interpretation of SFAS No. 143
 Accounting Changes and Error Corrections Reporting Accounting Changes in Interim Financial Statements  An Amendment of APB Opinion No.
28
 Accounting for Purchases and Sales of Inventory with the Same Counterparty Accounting for Nonmonetary Transactions
 Inventory Costs  an amendment of ARB No. 43, Chapter 4
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Exchanges of Nonmonetary Assets  an
amendment of APB Opinion No. 29
 
 Item 6. Directors, Senior Management and Employees
 Directors and Senior Management
  Directors and Executive Officers
    
    Age
    
    Position/TitleDefu Dong
    
    
    34
    
    
    Chairman and Chief Executive OfficerJy-Ber Gilbert Lee
    
    
    50
    
    
    Director, President and Chief Operating OfficerBaozhuang Huo
    
    
    34
    
    
    Director, Chief Executive Officer of Handset Design UnitHung Hsin (Robert) Chen
    
    
    62
    
    
    Independent DirectorPeter Clarke
    
    
    55
    
    
    Independent DirectorYing Han
    
    
    52
    
    
    Independent DirectorHui (Tom) Zhang
    
    
    33
    
    
    Independent DirectorYin Wah (Eva) Hon
    
    
    34
    
    
     (1)Christopher Patrick Holbert(2)
    
    
    35
    
    
    Chief Financial OfficerChangke He
    
    
    43
    
    
    Chief Technology OfficerGuoyi Wei
    
    
    42
    
    
    Acting Chief Financial Officer and Chief Accounting OfficerJun Liu
    
    
    33
    
    
    Chief Executive Officer of Smartphone and Pocket PC UnitJunhou Huang
    
    
    34
    
    
    Chief Executive Officer of Wireless Software and
Application UnitYibo Fang
    
    
    36
    
    
    President of STEP TechnologiesXiaonong Cai
    
    
    35
    
    
    Vice President
 
 (1)
    
    Ms. Eva Hon resigned as our Chief Financial Officer on February 10, 2006.(2)
    
    Mr. Holbert has been appointed as our Chief Financial Officer, effective on July 1, 2006. Executive Directors
 Mr. Defu Dong
 Dr. Jy-Ber Gilbert Lee
 49




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##### Table of Contents



Mr. Baozhuang Huo
 Independent Directors
 Mr. Hung Hsin (Robert) Chen
 Mr. Peter Clarke
 Ms. Ying Han
 Dr. Hui (Tom) Zhang
 50




---



##### Table of Contents



Executive Officers
 Mr. Christopher Patrick Holbert
 Mr. Changke He
 Mr. Guoyi Wei
 Mr. Jun Liu
 Mr. Junhou Huang
 51




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##### Table of Contents



Mr. Yibo Fang
 Mr. Xiaonong Cai
  Compensation of Directors and Executive Officers
  Share Incentives
   Ordinary SharesUnderlying
    
    
    Exercise PriceOptions Granted
    
    
    (US$/Share)
    
    
    Date of Grant
    
    
    Date of ExpirationHung Hsin (Robert) Chen
    
    
    131,636
    
    
    
    1.083
    
    
    March 19, 2006
    
    March 19, 2016Peter Clarke
    
    
    131,636
    
    
    
    1.083
    
    
    August 13, 2005
    
    August 13, 2015Jy-Ber Gilbert Lee
    
    
    131,636
    
    
    
    1.083
    
    
    August 13, 2005
    
    August 13, 2015Total
    
    
    394,908
  52




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##### Table of Contents



Types of Awards.
 §
    
    our ordinary shares;§
    
    options to purchase our ordinary shares;§
    
    restricted shares, which are non-transferable ordinary shares, subject to forfeiture
upon termination of a grantees employment or service;§
    
    restricted share units, which represent the right to receive our ordinary shares at
a specified date in the future, subject to forfeiture upon termination of a grantees
employment or service;§
    
    share appreciation rights, which provide for the payment to the grantee based upon
increases in the price of our ordinary shares over a set base price; and§
    
    dividend equivalent rights, which represent the value of the dividends per share
that we pay.
  Plan Administration.
 Award Agreement.
 Eligibility.
 Acceleration of Awards upon Corporate Transactions.
 Terms of Awards.
 53




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##### Table of Contents



Vesting Schedule.
 Amendment and Termination.
 C.
    
    Board Practices
  Committees of the Board of Directors
 Audit Committee
  Compensation Committee
  54




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##### Table of Contents



Corporate Governance and Nominating Committee
  Duties of Directors
  Terms of Directors and Officers
  D.
    
    Employees
  E.
    
    Share Ownership
   (1)
    
    each of our directors and executive officers; and(2)
    
    each of our principal shareholders.
 55




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##### Table of Contents



Ordinary Shares Beneficially Owned(1)Number
    
    %(2)Directors and Executive Officers:Defu Dong(3)
    
    
    249,250,000
    
    
    
    37.9
    %Hung Hsin (Robert) Chen (4)
    
    
    131,636
    
    
    
    *Peter Clarke(5)
    
    
    131,636
    
    
    
    *Jy-Ber Gilbert Lee (6)
    
    
    131,636
    
    
    
    *All directors and executive officers as a group(7)
    
    
    249,644,908
    
    
    
    37.9
    %Principal Shareholders:Hongmei Yue(8)
    
    
    100,000,000
    
    
    
    15.2
    %Crossvine Assets Limited(9)
    
    
    35,500,000
    
    
    
    5.4
    %Stone Column Assets Limited(10)
    
    
    17,318,750
    
    
    
    2.6
    %
 
 *
    
    Less than 1%.(1)
    
    Beneficial ownership is determined in accordance with the rules of the Securities and
Exchange Commission, or the SEC, and includes voting or investment power with respect to the
securities.(2)
    
    For each person and group included in this table, percentage ownership is calculated by
dividing the number of shares beneficially owned by such person or group by the sum of
658,183,409, being the number of ordinary shares outstanding as of June 23, 2006, and the
number of ordinary shares underlying share options held by such person or group, if any, that
were exercisable within 60 days after June 23, 2006.(3)
    
    Includes 165,750,000 ordinary shares held by Oasis Land Limited, which is ultimately owned by
Dongs Family Trust, and 83,500,000 ordinary shares held by Helio Glaze Limited, which is
ultimately owned by Huos Offshore Trust. Mr. Defu Dong is the sole director of each of Oasis
Land Limited and Helio Glaze Limited, with the sole power to vote on behalf of Oasis Land
Limited and Helio Glaze Limited on all matters of TechFaith requiring shareholder approval.
The business address for Defu Dong is 3/F M8 West No. 1 Jiu Xian Qiao East Road, Chao Yang
District, Beijing 100016, Peoples Republic of China.(4)
    
    Includes 131,636 ordinary shares that were issuable upon exercise of options exercisable
within 60 days after June 23, 2006 held by Mr. Chen.(5)
    
    Includes 131,636 ordinary shares that were issuable upon exercise of options exercisable
within 60 days after June 23, 2006 held by Mr. Clarke.(6)
    
    Includes 131,636 ordinary shares that were issuable upon exercise of options exercisable
within 60 days after June 23, 2006 held by Mr. Lee.(7)
    
    Shares owned by all of our directors and executive officers as a group include shares
beneficially owned by Defu Dong, Hung Hsin (Robert) Chen, Peter Clarke and Jy-Ber Gilbert Lee.(8)
    
    Includes 83,250,000 ordinary shares held by Bright Garnet Limited, which is ultimately owned
by Lius Offshore Trust, and 16,750,000 ordinary shares held by Geranium Joy Limited, which is
ultimately owned by Hes Offshore Trust. Ms. Hongmei Yue is the sole director of each of
Bright Garnet Limited and Geranium Joy Limited, with the sole power to vote on behalf of
Bright Garnet Limited and Geranium Joy Limited on all matters of TechFaith requiring
shareholder approval. The business address for Hongmei Yue is c/o Raymond Song, 3/F M8 West
No. 1 Jiu Xian Qiao East Road, Chao Yang District, Beijing 100016, Peoples Republic of China.(9)
    
    Crossvine Assets Limited is ultimately owned by Dongs 2 Family Trust. Mr. Lin Dong is the
sole director of Crossvine Assets Limited with the sole power to vote on behalf of Crossvine
Assets Limited on all matters of TechFaith requiring shareholder approval. The business address for Lin Dong is Room
1106, No. 103, Wang Jing, Li Zhe Xi Yuan, Chao Yang District, Beijing, Peoples Republic of
China.(10)
    
    Stone Column Assets Limited is ultimately owned by Tans Family Trust. Wensheng Tan is the
sole director of Stone Column Assets Limited with the sole power to vote on behalf of Stone
Column Assets Limited on all matters of TechFaith requiring shareholder approval. The business
address for Stone Column Assets Limited is 5/F M7 East No. 1 Jiu Xian Qiao Dong Road, Chaoyang
District, Beijing, Peoples Republic of China. 56




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##### Table of Contents



Item 7. Major Shareholders and Related Party Transactions
 A.
    
    Major Shareholders
  B.
    
    Related Party Transactions
 Transactions with Certain Directors and Officer
  Issuance and Sale of Convertible Notes
   Demand Registration Rights
 Form F-3 Registration Rights
 57




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##### Table of Contents



Piggyback Registration Rights
 Expenses of Registration
  Transactions with QUALCOMM
   58




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##### Table of Contents



Transactions with NEC
    Transactions with SEF
    59




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##### Table of Contents



Transactions with Beijing Qidi
 Transfer of Mobile Handset Design Contracts.
    60




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##### Table of Contents



Settlement with CECW.
 Transactions with an Employee
  C.
    
