UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form 10-Q





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





For
the Quarterly Period Ended March 31, 2010





OR





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





For
the transition period
from            to





Commission
File No. 000-52934





ZST
DIGITAL NETWORKS, INC.


(Exact
name of Registrant as specified in its charter)





Delaware
              
              20-8057756(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer
                Identification
      No.)




Building
28, Huzhu Road


Zhongyuan
District, Zhengzhou, People’s Republic of China


(ADDRESS
OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)





(86)
371-6771-6850


(COMPANY’S
TELEPHONE NUMBER, INCLUDING AREA CODE)





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





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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filero
            
            Accelerated
      filer oNon-accelerated
      filerx
            
            Smaller
      reporting company o(Do
      not check if a smaller reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YesoNox




The
number of shares outstanding of the registrant’s common stock, par value $0.0001
per share, was 11,650,442 as of May 14, 2010.









ZST
DIGITAL NETWORKS, INC.





FORM 10-Q





For
the Quarterly Period Ended March 31, 2010





INDEX





Part I
                Financial
      InformationItem
      1.
                Financial
      Statements
                
                3Consolidated
      Balance Sheets
                
                F-1Consolidated
      Statements of Income and Comprehensive Income
                
                F-2Consolidated
      Statements of Cash Flows
                
                F-3Notes
      to Consolidated Financial Statements
                
                F-4Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                
                4Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                
                14Item
      4.
                Controls
      and Procedures
                
                14Part II
                Other
      InformationItem
      1.
                Legal
      Proceedings
                
                15Item
      1A.
                Risk
      Factors
                
                15Item
      2.
                Unregistered
      Sale of Equity Securities and Use of Proceeds
                
                15Item
      3.
                Default
      Upon Senior Securities
                
                15Item
      4.
                (Removed
      and Reserved)
                
                15Item
      5.
                Other
      Information
                
                15Item
      6.
                Exhibits
                
                15Signatures
                
                16




2




PART
I.  FINANCIAL INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to
Form 10-Q. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying unaudited consolidated financial
statements reflect all adjustments that, in the opinion of management, are
considered necessary for a fair presentation of the financial position, results
of operations, and cash flows for the periods presented. The results of
operations for such periods are not necessarily indicative of the results
expected for the full fiscal year or for any future period. The accompanying
unaudited consolidated financial statements should be read in conjunction with
the audited financial statements of ZST Digital Networks, Inc. as contained in
its Annual Report on Form 10-K for the year ended December 31, 2009 filed with
the Securities and Exchange Commission on March 31, 2010.




3




ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
BALANCE SHEETS


(In
US Dollars)





December 31,
                              
                              
                              March 31,2009
                              
                              
                              2010(Unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                              
                              $
                              13,627,992
                              
                              
                              $
                              20,779,792Accounts
      receivable
                              
                              
                              24,885,497
                              
                              
                              
                              18,142,693Inventories
                              
                              
                              1,245,803
                              
                              
                              
                              890,441Advance
      to suppliers
                              
                              
                              7,399,141
                              
                              
                              
                              7,587,147Other
      receivables
                              
                              
                              -
                              
                              
                              
                              11,764Prepaid
      expenses
                              
                              
                              1,064,499
                              
                              
                              
                              1,017,409Total
      current assets
                              
                              
                              48,222,932
                              
                              
                              
                              48,429,246Property,
      machinery, equipment and software, net
                              
                              
                              875,806
                              
                              
                              
                              2,361,819Intangible
      asset
                              
                              
                              171,122
                              
                              
                              
                              161,886Prepaid
      expenses – long term
                              
                              
                              858,609
                              
                              
                              
                              601,140Total
      assets
                              
                              $
                              50,128,469
                              
                              
                              $
                              51,554,091LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                              
                              $
                              700,940
                              
                              
                              $
                              31,951Advance
      from customers
                              
                              
                              376,586
                              
                              
                              
                              559,999Accruals
      and other payables
                              
                              
                              295,410
                              
                              
                              
                              376,135Accrued
      payroll and related expense
                              
                              
                              66,370
                              
                              
                              
                              108,385VAT
      payable
                              
                              
                              198,828
                              
                              
                              
                              204,042Franchise
      tax payable
                              
                              
                              162,100
                              
                              
                              
                              -Income
      tax payable
                              
                              
                              547,917
                              
                              
                              
                              473,574Total
      current liabilities
                              
                              
                              2,348,151
                              
                              
                              
                              1,754,086Equity
      :Common
      stock $0.0001 par value, 100,000,000 shares authorized, 11,650,442 and
      11,650,442 shares issued and outstanding
                              
                              
                              1,165
                              
                              
                              
                              1,165Additional
      paid-in capital
                              
                              
                              30,677,932
                              
                              
                              
                              30,677,932Appropriated
      earnings
                              
                              
                              3,328,345
                              
                              
                              
                              3,328,345Retained
      earnings
                              
                              
                              13,752,791
                              
                              
                              
                              15,722,446Translation
      adjustment
                              
                              
                              20,085
                              
                              
                              
                              70,117Total
      equity
                              
                              
                              47,780,318
                              
                              
                              
                              49,800,005Total
      liabilities and equity
                              
                              $
                              50,128,469
                              
                              
                              $
                              51,554,091





See
accompanying notes to financial statements




F-1




ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


FOR
THREE MONTHS ENDED MARCH 31, 2009 AND 2010


(In
US Dollars)




Three Months Ended March 31,2009
                                        
                                        
                                        2010( Unaudited)
                                        
                                        
                                        (Unaudited)Revenues:Sales
      of products
                                        
                                        $
                                        17,760,628
                                        
                                        
                                        $
                                        16,427,903Sales
      of services
                                        
                                        
                                        -
                                        
                                        
                                        
                                        620,375Total
      revenue
                                        
                                        
                                        17,760,628
                                        
                                        
                                        
                                        17,048,278Cost
      of sales:Cost
      of products sold
                                        
                                        
                                        14,844,279
                                        
                                        
                                        
                                        12,824,789Cost
      of service
                                        
                                        
                                        -
                                        
                                        
                                        
                                        49,497Cost
      of sales
                                        
                                        
                                        14,844,279
                                        
                                        
                                        
                                        12,874,286Gross
      profit
                                        
                                        
                                        2,916,349
                                        
                                        
                                        
                                        4,173,992Selling
      expense
                                        
                                        
                                        18,572
                                        
                                        
                                        
                                        267,305Research
      and development expenses
                                        
                                        
                                        -
                                        
                                        
                                        
                                        235,524General
      and administrative expenses
                                        
                                        
                                        355,779
                                        
                                        
                                        
                                        730,610Merger
      cost
                                        
                                        
                                        566,654
                                        
                                        
                                        
                                        -Income
      from operations
                                        
                                        
                                        1,975,344
                                        
                                        
                                        
                                        2,940,553Interest
      income (expense), net
                                        
                                        
                                        (81,381
                                        )
                                        
                                        
                                        1,615Other
      income (expense)
                                        
                                        
                                        3,004
                                        
                                        
                                        
                                        -Income
      before income taxes
                                        
                                        
                                        1,896,967
                                        
                                        
                                        
                                        2,942,168,Income
      tax provision
                                        
                                        
                                        650,609
                                        
                                        
                                        
                                        972,513Net
      income
                                        
                                        $
                                        1,246,358
                                        
                                        
                                        $
                                        1,969,655Weighted
      average shares of common stock outstanding – basic
                                        
                                        
                                        7,641,573
                                        
                                        
                                        
                                        11,650,442Earnings
      per share – basic
                                        
                                        
                                        0.16
                                        
                                        
                                        
                                        0.17Weighted
      average shares of common stock outstanding – diluted
                                        
                                        
                                        7,796,929
                                        
                                        
                                        
                                        11,650,442Earnings
      per shares – diluted
                                        
                                        
                                        0.16
                                        
                                        
                                        
                                        0.17Other
      comprehensive income:Net
      income
                                        
                                        
                                        1,246,358
                                        
                                        
                                        
                                        1,969,655Translation
      adjustment
                                        
                                        
                                        (422,664
                                        )
                                        
                                        
                                        50,032Comprehensive
      income
                                        
                                        $
                                        823,694
                                        
                                        
                                        $
                                        2,019,687




See
accompanying notes to financial statements.




F-2




ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Increase
(Decrease) in Cash and Cash Equivalents


(In
US Dollars)




Three Months Ended March 31,2009
                    
                    
                    2010(Unaudited)
                    
                    
                    (Unaudited)Cash
      flows from operating activities:Net
      income
                    
                    $
                    1,246,358
                    
                    
                    $
                    1,969,655Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                    
                    
                    5,085
                    
                    
                    
                    177,478Share-based
      compensation
                    
                    
                    -
                    
                    
                    
                    42,624Imputed
      interest
                    
                    
                    31,400
                    
                    
                    
                    -Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    (10,524,172
                    )
                    
                    
                    6,742,705Inventory
                    
                    
                    305,400
                    
                    
                    
                    355,357Advance
      to suppliers
                    
                    
                    2,226,258
                    
                    
                    
                    (188,003
                    )Other
      receivables
                    
                    
                    5,594
                    
                    
                    
                    (52,349
                    )Prepayments
      and other assets
                    
                    
                    -
                    
                    
                    
                    290,642Accounts
      payable
                    
                    
                    5,698,353
                    
                    
                    
                    (668,999
                    )Accruals
      and other payable
                    
                    
                    522,386
                    
                    
                    
                    (34,144
                    )Advance
      from customers
                    
                    
                    -
                    
                    
                    
                    183,416Taxes
      payable
                    
                    
                    250,440
                    
                    
                    
                    (74,344
                    )Net
      cash provided by (used in) operating activities
                    
                    
                    (232,898
                    )
                    
                    
                    8,744,038Cash
      flows from investing activities:Additions
      to fixed assets
                    
                    
                    -
                    
                    
                    
                    (1,640,318
                    )Advance
      made to ZST PRC shareholders
                    
                    
                    (1,740,376
                    )
                    
                    
                    -Net
      cash used in investing activities
                    
                    
                    (1,740,376
                    )
                    
                    
                    (1,640,318
                    )Cash
      flows from financing activities:Repayments
      for short term bank loans
                    
                    
                    (219,724
                    )
                    
                    
                    -Net
      proceeds from sale of preferred stock
                    
                    
                    2,946,440
                    
                    
                    
                    -Net
      cash received from financing activities
                    
                    
                    2,726,716
                    
                    
                    
                    -Effect
      of changes in foreign exchange rates
                    
                    
                    (7,092
                    )
                    
                    
                    48,080Net
      increase in cash and cash equivalents
                    
                    
                    746,350
                    
                    
                    
                    7,151,800Cash
      and cash equivalents, beginning of the year
                    
                    
                    1,134,954
                    
                    
                    
                    13,627,992Cash
      and cash equivalents, end of the period
                    
                    $
                    1,881,304
                    
                    
                    $
                    20,779,792





See
accompanying notes to financial statements.




F-3




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
1 – ORGANIZATION AND BUSINESS BACKGROUND




SRKP 18,
Inc.(“SRKP 18”) was incorporated in the State of Delaware on December 7,
2006.  SRKP 18 was originally organized as a “blank check” shell
company to investigate and acquire a target company or business seeking the
perceived advantages of being a publicly held corporation.





Zhengzhou
Shenyang Technology Co., Ltd. (“ZST PRC”) was established on May 20, 1996 as a
private domestic corporation located in Zhengzhou City, Henan Province, People’s
Republic of China (“PRC”) with an authorized capital of RMB1.5 million. On April
8, 1999, ZST PRC increased its authorized capital from RMB1.5 million to RMB8
million.  On July 27, 2004, ZST PRC further increased its authorized
capital to RMB18 million.  On March 15, 2007, ZST PRC decreased its
authorized and invested capital to RMB11.5 million. In February 2009, ZST PRC
increased its authorized capital to RMB17 million. On November 20, 2009, ZST PRC
increased its authorized capital to RMB100 million.





ZST PRC
has been principally engaged in supplying digital and optical network equipment
to cable system operators in the Henan Province of China and derived its revenue
from sales of broadcasting equipment, hi-tech optical transmission devices, and
telecommunication products.  It has developed a line of Internet
protocol television (“IPTV”) set-top boxes that are used to provide bundled
cable television, Internet and telephone services to residential and commercial
customers.  At present, ZST PRC’s main clients are broadcasting TV
bureaus and cable network operators serving various cities and counties in Henan
Province.  In the near future, ZST PRC plans to joint venture with
cable network operators to provide bundled television programming, Internet and
telephone services to residential customers in cities and counties located in
Henan Province of China.





