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 June 30, 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.)




206
Tongbo Street, Boyaxicheng Second Floor


Zhengzhou
City, Henan Province


People’s
Republic of China 450007


(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 August 9, 2010.





ZST
DIGITAL NETWORKS, INC.





FORM 10-Q





For
the Quarterly Period Ended June 30, 2010





INDEX





Part I
                Financial
      InformationItem
      1.
                Financial
      Statements
                
                3Consolidated
      Balance Sheets
                
                4Consolidated
      Statements of Income and Comprehensive Income
                
                5Consolidated
      Statements of Cash Flows
                
                6Notes
      to Consolidated Financial Statements
                
                7Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                
                20Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                
                33Item
      4.
                Controls
      and Procedures
                
                33Part II
                Other
      InformationItem
      1.
                Legal
      Proceedings
                
                34Item
      1A.
                Risk
      Factors
                
                34Item
      2.
                Unregistered
      Sale of Equity Securities and Use of Proceeds
                
                34Item
      3.
                Default
      Upon Senior Securities
                
                34Item
      4.
                (Removed
      and Reserved)
                
                34Item
      5.
                Other
      Information
                
                34Item
      6.
                Exhibits
                
                35Signatures
                
                36




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/A for the year ended December 31, 2009 filed with
the Securities and Exchange Commission on May 18, 2010.


3




ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
BALANCE SHEETS


(In
US Dollars)





December 31,
                          
                          
                          June 30,2009
                          
                          
                          2010(Restated)
                          
                          
                          (Unaudited)ASSETSCurrent
      assets:Cash and cash
      equivalents
                          
                          $
                          13,627,992
                          
                          
                          $
                          15,781,269Accounts
      receivable
                          
                          
                          24,885,497
                          
                          
                          
                          28,944,450Inventories
                          
                          
                          1,245,803
                          
                          
                          
                          502,051Advance to
      suppliers
                          
                          
                          7,399,141
                          
                          
                          
                          8,847,600Prepaid
    expenses
                          
                          
                          1,064,499
                          
                          
                          
                          1,039,356Total
      current assets
                          
                          
                          48,222,932
                          
                          
                          
                          55,114,726Property,
      machinery, equipment and software, net
                          
                          
                          875,806
                          
                          
                          
                          2,347,573Intangible
      asset
                          
                          
                          171,122
                          
                          
                          
                          153,358Prepaid
      expenses – long term
                          
                          
                          858,609
                          
                          
                          
                          312,696Total
      assets
                          
                          $
                          50,128,469
                          
                          
                          $
                          57,928,353LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
payable
                          
                          $
                          700,940
                          
                          
                          $
                          2,650Advance from
      customers
                          
                          
                          376,586
                          
                          
                          
                          1,070,466Accruals and other
      payables
                          
                          
                          295,410
                          
                          
                          
                          138,953Accrued payroll and related
      expense
                          
                          
                          66,370
                          
                          
                          
                          98,845VAT payable
                          
                          
                          198,828
                          
                          
                          
                          535,947Franchise tax
      payable
                          
                          
                          162,100
                          
                          
                          
                          -Income tax
    payable
                          
                          
                          547,917
                          
                          
                          
                          827,985Total
      current liabilities
                          
                          
                          2,348,151
                          
                          
                          
                          2,674,846Equity
      :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
                          
                          
                          
                          20,926,558Translation
      adjustment
                          
                          
                          20,085
                          
                          
                          
                          319,507Total
      equity
                          
                          
                          47,780,318
                          
                          
                          
                          55,253,507Total
      liabilities and equity
                          
                          $
                          50,128,469
                          
                          
                          $
                          57,928,353





See
accompanying notes to financial statements


4


ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


FOR
SIX MONTHS ENDED JUNE 30, 2009 AND 2010


(In
US Dollars)





Six Months Ended June 30,
                                  
                                  
                                  Three Months Ended June 30,2009
                                  
                                  
                                  2010
                                  
                                  
                                  2009
                                  
                                  
                                  2010(Unaudited)
                                  
                                  
                                  (Unaudited)
                                  
                                  
                                  (Unaudited)
                                  
                                  
                                  (Unaudited)Revenues:Sales of products
                                  
                                  $
                                  41,439,540
                                  
                                  
                                  $
                                  47,993,924
                                  
                                  
                                  $
                                  23,678,912
                                  
                                  
                                  $
                                  31,566,021Sales of services
                                  
                                  
                                  -
                                  
                                  
                                  
                                  2,100,497
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,480,122Total
      revenue
                                  
                                  
                                  41,439,540
                                  
                                  
                                  
                                  50,094,421
                                  
                                  
                                  
                                  23,678,912
                                  
                                  
                                  
                                  33,046,143Cost
      of sales:Cost of products
    sold
                                  
                                  
                                  34,950,607
                                  
                                  
                                  
                                  37,581,909
                                  
                                  
                                  
                                  20,106,328
                                  
                                  
                                  
                                  24,757,120Cost of service
                                  
                                  
                                  -
                                  
                                  
                                  
                                  91,640
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  42,143Cost
      of sales
                                  
                                  
                                  34,950,607
                                  
                                  
                                  
                                  37,673,549
                                  
                                  
                                  
                                  20,106,328
                                  
                                  
                                  
                                  24,799,263Gross
      profit
                                  
                                  
                                  6,488,933
                                  
                                  
                                  
                                  12,420,872
                                  
                                  
                                  
                                  3,572,584
                                  
                                  
                                  
                                  8,246,880Selling
      expense
                                  
                                  
                                  69,243
                                  
                                  
                                  
                                  376,279
                                  
                                  
                                  
                                  50,671
                                  
                                  
                                  
                                  108,974Research
      and development expenses
                                  
                                  
                                  -
                                  
                                  
                                  
                                  330,891
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  95,367General
      and administrative expenses
                                  
                                  
                                  477,238
                                  
                                  
                                  
                                  1,565,765
                                  
                                  
                                  
                                  121,459
                                  
                                  
                                  
                                  835,155Merger
      cost
                                  
                                  
                                  566,654
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Income
      from operations
                                  
                                  
                                  5,375,798
                                  
                                  
                                  
                                  10,147,937
                                  
                                  
                                  
                                  3,400,454
                                  
                                  
                                  
                                  7,207,384Interest
      income (expense), net
                                  
                                  
                                  (72,514
                                  )
                                  
                                  
                                  32,222
                                  
                                  
                                  
                                  8,867
                                  
                                  
                                  
                                  30,607Other
      income (expense)
                                  
                                  
                                  (7,680
                                  )
                                  
                                  
                                  2,401
                                  
                                  
                                  
                                  (10,684
                                  )
                                  
                                  
                                  2,401Income
      before income taxes
                                  
                                  
                                  5,295,604
                                  
                                  
                                  
                                  10,182,560
                                  
                                  
                                  
                                  3,398,637
                                  
                                  
                                  
                                  7,240,392Income
      tax provision
                                  
                                  
                                  1,487,315
                                  
                                  
                                  
                                  3,008,793
                                  
                                  
                                  
                                  836,706
                                  
                                  
                                  
                                  2,036,280Net
      income
                                  
                                  $
                                  3,808,289
                                  
                                  
                                  $
                                  7,173,767
                                  
                                  
                                  $
                                  2,561,931
                                  
                                  
                                  $
                                  5,204,112Weighted
      average common shares outstanding – basic
                                  
                                  
                                  7,954,507
                                  
                                  
                                  
                                  11,650,442
                                  
                                  
                                  
                                  8,264,003
                                  
                                  
                                  
                                  11,650,442Earnings
      per share – basic
                                  
                                  
                                  0.48
                                  
                                  
                                  
                                  0.62
                                  
                                  
                                  