    Interests of Experts and Counsel
  
 Item 8. Financial Information
 A.
    
    Consolidated Statements and Other Financial Information
  Legal Proceedings
  Dividend Policy
   61




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##### Table of Contents



B.
    
    Significant Changes
  
 Item 9. The Offer and Listing
 A.
    
    Offer and Listing Details.
    Sales PriceHigh
    
    LowQuarterly High and LowThird Quarter 2005
    
    
    19.50
    
    
    
    8.75Fourth Quarter 2005
    
    
    18.80
    
    
    
    7.80First Quarter 2006
    
    
    18.00
    
    
    
    10.28Monthly Highs and LowsJanuary 2006
    
    
    16.20
    
    
    
    13.04February 2006
    
    
    18.00
    
    
    
    12.25March 2006
    
    
    14.52
    
    
    
    10.28April 2006
    
    
    15.30
    
    
    
    13.50May 2006
    
    
    15.50
    
    
    
    12.88June 2006 (through June 23, 2006)
    
    
    15.06
    
    
    
    13.00
 B.
    
    Plan of Distribution
  C.
    
    Markets
  62




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##### Table of Contents



D.
    
    Selling Shareholders
  E.
    
    Dilution
  F.
    
    Expenses of the Issue
  
 Item 10. Additional Information
 A.
    
    Share Capital
  B.
    
    Memorandum and Articles of Association
  C.
    
    Material Contracts
  D.
    
    Exchange Controls
   63




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##### Table of Contents



E.
    
    Taxation
  Cayman Islands Taxation
  64




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##### Table of Contents



United States Federal Income Taxation
   §
    
    banks;§
    
    financial institutions;§
    
    insurance companies;§
    
    broker dealers;§
    
    traders that elect to mark to market;§
    
    tax-exempt entities;§
    
    persons liable for alternative minimum tax;§
    
    persons holding an ADS or ordinary share as part of a straddle, hedging, conversion
or integrated transaction;§
    
    holders that actually or constructively own 10% or more of our voting stock;§
    
    persons holding ADSs or ordinary shares through partnerships or other pass-through
entities; or§
    
    persons who acquired ADSs or ordinary shares pursuant to the exercise of any
employee share option or otherwise as consideration.
   §
    
    a citizen or individual resident of the United States;
 65




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##### Table of Contents



§
    
    a corporation or partnership organized under the laws of the United States, any
State or the District of Columbia;§
    
    an estate whose income is subject to United States federal income taxation
regardless of its source;§
    
    a trust that (1) is subject to the supervision of a court within the United States
and the control of one or more United States persons or (2) has a valid election in
effect under applicable U.S. Treasury regulations to be treated as a United States
person.
    U.S. Holders
 Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares
   66




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Taxation of Disposition of ADSs or Ordinary Shares
  67




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##### Table of Contents



Passive Foreign Investment Company
  §
    
    at least 75% of its gross income is passive income (the income test), or§
    
    at least 50% of the value of its assets (based on an average of the quarterly values
of the assets during a taxable year) is attributable to assets that produce or are held
for the production of passive income (the asset test).
    §
    
    the excess distribution or gain will be allocated ratably over your holding period
for the ADSs or ordinary shares,
 68




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##### Table of Contents



§
    
    the amount allocated to the current taxable year, and any taxable year prior to the
first taxable year in which we were a passive foreign investment company, will be
treated as ordinary income, and§
    
    the amount allocated to each other year will be subject to tax at the highest tax
rate in effect for that year and the interest charge generally applicable to
underpayments of tax will be imposed on the resulting tax attributable to each such
year.
    de minimis
 69




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##### Table of Contents



Non-U.S. Holders
    Information Reporting and Backup Withholding
   §
    
    fails to provide an accurate taxpayer identification number,§
    
    is notified by the Internal Revenue Service that backup withholding will be
required, or§
    
    fails to comply with applicable certification requirements.
  70




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##### Table of Contents



F.
    
    Dividends and Paying AgentsNot applicable.G.
    
    Statement by ExpertsNot applicable.H.
    
    Documents on Display
     I.
    
    Subsidiary Information
 3⁄4
 71




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##### Table of Contents



Item 11. Quantitative and Qualitative Disclosures About Market Risk
 3⁄4
 
 Item 12. Description of Securities Other than Equity Securities
  
 PART II
 
 Item 13. Defaults, Dividend Arrearages and Delinquencies
  
 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
  
 Item 15. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls
  
 Item 16.A. Audit Committee Financial Expert
 3⁄4
 
 Item 16.B. Code of Ethics
  72




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##### Table of Contents



Item 16.C. Principal Accountant Fees and Services
  For the Year Ended December 31,2004
    
    2005Audit fees(1)
    
    
    22
    
    
    
    395Audit-related fees(2)
    
    
    1,201
    
    
    
    118Tax fees(3)
    
    
    36
    
    
    
    8All other fees(4)
    
    
    
    
    
    
    
 
 (1)
    
    Audit fees means the aggregate fees billed in each of the fiscal years listed for
professional services rendered by our principal auditors for the audit of our annual financial
statements.(2)
    
    Audit-related fees means the aggregate fees billed in each of the fiscal years listed for
assurance and related services by our principal auditors that are reasonably related to the
performance of the audit or review of our financial statements and are not reported under
Audit fees. Services comprising the fees disclosed under the category of Audit-related
fees involve principally the issue of comfort letter, rendering of listing advice, and other
audit-related services for the year ended December 31, 2005.(3)
    
    Tax fees means the aggregate fees billed in each of the fiscal years listed for
professional services rendered by the principal accountant for tax compliance, tax advice, and
tax planning.(4)
    
    All other fees means the aggregate fees billed in 2005 for consultation services rendered
by our principal auditors in connection with Section 404 of the Sarbanes-Oxley Act of 2002. 
 Item 16.D. Exemptions from the Listing Standards for Audit Committees
  
 Item 16.E. Purchases of Equity Securities by the Issuer and Affiliated
Purchasers.
  
 PART III
 
 Item 17. Financial Statements
  
 Item 18. Financial Statements
  73




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##### Table of Contents



Item 19. Exhibits
 Exhibit Number
    
    Document1.1
    
    Amended and Restated Memorandum and Articles of Association
of the Registrant (incorporated by reference to Exhibit 3.2
from our Registration Statement on Form F-1 (file no.
333-123921) filed with the Securities and Exchange
Commission on April 20, 2005).2.1
    
    Registrants Specimen American Depositary Receipt
(incorporated by reference to Exhibit 4.1 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).2.2
    
    Registrants Specimen Certificate for Ordinary Shares
(incorporated by reference to Exhibit 4.2 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
20, 2005).2.3
    
    Note Subscription and Rights Agreement, dated as of April
9, 2004, among the Registrant and other parties therein
(incorporated by reference to Exhibit 4.4 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).2.4
    
    Transfer and Assumption Agreement dated November 9, 2004
among the Registrant and other parties thereto
(incorporated by reference to Exhibit 4.5 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).2.5
    
    Share Swap Agreement dated November 9, 2004 among the
Registrant and other parties thereto (incorporated by
reference to Exhibit 4.6 from our Registration Statement on
Form F-1 (file no. 333-123921) filed with the Securities
and Exchange Commission on April 7, 2005).4.1
    
    2005 Share Incentive Plan (incorporated by reference to
Exhibit 10.1 from our Registration Statement on Form F-1
(file no. 333-123921) filed with the Securities and
Exchange Commission on April 20, 2005).4.2
    
    Form of Indemnification Agreement with the Registrants
directors (incorporated by reference to Exhibit 10.2 from
our Registration Statement on Form F-1 (file no.
333-123921) filed with the Securities and Exchange
Commission on April 7, 2005).4.3
    
    Form of Employment Agreement between the Registrant and a
Senior Executive Officer of the Registrant (incorporated by
reference to Exhibit 10.3 from our Registration Statement
on Form F-1 (file no. 333-123921) filed with the Securities
and Exchange Commission on April 7, 2005).
 74




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##### Table of Contents



Exhibit Number
    
    Document4.4
    
    Memorandum of Understanding dated December 24, 2003 between
a subsidiary of the Registrant and QUALCOMM (incorporated
by reference to Exhibit 99.1 from our Registration
Statement on Form F-1 (file no. 333-123921) filed with the
Securities and Exchange Commission on April 7, 2005).4.5
    
    CDMA Modem Card License Agreement dated March 9, 2004
between a subsidiary of the Registrant and QUALCOMM
(incorporated by reference to Exhibit 99.2 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).4.6
    
    Joint Venture Agreement dated September 26, 2003 between
the Registrant and NEC (incorporated by reference to
Exhibit 99.3 from our Registration Statement on Form F-1
(file no. 333-123921) filed with the Securities and
Exchange Commission on April 7, 2005).4.7
    
    Lease Agreement dated July 31, 2003 between the Registrant
and Beijing Sino-Electronics Future Telecommunication R&D,
Ltd. (incorporated by reference to Exhibit 99.4 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).4.8
    
    Code of Business Conduct and Ethics of the Registrant
(incorporated by reference to Exhibit 99.5 from our
Registration Statement on Form F-1 (file no. 333-123921)
filed with the Securities and Exchange Commission on April
7, 2005).4.9
    
    Agreement dated June 29, 2004 between the Registrant and a
PRC subsidiary of NEC (translation) (incorporated by
reference to Exhibit 99.6 from our Registration Statement
on Form F-1 (file no. 333-123921) filed with the Securities
and Exchange Commission on April 7, 2005).4.10
    
    Agreement dated December 20, 2004 between the Registrant
and a PRC subsidiary of NEC (translation) (incorporated by
reference to Exhibit 99.7 from our Registration Statement
on Form F-1 (file no. 333-123921) filed with the Securities
and Exchange Commission on April 7, 2005).4.11*
    
    Series A Preferred Share Purchase and Sale Agreement dated
March 22, 2006 among the Registrant, QUALCOMM and Techfaith
Software (China) Holding Limited.4.12*
    
    Contract for Purchase of Building dated March 23, 2006
between Beijing Electronics City Co., Ltd. and Techfaith
Wireless Communication Technology (Beijing) Limited
(English translation of the Chinese language document).4.13*
    
    Contract for Purchase of Building dated March 23, 2006
between Beijing Electronics City Co., Ltd. and Techfaith
Intelligent Handset Technology (Beijing) Limited (English
translation of the Chinese language document).8.1*
    
    Subsidiaries of the Registrant.12.1*
    
    CEO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
 75




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##### Table of Contents



Exhibit Number
    
    Document12.2*
    
    CFO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.13.1*
    
    CEO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.13.2*
    
    CFO Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.15.1*
    
    Consent of Conyers Dill & Pearman.15.2*
    
    Consent of Guantao Law Firm.
 