Pursuant
to PRC rules and regulations relating to mergers of PRC companies with foreign
entities, an offshore company controlled by PRC citizens that intends to merge
with a PRC company will be subject to strict examination by the relevant PRC
foreign exchange and security authorities.  To enable ZST PRC to go
public, the original owners of ZST PRC made the following restructuring
arrangements: (i) established Everfair Technologies Limited (“Everfair”) as a
Hong Kong holding company owned by a non-PRC citizen and indirectly controlled
the operations of Everfair, (ii) had Everfair enter into an equity transfer
agreement with ZST PRC by paying RMB12 million to the original owners of ZST
PRC, (iii) established World Orient Universal Limited (“World Orient”) as a
British Virgin Islands (“BVI”) holding company owned by a non PRC-citizen, (iv)
had World Orient and its wholly owned subsidiary Global Asia Universal Limited
(“Global Asia”), its subsidiary Everfair, and its subsidiary ZST PRC enter into
a share exchange agreement with SRKP 18, (v) concurrently conducted a private
investment in a public entity (“PIPE”) financing, and (vi) used proceeds from
the PIPE financing to pay RMB12 million to the original owners of ZST PRC
pursuant to an ownership transfer agreement.





World
Orient was incorporated in the BVI on August 12, 2008.  At December
31, 2008, World Orient had 50,000 capital shares authorized with $1.00 par value
and 50,000 shares issued and outstanding.  In November 2008, World
Orient acquired 100% ownership of Global Asia.





Global
Asia was incorporated in the BVI on August 12, 2008. At December 31, 2008,
Global Asia had 50,000 capital shares authorized with $1.00 par value and 50,000
shares issued and outstanding.  In October 2008, Global Asia acquired
100% ownership of Everfair.





Everfair
is a holding company incorporated in November 26, 2007 in Hong Kong with the
original sole shareholder, Kuk Kok Sun.  At December 31, 2008,
Everfair had 10,000 capital shares authorized with HKD1.00 par value and 10,000
shares issued and outstanding.  Pursuant to a share transfer
agreement, Global Asia paid Kuk Kok Sun HKD 10,000 for the ownership
transfer.




F-4




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE
1 – ORGANIZATION AND BUSINESS BACKGROUND (Continued)




In
October 2008, Everfair entered an equity transfer agreement with the original
owners of ZST PRC.  Pursuant to the equity transfer agreement,
Everfair agreed to pay the original owners RMB12 million for the equity transfer
within three months of the approval from the competent government
agency.  After this equity transfer, ZST PRC became a foreign
investment company with an operating life of 30 years since the approval of its
establishment on November 10, 2008.





On
January 9, 2009, SRKP 18 closed a share exchange transaction (the “Share
Exchange”) pursuant to which SRKP 18 (i) issued 806,408 shares of its common
stock to acquire 100% equity ownership of World Orient, which is the 100% parent
of Global Asia, which is the 100% parent of Everfair, which is the 100% parent
of ZST PRC, (ii) assumed the operations of World Orient and its subsidiaries,
and (iii) changed its name from SRKP 18, Inc. to ZST Digital Networks,
Inc.  In connection with the Share Exchange, ZST Digital completed a
private placement transaction pursuant to which ZST Digital received gross
proceeds of $4.9 million and by which ZST Digital was able to make payment of
RMB12 million to the original owners of ZST PRC pursuant to the equity transfer
agreement.





Subsequent
to the closing of the Share Exchange, on January 14, 2009, Zhong Bo, Chief
Executive Officer and Chairman of the Board of ZST Digital, Wu Dexiu, Huang
Jiankang, Sun Hui and Li Yuting (the "ZST Management"), each entered into a
Common Stock Purchase Agreement pursuant to which ZST Digital issued and the ZST
Management agreed to purchase an aggregate of 5,090,315 shares of common stock
at a per share purchase price of $0.6907 (the "Purchase Right") and obtained
control of ZST Digital.  The purchase consideration for the 5,090,315
shares would come from the proceeds raised through the PIPE transaction and the
conversion of shareholder loans lent to ZST PRC.





Upon
consummation of the Share Exchange and the ownership transfer transactions, ZST
Management owned a majority of the issued and outstanding shares of common stock
of ZST Digital.  Hereafter, ZST Digital and its subsidiaries, World
Orient, Global Asia, Everfair, and ZST PRC shall be collectively referred
throughout as the “Company”.





For
accounting purposes, this above Share Exchange transaction was being accounted
for as a reverse merger. The Share Exchange transaction has been treated as a
recapitalization of World Orient and its subsidiaries, with ZST Digital (the
legal acquirer of World Orient and its subsidiaries, including ZST PRC)
considered the accounting acquiree and ZST PRC, the only operating company, and
whose management took control of ZST Digital (the legal acquiree of ZST Digital)
is considered the accounting acquirer.  The Company did not recognize
goodwill or any intangible assets in connection with the Share Exchange
transaction.  The financial statements of the Company are the
continued financial statements of World Orient and its
subsidiaries.





On
October 6, 2009, the Company effected a 1-for-2.461538462 reverse stock split of
the Company’s issued and outstanding shares of common stock (the “Reverse Stock
Split”).  The par value and number of authorized shares of the common
stock remained unchanged.  All references to number of shares and per
share amounts included in these consolidated financial statements and the
accompanying notes have been adjusted to reflect the reverse stock split
retroactively.




F-5




ZST DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Article 10 of
Regulation S-X.  Accordingly, they do not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements.  In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for fair presentation have been included.  Operating results for the
three-month period ended March 31, 2010 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2010.





Principles
of Consolidation





The
financial statements include the accounts of the Company and its wholly-owned
subsidiaries.  All significant inter-company accounts and transactions
have been eliminated.  All of the consolidated financial statements
have been prepared based on generally accepted accounting principles in the
United States.





Foreign
Currency Translations and Transactions





The
Renminbi (“RMB”), the national currency of PRC, is the primary currency of the
economic environment in which the operations of the subsidiary ZST PRC are
conducted.  The Hong Kong dollar is the primary currency of the
economic environment in which the operations of Everfair are
conducted.  The Company uses the United States dollars (“U.S.
dollars”) for financial reporting purposes.





The
Company translates the above two subsidiaries’ assets and liabilities into U.S.
dollars using the rate of exchange prevailing at the balance sheet date, and the
statement of income is translated at average rate during the reporting
period.  Adjustments resulting from the translation of subsidiaries’
financial statements from the functional currency into U.S. dollars are recorded
in shareholders’ equity as part of accumulated comprehensive income (loss) –
translation adjustments.  Gains or losses resulting from transactions
in currencies other than the functional currency are reflected in the statements
of income for the reporting periods.





Revenue
Recognition





The
Company derives revenues principally from sale of products related to Cable TV
program distribution related system which include digital Cable TV network
equipments and IPTV set-top boxes; sale of GPS devices; provision of GPS devices
installation service and GPS subscription service.





Revenue
is recognized when the risk and rewards are transferred, delivery has occurred
or the services have been rendered, persuasive evidence of any arrangement
exists, the price to the buyer is fixed or determinable and collectability is
reasonably assured.  These criteria as they apply to standalone sale
of digital Cable TV network equipments, IPTV set-top boxes, and GPS devices, and
the sale of GPS devices with installation service, and provision of technical
services are as follows:




F-6




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Revenue
Recognition (Continued)





Sales
of Digital Cable TV Network Equipments and GPS Devices





The
Company recognizes revenues from the sale of digital Cable TV network equipments
and GPS devices when the price of products to be sold are predetermined, the
risk and rewards of ownership and title to the products have been transferred to
the buyer, which coincides with delivery and acceptance of the products by the
buyer.  When certain equipment requires installment service, revenue
is not recognized until customer acceptance has been obtained and/or the Company
has no further significant obligations with customers.





Sales
of IPTV Set-Top Boxes





The
Company recognizes revenues from the sale of IPTV set-top boxes when the price
of products to be sold are predetermined, the risk and rewards of ownership and
title to the products have been transferred to the buyer, which coincides with
delivery and acceptance of the products by the buyer.





Pursuant
to the terms of the Company’s IPTV set-top boxes sales contracts, the Company
has allowed its customers to hold back 10% of total contract price until the end
of one year after delivery of products for warranty purpose.  The
Company recognizes the total contract amount as revenue based on the following
reasons: (i) the customer’s obligation to pay 10% of the total contract amount
is not contingent on the resale of the product shipped; (ii) the Company does
not have significant obligation for future performance to directly bring about
resale of the products shipped other than replacement of defective products due
to hardware defects in materials and workmanship which, in turn, will be borne
by the Company’s supplier; (iii) the customer purchasing the products sold by
the Company has economic substance apart from the products provided by the
Company; and (iv) the amount of future returns can be reasonably estimated based
on the historical return experience whereas the Company does not have any
historical return experience.





Revenue
from selling all products is recognized netting of value added tax imposed by
Chinese government.





Multiple
Deliverable





In
October 2009, the Company started to sell GPS devices in conjunction with
subscription service and installation service.  The Company generally
recognizes revenue from the sale of GPS device hardware with the bundled
software that is essential to the functionality of the GPS device when there are
no continuing obligations upon the completion of installation.  The
Company sells the subscription services to customers with terms of the service
contracts offered ranges from 12 to 24 months and are payable in full upon
activation of the related unit or renewal of a previous service contract.
 The subscription services are deferred and recognized over the life of the
service contract upon activation.





In
instances where the Company sells a GPS device unit along with subscription
service and/or installation service, the Company recognizes revenue related to
the combined sale by allocating between the two or three deliverables using the
relative selling price method determined by using the hierarchy of the following
principles: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii)
third-party evidence of selling price (“TPE”), and (iii) best estimate of the
selling price (“ESP”).  VSOE generally exists only when the Company sells
the deliverable separately and it is the price actually charged by the
Company.




F-7




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Revenue
Recognition (Continued)





Sales
of Services





Revenue
is recognized when services are rendered.  The prepayments received
for GPS subscription services are treated as deferred revenue which will be
recognized over the terms of service contacts.





Warranty
Liabilities





The
Company has a return policy where the customers must make a request within 30
days of receipt to return the products when the products delivered have more
than 40% defects or the products are not delivered on time.  The
Company determines that warranty costs related to products sold are minimal in
monetary terms based on its historical return experience.  In the event of
defective product returns, the Company has the right to seek replacement of such
returned units from its supplier.  Based on the purchase agreement, the
supplier will replace the defective product when the defects are caused by
hardware defects in materials and workmanship during manufacturing process for a
period of one year.  Based on these facts, the Company records
warranty cost as incurred.





Regarding
warranty related to GPS devices, the Company has a policy that provides coverage
on repairs of its GPS devices for a period of one year after date of purchase.
 In the event when a repair is needed, the customers will be responsible
for the cost of the parts while the cost of labor will be covered by the
Company.  The Company estimates the costs to service its obligations based
on historical experience and expectation of future conditions.  The
Company did not incur warranty costs for the three months ended March 31, 2010
and for the year ended December 31, 2009.  Based on these facts, the
Company records warranty cost as incurred.





Cash
and Cash Equivalents





The
Company considers all highly liquid investments with maturity of three months or
less to be cash equivalents.





Accounts
Receivable





Accounts
receivable are stated at the historical carrying amount, net of an allowance for
doubtful accounts. The allowance for doubtful accounts is the Company’s best
estimate of the amount of probable credit losses in the Company’s existing
accounts receivable.  The Company determines the allowance based on
historical write-off experience, customer specific facts and economic
conditions.  Provisions for doubtful accounts are charged to general
and administrative expenses.





Outstanding
account balances are reviewed individually for
collectability.  Account balances are charged off against the
allowance after all means of collection have been exhausted and the potential
for recovery is considered remote.  The Company has not provided a bad
debt allowance as of March 31, 2010 and December 31, 2009.