                                  0.31
                                  
                                  
                                  
                                  0.45Weighted
      average common shares outstanding – diluted
                                  
                                  
                                  8,116,641
                                  
                                  
                                  
                                  11,650,442
                                  
                                  
                                  
                                  8,434,621
                                  
                                  
                                  
                                  11,650,442Earnings
      per shares – diluted
                                  
                                  
                                  0.47
                                  
                                  
                                  
                                  0.62
                                  
                                  
                                  
                                  0.30
                                  
                                  
                                  
                                  0.45Comprehensive
      income:Net income
                                  
                                  
                                  3,808,289
                                  
                                  
                                  
                                  7,173,767
                                  
                                  
                                  
                                  2,561,931
                                  
                                  
                                  
                                  5,204,112Translation
      adjustment
                                  
                                  
                                  (638,658
                                  )
                                  
                                  
                                  299,422
                                  
                                  
                                  
                                  (215,994
                                  )
                                  
                                  
                                  249,390Comprehensive
      income
                                  
                                  $
                                  3,169,631
                                  
                                  
                                  $
                                  7,473,189
                                  
                                  
                                  $
                                  2,345,937
                                  
                                  
                                  $
                                  5,453,502





See
accompanying notes to financial statements.


5


ZST
DIGITAL NETWORKS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Increase
(Decrease) in Cash and Cash Equivalents


(In
US Dollars)





Six Months Ended June 30,2009
                        
                        
                        2010(Unaudited)
                        
                        
                        (Unaudited)Cash
      flows from operating activities:Net
      income
                        
                        $
                        3,808,289
                        
                        
                        $
                        7,173,767Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:
                        
                        
                        -
                        
                        
                        
                        -Depreciation
      and amortization
                        
                        
                        9,687
                        
                        
                        
                        232,806Share-based
      compensation
                        
                        
                        -
                        
                        
                        
                        85,721Imputed
      interest
                        
                        
                        31,413
                        
                        
                        
                        -Changes
      in operating assets and liabilities:
                        
                        
                        -
                        
                        
                        
                        -Accounts
      receivable
                        
                        
                        (12,442,523
                        )
                        
                        
                        (4,033,881
                        )Inventory
                        
                        
                        185,069
                        
                        
                        
                        738,848Advance
      to suppliers
                        
                        
                        1,380,359
                        
                        
                        
                        (1,439,433
                        )Prepayments
      and other assets
                        
                        
                        (64,246
                        )
                        
                        
                        475,485Accounts
      payable
                        
                        
                        5,595,654
                        
                        
                        
                        (702,869
                        )Accruals
      and other payable
                        
                        
                        55,380
                        
                        
                        
                        52,644Advance
      from customers
                        
                        
                        -
                        
                        
                        
                        698,373Taxes
      payable
                        
                        
                        480,931
                        
                        
                        
                        281,860Net
      cash provided by(used in) operating activities
                        
                        
                        (959,987
                        )
                        
                        
                        3,563,321Cash
      flows from investing activities:Additions
      to fixed assets
                        
                        
                        (782,334
                        )
                        
                        
                        (1,664,612
                        )Additions
      to intangible assets
                        
                        
                        (191,330
                        )
                        
                        
                        -Net
      cash used in investing activities
                        
                        
                        (973,664
                        )
                        
                        
                        (1,664,612
                        )Cash
      flows from financing activities:Repayments
      for short term bank loans
                        
                        
                        (1,725,038
                        )
                        
                        
                        -Net
      proceeds from sale of preferred stock
                        
                        
                        3,533,955
                        
                        
                        
                        -Net
      cash received from financing activities
                        
                        
                        1,808,917
                        
                        
                        
                        -Effect
      of changes in foreign exchange rates
                        
                        
                        218,161
                        
                        
                        
                        254,568Net
      increase in cash and cash equivalents
                        
                        
                        93,427
                        
                        
                        
                        2,153,277Cash
      and cash equivalents, beginning of the year
                        
                        
                        1,134,954
                        
                        
                        
                        13,627,992Cash
      and cash equivalents, end of the period
                        
                        $
                        1,228,381
                        
                        
                        $
                        15,781,269Supplemental
      disclosures of cash flow information:Cash
      paid for interest
                        
                        $
                        84,894
                        
                        
                        $
                        -Cash
      paid for income taxes
                        
                        
                        1,094,566
                        
                        
                        
                        2,734,435





See
accompanying notes to financial statements


6


NOTE
1 – ORGANIZATION AND BUSINESS BACKGROUND





SRKP 18,
Inc. was incorporated in the State of Delaware on December 7,
2006.  SRKP 18, Inc. 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
Shengyang Technology Co., Ltd. (thereafter “ZST PRC”) was established on May 20,
1996 as a private domestic corporation located in Zhengzhou City, Henan
Province, 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.  ZST PRC gradually increased its authorized capital and
invested capital to meet its operating requirement of fund.  All
foreign investments made to Zhengzhou City enterprises required the approval of
Zhengzhou City Bureau of Commerce.  The approval method utilized by
ZST PRC to transfer proceeds from the financing was to increase its registered
capital.  Therefore, as of June 30, 2010, the authorized capital and
invested capital of ZST PRC were RMB260 million and RMB147.8 million,
respectively.





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, ZST management 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 ZST Management, (iii) established World Orient
Universal Limited (“World Orient”) as a 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 ZST Digital, (v) concurrently
conducted a private investment in a public entity (“PIPE”) financing, and (vi)
used proceeds from the PIPE transaction to pay RMB12 million to ZST Management
pursuant to an ownership transfer agreement.





World
Orient was incorporated in British Virgin Islands (“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 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, PRC 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.





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 competent government agency. After this equity
transfer, ZST PRC became a foreign investment company with the operating life of
30 years since the approval of its establishment on November 10,
2008.





On
January 9, 2009, SRKP 18, Inc. closed a share exchange transaction (the “Share
Exchange”) pursuant to which SRKP 18, Inc. (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 transaction, a PIPE
transaction to raise $5 million was also under implementation between an
investment bank and ZST Digial Networks, Inc. by which ZST Digital Networks,
Inc. will be able to make payment of RMB12 million to the original owners of ZST
PRC.





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 our 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.


7





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 Networks, Inc. and Mr. Zhong Bo was appointed as Chairman of the
Board and Chief Executive Officer of ZST Digital.  Thereafter, 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.





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 six-month period ended June 30, 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. 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:





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.


8


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.





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 contracts.





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 six months ended June 30, 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.


9


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 June 30, 2010 and December 31,
2009.





Inventories





Inventories
are composed of raw materials and 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 $190,136. The Company recorded the acquired know-how as intangible asset and
amortized the acquisition cost over five years using the straight-line
method.





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 six months ended
June 31, 2009 and 2010 were $0 and $0, respectively.


10


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.





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.


11


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 $23,554,179 at June 30, 2010,
respectively.





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 Networks, Inc. was established under the laws of the State of Delaware
and is subject to U.S. federal income tax and one state income
tax.  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 shareholders by the weighted average number of
common shares 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.  The stock warrants to purchase 156,250 shares of the Company’s
common stock issued to underwriters in connection with initial stock offering
conducted in October 2009 with the exercise price at $10.00 per share are
anti-dilutive for computing earnings per share purpose.  The stock
option to purchase 25,000 shares of the Company’s common stock issued to a
corporate officer with the exercise price at $8.00 per share are anti-dilutive
for computing earnings per share purpose.





Recently
Issued Accounting Pronouncements Adopted





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.