 *
    
    Filed with this annual report on Form 20-F. 76




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##### Table of Contents



SIGNATURES
  CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGYBy:
    
    /s/ Defu DongName:
    
    Defu DongTitle:
    
    Chief Executive Officer
  77




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION
TECHNOLOGY LIMITEDReport of Independent Registered Public Accounting Firm
and Consolidated Financial Statements
For the years ended December 31, 2004 and 2005




---



##### Table of Contents



Report of independent registered public accounting firm
    
    F - 1Consolidated balance sheets as of December 31, 2004 and 2005
    
    F - 2Consolidated statements of operations for the years ended December 31, 2003,
2004 and 2005
    
    F - 3Consolidated statements of shareholders equity and comprehensive income for
the years ended December 31, 2003, 2004 and 2005
    
    F - 4Consolidated statements of cash flows for the years ended December 31, 2003,
2004 and 2005
    
    F - 5Notes to the consolidated financial statements
    
    F - 6




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
     Deloitte Touche Tohmatsu
 F - 1




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##### Table of Contents



CONSOLIDATED BALANCE SHEETS
 (In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 Year Ended December 31,2004
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    35,086
    
    
    $
    137,207Accounts receivable, net of allowances of nil and $678 in
2004 and 2005
    
    
    7,760
    
    
    
    34,060Notes receivable
    
    
    2,296
    
    
    
    1,070Marketable securities
    
    
    346
    
    
    
    Deposit
    
    
    3,740
    
    
    
    Inventories
    
    
    5,030
    
    
    
    4,974Prepaid expenses and other current assets
    
    
    2,254
    
    
    
    926Total current assets
    
    $
    56,512
    
    
    $
    178,237Deposits for acquisition of plant, machinery and
equipment, and acquired intangible assets
    
    
    529
    
    
    
    597Plant, machinery and equipment, net
    
    
    9,556
    
    
    
    14,483Acquired intangible assets, net
    
    
    945
    
    
    
    846TOTAL ASSETS
    
    $
    67,542
    
    
    $
    194,163LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,834
    
    
    $
    3,294Accrued expenses and other current liabilities
    
    
    4,617
    
    
    
    9,714Advance from customers
    
    
    16,418
    
    
    
    2,273Income tax payable
    
    
    
    
    
    
    54Total current liabilities
    
    $
    23,869
    
    
    $
    15,335Convertible notes
    
    $
    11,887
    
    
    $
    Derivative liability
    
    $
    1,956
    
    
    $
    Minority interests
    
    $
    1,740
    
    
    $
    2,975Commitments (Note 17)Shareholders equity:Ordinary shares of par value $0.00002:
50,000,000,000,000 shares authorized; shares issued and
outstanding, 500,000,000 in 2004 and 658,183,409 in 2005
    
    $
    10
    
    
    $
    13Additional paid-in capital
    
    
    4,832
    
    
    
    109,798Accumulated other comprehensive income
    
    
    47
    
    
    
    1,456Retained earnings
    
    
    23,201
    
    
    
    64,586Total shareholders equity
    
    
    28,090
    
    
    
    175,853TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    67,542
    
    
    $
    194,163
  F - 2




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 Year Ended December 31,2003
    
    
    2004
    
    
    2005Revenues:Design fees
    
    $
    7,947
    
    
    $
    29,495
    
    
    $
    63,020Royalty income
    
    
    1,259
    
    
    
    6,961
    
    
    
    15,651Component products
    
    
    471
    
    
    
    10,104
    
    
    
    11,439Total net revenues
    
    $
    9,677
    
    
    $
    46,560
    
    
    $
    90,110Cost of revenuesDesign fees
    
    
    2,260
    
    
    
    10,951
    
    
    
    26,258Royalty income
    
    
    
    
    
    
    725
    
    
    
    Component products
    
    
    371
    
    
    
    8,208
    
    
    
    8,803Total cost of revenues
    
    
    2,631
    
    
    
    19,884
    
    
    
    35,061Gross profit
    
    
    7,046
    
    
    
    26,676
    
    
    
    55,049Operating expenses:General and administrative
    
    
    (968
    )
    
    
    (4,771
    )
    
    
    (9,574
    )Research and development
    
    
    (700
    )
    
    
    (2,506
    )
    
    
    (3,447
    )Selling and marketing
    
    
    (39
    )
    
    
    (694
    )
    
    
    (1,269
    )Impairment of acquired intangible assets
    
    
    (423
    )
    
    
    
    
    
    
    Total operating expenses
    
    
    (2,130
    )
    
    
    (7,971
    )
    
    
    (14,290
    )Income from operations
    
    
    4,916
    
    
    
    18,705
    
    
    
    40,759Interest expense
    
    
    (12
    )
    
    
    (1,756
    )
    
    
    (583
    )Interest income
    
    
    10
    
    
    
    108
    
    
    
    3,843Other income
    
    
    
    
    
    
    302
    
    
    
    192Change in fair value of call option
    
    
    
    
    
    
    862
    
    
    
    (1,303
    )Income before income taxes
    
    
    4,914
    
    
    
    18,221
    
    
    
    42,908Income taxes
    
    
    
    
    
    
    
    
    
    
    (54
    )Income before minority interests
    
    
    4,914
    
    
    
    18,221
    
    
    
    42,854Minority interests
    
    
    49
    
    
    
    23
    
    
    
    (1,469
    )Equity in loss of an affiliate
    
    
    (225
    )
    
    
    
    
    
    
    Gain on disposal of an affiliate
    
    
    218
    
    
    
    
    
    
    
    Net income
    
    $
    4,956
    
    
    $
    18,244
    
    
    $
    41,385Net income per share:Basic
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.07Diluted
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.07Shares used in computation:Basic
    
    
    242,465,753
    
    
    
    500,000,000
    
    
    
    604,011,009Diluted
    
    
    243,074,581
    
    
    
    551,823,942
    
    
    
    626,626,671
  F - 3




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
 AND COMPREHENSIVE
INCOME

(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 Accumulated
    
    
    
    
    
    
    TotalAdditional
    
    
    Other
    
    
    
    
    
    
    Share
    
    
    Com-Ordinary Shares
    
    
    Registered
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    holders
    
    
    prehensiveNumber
    
    
    Amount
    
    
    Capital
    
    
    Capital
    
    
    Income
    
    
    Earnings
    
    
    Equity
    
    
    IncomeBalance at January 1, 2003
    
    
    
    
    
    
    
    
    
    
    2,416
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    2,417
    
    
    $
    1Issue of ordinary shares on September 1, 2003
    
    
    500,000,000
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    $
    Cash injection as registered capital of Techfaith Beijing
upon its date of inception on September 5, 2003
    
    
    
    
    
    
    
    
    
    
    2,416
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,416
    
    
    
    Transfer of registered capital of Techfaith China and
Techfaith Beijing to Techfaith BVI
    
    
    
    
    
    
    
    
    
    
    (4,832
    )
    
    
    4,832
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    25
    
    
    
    25Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,956
    
    
    
    4,956
    
    
    
    4,956Balance at December 31, 2003
    
    
    500,000,000
    
    
    
    10
    
    
    
    
    
    
    
    4,832
    
    
    
    25
    
    
    
    4,957
    
    
    
    9,824
    
    
    $
    4,981Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    (10
    )
    
    $
    (10
    )Unrealized gain on available-for-sale marketable
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    32
    
    
    
    32Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,244
    
    
    
    18,244
    
    
    
    18,244Balance at December 31, 2004
    
    
    500,000,000
    
    
    
    10
    
    
    
    
    
    
    
    4,832
    
    
    
    47
    
    
    
    23,201
    
    
    
    28,090
    
    
    $
    18,266Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,441
    
    
    
    
    
    
    
    1,441
    
    
    $
    1,441Issuance of shares upon the initial public offering, net of
offering expenses
    
    
    158,183,409
    
    
    
    2
    
    
    
    
    
    
    
    89,491
    
    
    
    
    
    
    
    
    
    
    
    89,493
    
    
    
    Conversion of convertible notes
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    15,313
    
    
    
    
    
    
    
    
    
    
    
    15,314
    
    
    
    Unrealized gain on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74
    
    
    
    
    
    
    
    74
    
    
    