F-8




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Inventories





Inventories
are composed of mainly products for sale.  Inventories are valued at
the lower of cost (based on weighted average method) and the
market.  Full amount provisions were made for obsolete inventories
which are difficult to estimate future utilization.  Once the
inventory cost is written down, the written-down costs are treated as a new cost
basis for the inventory, and are not adjusted back up to the previous cost basis
in future periods.  For inventories which will be used in ordinary
course of production or sales, the net realizable value of the inventories is
compared with their carrying value, if the net realizable value is lower than
the carrying value, a provision for the difference between the net realizable
value and the carrying value of the inventories was recognized.  Net
realizable value is determined based on the most recent selling price of these
inventories less the estimated cost to sell.





Advertising
Costs





The
Company expenses advertising costs as incurred and are included in selling
expenses.





Shipping
and Handling Expense





Shipping
and handling costs are expensed as incurred and are included in selling
expenses.





Property,
Machinery, Equipment and Software





Plant,
properties, machinery, equipment and software are recorded at historical cost,
net of accumulated depreciation.  The amount of depreciation is
determined using the straight-line method over the shorter of the estimated
useful lives and the remaining contractual life related to leasehold
improvements, as follows:





Machinery
      and equipment
                
                5
      yearsOffice
      equipment
                
                5
      yearsElectronic
      equipment
                
                5
      yearsVehicles
                
                5
      yearsSoftware
                
                5
      years





Maintenance
and repairs are charged directly to expense as incurred, whereas betterment and
renewals are generally capitalized in their respective property
accounts.  When an item is retired or otherwise disposed of, the cost
and applicable accumulated depreciation are removed and the resulting gain or
loss is recognized and reflected as an item before operating income
(loss).





Intangible
Asset





In later
2009, the Company purchased certain technical know-how related to GPS business
for $453,402.  The Company recorded the acquired know-how as
intangible asset and amortized the acquisition cost over five years using the
straight-line method.




F-9




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Impairment
of Long-Lived Assets





The
Company reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable through the estimated undiscounted cash flows expected to result
from the use and eventual disposition of the assets.  Whenever any
such impairment exists, an impairment loss will be recognized for the amount by
which the carrying value exceeds the fair value.





Research
and Development





Research
and development costs are expensed as incurred.  Research and
development expenses are offset against government subsidies received for
supporting research and development efforts.  Government subsidies in
supporting research and development activities received and recognized during
the three months ended March 31, 2009 and 2010 were nil and nil,
respectively.





Share-Based
Payments





The
Company receives employee services in exchange for equity securities of the
Company that are based on the fair value of the Company’s equity
securities.  The Company uses a fair-value-based method to calculate
and account for above mentioned transactions





Value
Added Tax





ZST PRC
is subject to value added tax (VAT) imposed by the PRC government on its
domestic product sales.  VAT rate for the Company is
17%.  The input VAT can be offset against the output
VAT.  VAT payable or receivable balance presented on the Company’s
balance sheets represents either the input VAT less than or larger than the
output VAT.  The debit balance represents a credit against future
collection of output VAT instead of a receivable.





Fair
Value of Financial Instruments





The
standard for “Disclosures about Fair Value of Financial Instruments,” defines
financial instruments and requires fair value disclosures of those financial
instruments.  The Company adopts the standard “Fair Value
Measurements,” which defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances disclosures
requirements for fair value measures. Current assets and current liabilities
qualified as financial instruments and management believes their carrying
amounts are a reasonable estimate of fair value because of the short period of
time between the origination of such instruments and their expected realization
and if applicable, their current interest rate is equivalent to interest rates
currently available. The three levels are defined as follow:





·
            Level
      1 ─ inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.





·
            Level
      2 ─ inputs to the valuation methodology include quoted prices for
      similar assets and liabilities in active markets, and inputs that are
      observable for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.





·
            Level
      3 ─ inputs to the valuation methodology are unobservable and
      significant to the fair value.




F-10




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Fair
Value of Financial Instruments (Continued)





As of the
balance sheet date, the estimated fair values of the financial instruments were
not materially different from their carrying values as presented due to the
short maturities of these instruments and that the interest rates on the
borrowings approximate those that would have been available for loans of similar
remaining maturity and risk profile at respective period-ends.  Determining
which category an asset or liability falls within the hierarchy requires
significant judgment.  The Company evaluates the hierarchy disclosures each
quarter.





Comprehensive
Income (Loss)





The
Company adopted FASB Accounting Standards Codification 220, Comprehensive Income, which
establishes standards for reporting and presentation of comprehensive income
(loss) and its components in a full set of general-purpose financial
statements.  The Company has chosen to report comprehensive income
(loss) in the statements of income and comprehensive
income.  Comprehensive income (loss) is comprised of net income and
all changes to stockholders’ equity except those due to investments by owners
and distributions to owners.





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ materially
from those estimates.





Appropriations
to Statutory Reserve





Under the
corporate law and relevant regulations in China, ZST PRC is required to
appropriate a portion of its retained earnings to statutory
reserve.  It is required to appropriate 10% (the proportion is 15%
before 2006) of its annual after-tax income each year to statutory reserve until
the statutory reserve balance reaches 50% of the registered
capital.  In general, the statutory reserve shall not be used for
dividend distribution purpose.





Dividends
and Retained Earnings





It is the
intention of the Company to reinvest earnings of its overseas subsidiaries in
the operations of those subsidiaries.  Accordingly, no provision has
been made for U.S. income and foreign withholding taxes that would result if
such earnings were repatriated.  These taxes are undeterminable at
this time.  The amounts of earnings retained in ZST PRC were
$15,466,577 at December 31, 2009 and $17,845,136 at March 31, 2010,
respectively.




F-11




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Income
Taxes





The
Company recognizes deferred tax liabilities and assets when accounts for income
taxes.  Deferred tax assets and liabilities are recognized for the
future tax consequence attributable to the difference between the tax bases of
assets and liabilities and their reported amounts in the financial
statements.  Deferred tax assets and liabilities are measured using
the enacted tax rate expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that included the
enactment date.





World
Orient and Global Asia are BVI registered companies.  There is no
income tax for the company domiciled in the BVI.  Accordingly, the
Company’s financial statements do not present any income tax provision related
to the British Virgin Islands tax jurisdiction.  Everfair is
established in Hong Kong and subject to Hong Kong tax laws.  However,
there are no Hong Kong based income; therefore, there is no income tax impact
from Hong Kong.





ZST PRC
is registered at Zhengzhou and is subjected to a unified 25% enterprise income
tax rate.





ZST
Digital was established under the laws of the State of Delaware and is subject
to U.S. federal income tax and franchise tax, instead of income tax, imposed by
Delaware State because the Company does not have any operations in Delaware
State.  For U.S. income tax purposes no provision has been made for
U.S. taxes on undistributed earnings of overseas subsidiaries with which the
Company intends to continue to reinvest.  It is not practicable to
estimate the amount of additional tax that might be payable on the foreign
earnings if they were remitted as dividends, or lent to the Company, or if the
Company should sell its stock in these subsidiaries.





Earnings
(Loss) Per Share





Basic
earnings (loss) per share includes no dilution and is computed by dividing
income (loss) available to common stockholders by the weighted average number of
shares of common stock outstanding during the period.  Diluted
earnings (loss) per share reflect the potential dilution of securities that
could share in the earnings of an entity, similar to fully diluted earnings
(loss) per share.  Since the Company’s preferred stock has the same
voting right and dividends right as the common stock does, all outstanding
shares of preferred stock are deemed as the equivalent shares of common stock
for computing earnings per share purpose.  Stock warrants with the
exercise price at $0.0002462 per share issued by the shell company are diluted
whereas the stock warrants issued to underwriters in connection with initial
stock offering conducted in October 2009 with the exercise price at $10.00 per
share are anti-diluted for computing earnings per share purpose for the three
months ended March 31, 2010.  Stock
options to purchase 25,000 shares of the Company’s common stock with an exercise
price of $8.00 per share and granted on October 20, 2009 are anti-diluted for
computing earnings per share purpose for the three months ended March 31,
2010.




F-12




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)





Recently
Issued Accounting Pronouncements Adopted





FASB
Accounting Standards Codification





The
issuance of FASB Accounting Standards Codification (“FASB ASC”) on July 1, 2009
(effective for interim or annual reporting periods ending after September 15,
2009) establishes the FASB Accounting Standards Codification as the sole
source of authoritative generally accepted accounting principles. Pursuant to
the provisions of FASB ASC, the Company has updated references to U.S. GAAP in
its financial statements issued for the period ended September 30, 2009. The
adoption of FASB ASC did not impact the Company’s financial position or results
of operations.





FASB ASC
805





Effective
January 1, 2009, the Company adopted FASB ASC 805, “Business Combinations.” FASB ASC
805 changed accounting for acquisitions that close beginning in
2009.  FASB ASC 805 extends its applicability to all transactions and
other events in which one entity obtains control over one or more other
businesses.  It broadens the fair value measurement and recognition of
assets acquired, liabilities assumed, and interests transferred as a result of
business combinations.  FASB ASC 805 expands on required disclosures
to improve the statement users’ abilities to evaluate the nature and financial
effects of business combinations.  The adoption of FASB ASC 805 did
not have a material impact on the Company’s financial statements.





FASB ASC
805-20





Effective
January 1, 2009, the Company adopted FASB ASC 805-20, “Noncontrolling Interests in Consolidated Financial
Statements.” FASB ASC 805-20
requires that a noncontrolling interest in a subsidiary be reported as equity
and the amount of consolidated net income specifically attributable to the
noncontrolling interest be identified in the consolidated financial
statements.  It also calls for consistency in the manner of reporting
changes in the parent’s ownership interest and requires fair value measurement
of any noncontrolling equity investment retained in a
deconsolidation.  FASB ASC 805-20 requires retroactive adoption of the
presentation and disclosure requirements for existing minority
interests.





FASB ASC
815





Effective
January 1, 2009, the Company adopted FASB ASC 815, “Disclosures about
DerivativeInstruments and
Hedging Activities.” FASB ASC 815 requires
enhanced disclosures about (i) how and why the Company uses derivative
instruments, (ii) how the Company accounts for derivative instruments and
related hedged items, and (iii) how derivative instruments and related hedged
items affect the Company’s financial results.  The adoption FASB ASC
815 did not have any impact on the Company’s financial statements.




F-13




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)




Recently
Issued Accounting Pronouncements Adopted (Continued)




FASB ASC
350-30





Effective
January 1, 2009, the Company adopted FASB ASC 350-30, “Determination of the Useful Life of
Intangible Assets.” FASB ASC 350-30 amended the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset.  The adoption of
FASB ASC 350-30 did not have material impact on the Company’s financial
statements.





FASB ASC
470-20





Effective
January 1, 2009, the Company adopted FASB ASC 470-20, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).” FASB ASC 470-20 requires entities to account
separately for the liability and equity components of a convertible debt
security by measuring the fair value of a similar nonconvertible debt security
when interest cost is recognized in subsequent periods.  FASB ASC
470-20 requires entities to retroactively separate the liability and equity
components of such debt on the entities’ balance sheets on a fair value basis.
 The adoption of FASB ASC 470-20 did not have any impact on the Company’s
financial statements.





FASB ASC
860





In June
2009, the FASB issued ASC 860, which eliminates the concept of a qualifying
special-purpose entity, creates more stringent conditions for reporting a
transfer of a portion of a financial asset as a sale, clarifies other
sale-accounting criteria, and changes the initial measurement of a transferor’s
interest in transferred financial assets. FASB ASC 860 will be effective for
transfers of financial assets in years beginning after November 15, 2009 and in
interim periods within those years with earlier adoption prohibited. The
adoption of ASC 860 is not expected to have a material impact on the
Company’s consolidated financial position or results of operations.





FASB ASU
2009-05





Effective
January 1, 2010, the Company adopted Accounting Standards Update ("ASU")
No. 2009-05, "Measuring Liabilities at Fair Value," which amends the
guidance in ASC 820, Fair Value Measurements and Disclosures, to provide
guidance on fair value measurement of liabilities.  If a quoted price in an
active market is not available for an identical liability, ASU 2009-05 requires
companies to compute fair value by using quoted prices for an identical
liability when traded as an asset, quoted prices for similar liabilities
when traded as an asset or another valuation technique that is consistent with
the guidance in ASC 820.  ASU 2009-05 will be effective for interim and
annual periods beginning after its issuance.  The adoption of ASU
2009-05 did not have any impact on the Company’s financial
statements.