FASB ASU
2010-09





In
February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and
Disclosure Requirements.  This update addresses certain implementation
issues related to an entity’s requirement to perform and disclose
subsequent-events procedures, removes the requirement that public companies
disclose the date of their financial statements in both issued and revised
financial statements.  According to the FASB, the revised statements
include those that have been changed to correct an error or conform to a
retrospective application of U.S. GAAP.  The amendment is effective
immediately.  The adoption of this ASU did not have a
material impact on the Company’s consolidated financial
statements.


12


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.





FASB ASU
2009-17





Effective
January 1, 2010, the Company adopted ASU No. 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
2010-01





Effective
January 1, 2010, the Company adopted ASU No. 2010-01 – “Accounting for
Distributions to Shareholders with Components of Stock and Cash.”  The
amendments in this Update clarify that the stock portion of a distribution to
shareholders that allows them to elect to receive cash or stock with a potential
limitation on the total amount of cash that all shareholders can elect to
receive in the aggregate is considered a share issuance that is reflected in EPS
prospectively and is not a stock dividend for purposes of applying Topics 505
and 260 (Equity and Earnings Per Share).  The amendments in this
update are effective for interim and annual periods ending on or after December
15, 2009, and should be applied on a retrospective basis. The adoption of this
ASU did not have a material impact on its consolidated financial
statements.





FASB ASU
2010-02





Effective
January 1, 2010, the Company adopted ASU No. 2010-02 – “Accounting and
Reporting for Decreases in Ownership of a Subsidiary – a Scope
Clarification.”  The amendments in this Update affect accounting and
reporting by an entity that experiences a decrease in ownership in a subsidiary
that is a business or nonprofit activity.  The amendments also affect
accounting and reporting by an entity that exchanges a group of assets that
constitutes a business or nonprofit activity for an equity interest in another
entity.  The amendments in this update are effective beginning in the
period that an entity adopts SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements – An Amendment of ARB No. 51.”  If
an entity has previously adopted SFAS No. 160 as of the date the amendments in
this update are included in the Accounting Standards Codification, the
amendments in this update are effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009. The amendments in this
update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160.  The adoption of this ASU did not have
a material impact on the Company’s consolidated financial
statements.





Recently
Issued Accounting Pronouncements Not Adopted Yet





FSAB ASU
2010-06





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows:  1) Transfers in and out of Levels
1 and 2. A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2) Activity in Level 3
fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net
number).  This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows:  1) Level of
disaggregation. A reporting entity should provide fair value measurement
disclosures for each class of assets and liabilities.  A class is
often a subset of assets or liabilities within a line item in the statement of
financial position. A reporting entity needs to use judgment in determining the
appropriate classes of assets and liabilities.  2) Disclosures about
inputs and valuation techniques.  A reporting entity should provide
disclosures about the valuation techniques and inputs used to measure fair value
for both recurring and nonrecurring fair value measurements.  Those
disclosures are required for fair value measurements that fall in either Level 2
or Level 3.  The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.


13


FASB ASU
2010-13





In April
2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-13,
"Compensation - Stock Compensation (Topic 718): Effect of Denominating the
Exercise Price of a Share-Based Payment Award in the Currency of the Market in
Which the Underlying Equity Security Trades," which addresses the
classification of a share-based payment award with an exercise price denominated
in the currency of a market in which the underlying equity security
trades.  Topic 718 is amended to clarify that a share-based payment
award with an exercise price denominated in the currency of a market in which
a substantial portion of the entity’s equity securities trades shall not be
considered to contain a market, performance, or service
condition.  Therefore, such an award is not to be classified as a
liability if it otherwise qualifies as equity classification.  The
amendments in this Update should be applied by recording
a cumulative-effect adjustment to the opening balance of retained
earnings.  The cumulative-effect adjustment should be calculated for
all awards outstanding as of the beginning of the fiscal year in which the
amendments are initially applied, as if the amendments had been applied
consistently since the inception of the award. ASU 2010-13 is effective for
interim and annual periods beginning on or after December 15, 2010 and is not
expected to have a material impact on the Company’s consolidated financial
position or results of operations.





Reclassification





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





NOTE
3 – ACCOUNTS RECEIVABLES





The
accounts receivables are as follows:





December 31,
                      
                      
                      June 30,2009
                      
                      
                      2010(Unaudited)Accounts
      receivables
                      
                      $
                      18,982,676
                      
                      
                      $
                      22,125,463Accounts
      receivables – 10% hold back
                      
                      
                      5,902,821
                      
                      
                      
                      6,818,987$
                      24,885,497
                      
                      
                      $
                      28,944,450Provision
                      
                      
                      -
                      
                      
                      
                      -Accounts
      receivable, net
                      
                      $
                      24,885,497
                      
                      
                      $
                      28,944,450





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





December 31,
                      
                      
                      June 30,2009
                      
                      
                      2010(Unaudited)1-30
      days
                      
                      $
                      10,443,577
                      
                      
                      $
                      15,466,49031-60
      days
                      
                      
                      8,539,099
                      
                      
                      
                      6,658,973$
                      18,982,676
                      
                      
                      $
                      22,125,463





Most of
accounts receivables - 10% 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 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 June 30, 2010, Advances of $8,847,600 represents advances mainly made to
two suppliers accounting for 50% and 50%, respectively.  Total
purchases from these two suppliers for the six months ended June 30, 2010
accounted for approximately 12% and 25% of the total purchases by ZST PRC
for the six months ended June 30, 2010.


14


NOTE
5 – INVENTORIES





The
inventories are as follows:




December 31,
                      
                      
                      June 30,2009
                      
                      
                      2010(Unaudited)Products
      for sale
                      
                      $
                      1,245,803
                      
                      
                      
                      502,051Less:
      Provisions
                      
                      
                      -
                      
                      
                      
                      -Inventories,
      net
                      
                      $
                      1,245,803
                      
                      
                      $
                      502,051





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





NOTE
6 – MACHINERY, EQUIPMENT AND SOFTWARE





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





December 31,
                      
                      
                      June 30,2009
                      
                      
                      2010(Unaudited)Machinery
      and equipment
                      
                      $
                      89,203
                      
                      
                      $
                      89,936Electronic
      equipment
                      
                      
                      323,992
                      
                      
                      
                      184,276Office
      equipment
                      
                      
                      39,503
                      
                      
                      
                      39,828Vehicles
                      
                      
                      193,317
                      
                      
                      
                      229,285Software
                      
                      
                      453,402
                      
                      
                      
                      457,126Advance
      for purchasing office space
                      
                      
                      -
                      
                      
                      
                      1,641,230$
                      1,099,417
                      
                      
                      $
                      2,641,681Accumulated
      depreciation
                      
                      
                      (223,611
                      )
                      
                      
                      (294,108
                      )$
                      875,806
                      
                      
                      $
                      2,347,573





The
depreciation and amortization for six months ended June 30, 2009 and 2010 were
$9,687 and $215,167, respectively.





On March
12, 2010, the Company paid RMB11.13 million (approximately $1,641,230) for
purchasing an office space located in Zhengzhou City, Henan Province, PRC, which
is still under construction and will be available for use at the end of
2010.





NOTE
7 – EQUITY TRANSACTION





The
Company has two types of stock, common and preferred stocks.  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 Preferred Stock.  The Company is authorized to issue 100 million
shares of common stock with par value of 0.0001 per share.





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.


15





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.





Common
Stock Transactions in 2010





No common
stock transaction incurred during the first half year 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.


16


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:





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 transaction incurred during the first half year of
2010.





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
(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 will be 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 $85,721 for the six months ended June 30,
2010.