    Realized gain on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (106
    )
    
    
    
    
    
    
    (106
    )
    
    
    Share-based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    162
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,385
    
    
    
    41,385
    
    
    
    41,385Balance at December 31, 2005
    
    
    658,183,409
    
    
    $
    13
    
    
    $
    
    
    
    $
    109,798
    
    
    $
    1,456
    
    
    $
    64,586
    
    
    $
    175,853
    
    
    $
    42,826
  F - 4




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 Year Ended December 31,2003
    
    
    2004
    
    
    2005Operating activities:Net income
    
    $
    4,956
    
    
    $
    18,244
    
    
    $
    41,385Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation and amortization of plant, machinery and equipment
    
    
    574
    
    
    
    2,355
    
    
    
    4,415Amortization of acquired intangible assets
    
    
    60
    
    
    
    996
    
    
    
    372Amortization of discount on issuance of convertible notes
    
    
    
    
    
    
    705
    
    
    
    168Impairment of acquired intangible assets
    
    
    423
    
    
    
    
    
    
    
    Realised gain on investment in marketable securities
    
    
    
    
    
    
    (67
    )
    
    
    (106
    )Gain on disposal of an affiliate
    
    
    (218
    )
    
    
    
    
    
    
    Loss on disposal of plant, machinery and equipment
    
    
    
    
    
    
    215
    
    
    
    6Minority interests
    
    
    (49
    )
    
    
    (23
    )
    
    
    1,469Equity in loss of an affiliate
    
    
    225
    
    
    
    
    
    
    
    Change in fair value of call option
    
    
    
    
    
    
    (862
    )
    
    
    1,303Share-based compensation
    
    
    
    
    
    
    
    
    
    
    162Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (5,230
    )
    
    
    (2,530
    )
    
    
    (26,300
    )Notes receivables
    
    
    
    
    
    
    (2,296
    )
    
    
    1,226Inventories
    
    
    (732
    )
    
    
    (4,298
    )
    
    
    56Prepaid expenses and other current assets
    
    
    846
    
    
    
    (1,868
    )
    
    
    1,328Accounts payable
    
    
    730
    
    
    
    2,104
    
    
    
    460Accrued expenses and other current liabilities
    
    
    1,179
    
    
    
    2,668
    
    
    
    5,097Advance from customers
    
    
    5,952
    
    
    
    10,466
    
    
    
    (14,145
    )Income tax payable
    
    
    
    
    
    
    
    
    
    
    54Net cash provided by operating activities
    
    
    8,716
    
    
    
    25,809
    
    
    
    16,950Investing activities:Deposit paid
    
    
    (3,987
    )
    
    
    (3,740
    )
    
    
    Deposits paid for acquisition of plant, machinery and
equipment, and acquired intangible assets
    
    
    (1,061
    )
    
    
    (529
    )
    
    
    (597
    )Purchase of plant, machinery and equipment
    
    
    (4,531
    )
    
    
    (5,643
    )
    
    
    (8,832
    )Proceeds from sale of plant, machinery and equipment
    
    
    
    
    
    
    1
    
    
    
    13Purchase of marketable securities
    
    
    
    
    
    
    (4,289
    )
    
    
    (15,005
    )Purchase of acquired intangible assets
    
    
    
    
    
    
    (1,941
    )
    
    
    (273
    )Proceeds from sale of investment in an affiliate
    
    
    1,184
    
    
    
    
    
    
    
    Proceeds from sale of marketable securities
    
    
    
    
    
    
    8,029
    
    
    
    19,165Net cash used in investing activities
    
    
    (8,395
    )
    
    
    (8,112
    )
    
    
    (5,529
    )Financing activities:Proceeds from convertible notes
    
    
    4,000
    
    
    
    10,000
    
    
    
    Proceeds on issue of ordinary shares of Techfaith BVI
    
    
    10
    
    
    
    
    
    
    
    Capital contribution to Techfaith China, Techfaith Beijing and
STEP Technologies
    
    
    4,228
    
    
    
    
    
    
    
    Proceeds from short-term loan
    
    
    300
    
    
    
    
    
    
    
    Repayment of short-term loan
    
    
    
    
    
    
    (300
    )
    
    
    Advance from third parties
    
    
    635
    
    
    
    
    
    
    
    Repayment to third parties
    
    
    (1,831
    )
    
    
    
    
    
    
    Proceeds from issuance of shares upon initial public offering, net of
issuance cost of $10,104
    
    
    
    
    
    
    
    
    
    
    89,493Dividend paid to minority shareholder
    
    
    
    
    
    
    
    
    
    
    (234
    )Net cash provided by financing activities
    
    
    7,342
    
    
    
    9,700
    
    
    
    89,259Effect of exchange rate changes
    
    
    25
    
    
    
    (10
    )
    
    
    1,441Net increase in cash and cash equivalents
    
    
    7,688
    
    
    
    27,387
    
    
    
    102,121Cash and cash equivalents at the beginning of the year
    
    
    11
    
    
    
    7,699
    
    
    
    35,086Cash and cash equivalents at the end of the year
    
    $
    7,699
    
    
    $
    35,086
    
    
    
    137,207Supplemental cash flow information:Cash paid during the year for:Interest
    
    $
    1
    
    
    $
    12
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    
    
    
    $
    Non-cash financing activities:Conversion of convertible notes into ordinary shares upon the Groups initial
public offering
    
    $
    
    
    
    $
    
    
    
    $
    15,314
  F - 5




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 1.
    
    Organization and Principal ActivitiesChina Techfaith Wireless Communication Technology Limited (the Company) was incorporated
under the laws of the Cayman Islands on June 25, 2004 and its subsidiaries include the
following as of December 31, 2005:
 Date of
    
    Place of
    
    PercentageSubsidiary
    
    Incorporation
    
    Incorporation
    
    OwnershipTechfaith Wireless
Communication
Technology
(Beijing) Limited
(Techfaith China)
    
    July 26, 2002
    
    Peoples Republic
ofChina (the
PRC)
    
    
    100
    %Techfaith Wireless
Communication
Technology Limited
(Techfaith BVI)
    
    July 8, 2003
    
    British Virgin
Islands (the BVI)
    
    
    100
    %Great Earnest
Technology Limited
(Great Earnest)
    
    August 8, 2003
    
    BVI
    
    
    100
    %Techfaith Wireless
Communication
Technology
(Beijing) Limited
II (Techfaith
Beijing)
    
    September 5, 2003
    
    PRC
    
    
    100
    %Leo Technology
Limited (Leo
Technology)
    
    October 15, 2003
    
    BVI
    
    
    100
    %STEP Technologies
(Beijing) Co., Ltd.
(STEP
Technologies)
    
    November 20, 2003
    
    PRC
    
    
    70
    %Techfaith
Intelligent Handset
Technology (HK)
Limited (Techfaith
HK) (formerly
known as First
Achieve Technology
Ltd.)
    
    December 29, 2003
    
    Hong Kong
    
    
    100
    %Finest Technology
Limited (Finest
Technology)
    
    January 8, 2004
    
    BVI
    
    
    100
    %Techfaith Wireless
Communication
(Shanghai) Limited
(Techfaith
Shanghai)
    
    March 22, 2004
    
    PRC
    
    
    100
    %
 F - 6




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 1.
    
    Organization and Principal Activities  continued
 Date of
    
    Place of
    
    PercentageSubsidiary
    
    Incorporation
    
    Incorporation
    
    OwnershipInfoexcel
Technology Limited
(Infoexcel
Technology)
    
    April 18, 2005
    
    BVI
    
    
    100
    %Techfaith Wireless
Corporation
(Techfaith U.S.)
    
    August 22, 2005
    
    United States of
America(U.S.)
    
    
    100
    %Boost Time Limited
(Boost Time)
    
    August 25, 2005
    
    BVI
    
    
    100
    %Shenzhen Techfaith
Intelligent Handset
Technology Limited
(Techfaith
Shenzhen)
    
    August 25, 2005
    
    PRC
    
    
    100
    %Techfaith
Intelligent Handset
Technology
(Beijing) Limited
(Techfaith
Intelligent Handset
Beijing)
    
    September 9, 2005
    
    PRC
    
    
    100
    %
 These companies have been entities under common control which has established the basis to
consolidate them from their inception. Accordingly, the accompanying financial statements
include the financial statements of the Company, its wholly owned subsidiaries, which
consist of Techfaith China, Techfaith BVI, Great Earnest, Techfaith Beijing, Leo Technology,
Techfaith HK, Finest Technology, Techfaith Shanghai, Infoexcel Technology, Techfaith
Intelligent Handset Beijing, Boost-Time, Techfaith U.S., Techfaith Shenzhen, its joint
venture interest in STEP Technologies. The Company and all of its subsidiaries, including
STEP Technologies, are collectively referred to as the Group.The Group is principally engaged in the provision of customized handset design solutions,
which span the entire handset development cycle, from market and industry research, through
detailed design and prototype testing, to pilot production and production support. The
Group designs handsets for use on Global System for Mobile Communications (GSM)/General
Packet Radio Services (GPRS), Code Division Multiple Access (CDMA) and Wideband CDMA (WCDMA)
networks based on major baseband technology platforms, including those developed by
QUALCOMM, Inc., Philips AG and Texas Instruments, Inc.In March 2003, the Group commenced its planned principal operations.On November 9, 2004, all issued shares of Techfaith BVI were converted into ordinary shares
of the Company, who then became the holding company of the Group.
 F - 7




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies
 (a)
    