F-14




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)




Recently
Issued Accounting Pronouncements Adopted (Continued)




FASB ASU
2009-17





Effective
January 1, 2010, the Company adopted ASU 2009-17, “Consolidations (Topic 810) –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities,” which codifies FASB Statement No. 167, “Amendments to FASB
Interpretation No. 46(R).”  The ASU changes how a reporting entity
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be
consolidated.  The determination of whether a reporting entity is
required to consolidate another entity is based on, among other things, the
other entity’s purpose and design and the reporting entity’s ability to direct
the activities of the other entity that most significantly impact the other
entity’s economic performance.  The adoption of ASU 2009-05 did not
have any impact on the Company’s financial statements.





FASB ASU
2009-13





In
October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition:
Multiple-Deliverable Revenue Arrangements” (ASU 2009-13).  This update
removes the criterion that entities must use objective and reliable evidence of
fair value in separately accounting for deliverables and provides entities with
a hierarchy of evidence that must be considered when allocating arrangement
consideration.  The new guidance also requires entities to allocate
arrangement consideration to the separate units of accounting based on the
deliverables’ relative selling price.  The Company has early adopted
ASU No. 2009-13 for the year ended December 31, 2009.  The adoption of
ASU No. 2009-13 did not have any impact on the Company’s financial
statements.





Reclassification





Certain
line items presented on the comparative financial information have been
reclassified to conform to the presentation of current financial
statements.




F-15




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
3 ─ ACCOUNTS RECEIVABLES





The
accounts receivables are as follows:





December 31,
                      
                      
                      March 31,2009
                      
                      
                      2010(Unaudited)Accounts
      receivables
                      
                      $
                      18,982,676
                      
                      
                      $
                      11,648,896Accounts
      receivables ─ 10% hold back
                      
                      
                      5,902,821
                      
                      
                      
                      6,493,797$
                      24,885,497
                      
                      
                      $
                      18,142,693Provision
                      
                      
                      -
                      
                      
                      
                      -Accounts
      receivable, net
                      
                      $
                      24,885,497
                      
                      
                      $
                      18,142,693





The aging
of the accounts receivable except for the 10% hold back are as
follows:





December 31,
                        
                        
                        March 31,2009
                        
                        
                        2010(Unaudited)1-30
      days
                        
                        $
                        10,443,577
                        
                        
                        $
                        7,960,23531-60
      days
                        
                        
                        8,539,099
                        
                        
                        
                        2,897,10361-90
      days
                        
                        
                        -
                        
                        
                        
                        337,80991-120
      days
                        
                        
                        -
                        
                        
                        
                        453,749$
                        18,982,676
                        
                        
                        $
                        11,648,896





Most of
accounts receivables of the hold back, for which the customers held for one-year
warranty purpose, are aged over 90 days.





NOTE
4 ─ ADVANCE TO SUPPLIERS





In
accordance with the purchase contracts, ZST PRC is required to make advance
payments to its suppliers to purchase the IPTV set-top boxes and GPS devices,
materials and add-on process work. The advances are applied to the total invoice
balance upon satisfaction of the goods received by ZST PRC.





For the
year ended December 31, 2009, Advances of $7,399,141 represents advances mainly
made to two suppliers accounting for 55% and 45%, respectively.  As of
March 31, 2010, advances of $7,587,147 represents advances mainly made to three
suppliers accounting for 40%, 37% and 22%, respectively.  Total
purchases from these three suppliers for the three months ended March 31, 2010
accounted for approximately 7%, 24% and 20% of the total purchases by ZST
PRC for the first quarter of 2010.




F-16




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
5 ─ INVENTORIES





The
inventories are as follows:




December 31,
                    
                    
                    March 31,2009
                    
                    
                    2010(Unaudited)Products
      for sale
                    
                    $
                    1,245,803
                    
                    
                    $
                    890,441Less:
      Provisions
                    
                    
                    -
                    
                    
                    
                    -Inventories,
      net
                    
                    $
                    1,245,803
                    
                    
                    $
                    890,441





There was
no reserve for obsolete inventory for all the periods as the Company has
purchased products based on customers’ orders.





NOTE
6 ─PROPERTY, MACHINERY, EQUIPMENT AND SOFTWARE





A summary
of property, machinery, equipment and software at cost is as
follows:





December 31,
                    
                    
                    March 31,2009
                    
                    
                    2010(Unaudited)Machinery
      and equipment
                    
                    $
                    89,203
                    
                    
                    $
                    89,352Electronic
      equipment
                    
                    
                    323,992
                    
                    
                    
                    201,906Office
      equipment
                    
                    
                    39,503
                    
                    
                    
                    39,569Vehicles
                    
                    
                    193,317
                    
                    
                    
                    193,639Software
                    
                    
                    453,402
                    
                    
                    
                    454,159Advance
      for purchase of office space
                    
                    
                    -
                    
                    
                    
                    1,630,578$
                    1,099,417
                    
                    
                    $
                    2,609,203Accumulated
      depreciation
                    
                    
                    (223,611
                    )
                    
                    
                    (247,384
                    )$
                    875,806
                    
                    
                    $
                    2,361,819





The
depreciation and amortization for three months ended March 31, 2009 and 2010
were $5,085 and $168,242, respectively.





On March
12, 2010, the Company paid RMB11.1 million, approximately $1,630,578, to
purchase office space located in Zhengzhou City of Henan Province, PRC. The
building is still under construction and will be available for use at the end of
2010.





NOTE
7 ─ EQUITY TRANSACTIONS





The
Company has two types of stock: common stock and preferred stock.  The
Company is authorized to issue 10,000,000 shares of preferred stock with par
value of $0.0001 per share, of which 3,750,000 shares were designated as Series
A Convertible Preferred Stock.  The Company is authorized to issue
100,000,000 shares of common stock with par value of $0.0001 per
share.




F-17




ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 ─ EQUITY TRANSACTIONS (Continued)





Common
Stock Transactions in 2009





On
January 9, 2009, SRPK 18, Inc. (“SRKP 18”) closed a share exchange transaction
(the “Share Exchange”) pursuant to which SRPK 18 (i) issued 806,408
(post-reverse-split) shares of its common stock to acquire 100% equity ownership
of World Orient Universal Limited (“World Orient”), which is the 100% parent of
Global Asia Universal Limited (“Global Asia”), which is the 100% parent of
Everfair Technologies Limited (“Everfair”), which is a 100% parent of Zhengzhou
Shenyang Technology Company Limited (“ZST PRC”), (ii) assumed the operations of
World Orient and its subsidiaries, and (iii) changed its name from SRKP 18, Inc.
to ZST Digital Networks, Inc.





On
January 14, 2009, Zhong Bo, the Company’s Chief Executive Officer and Chairman
of the Board, Wu Dexiu, Huang Jiankang, Sun Hui and Li Yuting (the “ZST
Management”), each entered into a Common Stock Purchase Agreement pursuant to
which the Company issued and the ZST Management purchased an aggregate of
5,090,315 shares of the Company’s common stock at a per share purchase price of
$0.6907 (the “Purchase Right”).  On the balance sheet of ZST PRC at
December 31, 2008, there were shareholder loans payable of approximately RMB16
million (approximately US$2,334,400 at December 31, 2008).  In
accordance with the arrangement accepted by both ZST Management and the former
stockholders of SRKP 18, ZST Management converted the above outstanding
shareholder loans of RMB16 million into 2,929,097 shares of common stock to
partially complete the obligation under the Common Stock Purchase Agreement in
May 2009.  When the private placement closed in May 2009, Everfair
paid RMB12 million to ZST Management by using a portion of the proceeds from
this private placement to purchase 100% equity of ZST PRC. In turn, ZST
Management used the same RMB12 million to fulfill the remaining obligation to
purchase 2,161,218 shares of common stock under the Common Stock Purchase
Agreement.  For cash flow purposes, the above two transaction were
deemed as non-cash transactions.  For financial reporting purpose,
these 5,090,315 shares of common stock were deemed issued in the earliest period
of financial statements presented.





At
December 31, 2008, there were 7,096,390 shares of common stock outstanding and
warrants to purchase 7,096,390 shares of common stock with an exercise price of
$0.0001 per share outstanding.  In connection with the Purchase Right,
the former stockholders of SRPK18 agreed to cancel 4,156,390 shares of common
stock and warrants to purchase 6,676,390 shares of common stock, resulting in
2,940,000 shares of common stock and warrants to purchase 420,000 shares of
common stock issued and outstanding.  After the reverse-split,
1,194,350 shares of common stock and warrants to purchase 170,629 shares of
common stock with an exercise price of $0.0002462 per share were held by the
former stockholders of SRKP 18. The
aforementioned warrants to purchase 170,629 shares of common stock were
exercised via cashless exercise in the fourth quarter of 2009 pursuant to the
cashless exercise provision in the warrant document.  As a result, the
Company did not receive any cash proceeds from issuing an aggregate of 170,616
shares of its common stock to the warrant holders and the remaining warrants to
purchase an aggregate 13 shares of common stock were
forfeited.




In
October 2009, the Company completed a public offering and sold 3,125,000 shares
of its common stock at $8.00 per share.  The shares of the Company’s
common stock were sold to the public for gross proceeds of approximately $25
million. Deducting all relevant issuing cost, the net proceeds from this
offering was $22,015,483.





In
connection with the public offering, on October 20, 2009, the Company issued to
the underwriters warrants to purchase 156,250 shares of the Company’s common
stock at an exercise price of $10 per share.  The warrants have a
five-year term and are not exercisable until at least one year from the date of
issuance.




F-18





ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 — EQUITY TRANSACTIONS (Continued)





Common
Stock Transactions in 2010





No common
stock transactions occurred during the first quarter of 2010.





Preferred
Stock Transaction in 2009





On
January 5, 2009, the Company filed a Certificate of Designations, Preferences
and Rights (the “Certificate”) whereby it designated 3,750,000 shares of its
preferred stock, $0.0001 par value per share, as Series A Convertible Preferred
Stock.  Each share of Series A Convertible Preferred Stock has a
stated value of $3.94 with liquidation preference at (i) 100% stated value plus
(ii) any accrued and unpaid dividends, other fees or liquidated damages owing
thereon.  Each share of Series A Convertible Preferred Stock is
convertible, at the option of the holder at any time and from time to time after
the original issue date of the Series A Convertible Preferred Stock, into one
share of common stock, at a conversion price equal to the per share purchase
price, subject to adjustment as more fully described in the
Certificate.  Each share of Series A Convertible Preferred Stock has
the right to one vote per share of common stock issuable upon conversion of the
shares of Series A Convertible Preferred Stock. In accordance with the
designation certificate document, each share of Series A Convertible Preferred
Stock will be subject to certain adjustments if certain events
happen.  If the closing price of the common stock of the Company for
each of any ten consecutive trading day period exceeds $8.62 (adjusted after the
reverse split) above the effective conversion price and on such date all of the
Equity Conditions (as defined in the Certificate) are met, the Company may,
within one trading day after the end of any such period, deliver a written
notice to all Series A Convertible Preferred Stock holders to cause each holder
to convert all or part of such Series A Convertible Preferred
Stock.





During
the period from January to May 2009, the Company conducted five closings of a
private placement transaction (the “Private Placement”).  As a result
of the Private Placement, the Company sold an aggregate of 1,263,723 shares of
Series A Convertible Preferred Stock at $3.94 per share for gross proceeds of
$4,976,953.  Deducting all relevant issuing cost, the net proceeds
from the Private Placement were $3,173,634.





In
accordance with the standard of “Beneficial Conversion Feature” codified within
ASC 470, the Series A Convertible Preferred Stock does not have an embedded
beneficial conversion feature (BCF) because the effective conversion price of
such shares equals the fair value of the Company’s common stock. The Company
determined that the fair value of the common stock at $3.94 per share based on
the fact that (1) the common stock is not readily tradable in an open market at
the time of issuance, and (2) the Company has recently sold the convertible
preferred stock that is convertible into common stock at 1:1 ratio for $3.94 per
share in a private placement, therefore the market price of the common stock is
$3.94 per share. However, if in the future the Company has a dilutive issuance
of securities, as defined in the Series A Convertible Preferred Stock
Certificate of Designation, the Company must recognize a beneficial conversion
if and when a reset of the conversion price occurs.