17


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:





Six Months Ended June 30,2009
                      
                      
                      2010(Unaudited)
                      
                      
                      (Unaudited)Numerator:Net
      income attributable to the Company
                      
                      $
                      3,808,289
                      
                      
                      $
                      7,173,767Net
      income used in computing diluted earnings per share
                      
                      $
                      3,808,289
                      
                      
                      $
                      7,173,767Denominator:Weighted
      average common shares outstanding – basic
                      
                      
                      7,954,507
                      
                      
                      
                      11,650,442Potential
      diluted shares from stock warrants granted
                      
                      
                      162,134
                      
                      
                      
                      -Weighted
      average common share outstanding – diluted
                      
                      
                      8,116,641
                      
                      
                      
                      11,650,442Basic
      earnings per share
                      
                      $
                      0.48
                      
                      
                      $
                      0.62Diluted
      earnings per share
                      
                      $
                      0.47
                      
                      
                      $
                      0.62





Three Months Ended June 30,2009
                      
                      
                      2010(Unaudited)
                      
                      
                      (Unaudited)Numerator:Net
      income attributable to the Company
                      
                      $
                      2,561,931
                      
                      
                      $
                      5,204,112Net
      income used in computing diluted earnings per share
                      
                      $
                      2,561,931
                      
                      
                      $
                      5,204,112Denominator:Weighted
      average common shares outstanding – basic
                      
                      
                      8,264,003
                      
                      
                      
                      11,650,442Potential
      diluted shares from stock warrants granted
                      
                      
                      170,618
                      
                      
                      
                      -Weighted
      average common share outstanding – diluted
                      
                      
                      8,434,621
                      
                      
                      
                      11,650,442Basic
      earnings per share
                      
                      $
                      0.31
                      
                      
                      $
                      0.45Diluted
      earnings per share
                      
                      $
                      0.30
                      
                      
                      $
                      0.45





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
in only 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.





Six Months Ended June 30,
                        
                        
                        Three Months Ended June 30,2009
                        
                        
                        2010
                        
                        
                        2009
                        
                        
                        2010(Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        (Unaudited)Sales
      of Cable TV Equipments:Revenue
                        
                        $
                        41,439,540
                        
                        
                        $
                        41,313,276
                        
                        
                        $
                        23,678,912
                        
                        
                        $
                        27,038,184Cost
                        
                        
                        34,950,607
                        
                        
                        
                        32,297,100
                        
                        
                        
                        20,106,328
                        
                        
                        
                        21,163,122Gross
      margin
                        
                        
                        16
                        %
                        
                        
                        22
                        %
                        
                        
                        15
                        %
                        
                        
                        22
                        %Sales
      of GPS Devices:Revenue
                        
                        
                        -
                        
                        
                        
                        6,680,648
                        
                        
                        
                        -
                        
                        
                        
                        4,527,837Cost
                        
                        
                        -
                        
                        
                        
                        5,284,809
                        
                        
                        
                        -
                        
                        
                        
                        3,593,998Gross
      margin
                        
                        
                        -
                        
                        
                        
                        21
                        %
                        
                        
                        -
                        
                        
                        
                        21
                        %GPS
      Related Service:Revenue
                        
                        
                        -
                        
                        
                        
                        2,100,497
                        
                        
                        
                        -
                        
                        
                        
                        1,480,122Cost
                        
                        
                        -
                        
                        
                        
                        91,640
                        
                        
                        
                        -
                        
                        
                        
                        42,143Gross
      margin
                        
                        
                        -
                        
                        
                        
                        97
                        %
                        
                        
                        -
                        
                        
                        
                        97
                        %Total
      revenue
                        
                        
                        41,439,540
                        
                        
                        
                        50,094,421
                        
                        
                        
                        23,678,912
                        
                        
                        
                        33,046,143Total
      cost
                        
                        
                        34,950,607
                        
                        
                        
                        37,673,549
                        
                        
                        
                        20,106,328
                        
                        
                        
                        24,799,263Overall
      gross margin
                        
                        
                        16
                        %
                        
                        
                        25
                        %
                        
                        
                        15
                        %
                        
                        
                        25
                        %




18





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 six months ended June 30, 2010, the amortization of
this long-term prepayment was $71,250.





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 Agreement 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 $387,500 for the
six months ended June 30, 2010.





NOTE
12 – SUBSEQUENT EVENTS





Stock
Incentive Plan





At our
annual meeting of stockholders to be held on August 23, 2010, it is expected
that our stockholders will approve the ZST Digital Networks, Inc. 2010 Omnibus
Incentive Plan covering five hundred thousand (500,000) shares of our common
stock.  We may issue various types of awards under the plan,
including, but not limited to, stock options and restricted shares of common
stock. Grants or other stock awards pursuant to the plan will cause us to
incur significant non-cash equity-based compensation charges. This non-cash
charge will be amortized over the vesting period of the awards. These non-cash
charges will negatively impact our results of operations, specifically our net
income and net income per share.  Additionally, any future awards made
pursuant to the plan could have a significant adverse effect on the trading
price of our common stock, especially if a significant volume of the stock
issued is sold into the public market. Further, the issuance of any stock awards
pursuant to the plan will have a dilutive impact on other stockholders by
decreasing their ownership percentage of our outstanding common stock. An
adverse impact on the trading price of our common stock may negatively affect
our ability to use to our securities to raise capital or to acquire other
companies using our securities.





The
Company evaluated all events or transactions that occurred after June 30, 2010
up through the date the Company issued these financial statements. During this
period the Company did not have any material recognizable subsequent
events.


19


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 JUNE 30, 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 June 30, 2010, ZST PRC had approximately 91 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 for the second quarter of 2010.





·
            Total
      revenue was $33.0 million, an increase of 40% compared to the second
      quarter of 2009.


·
            Gross
      profit for the second quarter of 2010 was $8.2 million, an increase of
      131% compared to the second quarter of 2009. Gross profit ratio for the
      second quarter of 2010 was 25%, compared to 15% for the second quarter of
      2009.


·
            Net
      income for the second quarter of 2010 was $5.2 million, an increase of
      103% compared to the second quarter of
2009.


·
            Net
      income to revenue ratio for the second quarter of 2010 was 16%, compared
      to 11% for the second quarter of
2009.


·
            Basic
      and diluted earnings per share were both $0.45 for the second quarter of
      2010, an increase of $0.14 compared to $0.31 and $0.30 for basic earnings
      and diluted earnings per share, respectively, for the second quarter of
      2009.


20





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 a
choice of video programs offered by the network video providers on the broadband
IP network.  We also offer power supplies, remote controls, and other
devices and accessories.  Our product sales also include a line of
fiber-optic receivers, which convert fiber-optic transmissions 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 substantially focus
our resources on determining customer requirements, design, development and
support of the 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 for 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. Our cable services include networking in
buildings.





Since the
fourth quarter of 2009, we began providing GPS location and tracking services to
third parties, mainly automobile dealers. We plan to participate in the GPS
service provider business by 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, opportunities to bid for these projects
exist.





We expect
that our profitability will be adversely affected by the business expenses
associated with our efforts to expand 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, including costs associated
with financial reporting, information technology, complying with federal
securities laws (including the Sarbanes-Oxley Act of 2002), tax administration
and human resources related functions.  While we are striving for
business growth, we also intend to focus on measures to control operational
costs.





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 a one-time retention payment of $285,000 (the
“Retention Amount”) if he remains continuously employed 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.





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 in
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.