    Basis of PresentationThe consolidated financial statements of the Group have been prepared in accordance
with the accounting principles generally accepted in the United States of America
(U.S. GAAP).(b)
    
    Basis of ConsolidationThe consolidated financial statements include the financial statements of the Company
and its majority-owned subsidiaries. All significant intercompany transactions and
balances are eliminated on consolidation.(c)
    
    Cash and Cash EquivalentsCash and cash equivalents consist of cash on hand, demand deposits and highly liquid
investments, which are unrestricted as to withdrawal and use, and which have
maturities of three months or less when purchased.(d)
    
    Notes receivableNotes receivable represent bank and commercial acceptance drafts that are
non-interest bearing and due within one year.(e)
    
    Marketable SecuritiesMarketable securities primarily consist of debt securities and are classified as
available for sale marketable securities. Investments with maturities beyond one
year may be classified as short-term based on their liquid nature and because such
securities available for current operations. Marketable securities are carried at
fair market value with unrealized gains (losses) reported as a component of
accumulated other comprehensive income in shareholders equity. The specific
identification method is used to determine the cost of securities. Realized gains
and losses are reflected in other income in the Statement of Operation.(f)
    
    Use of EstimatesThe preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses in the financial statements and
accompanying notes. Significant accounting estimates reflected in the groups
financial statements include revenue recognition, allowance for doubtful accounts,
useful lives and impairment for plant, machinery and equipment and intangible assets,
and valuation allowance for deferred tax assets.
 F - 8




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (g)
    
    Certain Significant Risks and UncertaintiesThe Group participates in a dynamic high technology industry and believes that
changes in any of the following areas could have a material adverse effect on the
Groups future financial position, results of operations, or cash flows: changes in
the overall demand for customized handset design solutions; competition from other
competitors; advances and trends in new technologies and industry standards; changes
in certain strategic relationship or customer relationships; regulatory or other
factors; risks associated with the Groups ability to attract and retain employees
necessary to support its growth; pressures in the form of new products or price
reductions on current products; and changes in third party manufacturers.(h)
    
    Plant, Machinery and Equipment, NetPlant, machinery and equipment, net are carried at cost less accumulated depreciation
and amortization. Depreciation and amortization are calculated on a straight-line
basis over the following estimated useful lives:
 Leasehold improvements
    
    Shorter of the lease terms or 4 yearsMotor vehicles
    
    4 yearsPlant and machinery
    
    4 yearsFurniture, fixtures and equipment
    
    4 yearsSoftware
    
    3 years
 (i)
    
    Acquired Intangible Assets, NetAcquired intangible assets, net have definite lives and are capitalized and amortized
on a straight-line basis over their expected useful economic lives as summarized in
Note 9.(j)
    
    InventoriesInventories are stated at the lower of cost or market. Cost is determined using the
weighted average method.(k)
    
    Impairment of Long-Lived AssetsThe Group reviews its long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may no longer be
recoverable. When these events occur, the Group measures impairment by comparing the
carrying value of the long-lived assets to the estimated undiscounted future cash
flows expected to result from the use of the assets and their eventual disposition.
If the sum of the expected undiscounted cash flow is less than the carrying amount of
the assets, the Group would recognize an impairment loss based on the fair value of
the assets.(l)
    
    Research and Development CostsResearch and development costs are expensed as incurred.
 F - 9




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (m)
    
    Revenue RecognitionThe Groups revenues are primarily derived from design and development of handset
solutions, and to a lesser extent, sales of component products which include the sale
of printed circuit board (PCB), wireless modules and other electronic components.
The Group earns its revenue mainly through design fee, royalties, and sales of
component products. The Group recognizes revenue when persuasive evidence of an
arrangement exists, the fee is fixed or determinable, collection is reasonably
assured, and in the period in which delivery or performance has occurred.Design fee is generated from design and development of handset solutions for
customers. The handset design process normally includes industry, hardware,
software, mechanical engineering design, testing and quality assurance, pilot
production, production support and other incidental support requested by customers.
Because the software element of the handset has been deemed more than incidental for
the handset design process taken as a whole, the Company recognizes revenues in
accordance with Statement of Position (SOP) 97-2. The handset design process
requires significant production, development and customization of software,
accordingly, as prescribed by SOP97-2 revenue is recognized using the percentage of
completion method in accordance with SOP81-1, Accounting for Performance of
Construction Type and Certain Performance Type Contracts. In general, three
milestones are identified in the Groups design contracts with customers. When the
mobile handset design receives the approval verifying its conformity with applicable
industry standards, in the case of GSM-based handsets, the full type approval, or
FTA, for its conformity with GSM standards, the Group achieves the first milestone
with respect to the design. When the mobile handset design receives regulatory
approval for its use in the intended country, in the case of China, a China type
approval, or CTA, the Group achieves the second milestone. When the customer accepts
the mobile handset design and is ready to begin mass production of mobile handsets
based on the Groups design, the Group achieves the last milestone, which the Group
refers to as shipping acceptance, or SA. The Group recognizes revenue only upon
achievement of each milestone (i.e. FTA, CTA and SA), which is consistent with the
use of an output measure. The percentage of completion designated for each
milestone, however, is the percentage that would be obtained by using an imput
measure (i.e. labor hours and other relevant costs incurred). The Group believes
that designating the percentage of completion for each milestone based on labor hours
and other relevant costs incurred, as opposed to by reference to the amounts that
become billable at the milestone, is more reflective of the progress completed
through the date of the milestone. In the event that a milestone has not been
reached, the associated cost is deferred and revenue is not recognized until the
milestone has been achieved and/or accepted by the customer.
 F - 10




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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (m)
    
    Revenue Recognition continuedRecognized revenues and profit are subject to revisions as the contract progresses to
completion. Revisions in profit estimates are charged to income in the period in
which the facts that give rise to the revision become known. When current cost
estimates indicate a loss is expected to be incurred, the entire loss is recorded in
the period in which it is identified.Amounts billed in excess of revenue recognized are recorded as advance from
customers.In addition, design fee is also generated from the sale of customerized handset
software and/or hardware design in other design contracts with customers. Revenue is
recognized when the Company delivers its design to customer and the customer signs
the acceptance report.Royalty income is derived from a variable prescribed rate for each unit of handset
manufactured by the customer as the Group retains the design of schematic and layout
of the PCB of the handset.Revenue from sales of component products, including PCBs, wireless modules and other
electronics components is recognized upon delivery of the component products. The
customer orders the component products it requires to manufacture mobile handsets
from the Group. The Group then outsources the production of the component products
to outside manufactures. The Group records the gross amounts billed to its customers
as the Group is the primary obligor in these transactions as the Group has latitude
in establishing prices, the Group is involved in the determination of the service
specifications, the Group bears the credit risk, the Group bears the inventory risk
and the Group has the right to select the suppliers.The Group presents sales net of business tax incurred, which amounts to $523, Nil and
$185 for the year ended December 31, 2003, 2004 and 2005, respectively.(n)
    
    Income TaxesDeferred income taxes are recognized for temporary differences between the tax basis
of assets and liabilities and their reported amounts in the financial statements, net
operating loss carryforwards and credits by applying enacted statutory tax rates
applicable to future years. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion or
all of the deferred tax assets will not be realized. Current income taxes are
provided for in accordance with the laws of the relevant taxing authorities.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (o)
    
    Comprehensive IncomeComprehensive income included unrealized gains and losses on investments and foreign
currency translation adjustments and is reported in the consolidated statement of
shareholders equity.(p)
    
    Foreign Currency TranslationThe functional currency of the Companys subsidiaries established in the PRC is
Renminbi (RMB). Transactions denominated in currencies other than RMB are
translated into RMB at the exchange rates quoted by the Peoples Bank of China (the
PBOC) prevailing at the dates of the transactions. Monetary assets and liabilities
denominated in foreign currencies are translated into RMB using the applicable
exchange rates quoted by the PBOC at the balance sheet dates. The resulting exchange
differences are included in the statement of operations.The Company has determined that the U.S. dollar is its functional and reporting
currency. Accordingly, assets and liabilities are translated using exchange rates in
effect at each year end and average exchange rates are used for the consolidated
statements of operations. Translation adjustments resulting from translation of these
consolidated financial statements are reflected as accumulated other comprehensive
income included in the shareholders equity.(q)
    
    Share-based compensationThe Company grants stock options to its employees and directors of the Group. The
Group has elected to account for its stock option plan using the fair value method in
accordance with Statement of Financial Accounting Standards (SFAS) No. 123
Accounting for Stock-Based Compensation. Under the fair value method, compensation
expense is measured at the grant date based on the value of the award and is
recognised over the applicable service period, which is usually the vesting period.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (r)
    
    Concentration of Credit RiskFinancial instruments that potentially expose the Group to concentrations of credit
risk consist primarily of cash and cash equivalents, and accounts receivable. The
Group places its cash and cash equivalents with financial institutions with
high-credit ratings and quality.The Group conducts credit evaluations of customers and generally does not require
collateral or other security from its customers; however, upfront deposit based on a
portion of the design fee under the contract will generally be required to be
received when the design contract is entered into. The Group establishes an
allowance for doubtful accounts primarily based upon the age of the receivables and
factors surrounding the credit risk of specific customers.(s)
    
    Fair Value of Financial InstrumentsThe carrying amounts of cash and cash equivalents, account receivables, note
receivable, accounts payable, accrued liabilities and advance from customers
approximate their fair values due to the short-term maturity of these instruments.(t)
    
    Advertising CostsThe Group expenses advertising costs as incurred and such expenses were minimal for
the periods presented. Advertising costs have been included as part of selling and
marketing expenses.(u)
    