The
Company evaluated whether or not the Series A Convertible Preferred Stock
contained any embedded conversion features that meet the definition of
derivatives under the “Embedded Derivative” standard codified within ASC 815,
and related interpretations.  The standard states that an embedded
derivative instrument shall be separated from the host contract and accounted
for as a derivative instrument pursuant to the statement if and only if all the
following criteria are met:


F-19


ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 — EQUITY TRANSACTIONS (Continued)





Preferred
Stock Transaction in 2009 (Continued)





1.
            The
      economic characteristics and risks of the embedded derivative instrument
      are not clearly and closely related to the economic characteristic and the
      risks to the host contact. (Additional guidance on applying this criterion
      to various contracts containing embedded derivative instrument s is
      included in Appendix A of this
statement.)





2.
            The
      contract that embodies both the embedded derivative instrument and the
      host contract are not measured at fair value under otherwise applicable
      generally accepted accounting principles with changes in fair value
      reported in earnings as they occur.





3.
            A
      separate instrument with the same terms as the embedded derivative
      instrument would, pursuant to subtopic 10 of the standard codified within
      ASC 815, be a derivative instrument subject to the requirements of this
      statement. However, this criterion is not met if the separate instrument
      with the same terms as the embedded derivative instrument would be
      classified as a liability (or an asset in some circumstance) under the
      provisions of the standard codified within ASC 480 but would be classified
      in stockholders’ equity absent the provisions in the standard codified
      within ASC 480.





The
Series A Convertible Preferred Stock has a fixed conversion provision of 1 share
of preferred stock for 1 share of common stock and is convertible at the option
of the holder and automatically upon the occurrence of certain
events.  Based upon the above requirement of subtopic 15 of ASC 815,
it is clear that any potential embedded derivatives in the Series A Convertible
Preferred Stock are clearly and closely related and do not require bifurcation
from the host.





The
Company evaluated whether or not the Series A Convertible Preferred Stock should
be classified as a liability or equity under the standard codified within ASC
480, “Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity” and EITF Topic D-98 “Classification and Measurement of
Redeemable Securities.” The Company concluded that under EITF Topic D-98,
preferred securities that are redeemable for cash or other assets are to be
classified outside of permanent equity if they are redeemable (i) at a fixed or
determinable price on a fixed or determinable date, (ii) at the option of the
holder, or (iii) upon the occurrence of an event that is not solely within the
control of the issuer.  Accordingly, the Company classified the Series
A Convertible Preferred Stock as permanent equity since there was no deemed
liquidation events that require one or more class or type of equity security to
be redeemed.





All of
the 1,263,723 shares of Series A Convertible Preferred Stock issued during the
period from January to May of 2009 were converted to 1,263,723 shares of common
stock during the fourth quarter of 2009.





Preferred
Stock Transactions in 2010





No
preferred stock transactions occurred during the first quarter of
2010.


F-20


ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
8 — STOCK OPTIONS





On
October 8, 2009, the Company entered into an employment agreement with John
Chen, M.D., regarding his employment by the Company as its new Chief Financial
Officer (the “Employment Agreement”).  Dr. Chen’s appointment as Chief
Financial Officer was effective upon the pricing date of the Company’s public
offering, which was on October 20, 2009 (the “Effective
Date”).  Pursuant to the Employment Agreement, Dr. Chen was granted
options to purchase 25,000 shares of the common stock of the Company at an
exercise price of $8.00 per share and exercisable until October 20,
2014.  The options are immediately exercisable but, to the extent they
are exercised, will be subject to a repurchase right of the Company which will
lapse as follows: 50% of the options and shares will vest six (6) months after
the Effective Date and the remaining 50% will vest twelve (12) months after the
Effective Date.





The
Company determined the fair value of the stock options granted was $172,863
using the Black-Scholes option-pricing model with risk-free interest rate of
0.39%, warrant life is the contractual term of five years, expected volatility
of 133% and zero expected dividends.  The Company amortized the fair
value of stock options granted as compensation over a period of 12
months.  Accordingly, the share-based compensation was $42,624 for the
three months ended March 31, 2010.





NOTE
9 — EARNINGS PER SHARE





The
following table sets forth the computation of basic and diluted net earnings per
share for the periods as indicated:





Three Months Ended March31,2009
                    
                    
                    2010(Unaudited)
                    
                    
                    (Unaudited)Numerator:Net
      income attributable to the Company
                    
                    $
                    1,246,358
                    
                    
                    $
                    1,969,655Net
      income used in computing diluted earnings per share
                    
                    $
                    1,246,358
                    
                    
                    $
                    1,969,655Denominator:Weighted
      average shares of common stock outstanding – basic
                    
                    
                    7,641,573
                    
                    
                    
                    11,650,442Potential
      diluted shares from stock warrants granted
                    
                    
                    155,356
                    
                    
                    
                    -Weighted
      average common share outstanding – diluted
                    
                    
                    7,796,929
                    
                    
                    
                    11,650,442Basic
      earnings per share
                    
                    $
                    0.16
                    
                    
                    $
                    0.17Diluted
      earnings per share
                    
                    $
                    0.16
                    
                    
                    $
                    0.17




F-21


ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
10 — SEGMENT REPORTING





Taking
into consideration of operating activities, the Company currently conducts
businesses in two segments: (i) Cable TV program distribution related equipment;
and (ii) GPS devices and services.  As the Company’s current
operations are based only in Henan Province of China, management believes that
the following tables present useful information to chief operation decision
makers for measuring business performance, financing needs, and preparing
corporate budget, etc.





Three Months Ended March 31,2009
                      
                      
                      2010(Unaudited)
                      
                      
                      (Unaudited)Sales
      of Cable TV Equipments:Revenue
                      
                      $
                      17,760,628
                      
                      
                      $
                      14,275,092Cost
                      
                      
                      14,844,279
                      
                      
                      
                      11,133,978Gross
      margin
                      
                      
                      16
                      %
                      
                      
                      22
                      %Sales
      of GPS Devices:Revenue
                      
                      $
                      -
                      
                      
                      $
                      2,152,811Cost
                      
                      
                      -
                      
                      
                      
                      1,690,811Gross
      margin
                      
                      
                      -
                      
                      
                      
                      21
                      %GPS
      Related Service:Revenue
                      
                      $
                      -
                      
                      
                      $
                      620,375Cost
                      
                      
                      -
                      
                      
                      
                      49,497Gross
      margin
                      
                      
                      -
                      
                      
                      
                      92
                      %Total
      revenue
                      
                      $
                      17,760,628
                      
                      
                      $
                      17,048,278Total
      cost
                      
                      
                      14,844,279
                      
                      
                      
                      12,874,286Overall
      gross margin
                      
                      
                      16
                      %
                      
                      
                      24
                      %





NOTE
11 — LONG TERM PREPAYMENTS





On
November 14, 2009 (the “Effective Date”), the Company entered into a Retention
Agreement with Mr. Zhong Lin, the Chief Operating Officer of the Company, a
member of Board of Directors of the Company, and son of Mr. Zhong Bo, CEO and
Chairman of the Board of Directors of the Company (the “Retention
Agreement”).  Pursuant to the Retention Agreement, Mr. Zhong will
receive a one-time retention payment equal to $285,000 (the “Retention Amount”)
if Mr. Zhong remains continuously employed with the Company for a period of 24
months from the Effective Date (the “Expiration Date”).  The Company
advanced the entire Retention Amount upon the Effective Date, which will be
earned ratably over a period of 24 months.  Upon the occurrence of
certain termination events (the “Disqualifying Termination Date”), Mr. Zhong
will be required to return the pro-rata amount of the Retention Amount based on
a daily amortization rate of $390.41 times the number of days remaining from the
Disqualifying Termination Date to the Expiration Date to the Company within 10
days of the Disqualifying Termination Date.  For the three months
ended March 31, 2010, the amortization of this long-term prepayment was
$35,710.


F-22


ZST
DIGITAL NETWORKS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
11 — LONG TERM PREPAYMENTS (Continued)





On
October 28, 2009, the Company entered into a Consulting Agreement (the
“Consulting Agreement”) with Finance Access, Inc. (“Finance
Access”).  In connection with the Consulting Agreement, the Company
also entered into professional services agreements with other third parties
(together with the Consulting Agreement, the “Services
Agreements”).  Pursuant to the Services Agreement, Finance Access and
the third parties agreed to provide the Company with certain professional and
business development services in order to aid and augment the Company’s business
development efforts.  The term of the Services Agreements is 24
months.  The Company paid an aggregate of $1.55 million as
compensation to Finance Access and the third parties, which will be amortized on
a quarterly basis over the twenty-four (24) month period at a daily rate of
$2,123.29.  The amortization of this long-term prepayment was $194,769
for the three months ended March 31, 2010.





NOTE
12 — SUBSEQUENT EVENTS





The
Company evaluated all events or transactions that occurred after March 31, 2010
up through the date the Company issued these financial
statements.  During this period the Company did not have any material
recognizable subsequent events.




F-23


ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




THIS
REPORT CONTAINS FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS THAT INCLUDE
THE WORDS "BELIEVES," "EXPECTS," "ESTIMATES," "ANTICIPATES" OR SIMILAR
EXPRESSIONS.  SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND
UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL
RESULTS, PERFORMANCE OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED
OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.  RISK FACTORS INCLUDE,
BUT ARE NOT LIMITED TO, COSTS ASSOCIATED WITH FINANCING NEW PRODUCTS; OUR
ABILITY TO COST-EFFECTIVELY MANUFACTURE OUR PRODUCTS ON A COMMERCIAL SCALE; THE
CONCENTRATION OF OUR CURRENT CUSTOMER BASE; COMPETITION; OUR ABILITY TO COMPLY
WITH APPLICABLE REGULATORY REQUIREMENTS; POTENTIAL NEED FOR EXPANSION OF OUR
PRODUCTION FACILITY; THE POTENTIAL LOSS OF A STRATEGIC RELATIONSHIP; INABILITY
TO ATTRACT AND RETAIN KEY PERSONNEL; MANAGEMENT'S ABILITY TO EFFECTIVELY MANAGE
OUR GROWTH; DIFFICULTIES AND RESOURCE CONSTRAINTS IN DEVELOPING NEW PRODUCTS;
PROTECTION AND ENFORCEMENT OF OUR INTELLECTUAL PROPERTY AND INTELLECTUAL
PROPERTY DISPUTES; COMPLIANCE WITH ENVIRONMENTAL LAWS; CLIMATE UNCERTAINTY;
CURRENCY FLUCTUATIONS; CONTROL OF OUR MANAGEMENT AND AFFAIRS BY PRINCIPAL
STOCKHOLDERS




THE
READER SHOULD CAREFULLY CONSIDER, TOGETHER WITH THE OTHER MATTERS REFERRED TO
HEREIN, THE INFORMATION CONTAINED UNDER THE CAPTION "RISK FACTORS" IN THE
COMPANY’S MOST RECENT ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION ON MARCH 31, 2010 FOR A MORE DETAILED DESCRIPTION OF THESE
SIGNIFICANT RISKS AND UNCERTAINTIES.  WE CAUTION THE READER, HOWEVER,
NOT TO UNDULY RELY ON THESE FORWARD-LOOKING STATEMENTS.





Investment
in our common stock involves risk. You should carefully consider the investing
risks before deciding to invest. The market price of our common stock could
decline due to any of these risks, in which case you could lose all or part of
your investment. In assessing these risks, you should also refer to the other
information included in this prospectus, including our consolidated financial
statements and the accompanying notes. You should pay particular attention to
the fact that we are a holding company with substantial operations in China and
are subject to legal and regulatory environments that in many respects differ
from that of the United States.  Our business, financial condition or
results of operations could be affected materially and adversely by any of the
risks discussed below and any others not foreseen. This discussion contains
forward-looking statements.





The
following discussion relates to the financial condition and results of
operations of ZST Digital Networks, Inc. (the “Company”) and its wholly-owned
subsidiary World Orient Universal Limited, a company organized under the laws of
the British Virgin Islands (“World Orient”), its wholly-owned subsidiary, Global
Asia Universal Limited, a company organized under the laws of the British Virgin
Islands (“Global Asia”), its wholly-owned subsidiary Everfair Technologies,
Ltd., a company organized under the laws of Hong Kong (“Everfair”), and its
wholly-owned subsidiary Zhengzhou Shenyang Technology Company Limited, a company
organized under the laws of the People’s Republic of China (“ZST
PRC”).  This management’s discussion and analysis of financial
condition and results of operations should be read in conjunction with the
Company’s financial statements and the related notes included in this
report.





We
conduct our business principally through the operations of ZST PRC, which is
based in Zhengzhou City of Henan Province where our headquarter is
located.