21





Stock
Incentive Plan


At our
annual meeting of stockholders to be held on August 23, 2010, it is expected
that our stockholders will approve the ZST Digital Networks, Inc. 2010 Omnibus
Incentive Plan covering five hundred thousand (500,000) shares of our common
stock.  We may issue various types of awards under the plan,
including, but not limited to, stock options and restricted shares of common
stock. Grants or other stock awards pursuant to the plan will cause us to
incur significant non-cash equity-based compensation charges. This non-cash
charge will be amortized over the vesting period of the awards. These non-cash
charges will negatively impact our results of operations, specifically our net
income and net income per share.  Additionally, any future awards made
pursuant to the plan could have a significant adverse effect on the trading
price of our common stock, especially if a significant volume of the stock
issued is sold into the public market. Further, the issuance of any stock awards
pursuant to the plan will have a dilutive impact on other stockholders by
decreasing their ownership percentage of our outstanding common stock. An
adverse impact on the trading price of our common stock may negatively affect
our ability to use to our securities to raise capital or to acquire other
companies using our securities.





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 future laws and regulations that may have material effect on
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 the sale of products related to Cable TV program
distribution systems, which include digital Cable TV network equipment 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 stand-alone 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 to 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 the total contract price for one year after the
delivery of products for warranty purposes.  We recognize 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; however, we do not have any
historical return experience.





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


22





Multiple
Deliverables





In
October 2009, we started to sell GPS devices in conjunction with subscription
and installation service.  We generally recognize revenue from the
sale of the 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 12-month service contracts 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 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% of 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 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 on GPS devices, we have a policy that provides coverage on repairs of
GPS devices for a period of one year after the date of purchase.  In
the event that repair is needed, customers will be responsible for the cost of
parts while the cost of labor will be covered by us.  We estimate the
costs to service our obligations based on historical experience and expectations
of future conditions.  We did not incur warranty costs for
the three months ended June 30, 2010 and for the year ended December 31,
2009.  Based on these facts, we record 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 written 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 June 30, 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 accounting 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.


23





Recently
Issued Accounting Pronouncements Adopted





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.





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.





FASB ASU
2009-17





Effective
January 1, 2010, the Company adopted ASU No. 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
2010-01





Effective
January 1, 2010, the Company adopted ASU No. 2010-01 ─ “Accounting for
Distributions to Shareholders with Components of Stock and Cash.”  The
amendments in this Update clarify that the stock portion of a distribution to
shareholders that allows them to elect to receive cash or stock with a potential
limitation on the total amount of cash that all shareholders can elect to
receive in the aggregate is considered a share issuance that is reflected in EPS
prospectively and is not a stock dividend for purposes of applying Topics 505
and 260 (Equity and Earnings Per Share).  The amendments in this
update are effective for interim and annual periods ending on or after December
15, 2009, and should be applied on a retrospective basis. The adoption of this
ASU did not have a material impact on its consolidated financial
statements.





FASB ASU
2010-02





Effective
January 1, 2010, the Company adopted ASU No. 2010-02 – “Accounting and Reporting
for Decreases in Ownership of a Subsidiary – a Scope
Clarification.”  The amendments in this Update affect accounting and
reporting by an entity that experiences a decrease in ownership in a subsidiary
that is a business or nonprofit activity.  The amendments also affect
accounting and reporting by an entity that exchanges a group of assets that
constitutes a business or nonprofit activity for an equity interest in another
entity.  The amendments in this update are effective beginning in the
period that an entity adopts SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements – An Amendment of ARB No. 51.”  If
an entity has previously adopted SFAS No. 160 as of the date the amendments in
this update are included in the Accounting Standards Codification, the
amendments in this update are effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009. The amendments in this
update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160.  The adoption of this ASU did not have
a material impact on the Company’s consolidated financial
statements.





FASB ASU
2010-09





In
February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and
Disclosure Requirements.  This update addresses certain implementation
issues related to an entity’s requirement to perform and disclose
subsequent-events procedures, removes the requirement that public companies
disclose the date of their financial statements in both issued and revised
financial statements.  According to the FASB, the revised statements
include those that have been changed to correct an error or conform to a
retrospective application of U.S. GAAP.  The amendment is effective
immediately.  The adoption of this ASU did not have a
material impact on the Company’s consolidated financial
statements.


24


Recently
Issued Accounting Pronouncements Not Adopted Yet





FSAB ASU
2010-06





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows:  1) Transfers in and out of Levels
1 and 2. A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2) Activity in Level 3
fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net
number).  This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows:  1) Level of
disaggregation. A reporting entity should provide fair value measurement
disclosures for each class of assets and liabilities.  A class is
often a subset of assets or liabilities within a line item in the statement of
financial position. A reporting entity needs to use judgment in determining the
appropriate classes of assets and liabilities.  2) Disclosures about
inputs and valuation techniques.  A reporting entity should provide
disclosures about the valuation techniques and inputs used to measure fair value
for both recurring and nonrecurring fair value measurements.  Those
disclosures are required for fair value measurements that fall in either Level 2
or Level 3.  The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.





FASB ASU
2010-13





In April
2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-13,
"Compensation - Stock Compensation (Topic 718): Effect of Denominating the
Exercise Price of a Share-Based Payment Award in the Currency of the Market in
Which the Underlying Equity Security Trades," which addresses the
classification of a share-based payment award with an exercise price denominated
in the currency of a market in which the underlying equity security
trades.  Topic 718 is amended to clarify that a share-based payment
award with an exercise price denominated in the currency of a market in which
a substantial portion of the entity’s equity securities trades shall not be
considered to contain a market, performance, or service
condition.  Therefore, such an award is not to be classified as a
liability if it otherwise qualifies as equity classification.  The
amendments in this Update should be applied by recording
a cumulative-effect adjustment to the opening balance of retained
earnings.  The cumulative-effect adjustment should be calculated for
all awards outstanding as of the beginning of the fiscal year in which the
amendments are initially applied, as if the amendments had been applied
consistently since the inception of the award. ASU 2010-13 is effective for
interim and annual periods beginning on or after December 15, 2010 and is not
expected to have a material impact on the Company’s consolidated financial
position or results of operations.





Results
of Operations





Comparison
of Three months Ended June 30, 2009 and 2010





Revenue





We are
currently engaged in two main business lines: the provision of Cable TV program
distribution related equipment and the provision of GPS devices and related
location and tracking services. Total revenue by business line is as
follows:





Three Months Ended June 30,2009
                  
                  
                  2010Sales
      Revenue:Sales
      of cable TV equipments
                  
                  
                  23,678,912
                  
                  
                  
                  27,038,184Sales
      of GPS devices
                  
                  
                  -
                  
                  
                  
                  4,527,837Revenue
      from sales of goods
                  
                  
                  23,678,912
                  
                  
                  
                  31,566,021Revenue
      from service:GPS
      related service
                  
                  
                  -
                  
                  
                  
                  1,480,122Total
      revenue
                  
                  
                  23,678,912
                  
                  
                  
                  33,046,143





Overall
our revenue was $33 million for the second quarter of 2010, representing an
increase of $9,367,231 or a 40% increase in comparison to $23.7 million for the
second quarter of 2009.  The significant increase in revenue was
contributed by the two main business lines respectively: revenue from Cable TV
equipment sales for the current quarter increased by approximately 14%
compared to the same period of the prior year; and revenue from sales of GPS
devices and related service amounted to $6.0 million, accounted for 18% of total
revenue for the second quarter of 2010.  We did not have GPS business
related revenue during the same period of the prior year because GPS related
businesses were established in October 2009.