    Government subsidiesGovernment subsidies are recognized when received and all the conditions for their
receipt have been met. Government subsidies are recognized as other income in the
consolidated statements of income and comprehensive income in the period in which the
related expenditure are recorded. Capital grants for the acquisition of equipment
are recorded as a liability until earned and then offset against the related capital
assets.(v)
    
    Net Income Per ShareBasic net income per share is computed by dividing net income by the weighted average
number of ordinary shares outstanding during the period. Diluted net income per
ordinary share reflects the potential dilution that could occur if securities or
other contracts to issue ordinary shares were exercised or converted into ordinary shares.
Ordinary share equivalents are excluded from the computation of the diluted
net loss per share in periods when their effect would be anti-dilutive.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (w)
    
    Segment ReportingThe Group operates and manages its business as a single segment. The Group primarily
generates its revenues from customers in the PRC, and accordingly, no geographical
information is presented.(x)
    
    Recently Issued Accounting PronouncementsIn December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R).
Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123R supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees. Generally, the
approach in SFAS No. 123R is similar to the approach described in SFAS No. 123.
However, SFAS No. 123R requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based on
the grant-date fair values. The new standard, as recently amended, will be effective
for the Group in the annual reporting period beginning after January 1, 2006. The
Group has applied the provision of SFAS No. 123R and it did not have a significant
effect on the Groups financial position or results of operations.In March 2005, the FASB issued FASB Interpretation No. (FIN) 47, Accounting for
Conditional Asset Retirement Obligations, an interpretation of SFAS No. 143.FIN 47
clarifies that an entity is required to recognize a liability for a legal obligation
to perform an asset retirement activity if the fair value can be reasonably estimated
even though the timing and/or method of settlement are conditional on a future event.
FIN 47 is required to be adopted for annual reporting periods ending after December
15, 2005. The Group is evaluating the effect of the adoption of FIN 47. It is not
expected to have a material impact on the Groups financial position, results of
operations or cash flows.In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections
(SFAS 154) which replaces Accounting Principles Board Opinions No. 20, Accounting
Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial
Statements  An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the
accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable date, as the
required method for reporting a change in accounting principle and the reporting of a
correction of an error. SFAS 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. The Group does not
anticipate that the adoption of this statement will have a material effect on the
Groups financial position or results of operations.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 2.
    
    Summary of Significant Accounting Policies  continued
 (x)
    
    Recently Issued Accounting Pronouncements- continuedIn September 2005, the FASBs Emerging Issues Task Force (EITF) reached a final
consensus on Issue 04-13, Accounting for Purchases and Sales of Inventory with the
Same Counterparty. EITF 04-13 requires that two or more legally separate exchange
transactions with the same counterparty be combined and considered a single
arrangement for purposes of applying APB Opinion No. 29, Accounting for Nonmonetary
Transactions, when the transactions are entered into in contemplation of one
another. EITF 04-13 is effective for new arrangements entered into, or modifications
or renewals of existing arrangements, in interim or annual periods beginning after
March 15, 2006. The Group does not expect this provision to have a material impact
on the Groups financial position, results of operations or cash flows.In November 2005, the Financial Accounting Standards Board (FASB) issued SFAS No.
151, Inventory Costs  an amendment of ARB No. 43, Chapter 4. SFAS No. 151
clarifies the accounting that requires abnormal amounts of idle facility expenses,
freight, handling costs, and spoilage costs to be recognized as current-period
charges. It also requires that allocation of fixed production overheads to the costs
of conversion be based on the normal capacity of the production facilities. SFAS No.
151 will be effective for inventory costs incurred on or after July 1, 2005. The
adoption of this standard did not have a material effect on the Groups financial
position or results of operations.In December 2005, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets  an
amendment of APB Opinion No. 29 (SFAS 153), which amends Accounting Principles
Board Opinion No. 29, Accounting for Nonmonetary Transactions to eliminate the
exception for nonmonetary exchanges of similar productive assets and replaces it with
a general exception for exchanges of nonmonetary assets that do not have commercial
substance. SFAS 153 is effective for nonmonetary assets exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this statement did not have a
material effect on the Groups financial position or results of operations.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 3.
    
    Accounts ReceivableAccounts receivable consists of the following:
 December 31,2004
    
    
    2005Billed receivables
    
    $
    6,183
    
    
    $
    17,991Unbilled receivables
    
    
    1,577
    
    
    
    16,069$
    7,760
    
    
    $
    34,060
 Unbilled receivables represent amounts earned under design service contracts in progress but
not billable at the respective balance sheet dates. These amounts become billable according
to the contract terms, which usually consider the achievement of certain milestones or
completion of the project. The Group anticipates that substantially all of such unbilled
amounts will be billed and collected within twelve months of balance sheet date.4.
    
    Marketable securitiesMarketable securities, carried in the accompanying balance
sheets at estimated
market value consist of the following:
 December 31, 2004Gross
    
    
    Estimatedunrealized
    
    
    MarketCost
    
    
    gains
    
    
    valueCorporate bond due after one year
through five years
    
    $
    314
    
    
    $
    32
    
    
    $
    346
 No marketable securities were held by the Group as of December 31, 2005.5.
    
    DepositAs of December 31, 2004, the Group placed deposit amounting to $3,740 with a securities
house pending investment opportunities in the PRC capital market. The deposit was unsecured
and bore interest at prevailing commercial rates. During 2005, the entire deposit was
utilized in the acquisition of marketable debt securities.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 6.
    
    InventoriesInventories consist of the following:
 December 31,2004
    
    
    2005Work in progress
    
    $
    3,445
    
    
    $
    2,865Component products
    
    
    1,585
    
    
    
    2,109$
    5,030
    
    
    $
    4,974
 7.
    
    Prepaid Expenses and Other Current AssetsPrepaid expenses and other current assets consist of the following:
 December 31,2004
    
    
    2005Prepaid expenses
    
    $
    1,552
    
    
    $
    413Staff advances
    
    
    176
    
    
    
    180Business and value added taxes recoverable
    
    
    77
    
    
    
    3Other
    
    
    449
    
    
    
    330$
    2,254
    
    
    $
    926
 8.
    
    Plant, Machinery and Equipment, NetPlant, machinery and equipment, net consist of the following:
 December 31,2004
    
    
    2005Leasehold improvements
    
    $
    1,817
    
    
    $
    4,431Motor vehicles
    
    
    88
    
    
    
    215Plant and machinery
    
    
    5,697
    
    
    
    9,349Furniture, fixtures and equipment
    
    
    2,418
    
    
    
    4,757Software
    
    
    2,313
    
    
    
    2,904Total
    
    
    12,333
    
    
    
    21,656Less: Accumulated depreciation and
amortization
    
    
    (2,777
    )
    
    
    (7,173
    )Plant, machinery and equipment, net
    
    $
    9,556
    
    
    $
    14,483
 The Group also paid deposits for acquisitions of plant, machinery and equipment, amounted to
$529 and $597 as of December 31, 2004 and 2005, respectively.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 9.
    
    Acquired Intangible Assets, Net
 Acquired intangible assets, net consist of the following:
 December 31,2004
    
    
    2005Cost:Technology
    
    $
    60
    
    
    $
    60Licenses
    
    
    1,216
    
    
    
    1,489Royalty rights
    
    
    725
    
    
    
    7252,001
    
    
    
    2,274Accumulated amortization:Technology
    
    
    (60
    )
    
    
    (60
    )Licenses
    
    
    (271
    )
    
    
    (643
    )Royalty rights
    
    
    (725
    )
    
    
    (725
    )(1,056
    )
    
    
    (1,428
    )Acquired intangible assets, net
    
    $
    945
    
    
    $
    846
 In 2003, the Group acquired a technology for monochrome screen interface of cellular phone
from a third party for $483. Due to technological advancement and market changes, the Group
ceased the design and development of monochrome screen cellular phone in the same year and
recognized a non-cash impairment charge of this acquired technology. The Group evaluated
the recoverability of the acquired intangible asset and fully wrote off its then carrying
value of $423 as the asset was no longer expected to recover its net book value through
future cash flows.In 2004, the Group acquired royalty rights for cellular phone project co-operation
agreements from Beijing Qidi Century Communication Technology Limited (Qidi Century), a
then former equity affiliate, through a litigation settlement on behalf of Qidi Century and
certain management members of the Group. The royalty rights were recorded at their
estimated fair market value of $725 and were amortized over their estimated economic life of
1 year.In 2004 and 2005, the Group also acquired licenses for technology platform from third
parties for $1,216 and $273, respectively, which are amortized over the shorter of the
useful economic life of the relevant technology platform or license period, which is usually
2 to 5 years.The Group has recorded amortization expense of $60, $996 and $372 for the years ended
December 31, 2003, 2004 and 2005, respectively. The Group will record $378, $245, $164 and
$59 for 2006, 2007, 2008 and 2009, respectively.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 10.
    
    Accrued Expenses and Other Current Liabilities
 Accrued expenses and other current liabilities consist of the following:
 December 31,2004
    
    
    2005Accrued interest
    
    $
    997
    
    
    $
    Accrued professional fees
    
    
    927
    
    
    
    996Payable for acquisition of plant,
machinery and equipment
    
    
    765
    
    
    
    595Accrued wages
    
    
    611
    
    
    
    3,404Warranty provision
    
    
    508
    
    
    
    1,643Business and value added tax payable
    
    
    255
    
    
    
    465Payable for certification fees
    
    
    188
    
    
    
    78Government subsidies
    
    
    97
    
    
    
    1,442Rental payable
    
    
    43
    
    
    
    95Other
    
    
    226
    
    
    
    996$
    4,617
    
    
    $
    9,714
 11.
    