ZST PRC
was established in Zhengzhou under the laws of the People’s Republic of China
(the “PRC”) on May 20, 1996.  After the share exchange and stock
purchase transactions incurred in January 2009, ZST PRC became a foreign
investment company in China with an operating life of 30 years since November
10, 2008.  As of March 31, 2010, ZST PRC had approximately 96
full-time employees.





The other
three companies, our wholly-owned subsidiaries World Orient, Global Asia, and
Everfair, have no operating activity.





Executive
Summary of Financial Position and Operating Results





The
following executive summary is intended to provide significant highlights of the
discussion and analysis that follows.





·
            Total
      revenue was $17.0 million, a slight decrease of 4% compared to the first
      quarter of 2009.


·
            Gross
      profit for the first quarter 2010 was $4.2 million, an increase of 43%
      compared to the first quarter 2009.  Gross profit margin for the
      first quarter 2010 was 24%, compared to 16% for the first quarter
      2009.


·
            Net
      income for the first quarter 2010 was $2.0 million, an increase of 58%
      compared to the first quarter of
2009.


·
            Net
      income to revenue ratio for the first quarter of 2010 was 12%, compared to
      7% for the first quarter 2009.


4





·
            Basic
      and diluted earnings per share were both $0.17 for the first quarter of
      2010, an increase of $0.01 compared with $ 0.16 for basic earnings and
      diluted earnings per share for the first quarter of
  2009.





Overview





Business
Summary





We are
principally engaged in supplying digital and optical network equipment to cable
system operators in the Henan Province of China.  We offer a range of
cable television devices and related networking products, including Internet
protocol television (“IPTV”) set-top boxes, which integrate Internet,
multi-media, and communication technologies, and provide residential and
commercial customers with high definition digital multi-media service, as well
as facilitate to choose video programs offered by the network video providers on
broadband IP network; and power supplies, remote controls, and other devices and
accessories.  Our product sales also include a line of fiber-optic
receivers, which convert a fiber-optic transmission into digital RF signals that
are amplified and distributed through an optical cable system; optical
transmitters that are used in the transmission of cable system front optical
fiber signal; and cable transmission amplifiers, which enhance the signal
quality in cable networks.





We
purchase the products specified by our customers from suppliers on a turnkey
basis, which means that our suppliers deliver fully assembled and tested
products based on our proprietary designs.  The assembled products are
delivered to our facilities for final system quality control testing against
product specifications and product configuration, including software
installation.  The use of this model allows us to focus substantially
all of our resources on determining customer requirements and on the design,
development and support of products we are selling.  This model also
allows us to significantly reduce capital requirements.  We work
closely with our suppliers to manage costs and delivery times, and we have not
experienced material delays in the delivery of products we have
ordered.





We also
provide installation services related to system equipment ordered by local
broadcasting TV bureaus and cable network operators through a network of
distributors and resellers in Henan Province.  Our customer base
covers more than 20 regional cities and counties.  In addition, we
offer security and monitoring services, including design, installation, and
implementation of various devices, such as coding and decoding devices, digital
cameras, and matrix exchanges; and cable services, which include networking in
buildings.





Since the
fourth quarter of 2009, we began providing GPS location and tracking services to
third parties, mainly automobile sales companies, with which we plan to
participate in the GPS service provider business through establishing a
partnership with China Unicom, a wireless network provider.  In
March 2009, we entered into a network access right agreement with the Henan
Subsidiary of China Unicom that allows us to use the China Unicom wireless
network for providing GPS location and tracking services to third
parties.





We expect
that for the foreseeable future that the source of revenue for our business will
be from selling network system equipment and set-top boxes to cable system
operators and residential users.  There are 118 counties within Henan
Province whereas we currently serve only 26 counties.  Consequently,
we believe there is opportunity for future growth.  In the future, we
may expand our business activities beyond the border of Henan
Province.  Since we believe that the broadcasting and TV bureau at the
provincial level is planning to redesign and enhance the entire network system
in the entire Henan province, we perceive that there are potential business
opportunities in biding these potential projects.





We expect
that our profitability will be adversely affected by the business expenses
associated with our efforts to expand our sales, marketing, product development
and general and administrative capabilities in all of our businesses, as well as
expenses that we incur as a publicly-traded company.  These costs
include costs associated with, among other things, financial reporting,
information technology, complying with federal securities laws (including
compliance with the Sarbanes-Oxley Act of 2002), tax administration and human
resources related functions.  While we are striving for the growth of
our business, we also intend to focus on measures to control operational costs
and expenses.





Recent
Events





Retention
Agreement/Consulting and Personal Services Agreements





On
November 14, 2009 (the “Effective Date”), we entered into a Retention Agreement
with Zhong Lin, our Chief Operating Officer and a member of our board of
directors (the “Retention Agreement”).  Pursuant to the Retention
Agreement, Mr. Zhong will receive one-time retention payment equal to $285,000
(the “Retention Amount”) if Mr. Zhong remains continuously employed with us for
a period of 24 months from the Effective Date (the “Expiration
Date”).  We advanced the entire Retention Amount upon the Effective
Date, which will be earned ratably over a period of 24 months.  Upon
the occurrence of certain termination events (the “Disqualifying Termination
Date”), Mr. Zhong will be required to return the pro-rata amount of the
Retention Amount based on a daily amortization rate of $390.41 times the number
of days remaining from the Disqualifying Termination Date to the Expiration Date
to us within 10 days of the Disqualifying Termination Date.


5





On
December 30, 2009, we entered into a Consulting Agreement (the “Consulting
Agreement”) with Finance Access, Inc. (“Finance Access”).  In
connection with the Consulting Agreement, we also entered into professional
services agreements with other third parties (together with the Consulting
Agreement, the “Services Agreements”).  Pursuant to the Services
Agreement, Finance Access and the third parties agreed to provide us with
certain professional and business development services in order to aid and
augment our business development efforts.  The term of the Services
Agreement is 24 months.  We paid an aggregate of $1.55 million as
compensation to Finance Access and the third parties, which will be amortized on
a quarterly basis over the twenty-four (24) month period at a daily rate of
$2,123.29.





Critical
Accounting Policies and Estimates





The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements which have been prepared in accordance with
accounting principles generally accepted in the United States.  The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and
liabilities.  On an on-going basis, we evaluate our estimates
including the allowance for doubtful accounts, the salability and recoverability
of inventory, income taxes and contingencies.  We base our estimates
on historical experience and on other assumptions that we believe to be
reasonable under the circumstances, the results of which form our basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources.  Actual results may differ
from these estimates under different assumptions or conditions.





We are
unable to predict what future laws and regulations might be passed that could
have a material effect on our results of operations.  We assess the
impact of significant changes in laws and regulations on a regular basis and
update the assumptions and estimates used to prepare our financial statements
when we deem it necessary.





Revenue
Recognition





We derive
revenues principally from sale of products related to Cable TV program
distribution related system which include digital Cable TV network equipments
and IPTV set-top boxes; sale of GPS devices; provision of GPS devices
installation service and GPS subscription service.





Revenue
is recognized when the risk and rewards are transferred, delivery has occurred
or the services have been rendered, persuasive evidence of any arrangement
exists, the price to the buyer is fixed or determinable and collectability is
reasonably assured.  These criteria as they apply to standalone sale
of digital Cable TV network equipments, IPTV set-top boxes, and GPS devices, and
the sale of GPS devices with installation service, and provision of technical
services are as follows:





Sales
of Digital Cable TV Network Equipments and GPS Devices





We
recognize revenues from the sale of digital Cable TV network equipments and GPS
devices when the price of products to be sold are predetermined, the risk and
rewards of ownership and title to the products have been transferred to the
buyer, which coincides with delivery and acceptance of the products by the
buyer.  When certain equipment requires installment service, revenue
is not recognized until customer acceptance has been obtained and/or the Company
has no further significant obligations with customers.





Sales
of IPTV Set-Top Boxes





We
recognize revenues from the sale of IPTV set-top boxes when the price of
products to be sold are predetermined, the risk and rewards of ownership and
title to the products have been transferred to the buyer, which coincides with
delivery and acceptance of the products by the buyer.





Pursuant
to the terms of our IPTV set-top boxes sales contracts, we have allowed our
customers to hold back 10% of total contract price until the end of one year
after delivery of products for warranty purpose.  We recognizes the
total contract amount as revenue based on the following reasons: (i) the
customer’s obligation to pay 10% of the total contract amount is not contingent
on the resale of the product shipped; (ii) we do not have significant obligation
for future performance to directly bring about resale of the products shipped
other than replacement of defective products due to hardware defects in
materials and workmanship which, in turn, will be borne by our supplier; (iii)
the customer purchasing the products sold by us has economic substance apart
from the products provided by us; and (iv) the amount of future returns can be
reasonably estimated based on the historical return experience whereas we do not
have any historical return experience.





Revenue
from selling all products is recognized netting of value added tax imposed by
Chinese government.





Multiple
Deliverable





In
October 2009, we started to sell GPS devices in conjunction with subscription
service and installation service.  We generally recognize revenue from
the sale of GPS device hardware with the bundled software that is essential to
the functionality of the GPS device when there are no continuing obligations
upon the completion of installation.  We sell the subscription
services to customers with terms of the service contracts offered ranges from 12
to 24 months and are payable in full upon activation of the related unit or
renewal of a previous service contract.  The subscription services are
deferred and recognized over the life of the service contract upon
activation.


6





In
instances where we sell a GPS device unit along with subscription service and/or
installation service, we recognize revenue related to the combined sale by
allocating between the two or three deliverables using the relative selling
price method determined by using the hierarchy of the following principles: (i)
vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party
evidence of selling price (“TPE”), and (iii) best estimate of the selling price
(“ESP”).  VSOE generally exists only when we sell the deliverable
separately and it is the price actually charged by us.





Sales
of Services





Revenue
is recognized when services are rendered.  The prepayments received
for GPS subscription services are treated as deferred revenue which will be
recognized over the terms of service contacts.





Warranty
Liabilities





We have a
return policy where the customers must make a request within 30 days of receipt
to return the products when the products delivered have more than 40% defects or
the products are not delivered on time.  We determine that warranty
costs related to products sold are minimal in monetary terms based on its
historical return experience.  In the event of defective product
returns, we have the right to seek replacement of such returned units from its
supplier.  Based on the purchase agreement, the supplier will replace
the defective product when the defects are caused by hardware defects in
materials and workmanship during manufacturing process for a period of one
year.  Based on these facts, we record warranty cost as
incurred.





Regarding
warranty related to GPS devices, we have a policy that provides coverage on
repairs of our GPS devices for a period of one year after date of
purchase.  In the event when a repair is needed, the customers will be
responsible for the cost of the parts while the cost of labor will be covered by
us.  We estimate the costs to service our obligations based on
historical experience and expectation of future conditions.  We did
not incur warranty costs for the three months ended March 31, 2010 and for the
year ended December 31, 2009.  Based on these facts, we records
warranty cost as incurred.





Accounts
Receivable





Accounts
receivable are stated at the historical carrying amount, net of an allowance for
doubtful accounts.  The allowance for doubtful accounts is our best
estimate of the amount of probable credit losses in our existing accounts
receivable.  We determine the allowance based on historical write-off
experience, customer specific facts and economic
conditions.  Provisions for doubtful accounts are charged to general
and administrative expenses.





Outstanding
account balances are reviewed individually for
collectability.  Account balances are charged off against the
allowance after all means of collection have been exhausted and the potential
for recovery is considered remote.  We have not provided a bad debt
allowance as of March 31, 2010 and December 31, 2009.





Impairment
of Long-Lived Assets





We review
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets.  Whenever any such impairment exists, an
impairment loss will be recognized for the amount by which the carrying value
exceeds the fair value.





Income
Taxes





We
recognize deferred tax liabilities and assets when accounts for income
taxes.  Deferred tax assets and liabilities are recognized for the
future tax consequence attributable to the difference between the tax bases of
assets and liabilities and their reported amounts in the financial
statements.  Deferred tax assets and liabilities are measured using
the enacted tax rate expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that included the
enactment date.





ZST
Digital Networks, Inc. was established under the laws of the State of Delaware
and is subject to U.S. federal income tax and state franchise
tax.  For U.S. income tax purposes no provision has been made for U.S.
taxes on undistributed earnings of overseas subsidiaries with which we intend to
continue to reinvest.  It is not practicable to estimate the amount of
additional tax that might be payable on the overseas earnings if they were
remitted as dividends, or lent to us, or if we should sell its stock in the
subsidiaries.