25


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 are as follows:





Three Months Ended June 30,2009
                  
                  
                  2010Sales
      Revenue from Cable TV products:Sales
      of IPTV set-top boxes
                  
                  
                  15,230,132
                  
                  
                  
                  14,275,906Sales
      of cable TV network equipments
                  
                  
                  8,448,780
                  
                  
                  
                  12,762,278Total
                  
                  
                  23,678,912
                  
                  
                  
                  27,038,184





Sales of IPTV set-top
boxes





Revenue
from sales of IPTV set-top boxes was $14.3 million, a decrease of $954,226 or 6%
compared with $15.2 million for the same quarter in 2009.  The sales
volume of IPTV set-top boxes increased by 80% compared to the same period of
2009.  The slight decrease in sales revenue and significant increase
in sales volume was due to changes in sales mix of High Definition and Standard
Definition products.  During the second quarter of 2009, we sold only
High Definition IPTV set-top boxes, primarily to users in the larger regional
cities in Henan Province. The High Definition IPTV set-top box had higher
selling prices.  We launched the Standard Definition IPTV set-top
boxes line with a lower average selling price in the first quarter of 2010 to
capture additional market share in rural cities and counties.  The
average selling price of Standard Definition IPTV set-top box was approximately
38.5% of the selling price of High Definition products.  For the
second quarter of 2010, sales of Standard Definition IPTV set-top boxes
accounted for 58% in quantity of the total IPTV set-top boxes sold.





The
average selling price of High Definition IPTV set-top boxes decreased by
approximately 19% during the second quarter of 2010 compared to the average
selling price during the same period in 2009.  This decline led to a
negative impact of $2.8 million on sales revenue, without taking into
consideration changes in volume.  Concurrently, sales volume of High
Definition set-top boxes decreased by approximately 25% compared to the same
quarter of 2009, which led to a negative impact of $3.86 million on sales
revenue.  The overlapping impact of changes in volume and average
selling price is approximately $0.72 million.  The decrease in selling
price and sales volume resulted in a net decrease of approximately $5.97 million
in the sales of High Definition set-top boxes.





The sales
of Standard Definition products accounted for 35% in total revenue from IPTV
set-top boxes during the second quarter of 2010.  The quantity of
Standard Definition models accounted for 58% of total IPTV set-top boxes
sold.  We expect the sales mix of High Definition IPTV set-top boxes
and Standard Definition set-up boxes will approach 40% to 60% in quantity on a
going -forward basis.





Sales of cable TV network
equipments





Sales of
cable TV network equipments amounted to $12.8 million for the second quarter of
2010, an increase of $4.4 million or 51% compared with $8.4 million for the same
period of 2009.  The Chinese governmental regulation encouraged the
continued integration of telecommunications networks, cable TV networks and the
Internet in 2010.  Accordingly, the regional TV broadcast stations
increased the system-wide upgrade process in order to conform to the government
mandate of provincial-wide uniform networks.  As a result, we achieved
a significant increase in sales for cable TV network equipment.





GPS Products:





We
entered into GPS related business in the fourth quarter of 2009 whereas there
were no revenue from GPS operations in the second quarter of 2009.





Revenue
from sales of GPS devices was $4.5 million for the second quarter of 2010
including GPS related service fees amounted to $1.5 million in revenues for that
period.  GPS related services include installation service and
subscription service for tracking and locating.





Cost of Sales





Cost of
sales was driven primarily by procurement costs, given that our products sold
are purchased from suppliers on a turnkey basis.  Total cost of sales
was $24.8 million in the second quarter of 2010, compared with $20.1 million
during the same period in 2009, representing an increase of approximately $4.7
million or 23%.  The 23% increase in cost of sales was comparatively
lower than the 40% increase in sales revenue.  The primary reason for
the increase in gross profit margin was that the newly launched GPS business and
Standard Definition IPTV set-top boxes sales had a higher gross margin than both
Cable TV network equipments and High-Definition IPTV set-top boxes sold in the
second quarter of 2009.





For the
second quarter of 2010, cost of sales related to cable TV network equipment sold
and GPS devices sold was $21.2 million and $3.6 million, representing 85% and
15% of total cost of sales, respectively.


26





The cost
of cable TV network equipments sold was $10.6 million in the second quarter of
2010, compared with $7.4 million during the same period in 2009, representing an
increase of approximately $3.2 million or 43%.  This increase in cost
was lower than 51% increase in sales revenue.





The cost
of IPTV set-top boxes sold was $10.6 million in the second quarter of 2010,
compared with $12.7 million during the same period in 2009, representing a
decrease of approximately $2.1 million or 17%.  The decrease in cost
was significantly lower than the 6% decrease observed in sales revenue, driven
mainly by the recently introduced Standard Definition IPTV set-top boxes, which
carry a higher gross margin.





Regarding
the recently launched GPS business, the cost of products sold and service
provided was $3.6 million. We do not perform analysis and discussion on GPS
business as there were no such products sold during in the same period of
2009.





Gross Margin





Gross
margin for the second quarter of 2010 was 25% compared with gross margin of 15%
for the same period of 2009.





The
overall gross margin in sales of products was 22% for the second quarter of 2010
compared with 15% for the same period of 2009.





The
increase in gross margin was driven mainly by sales of Standard Definition
set-top boxes, which had a gross margin of 40% in the second quarter of
2010.  We did not have sales of Standard Definition set-top boxes
during the same period in 2009. The gross margin of cable TV network equipment
and High Definition IPTV set-top boxes were 17% and 18% in the second quarter of
2010, compared with 13% and 16% during the same period of 2009
respectively.





The gross
margin in sales of GPS device was 21% for the second quarter of
2010.





The gross
margin for the GPS related service during the second quarter of 2010 was 97%.
The high gross margin in GPS related service contributed to the increase in
overall gross margin in the second quarter of 2010.  We did not have
sales of GPS related service during the same period in 2009





Selling Expense





Selling
expense was $109,000 for the second quarter of 2010, representing an increase of
$58,000 compared with $51,000 for the second quarter of 2009.  Selling
expenses consist mainly of shipping costs, after-sale service, and salary of
sales staff.  Selling expense in the second quarter of 2009 contained
only salary expenses.





Selling
expenses accounted for 0.3% and 0.2% of total revenue for the second quarter of
2010 and 2009, respectively.





Research and Development
Expense





Research
and development expense was $95,000 for the second quarter of 2010 compared to
nil in the same period of 2009.  Research and development expense 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 second
quarter of 2009.


As a
percentage to total revenue, research and development expense accounted for 0.3%
and nil for the first quarter of 2010 and 2009, respectively.





General and Administrative
Expense





General
and administrative expense was $835,000 for the second quarter of 2010,
representing an increase of $714,000 or a 588% increase, compared with $121,000
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,
consulting service fee, legal fee, and other expenses for being public
company.  We raised staff salary in October 2009, and 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 which is amortized though the
life of the agreement; as a result, the salary expense for the second quarter of
2010 amounted to $218,000, compared to $46,000 during the second quarter of
2009.  The consulting fees was $258,700, an increase of $254,000,
compared with $4,000 for the same period, mainly due to a Consulting Agreement
signed with Finance Access, Inc. and other third parties.  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 with a
quarterly amortization of approximate $195,000.   The legal fees
and 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
2.5% and 0.5% for the second quarter of 2010 and 2009,
respectively.


27





Interest Income (Expense)





Interest
income was $31,000 for the second quarter of 2010, compared with net interest
income of $9,000 for the second 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 second quarter of 2010.





Income Tax Provision





Income
tax provision for the second quarter of 2010 was $2,036,000, an increase of
$1,199,000 or 143%, compared with $837,000 for the second quarter of
2009.  The increase of income tax provision was the result of the
increase in income before tax, primarily driven by the increase in sales revenue
and increased gross margin.





As a
percentage to total revenue, income tax provision accounted for 6.2% and 3.6%
for the second quarter of 2010 and 2009, respectively.





Net Income





Net
income was $5.2 million for the second quarter of 2010, an increase of $2.6
million or 100%, compared with $2.6 million for the second quarter of
2009.