    Income TaxesThe Company is a tax exempted company incorporated in the Cayman Islands.Under the current BVI law, income from Techfaith BVI, Great Earnest, Leo Technology, Finest
Technology, Infoexcel Technology, and Boost Time is not subject to taxation.Hong Kong Profits Tax is calculated at 17.5% of the estimated profit of Techfaith HK for the
year ended December 31, 2005. No provision for Hong Kong Profits Tax was made for the year
ended December 31, 2004 as Techfaith HK had no assessable profit for that year.No provision for United States Federal and state income taxes was made for the year ended
December 31, 2005 as Techfaith U.S. had no assessable profit for the year.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 11.
    
    Income Taxes  continuedThe subsidiaries incorporated in the PRC are governed by the Income Tax Law of the PRC
Concerning Foreign Investment Enterprises and Foreign Enterprises and various local income
tax laws (Income Tax Laws). Pursuant to the PRC Income Tax Laws, the foreign investment
enterprises are subject to income tax at a statutory rate of 33% (30% of state income tax
plus 3% local income tax) on PRC taxable income. However, preferential tax treatment as
new and high technology companies has been agreed for Techfaith China, Techfaith Beijing
and STEP Technologies with the relevant tax authorities and effective in 2003, 2003 and
2004, respectively. All new and high technology companies are entitled to a preferential
tax rate of 15% and are entitled to a three-year exemption from income tax, followed by a
50% reduction in tax rates for the succeeding three years, in accordance with the Income Tax
Laws of the PRC. Techfaith Shanghai is qualified as productive enterprise and has been
agreed with the relevant tax authorities for a two-year exemption from income tax, followed
by a 50% reduction in tax rates for the succeeding three years effective 2005. For the
newly established company, Techfaith Shenzhen, is also qualified as productive enterprise
and has been agreed by the relevant tax authorities to entitle to a two-year exemption from
income tax, followed by a 50% reduction in tax rate for succeeding three years effective
upon the first assessable profit year. As of December 31, 2005, Techfaith Intelligent
Handset Beijing is in the process of making an application to the relevant tax authorities
for the new and high technology status.The current and deferred components of the income tax expense appearing in the consolidated statements of operation are as follows:
 Year Ended December 31,2003
    
    
    2004
    
    
    2005Current tax
    
    $
    
    
    
    $
    
    
    
    $
    54Deferred tax
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    54
 The principal components of the Groups deferred tax assets and liabilities are as follows:
 December 31,2004
    
    
    2005Deferred tax assets:Depreciation and amortization
    
    $
    44
    
    
    $
    273Expenditure deductible for tax purpose in future
years warranty provision
    
    
    16
    
    
    
    104Deferred tax liability:Revenue taxable for tax purpose in future years
    
    
    
    
    
    
    (134
    )Valuation allowance
    
    
    (60
    )
    
    
    (243
    )$
    
    
    
    $
    
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CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 11.
    
    Income Taxes  continuedAs the management does not believe that it is more likely than not that all of the deferred
tax asset will be realized a full valuation allowance has been established as of December
31, 2004 and 2005.A reconciliation between the provision for income tax computed by PRC enterprise income tax
rate of 15% to income before income taxes and actual provision for income taxes is as
follows:
 Year Ended December 31,2003
    
    
    2004
    
    
    2005Tax provision at PRC enterprise
income tax rate of 15%
    
    $
    737
    
    
    $
    2,733
    
    
    $
    6,436Tax exemption granted to a PRC
subsidiary
    
    
    (852
    )
    
    
    (3,170
    )
    
    
    (5,736
    )Effect of the different income tax rate
in other jurisdiction
    
    
    
    
    
    
    334
    
    
    
    (473
    )Tax effect of tax losses not recognized
    
    
    115
    
    
    
    163
    
    
    
    10Changes in valuation allowances
    
    
    
    
    
    
    (60
    )
    
    
    (183
    )$
    
    
    
    $
    
    
    
    $
    54
 Tax that would have been payable without the tax exemptions amounts to approximately $852,
$3,170 and $5,736 for the year ended December 31, 2003, 2004 and 2005, respectively,
representing a decrease in the basic and diluted earnings per share of $0.004, $0.006 and
$0.010, $0.004, $0.006 and $0.009 for the year ended December 31, 2003, 2004 and 2005,
respectively.12.
    
    Convertible NotesOn December 19, 2003, Techfaith BVI issued eight convertible notes in an aggregate principal
amount of $4,000 to a strategic investor (the 1st Notes). The 1st Notes were
interest-free; however, should any dividend be declared and distributed by Techfaith BVI, a
special interest payment calculated based on an as converted basis as if the notes had
been converted into ordinary shares of Techfaith BVI, was payable to the noteholder. The
conversion price for the notes was subject to certain adjustments and was $0.234 per
ordinary share of Techfaith BVI initially. The holder of the 1st Notes could convert the
notes into such shares at any time during the period from the date of issuance to December
19, 2005 or the date of listing of the shares of the Company on The Stock Exchange of Hong
Kong Limited, whichever was earlier.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 12.
    
    Convertible Notes  continuedOn April 16, 2004, the 1st Notes were, at the election of the
noteholder, cancelled and replaced with new notes with the same
principal amount, which was issued by Techfaith BVI concurrently with
the issuance of additional convertible notes in an aggregate principal
amount of $10,000 to three other strategic investors (hereinafter
collectively referred to as 2nd Notes) pursuant to a note
subscription and rights agreement dated April 9, 2004 (the
Agreement) with the same interest terms as the 1st Notes. The
conversion price for the 2nd Notes was $0.212 per ordinary share of
Techfaith BVI, subject to certain adjustments and could be converted
into such shares at any time from the date of issuance to April 16,
2007. The notes not previously converted or repaid, would be
automatically converted into ordinary shares of Techfaith BVI or its
parent company without any further action of any party, into that
number of ordinary shares pursuant to the then effective conversion
price, upon the closing of Techfaith BVIs or its parent companys
initial public offering or a substantial sale of the shares in
Techfaith BVI pursuant to the relevant terms as stipulated in the
Agreement. After April 16, 2007, the holders of the then outstanding
notes may require Techfaith BVI to redeem all or part of the notes
upon occurrence of certain events, including an event of default or
Techfaith BVIs merger or consolidation with another entity. The
redemption price is the greater of (a) principal amount plus accrued
and unpaid interest or (b) the fair value of the ordinary shares into
which such notes are convertible.The embedded conversion option of the convertible notes has been
recorded at its fair value of $2,818 at the issuance and accounted for
separately as a derivative liability. The Group accounted for the
derivative liability relating to the conversion option by adjusting
the liability to its estimated fair value at each subsequent balance
sheet date before the conversion, with adjustments recorded as other
non-operating income or expense.The holders of the 2nd Notes had on April 1, 2005 waived their rights
to require the Group to redeem the 2nd Notes at the holders election
upon occurrence of certain events after April 16, 2007, thereby ceased
the adjustment of the liabilities to its estimated fair value at each
reporting date.Upon the completion of initial public offering of American Depositary
Shares (ADSs) of the Company on May 6, 2005, all the then
outstanding convertible notes were converted automatically into shares
of the Company pursuant to the terms of the Agreement.13.
    
    Share-based compensationIn March 2005, the Group adopted the 2005 share Incentive Plan (the Plan) which allows the
Group to offer a variety of incentive awards to employees and directors of the Group. For
the year ended December 31, 2005, options to purchase 40,000,000 ordinary shares were
authorised under the Plan. Under the terms of the Plan, options are generally granted at
prices equal to the fair market value of the Groups shares listed on NASDAQ and expire 10
years from the date of grant. The options vest in accordance with the terms of the
agreement separately entered into by the Group and grantee at the time of the grant.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
 13.
    
    Share-based compensation  continuedIn 2005, the Group granted 263,272 share options to purchase ordinary shares to the then two
independent directors which would vest entirely in November 2005. The Group recorded a
stock-based compensation expense of $162 for the year ended December 31, 2005 using the fair
value method in accordance with SFAS No. 123. There are 39,736,728 remaining options to be
issued under the Plan.The fair value of the options granted is estimated on the date of grant using Black-Scholes
option pricing model with the following assumptions used.
 Option grants to independent directors
    
    2005Average risk-free rate of return
    
    
    4.1
    %Weighted average expected option life
    
    10 yearsVolatility rate
    
    
    35
    %Dividend yield
    
    Nil
 A summary of the stock option activity is as follows:
 WeightedaverageNumber of
    
    
    exerciseoptions
    
    
    priceOptions granted during 2005 and outstanding at
December 31, 2005
    
    
    263,272
    
    
    $
    1.083
 The fair value of option as of the grant date was $0.62 and they are all exercisable as of
December 31, 2005 with a remaining contractual life of 9.7 years.14.
    