7





Recently
Issued Accounting Pronouncements Adopted





FASB
Accounting Standards Codification





The
issuance of FASB Accounting Standards Codification (“FASB ASC”) on July 1, 2009
(effective for interim or annual reporting periods ending after September 15,
2009) establishes the FASB Accounting Standards Codification as the sole source
of authoritative generally accepted accounting principles. Pursuant to the
provisions of FASB ASC, we have updated references to U.S. GAAP in its financial
statements issued for the period ended September 30, 2009.  The
adoption of FASB ASC did not impact our financial position or results of
operations.





FASB ASC
805





Effective
January 1, 2009, we adopted FASB ASC 805, “Business
Combinations.”   FASB ASC 805 changed accounting for
acquisitions that close beginning in 2009.  FASB ASC 805 extends its
applicability to all transactions and other events in which one entity obtains
control over one or more other businesses.  It broadens the fair value
measurement and recognition of assets acquired, liabilities assumed, and
interests transferred as a result of business combinations.  FASB ASC
805 expands on required disclosures to improve the statement users’ abilities to
evaluate the nature and financial effects of business
combinations.  The adoption of FASB ASC 805 did not have a material
impact on our financial statements.





FASB ASC
805-20





Effective
January 1, 2009, we adopted FASB ASC 805-20, “Noncontrolling Interests in
Consolidated Financial Statements.”  FASB ASC 805-20 requires
that a noncontrolling interest in a subsidiary be reported as equity and the
amount of consolidated net income specifically attributable to the
noncontrolling interest be identified in the consolidated financial
statements.  It also calls for consistency in the manner of
reporting changes in the parent’s ownership interest and requires fair value
measurement of any noncontrolling equity investment retained in a
deconsolidation.  FASB ASC 805-20 requires retroactive adoption of the
presentation and disclosure requirements for existing minority
interests.





FASB ASC
815





Effective
January 1, 2009, we adopted FASB ASC 815, “Disclosures about DerivativeInstruments and Hedging
Activities.”  FASB ASC 815 requires enhanced disclosures about
(i) how and why we use derivative instruments, (ii) how the Company accounts for
derivative instruments and related hedged items, and (iii) how derivative
instruments and related hedged items affect the Company’s financial
results.  The adoption FASB ASC 815 did not have any impact on our
financial statements.





FASB ASC
350-30





Effective
January 1, 2009, we adopted FASB ASC 350-30, “Determination of the Useful Life of
Intangible Assets.”  FASB ASC 350-30 amended the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset.  The
adoption of FASB ASC 350-30 did not have material impact on our financial
statements.





FASB ASC
470-20





Effective
January 1, 2009, we adopted FASB ASC 470-20, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).”  FASB ASC 470-20 requires entities to account
separately for the liability and equity components of a convertible debt
security by measuring the fair value of a similar nonconvertible debt security
when interest cost is recognized in subsequent periods.  FASB ASC
470-20 requires entities to retroactively separate the liability and equity
components of such debt on the entities’ balance sheets on a fair value
basis.  The adoption of FASB ASC 470-20 did not have any impact on our
financial statements.





FASB ASC
860





In June
2009, the FASB issued ASC 860, which eliminates the concept of a qualifying
special-purpose entity, creates more stringent conditions for reporting a
transfer of a portion of a financial asset as a sale, clarifies other
sale-accounting criteria, and changes the initial measurement of a transferor’s
interest in transferred financial assets. FASB ASC 860 will be effective for
transfers of financial assets in years beginning after November 15, 2009 and in
interim periods within those years with earlier adoption prohibited. The
adoption of ASC 860 is not expected to have a material impact on our
consolidated financial position or results of operations.





FASB ASU
2009-05





Effective
January 1, 2010, we adopted Accounting Standards Update ("ASU")
No. 2009-05, "Measuring Liabilities at Fair Value," which amends the
guidance in ASC 820, Fair Value Measurements and Disclosures, to provide
guidance on fair value measurement of liabilities.  If a quoted price
in an active market is not available for an identical liability, ASU 2009-05
requires companies to compute fair value by using quoted prices for an
identical liability when traded as an asset, quoted prices for similar
liabilities when traded as an asset or another valuation technique that is
consistent with the guidance in ASC 820.  ASU 2009-05 will be
effective for interim and annual periods beginning after its
issuance.  The adoption of ASU 2009-05 did not have any impact on our
financial statements.


8





FASB ASU
2009-17





Effective
January 1, 2010, we adopted ASU 2009-17, “Consolidations (Topic 810) –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities,” which codifies FASB Statement No. 167, “Amendments to FASB
Interpretation No. 46(R).”  The ASU changes how a reporting entity
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be
consolidated.  The determination of whether a reporting entity is
required to consolidate another entity is based on, among other things, the
other entity’s purpose and design and the reporting entity’s ability to direct
the activities of the other entity that most significantly impact the other
entity’s economic performance.  The adoption of ASU 2009-05 did not
have any impact on our financial statements.





FASB ASU
2009-13





In
October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition:
Multiple-Deliverable Revenue Arrangements” (ASU 2009-13).  This update
removes the criterion that entities must use objective and reliable evidence of
fair value in separately accounting for deliverables and provides entities with
a hierarchy of evidence that must be considered when allocating arrangement
consideration.  The new guidance also requires entities to allocate
arrangement consideration to the separate units of accounting based on the
deliverables’ relative selling price.  The Company has early adopted
ASU No. 2009-13 for the year ended December 31, 2009.  The adoption of
ASU No. 2009-13 did not have any impact on the Company’s financial
statements.





Results
of Operations





Comparison
of Three months Ended March 31, 2009 and 2010





Revenue





We are
currently engaged in two main business lines: provision of Cable TV program
distribution related equipment; and provision of GPS devices and related
location and tracking services. The total revenue can be divided by business
line as follows:





Three Months Ended March 31,2009
                  
                  
                  2010Sales
      Revenue:Sales
      of cable TV equipments
                  
                  
                  17,760,628
                  
                  
                  
                  14,275,092Sales
      of GPS devices
                  
                  
                  -
                  
                  
                  
                  2,152,811Revenue
      from sales of goods
                  
                  
                  17,760,628
                  
                  
                  
                  16,427,903Revenue
      from service:GPS
      related service
                  
                  
                  -
                  
                  
                  
                  620,375Total
      revenue
                  
                  
                  17,760,628
                  
                  
                  
                  17,048,278





Overall
our revenue was $17 million for the first quarter of 2010, representing a
decrease of $712,000 or a 4% decrease in comparison with $17.8 million for the
first quarter of 2009.  Revenue from Cable TV equipment sales for the
current quarter was decreased by almost 20% compared to the comparable 2009
fiscal period whereas the reduction of revenue was offset by newly added GPS
product sales of approximately $2.2 million and $620,000 of newly added GPS
service.  We started GPS related businesses in October
2009.  Consequently, there was no comparison of GPS business related
revenue between the first quarter of 2010 and 2009.





Cable
TV Related Equipment:





We sell
two types of Cable TV related equipments: digital Cable TV network equipments
and IPTV (internet protocol television) set-top Boxes.  Net revenue
from these two product lines was as follows:





Three Months Ended March 31,2009
                  
                  
                  2010Sales
      Revenue from Cable TV products:Sales
      of IPTV set-top boxes
                  
                  
                  11,724,578
                  
                  
                  
                  7,190,561Sales
      of cable TV network equipments
                  
                  
                  6,036,050
                  
                  
                  
                  7,084,531Total
                  
                  
                  17,760,628
                  
                  
                  
                  14,275,092




9





Sales of IPTV set-top
boxes





Revenue
from sales of IPTV set-top boxes was $7.2 million, a decrease of $4.5 million or
a 39% decrease compared with $11.7 million for the same quarter in
2009.  The decrease in sales of IPTV set-top boxes was the result of
decreases both in sales price and volume for High Definition set-top boxes,
offset by $2.2 million in revenue from the sales of Standard Definition set-top
boxes introduced in the first quarter of 2010.





During
the first quarter of 2009, we sold only High Definition IPTV set-top boxes,
primarily to users in the larger regional cities in Henan
Province.  The average selling price of these models decreased by
approximately 19% during the first quarter of 2010 compared to the average
selling price during the same period in 2009. This decline led to a negative
impact of $2.2 million on sales revenue, without taking into consideration
changes in volume.  Concurrently, sales volume of High Definition
set-top boxes decreased by approximately 47% compared to the same quarter of
2009, which led to a negative impact of $5.57 million on sales revenue. The
overlapping impact of changes in volume and average selling price is
approximately $1.05 million.  The decrease in selling price and sales
volume resulted in the net decrease of approximately $6.7 million in the sales
of High Definition set-top boxes.





We
launched the Standard Definition IPTV set-top boxes line with a comparatively
lower average selling price in the first quarter of 2010 for the purpose of
capturing additional market share in rural cities and counties.  The
sales of Standard Definition products accounted for 53% in quantity of total
IPTV set-top box sold during the first quarter of 2010.  We believe
the sales mix of High Definition IPTV set-top boxes and Standard Definition
set-up boxes will approach half-and-half in quantity on a going forward
basis.





Sales of cable TV network
equipments





Sales of
cable TV network equipments amounted to $7.1 million for the first quarter of
2010, an increase of $1.1 million or 18% compared with $6.0 million for the same
period of 2009.  The increase in sales of cable TV network equipments
is in line with the trend of our business operations when regional TV broadcast
stations are upgrading their broadcast systems to expand coverage to suburban
areas and township areas.





GPS
Products:





We
entered into GPS related business since the fourth quarter of 2009 and there was
no revenue from GPS operations in the first quarter of 2009.





Revenue
from sales of GPS devices was $2.2 million for the first quarter of 2010 while
GPS related service fees contributed $0.6 million in revenues for the same
period.  GPS related services include installation service and
subscription service for tracking and location.





Cost
of Sales





Our cost
of sales is driven primarily by the procurement costs, given the fact that our
products sold to our customers are purchased from our suppliers on a turnkey
basis.  Total cost of sales was $12.8 million in the first quarter of
2010, compared with $14.8 million during the same period in 2009, representing a
decrease of approximately $2.0 million or a 13% decrease in cost of
sales.  For the first quarter of 2010, cost of sales related to cable
TV equipment sold and GPS devices sold was $11.1 million and $1.7 million, and
represented 87% and 13% of total cost of sales, respectively.





The
decrease in cost of products sold was primarily attributable to the decrease of
acquisition cost for High Definition set-top boxes.  The acquisition
costs for the 95,000 units of High Definition set-top boxes sold in 2009 was
approximately $9.8 million whereas the acquisition costs for the 51,200 units of
High Definition set-top boxes sold in the first quarter of 2010 was $4.1
million.  Except for impact of decrease in purchase volume, purchase
price of High Definition products dropped approximately by 20% compared with the
same period of 2009. The decrease in purchase price of High Definition products
is deeper than decrease in selling price, which contributed to an improvement of
our overall gross profit.





Regarding
the cost of other Cable TV equipment sold, our cost of system equipment
increased by $659,000.  Due to the newly added GPS products sold, the
corresponding cost of products sold was $1.69 million whereas the cost of
products sold from selling Standard Definition set-top boxes was $1.3
million.  We do not perform analysis and discussion about the above
products sold in the first quarter of 2010 as there were no such products sold
during in the same period of 2009.





Cost of
service was $0.05 million in the first quarter of 2010, which mainly consists of
salary for the support staff and depreciation of GPS related
equipments.





Gross
Margin





Gross
margin for the first quarter of 2010 was 24% compared with gross margin of 16%
for the same period of 2009.


10


The gross
margin on the service revenue recognized for the first quarter of 2010 was 92%,
while there was no service revenue incurred during the same quarter of
2009.  Since the service revenue amounted only 3.6% of total revenue,
the high gross margin on service revenue did not have material effect on the
overall gross margin for the first quarter of 2010.





The
overall gross margin in sales of products was 22% for the first quarter of
2010 compared with 16% for the same period of 2009.





The gross
margin in sales of cable TV networks was 19% in the first quarter of
2010 compared with 16% for the first quarter of 2009.  The gross
margin in sales of IPTV set-top boxes was 25% in the first quarter of 2010
compared with 17% in the first quarter in 2009. Our newly launched Standard
Definition set-top boxes contributed a high gross margin of 40% in the first
quarter of 2010, while the High Definition products had a gross margin of 18%
compared with 17% in the same period of 2009.