Earnings per Share





Basic
earnings per share were $0.45 for the second quarter of 2010, an increase of
$0.14 compared with $0.31 for the second 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 8,264,003 shares, respectively, for the second
quarter of 2010 and 2009.  Of the aforementioned 8,264,003 weighted
average shares outstanding, we included the equivalent 1,263,723 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 and the holders of these preferred shares have the right to convert
any time they want; therefore, these shares were deemed as the equivalent shares
of common stock for computing earnings per share purpose.





Comparison
of Six months Ended June 30, 2009 and 2010





Revenue





We are
currently engaged in two main business lines: the provision of Cable TV program
distribution related equipment and the provision of GPS devices and related
location and tracking services. Total revenue by business line is as
follows:





Six Months Ended June 30,2009
                  
                  
                  2010Sales
      Revenue:Sales
      of cable TV equipments
                  
                  
                  41,439,540
                  
                  
                  
                  41,313,276Sales
      of GPS devices
                  
                  
                  -
                  
                  
                  
                  6,680,648Revenue
      from sales of goods
                  
                  
                  41,439,540
                  
                  
                  
                  47,993,924Revenue
      from service:GPS
      related service
                  
                  
                  -
                  
                  
                  
                  2,100,497Total
      revenue
                  
                  
                  41,439,540
                  
                  
                  
                  50,094,421





Overall
our revenue was $50.1 million for the six months of 2010, representing an
increase of $8.7 million or a 20.9% increase in comparison with $41.4 million
for the same period of 2009.  Revenue from Cable TV related equipment
sales for the six months decreased by 0.3% compared to the same period of
prior year. The increase in revenue was contributed solely by GPS business. We
started GPS related businesses in October 2009.  Consequently, there
was no comparison of GPS business related revenue between the six months
end June 30, 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 are as follows:





Six Months Ended June 30,2009
                  
                  
                  2010Sales
      Revenue from Cable TV products:Sales
      of IPTV set-top boxes
                  
                  
                  26,954,710
                  
                  
                  
                  21,466,467Sales
      of cable TV network equipments
                  
                  
                  14,484,830
                  
                  
                  
                  19,846,809Total
                  
                  
                  41,439,540
                  
                  
                  
                  41,313,276


28





Sales of IPTV set-top
boxes





Revenue
from sales of IPTV set-top boxes was $21.5 million, a decrease of $5.5 million
or 20% compared with $27.0 million for the same period in 2009.  The
sales volume of IPTV set-top boxes increased by 50% compared to the same period
in 2009.   The slight decrease in sales revenue and significant
increase in sales volume were due to changes in sales mix of High Definition and
Standard Definition product sales.  During the year of 2009, we sold
only High Definition IPTV set-top boxes, primarily to users in the larger
regional cities in Henan Province. The High Definition IPTV set-top box had
higher selling prices.  We launched the Standard Definition IPTV
set-top boxes line with a much lower average selling price in the first quarter
of 2010 to capture additional market share in rural cities and
counties.  The average selling price of Standard Definition IPTV
set-top box was approximately 38% of the selling price of the High Definition
product.  For the first half year of 2010, sales of Standard
Definition IPTV set-top boxes accounted for 57% in quantity of the total IPTV
set-top boxes sold.





The
average selling price of these models decreased by approximately 18.6% during
the six months of 2010 compared to the average selling price during the
same period in 2009.  This decline led to a negative impact of $5.0
million on sales revenue, without taking into consideration changes in
volume.  Concurrently, sales volume of High Definition set-top boxes
decreased by approximately 35% compared to the same quarter of 2009, which led
to a negative impact of $9.5 million on sales revenue.  The
overlapping impact of changes in volume and average selling price is
approximately $1.8 million.  The decrease in selling price and sales
volume resulted in a net decrease of approximately $12.7 million in the sales of
High Definition set-top boxes.





The sales
of Standard Definition products accounted for 34% of total revenue from IPTV
set-top boxes during the second quarter of 2010.  The quantity of
Standard Definition models accounted for 57% of total IPTV set-top boxes
sold.  We expect the sales mix of High Definition IPTV set-top boxes
and Standard Definition set-up boxes will approach 40% to 60% in quantity on a
going-forward basis.





Sales of cable TV network
equipments





Sales of
cable TV network equipments amounted to $19.8 million for the first half of
2010, an increase of $5.3 million or 36.6% compared with $14.5 million for the
same period in 2009.  Chinese government policy encouraged the
continued integration of telecommunications networks, cable TV networks and the
Internet in 2010.  Accordingly, the regional TV broadcast stations
increased the rate of system-wide upgrades in order to conform to the
government mandate of provincial-wide uniform networks.  As a result,
we achieved a significant increase in sales of cable TV network
equipment.





GPS Products:





We
entered into GPS related business in the fourth quarter of 2009 whereas there
were no revenue from GPS operations in the first half of 2009.





Revenue
from sales of GPS devices was $6.7 million for the first half of 2010 including
GPS related service fees amounted to $2.1 million in revenues for the same
period. GPS related services include installation service and subscription
service for tracking and locating (positioning).





Cost of Sales





Cost of
sales was driven primarily by procurement costs, given that our products sold
are purchased from suppliers on a turnkey basis.  Total cost of sales
was $37.7 million in the first six months of 2010, compared to $35.0 million
during the same period in 2009, representing an increase of approximately $2.7
million or 7.7%.  The 7.7% increase in cost of sales was lower than
the 20.9% increase in sales revenue.  The primary reason for the
increase in gross profit margin was that the newly launched GPS business and
Standard Definition IPTV set-top boxes had higher gross margins than both Cable
TV network equipments and High-Definition IPTV set-top box products sold in the
second quarter of 2009.





For the
first half year of 2010, cost of sales related to cable TV equipment and GPS
devices sold were $32.3 million and $5.3 million, respectively, and represented
85.7% and 14.1% of total cost of sales, respectively.





The cost
of cable TV network equipments sold was $16.3 million in the first two quarters
of 2010, compared to $12.4 million during the same period in 2009, representing
an increase of approximately $3.8 million or 31%. The increase in cost was lower
than the 36.6% increase in sales revenue.





The cost
of IPTV set-top boxes sold was $16 million in the first half year of 2010,
compared to $22.5 million during the same period in 2009, representing a
decrease of approximately $6.5 million or 29%.  The decrease in cost
was significantly lower than the 20% decrease observed in sales revenue, mainly
driven by the recently introduced Standard Definition IPTV set-top boxes, which
carry a higher gross margin.





Regarding
the recently launched GPS business, the cost of products sold and service was
$5.4 million. No GPS-related products or services were offered during the same
period in 2009.


29





Gross Margin





Gross
margin for the first half year of 2010 was 25% compared with a gross margin
of 16% for the same period in 2009.





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





The
increase in gross margin was driven mainly by sales of Standard Definition
set-top boxes, which had a gross margin of 40% in the first two quarters of
2010.  We did not have sales of Standard Definition set-top boxes
during the same period in 2009.  The gross margin of cable TV network
equipment and High Definition IPTV set-top boxes were both 18% in the first two
quarters of 2010, compared to 14% and 16% during the same period of 2009,
respectively.





The gross
margin of GPS devices was 21% for the first half year of 2010, slight lower than
overall gross margin in sales of products.





The gross
margin on the GPS related services for the first half year of 2010 was
96%. The high gross margin in GPS related service contributed to increase
overall gross margin in the first half year.  We did not have GPS
related products and services during the same period in 2009.





Selling Expense





Selling
expense was $376,000 for the first half of 2010, representing an increase of
$307,000 compared to $69,000 for the first half of 2009. During the first
quarter of 2010, we spent $176,000 on promotional activities for our GPS
business. Selling expenses this period consists mainly of shipping costs,
after-sale service, and salary of sales staff.  Selling expense in the
first half of 2009 contained only salary expenses.