    Ordinary SharesIn March 2005, the Groups shareholders approved a 50,000-for-1 share split. All share and
per share data have been restated to give retroactive effect to this share split.In May 2005, the Group offered 6,143,045 ADSs, representing 92,145,675 ordinary shares, to
the public and listed the ADSs on the NASDAQ stock market.Upon the Groups initial public offering in May 2005, all of the outstanding convertible
notes were converted into an aggregate of 66,037,734 ordinary shares of the Group.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
  15.
    Related Party Transactions Transactions with Directors and Management MembersIn October 2003, Techfaith China, and Mr. Dong Defu, a director of Techfaith BVI, and Mr.
Fang Yibo and Mr. Liu Jun, management members of Techfaith China, entered into a patent
application transfer agreement pursuant to which Mr. Dong Defu, Mr. Fang Yibo and Mr. Liu
Jun agreed to transfer a patent application to Techfaith China for nil consideration.Transactions with Beijing Sino-Electronics Future Telecommunication R&D, Ltd. (SEF)A principal shareholder of the Company was during the relevant time periods below, a
principal shareholder in SEF. On January 18, 2004, SEF, Techfaith China and Skyworks
Solutions, Inc. (Skyworks) entered into an agreement pursuant to which SEF assigned to
Techfaith China all the rights under an April 2002 development and license agreement between
SEF and Skyworks in return for Techfaith Chinas payment of $338 to SEF. The consideration
was determined based on the remaining pro rata share of the total license fee previously
paid by SEF to Skyworks for the five-year license period.On September 18, 2003, an external customer, SEF and Techfaith China entered into an
agreement pursuant to which SEF assigned and novated to Techfaith China without
consideration all the rights and obligations under three product technology development
cooperation agreements entered into between the outside customer and SEF. Under the
assignment and novation agreement, SEF agreed to act as guarantor of the obligations of
Techfaith China and continue to observe certain restrictions.On October 20, 2003, Techfaith China and SEF entered into five transfer agreements pursuant
to which SEF agreed to transfer to Techfaith China without consideration three patents and
two patent applications that were principally developed by certain key members of SEF who
subsequently joined Techfaith China.For the year ended December 31, 2003, 2004 and 2005, the Group reimbursed SEF an aggregate
amount of $294, Nil and Nil, respectively, for certain staff remuneration that SEF paid on
behalf of the Group.The Group also entered into a lease agreement dated July 31, 2003 with SEF with respect to
office premises in Beijing which expires in July 2008. During the term of the lease, the
Group are required to pay SEF a quarterly rent of $34. The lease agreement was assigned
from SEF to a third party during 2005 upon disposal of the premises to the third party.Transaction with an employeeIn 2005, the Group sold component products to a corporate customer, in which 30% of
shareholding is owned by an employee of the Group. Total net revenues for 2005 amounted to
$1,622 and the related accounts receivable as of December 31, 2005 was $1,622.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
  16.
    Segment and Geographic Information The Groups chief operating decision maker has been identified as the Chief Executive
Officer, who reviews consolidated results when making decisions about allocating resources
and assessing performance of the Group. The Company believes it operates in one segment,
and all financial segment information can be found in the consolidated financial statements.Geographic InformationThe Group operates in the PRC and all of the Groups long lived assets are located in the
PRC.
  17.
    Commitments (a)
    Operating lease as lessee
 The Group leases certain office premises under non-cancelable leases which expire in
2009. The Group also leased certain plant and machinery during the year ended
December 31, 2003. Rental expense under operating leases for the years ended
December 31, 2003, 2004 and 2005 were $457, $509 and $963, respectively.
 Future minimum lease payments under non-cancelable operating lease agreements as of
December 31, 2005 were as follows:
 Fiscal year ending2006
    
    $
    1,7872007
    
    
    1,6272008
    
    
    1,3002009
    
    
    321Total
    
    $
    5,035
 (b)
    Capital commitments
 Capital commitments for purchase of plant, machinery and equipment as of December 31,
2003, 2004 and 2005 were $299, $655 and $418, respectively.The Company is also committed to contribute approximately $1,239 as paid-in capital
in a newly established foreign investment enterprise in China where the Company will
hold a minority interest pursuant to a joint venture agreement entered into with a
third party during 2005.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
  17.
    Commitments  continued (c)
    Product warranty
 The Groups product warranty relates to the warranties to the Groups customers on
the hardware and software design component of the mobile handset for a period of one
to three years commencing upon the mass production of the mobile handset.
Accordingly, the Groups product warranty accrual reflects managements best estimate
of probable liability under its product warranties. Management determines the
warranty based on historical experience and other currently available evidence.
 Year endedDecember 31,2004
    
    
    2005Balance at beginning of year
    
    $
    48
    
    
    $
    508Current period provision
    
    
    820
    
    
    
    2,426Utilized during the year
    
    
    (360
    )
    
    
    (1,291
    )Balance at end of year
    
    $
    508
    
    
    
    1,643
  18.
    Major Customers The following table summarizes net revenues and accounts receivable for customers which
accounted for 10% or more of the Groups net revenues and accounts receivable:
 Net revenuesYear ended December 31,2003
    
    2004
    
    2005A
    
    
    42.6
    %
    
    
    32.0
    %
    
    
    41.2
    %B
    
    
    N/A
    
    
    
    8.8
    %
    
    
    8.0
    %C
    
    
    13.1
    %
    
    
    10.2
    %
    
    
    N/AD
    
    
    32.5
    %
    
    
    5.8
    %
    
    
    N/A88.2
    %
    
    
    56.8
    %
    
    
    49.2
    %
 Accounts receivableYear ended December 31,2003
    
    2004
    
    2005A
    
    
    52.8
    %
    
    
    46.1
    %
    
    
    44.8
    %B
    
    
    N/A
    
    
    
    13.3
    %
    
    
    15.8
    %C
    
    
    7.7
    %
    
    
    9.2
    %
    
    
    N/AD
    
    
    37.8
    %
    
    
    0.7
    %
    
    
    N/A98.3
    %
    
    
    69.3
    %
    
    
    60.6
    %
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
  19.
    Net income per share The following table sets forth the computation of basic and diluted net income per share for the years
indicated:
 Year ended December 31,2003
    
    
    2004
    
    
    2005Net income (numerator), basic
    
    $
    4,956
    
    
    $
    18,244
    
    
    $
    41,385Effect of dilutive securities: convertible notes
    
    
    11
    
    
    
    840
    
    
    
    490Net income (numerator), diluted
    
    $
    4,967
    
    
    $
    19,084
    
    
    $
    41,875Shares (denominator):Weighted average ordinary shares outstanding used
in computing basic net income per share
    
    
    242,465,753
    
    
    
    500,000,000
    
    
    
    604,011,009Effect of dilutive securities:Weighted average shares from assumed conversions of
convertible notes
    
    
    608,828
    
    
    
    51,823,942
    
    
    
    22,615,662Weighted average shares used in computing diluted
net income per share
    
    
    243,074,581
    
    
    
    551,823,942
    
    
    
    626,626,671Net income per share, basic
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.07Net income per share, diluted
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.07
 As of December 31, 2005, the Company had 263,272 ordinary shares equivalents
outstanding that could have potentially diluted basic income per share in the future, but
which were excluded in the computation of diluted income per share in the year presented, as
their effect would have been anti-dilutive.
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##### Table of Contents



CHINA TECHFAITH WIRELESS COMMUNICATION TECHNOLOGY LIMITED
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  Continued
(In thousands of U.S. dollars, except share and per share data and unless otherwise stated)
  20.
    Mainland China Contribution and Profit Appropriation  Full time employees of the Group in the PRC participate in a government-mandated
multi-employer defined contribution plan pursuant to which certain pension benefits, medical
care, unemployment insurance, employee housing fund and other welfare benefits are provided
to employees. Chinese labor regulations require the Group to accrue for these benefits
based on certain percentages of the employees salaries. The total provisions for such
employee benefits were $8, $493 and $1,547 for the years ended December 31, 2003, 2004 and
2005, respectively.The Group is required to make contributions to the plan out of the amounts accrued for
medical and pension benefits to relevant local labor bureaus. The contributions for the
years ended December 31, 2003, 2004 and 2005 amounted to $4, $352 and $1,101, respectively.
The local labor bureaus are responsible for the medical benefits and pension liability to be
paid to these employees. The Group has no further commitments beyond its monthly
contribution.Pursuant to the laws applicable to the PRCs Foreign Investment Enterprises, the Companys
subsidiaries in the PRC registered as foreign-owned enterprise must make appropriations from
after-tax profit to non-distributable reserve funds as determined by the Board of Directors
of the relevant PRC subsidiaries. These reserves include a (1) general reserve, (2)
enterprise expansion fund and (3) staff bonus and welfare fund. Subject to certain
cumulative limits, the general reserve fund requires annual appropriations of not less than
10% of after-tax profit (as determined under accounting principles and financial regulations
applicable to PRC enterprises at each year-end); the other fund appropriations are at the
Groups discretion. These reserve funds can only be used for specific purposes and are not
distributable as cash dividends. Prior to the conversion into wholly foreign-owned
enterprises, Techfaith China and Techfaith Beijing, as domestic enterprises established in
the PRC, were also subject to similar statutory reserve funds requirements. The Company has
made appropriation to these statutory reserve funds of $3,454 and $633 for the year ended
December 31, 2004 and 2005, respectively.
  21.
    Subsequent events  On March 22, 2006, the Group entered into an agreement with Qualcomm Incorporated to
establish a wholly-owned foreign investment enterprise, Techfaith Software (China) Holding
Limited (Techfaith Software), in developing software applications for wireless
communication devices. According to the agreement, the Group will invest 70% in
shareholding in Techfaith Software by cash injection of US$17,500 and a transfer of certain
of its designs and licensed software.On March 23, 2006, the Group entered into agreements with an independent third party to
acquire certain properties in Beijing, the PRC, for an aggregate consideration of
approximately US$11,180. Pursuant to the agreements, the Group is committed to settle the
consideration by two instalments of US$6,222 and US$4,958 by July 30, 2006 and January 10,
2007, respectively.
  F-28