The gross
margin in sales of GPS device was 21% for the first quarter of 2010, which is
slightly lower than the overall gross margin in sales of products.





Selling
Expense





Selling
expense was $267,000 for the first quarter of 2010, representing an increase of
$248,000 compared with $19,000 for the first quarter of 2009.  During
the first quarter of 2010, we spent $176,000 on promotion activities for our GPS
business.  The remaining $91,000 consists mainly of shipping costs,
after-sale service, and salary of sales staff.  Selling expense in the
first quarter of 2009 contained only salary expenses.





As a
percentage to total revenue, selling expenses accounted for 2% and 0.1% for the
first quarter of 2010 and 2009, respectively.





Research
and Development Expense





Research
and development expense was $236,000 for the first quarter of 2010 compared to
nil in the first quarter of 2009.  Among research and development
expenses incurred in the first quarter of 2010, $145,000 was related to module
expenses for development of GPS devices; the remaining $91,000 is primarily
attributed to amortization of GPS related technologies, as well as software, and
salaries for R&D staff.  We did not have a separate research and
development department until June of 2009.  As a result, no expense
was allocated as research and development expense for the first quarter of
2009.





As a
percentage to total revenue, research and development expense accounted for 1.4%
and nil for the first quarter of 2010 and 2009, respectively.





General
and Administrative Expense





General
and administrative expense was $731,000 for the first quarter of 2010,
representing an increase of $375,000 or a 105% increase, compared with $356,000
for the same period of 2009.  General and administrative expense
consists mainly of salary expense, consulting service fee, legal service fee,
audit related service fee and other office expenses.  The increase in
general and administrative expense was primarily due to increase in salary
expense and consulting service fee.  On November 14, 2009, we entered
into a 24-month Retention Agreement with our Chief Operating Officer for a total
retention bonus of $285,000 that is amortized though the life of the agreement;
as a result, the salary expense for the first quarter of 2010 amounted to
$241,000, compared to $64,000 during the first quarter of 2009.  On
October 28, 2009, we entered into a Consulting Agreement with Finance Access,
Inc. and other third parties for a 24 months consulting service at total
consideration of $1.55 million; which will be amortized during the following 24
months.  Other administrative expenses increased primarily as a result
of the Company becoming a publicly reported entity.





As a
percentage to total revenue, general and administrative expense accounted for 4%
and 2% for the first quarter of 2010 and 2009, respectively.





Merger
Cost





Merger
cost occurred for the first quarter of 2009 was $567,000, which were expenses
paid during the process of reverse acquisition and private placement. There was
no such merger activity and no merger cost occurred for the first quarter of
2010.





Interest
Income (Expense)





Interest
income was $2,000 for the first quarter of 2010, compared with income expense of
$81,000 for the first quarter of 2009.  We paid off all the loans from
the bank in the first half year of 2009 and no interest expense occurred in the
first quarter of 2010.





Income
Tax Provision





Income
tax provision for the first quarter of 2010 was $973,000, an increase of
$322,000 or 49%, compared with $651,000 for the first quarter of
2009.  The increase of income tax provision was the result of the
increase in income before tax, which was the result of increase in gross profit,
and which was the result of increase in gross margin.


11





As a
percentage to total revenue, income tax provision accounted for 6% and 4% for
the first quarter of 2010 and 2009, respectively.





Net
Income





Net
income was nearly $2.0 million for the first quarter of 2010, an increase of
$0.7 million or 54%, compared with $1.3 million for the first quarter of
2009.





Earnings
per Share





Basic
earnings per share were $0.17 for the first quarter of 2010, an increase of
$0.01 compared with $0.16 for the first quarter of 2009.  The increase
in earnings per share was a result of the increase in net income while offset in
part by the increase in basic weighted average shares outstanding, which were
11,650,442 shares and 7,641,573 shares, respectively, for the first quarter of
2010 and 2009.  Of the aforementioned 7,641,573 weighted average
shares outstanding, we included the equivalent outstanding shares from the
outstanding shares of preferred stock.  The shares of preferred stock
had the same voting right and dividends right as the shares of common stock;
therefore, these shares were deemed as the equivalent shares of common stock for
computing earnings per share purpose.





Liquidity
and Capital Resources





As of
March 31, 2010 and December 31, 2009, we had cash and cash equivalents of $20.8
million and $13.6 million, respectively.  Our working capital was
approximately $46.7 million and $45.9 million, respectively, as of March 31,
2010 and December 31, 2009.  The increase in cash and cash
equivalents was mainly contributed to operating activities.





Our
operations historically have been financed through the issuance and sale of
equity securities, specifically through proceeds from private placements and
public offering of our shares of common stock. For the first quarter of 2010,
the cash provided by operating activities became main capital
resources.  We did not have material capital commitments as of March
31, 2010.  The cash and cash equivalents is enough to meet our
day-to-day requirements at current operating level.  We may need to
seek for external financing resources to supplement operating cash flows if we
successfully expand our GPS related business rapidly.





For the
three months ended March 31, 2010, net cash provided by operating activities was
$8.7 million, which represented an increase of $9.0 million as compared to
the net cash used in operating activities of $0.3 million for the same
period of the prior year.  Of the $9.0 million increase, net income
contributed $0.7 million, non-cash items contributed $0.2 million and
changes in operating assets and liabilities contributed $8.1
million.  Of the non-cash items, depreciation and amortization
increased $0.2 million.





Cash flow
from changes in operating assets and liabilities increased approximately $8.1
million, as compared to the negative cash flow of $1.5 million from changes in
operating assets and liabilities for the same period of the prior
year.  Of the $8.1 million increase, $17.3 million was attributable to
the change of cash flow from accounts receivable due to the improvement in our
cash collection cycle.  The increase in advances to suppliers for
the first quarter 2010 compared with the same period in 2009 was $2.4
million.  The decrease in accounts payable for the first quarter 2010
compared with the same period in 2009 was $6.4 million.





We have
established and implemented corporate policies to manage our cash flows
generated by our operating activities.  We have established strict
credit policies to manage the credit we give to our customers, and we give
different credit terms to different types of customers in different business
lines. For cable TV related sales, we typically provide 30 to 90 day’s credit
terms; for GPS device sales, the credit terms we provide are much shorter,
some customers were requested to pay in full before delivery; and all GPS
subscription service fee were received on prepayment basis.  The
credit terms are subject to negotiation if requested by our customers, but any
adjustment must be approved by designated management.  In general, we will
advance 20% of total purchase order amount to our suppliers, and pay in full
within 30 days on receipts of products purchased.





Net cash
used in investing activities was $1.6 million for the three months ended March
31, 2010, which was advance payment for acquisition of office
space.  The $1.7 million net cash used in investing activities in the
first quarter of 2009 was advance payment made to shareholders of ZST PRC, which
was refunded in the second quarter.





There was
no financing cash flow during the first quarter of 2010; while net cash provided
by financing activities was $2.7 million during the same period of
2009.  We conducted three closings of a private placement transaction
and received net proceeds of $2.9 million by sales of 911,055 shares of Series A
Convertible Preferred Stock.  Then we repaid $0.2 million of short
term bank loan using the proceeds from private placement.





Contractual
Obligations





None.


12





Seasonality





Our
business is not seasonal in nature.  The seasonal effect does not have
material impact on our sales.





Off-Balance
Sheet Arrangements




We have
no material off-balance sheet transactions.


13


ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




Interest
Rate Risk





We may
face some risk from potential fluctuations in interest rates, although our debt
obligations are primarily short-term in nature, but some bank loans have
variable rates.  If interest rates have great fluctuations, our
financing cost may be significantly affected.





Foreign
Currency Risk





Substantially
all of our operations are conducted in the PRC and our primary operational
currency in Chinese Renminbi (“RMB”).  As a result, currently the
effect of the fluctuations of RMB exchange rates only has minimum impact on our
business operations, but will be increasingly material if we introduce our
products widely into new international markets. Substantially all of our
revenues and expenses are denominated in RMB. However, we use the United States
dollar for financial reporting purposes. Conversion of RMB into foreign
currencies is regulated by the People’s Bank of China through a unified floating
exchange rate system. Although the PRC government has stated its intention to
support the value of the RMB, there can be no assurance that such exchange rate
will not again become volatile or that the RMB will not devalue significantly
against the U.S. dollar. Exchange rate fluctuations may adversely affect the
value, in U.S. dollar terms, of our net assets and income derived from our
operations in the PRC.





Country
Risk





The
substantial portion of our assets and operations are located and conducted in
China. While the PRC economy has experienced significant growth in the past
twenty years, growth has been uneven, both geographically and among various
sectors of the economy. The Chinese government has implemented various measures
to encourage economic growth and guide the allocation of resources. Some of
these measures benefit the overall economy of China, but may also have a
negative effect on us. For example, our operating results and financial
condition may be adversely affected by government control over capital
investments or changes in tax regulations applicable to us. If there are any
changes in any policies by the Chinese government and our business is negatively
affected as a result, then our financial results, including our ability to
generate revenues and profits, will also be negatively affected.





ITEM
4.  CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures




We
maintain disclosure controls and procedures, which are designed to ensure that
information required to be disclosed in the reports we file or submit under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer, or CEO,
and Chief Financial Officer, or CFO, as appropriate to allow timely decisions
regarding required disclosure.




Based on
an evaluation carried out as of the end of the period covered by this quarterly
report, under the supervision and with the participation of our management,
including our CEO and CFO, our CEO and CFO have concluded that, as of the end of
such period, our disclosure controls and procedures (as defined in
Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934) were effective as of March 31, 2010.




Changes
in Internal Control Over Financial Reporting




Based on
the evaluation of our management as required by paragraph (d) of
Rule 13a-15 or 15d-15 of the Exchange Act, there were no changes in our
internal control over financial reporting during the fiscal quarter to which
this report relates that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.


14


PART
II.  OTHER INFORMATION




ITEM
1.  LEGAL PROCEEDINGS




We are
not currently a party to any material legal proceedings.




ITEM
1A.  RISK FACTORS




Any
investment in our common stock involves a high degree of risk. Investors should
carefully consider the risks described in our Annual Report on Form 10-K as
filed with the SEC on March 31, 2010 and all of the information contained in our
public filings before deciding whether to purchase our common
stock.  There have been no material revisions to the “Risk Factors” as
set forth in our Annual Report on Form 10-K as filed with the SEC on March 31,
2010.





ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





In
October 2009, we completed our public offering of common stock in which we sold
3,125,000 shares of common stock at an issue price of $8.00 per share.  The
SEC declared the registration statement for the public offering, File No.
333-160343 effective on October 20, 2009. We raised a total of approximately $25
million in gross proceeds from our public offering, or approximately $22 million
in net proceeds after deducting underwriting discounts and commissions of
approximately, other offering costs, and related expenses of approximately $3
million.  As of May 14, 2010, we have used approximately $10 million
of such proceeds for working capital purposes to finance our existing
operations.





ITEM
3.  DEFAULT UPON SENIOR SECURITIES





None.





ITEM
4.  (REMOVED AND RESERVED)




ITEM
5.  OTHER INFORMATION




None.




ITEM
6.  EXHIBITS




Exhibit
                Number
              
              Description of Document31.1
              
              Certification
      of Chief Executive Officer Pursuant to Item 601(b)(31) of
      Regulation S-K, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
              
              Certification
      of Chief Financial Officer Pursuant to Item 601(b)(31) of
      Regulation S-K, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
              
              Certification
      of the Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*





*
            This
      exhibit shall not be deemed “filed” for purposes of Section 18 of the
      Securities Exchange Act of 1934 or otherwise subject to the liabilities of
      that section, nor shall it be deemed incorporated by reference in any
      filing under the Securities Act of 1933 or the Securities Exchange Act of
      1934, whether made before or after the date hereof and irrespective of any
      general incorporation language in any
filings.




15


ZST
DIGITAL NETWORKS, INC.





SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.




ZST
      DIGITAL NETWORKS, INC.Date:
      May 14, 2010
              By:
              /s/ Zhong BoZhong
      BoChief
      Executive Officer and Chairman of the BoardDate:
      May 14, 2010
              By:
              /s/ John ChenJohn
      Chen
                Chief
      Financial Officer


16