As a
percentage to total revenue, selling expenses accounted for 0.8% and 0.2% for
the first half of 2010 and 2009, respectively.





Research and Development
Expense





Research
and development expense was $331,000 for the six months of 2010 compared to nil
in the first half of 2009. Among research and development expenses incurred in
the six months of 2010, $145,000 was related to module expenses for development
of GPS devices; the remaining $186,000 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 second quarter of 2009.





As a
percentage to total revenue, research and development expense accounted for 0.7%
and nil for the first quarter of 2010 and 2009, respectively.





General and Administrative
Expense





General
and administrative expense was $1,566,000 for the first half of 2010,
representing an increase of $1,089,000 or 228%, compared to $477,000 for the
same period in 2009.  General and administrative expense consists
mainly of salary expense, consulting service fees, legal service fees, audit
related service fees and other office expenses.  The increase in general
and administrative expense was primarily due to increases in salary expense,
consulting service fees, legal fees and other expenses for becoming a public
reporting company.  We raised staff salary in October 2009, and 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
half of 2010 amounted to $460,000, an increase of $350,000 compared to $110,000
during the same period in 2009.  The consulting fees increased to
$455,000, an increase of $329,000 compared with $126,000 for the same period in
2009, mainly due to a Consulting Agreement signed with Finance Access, Inc. and
other third parties.  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 and the amortization during the first
half year was approximate $389,000.   The legal fees and 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
3.1% and 1.2% for the first half of 2010 and 2009, respectively.





Merger Cost





Merger
cost incurred for the first quarter of 2009 was $567,000 and consisted of
expenses incurred during the process of a reverse acquisition and private
placement. There was no such merger activity and no merger cost incurred for the
first two quarters of 2010.


30


Interest Income (Expense)





Interest
income was $32,000 for the first half of 2010, compared with income expense of
$73,000 for the same period of 2009.  We paid off all bank loans
in the first half year of 2009; therefore, no interest expense was incurred in
the second quarter of 2010.





Income Tax Provision





Income
tax provision for the first six months of 2010 was $3,009,000, an increase of
$1,522,000 or 102%, compared to $1,487,000 for the first six months of
2009.  The increase in income tax was primarily due to the increase in
sales revenue and gross margin.





As a
percentage of total revenue, income tax provision accounted for 6.0% and 3.6%
for the first half of 2010 and 2009, respectively.





Net Income





Net
income was nearly $7.2 million for the first half of 2010, an increase of $3.4
million or 89.5%, compared to $3.8 million for the first half of
2009.





Earnings per Share





Basic
earnings per share were $0.62 for the first half of 2010, an increase of $0.14
compared to $0.48 for the same period in 2009.  The increase in
earnings per share was a result of an increase in net income offset partly by an
increase in basic weighted average shares outstanding, which were 11,650,442
shares and 7,954,507 shares, respectively, for the first half 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
June 30, 2010 and December 31, 2009, we had cash and cash equivalents of $15.8
million and $13.6 million, respectively. Our working capital was approximately
$52.4 million and $45.9 million as of June 30, 2010 and December 31, 2009,
respectively.  The increase in cash and cash equivalents was mainly
attributed 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 half
year of 2010, cash provided by operating activities contributed significantly to
capital resources.  We did not have material capital investment
commitments as of June 30, 2010.  Cash and cash equivalents are enough
to meet our day-to-day operating requirements at the level of operating
activities.  We may need external financing to supplement operating
cash flows if we successfully rapidly expand our GPS related
business.





For the
six months ended June 30, 2010, net cash provided by operating activities was
$3.6 million, representing an increase of $4.6 million as compared to the
net cash used in operating activities of $1.0 million for the same period in
2009. Of the $4.6 million increase, net income contributed $3.4 million,
non-cash items contributed $0.3 million and changes in operating assets and
liabilities contributed $0.9 million.  Of the non-cash items,
depreciation and amortization increased by $0.3 million.





Negative
cash flow from changes in operating assets and liabilities decreased to
approximately $3.9 million as compared to the negative cash flow of $4.8 million
for the same period in 2009.  Of the $0.9 million increase, $8.4
million was attributed to the change in cash flow from collecting accounts
receivable, offset by $2.8 million in cash outflow for advances to suppliers for
the first half of 2010 compared to the same period in 2009 and $6.3
million in cash outflow from paying accounts payable for the first half of
2010 compared to the same period in 2009.





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 product sales, we typically provide 30 to
90-day 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 $1.7 million for the six months ended June 30,
2010, which was mainly the advanced payment for purchasing office
space.





There was
no financing cash flow during the first half of 2010, while net cash provided by
financing activities was $1.8 million during the same period in
2009.  We conducted five closings of a private placement transaction
and received net proceeds of $3.5 million for the sale of 1,263,723 shares of
Series A Convertible Preferred Stock.  Then we repaid $1.7 million in
short term bank loans using the proceeds from the private
placement.


31





Contractual
Obligations





None.





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.


32


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 not effective as of June 30, 2010.





Our
controls and procedures were primarily adversely affected by the lack of
experience within the company in complying with the requirements of a publicly
reporting entity.  With the exception of our CFO, our current internal
accounting department responsible for financial reporting of the Company, on a
consolidated basis, is relatively new to U.S. GAAP and the related internal
control procedures required of U.S. public companies. Although our accounting
staff is professional and experienced in accounting requirements and procedures
generally accepted in the PRC, management has determined that they require
additional training and assistance in US GAAP matters.  Management has
determined that our internal audit function is also significantly deficient due
to insufficient qualified resources to perform internal audit
functions.  We have engaged a third-party internal controls consultant
to assist the Company to address issues of timeliness and completeness in
financial reporting when we are preparing SEC filings. We are currently in the
process of validating the recommendations made by the internal controls
consultant, and we envision that our internal controls and procedures will be
effective by the end of 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.


33


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/A as
filed with the SEC on May 18, 2010 and all of the information contained in our
public filings before deciding whether to purchase our common stock.There have
been the following material changes to the “Risk Factors” as set forth in our
Annual Report on Form 10-K/A as filed with the SEC on May 18, 2010:





We
intend to grant shares of or stock options to purchase shares of our common
stock to various of our officers, directors and employees pursuant to our 2010
Omnibus Incentive Plan for which we will incur significant non-cash charges
which will negatively affect our results of operations and which may cause the
market price of our common stock to drop significantly, even if our business is
doing well.





At our
annual meeting of stockholders to be held on August 23, 2010, it is expected
that our stockholders will approve the ZST Digital Networks, Inc. 2010 Omnibus
Incentive Plan covering five hundred thousand (500,000) shares of our common
stock.  We may issue various types of awards under the plan,
including, but not limited to, stock options and restricted shares of common
stock. Grants or other stock awards pursuant to the plan will cause us to
incur significant non-cash equity-based compensation charges. This non-cash
charge will be amortized over the vesting period of the awards. These non-cash
charges will negatively impact our results of operations, specifically our net
income and net income per share.  Additionally, any future awards made
pursuant to the plan could have a significant adverse effect on the trading
price of our common stock, especially if a significant volume of the stock
issued is sold into the public market. Further, the issuance of any stock awards
pursuant to the plan will have a dilutive impact on other stockholders by
decreasing their ownership percentage of our outstanding common stock. An
adverse impact on the trading price of our common stock may negatively affect
our ability to use to our securities to raise capital or to acquire other
companies using our securities.





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 August 9, 2010, we have used
approximately $14 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.


34


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.


35


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:  August
      10, 2010
            By:
            /s/
      Zhong BoZhong
      BoChief
      Executive Officer and Chairman of the BoardDate:  August
      10, 2010
            By:
            /s/
      John ChenJohn
      Chen
              Chief
      Financial Officer


36