Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our financial statements and the notes to those statements. This discussion contains forward-looking statements reflecting our management's current expectations that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed on page 18 entitled "Risk Factors" and elsewhere in this Form 10-K.

We provide technology platform solutions for mobile telecom operators in the People's Republic of China. Our patented platforms provide a comprehensive solution for Chinese telecom operators to deliver and manage the distribution of various mobile value added service ("MVAS") applications to their subscribers. We believe that the Trunkbow brand is regarded by the telecom operators as a well managed, trusted provider of technology solutions. Our research and development focused business model provides us with a defensible market position as a technology provider to the telecom operators.

As of December 31, 2010, our technology is the subject of 164 filed patent applications, of which 50 have been granted by the National Intellectual Property Administration of the People's Republic of China. We have recently begun the process of filing for international and U.S. patents in order to protect our intellectual properties globally.

The primary geographic focus of our operations is in the PRC, where we derive substantially all of our revenues. We conduct our business operations primarily through our wholly-owned subsidiaries Trunkbow Asia Pacific (Shenzhen) Limited and Trunkbow Asia Pacific (Shandong) Limited. Both companies are registered in PRC as Wholly-Owned Foreign Enterprises.

Overview

Our History and Corporate Structure

We were incorporated as a "shell" company with nominal assets under the name Bay Peak 5 Acquisition Corp. We were incorporated in the State of Nevada on September 3, 2004 as a wholly owned subsidiary of Visitalk Capital Corporation ("VCC"). We were formed as part of the implementation of the Chapter 11 reorganization plan (the "Visitalk Plan") of visitalk.com, Inc. ("Visitalk.com"), a former provider of VOIP services. The Visitalk Plan was deemed effective by the Bankruptcy Court on September 17, 2004 (the "Effective Date"). On September 22, 2004, Visitalk.com was merged into VCC, which was authorized as the reorganized debtor under the Visitalk Plan.

On July 28, 2008, pursuant to Stock Purchase Agreements ("SPAs"), we sold 5,971,898 shares of common stock to two parties unaffiliated with us (the "Purchasing Shareholders") for a total payment of $51,000, or approximately $.008 per share (the "Change of Control Transactions"). On August 29, 2008, the SPAs were approved by our shareholders at a special shareholders' meeting and all the closing conditions of the SPAs were met. After the Change of Control Transactions, including the impact of a related master settlement agreement, these newly issued shares represented 85.5% ownership of us. One of the parties, Bay Peak, LLC ("Bay Peak"), had contacts with various companies and individuals in Asia, in particular the PRC. Cory Roberts, the managing member of Bay Peak, was appointed to our Board of Directors and elected President in conjunction with the Change of Control Transactions. Mr. Roberts resigned as a member of our Board of Directors on March 30, 2011. On August 28, 2008, shareholders authorized adopting the name of Bay Peak 5 Acquisition Corp. Also on August 28, 2008, shareholders ratified a one-for-seven reverse stock split (the "First Reverse Split"), which was implemented on January 6, 2010 and in January 2010, authorized a further reverse split of 4.14 for 1, which was implemented on January 27, 2010 (the "Second Reverse Split").

Effective as of September 24, 2008, we entered into a Plan and Agreement of Merger (the "Plan and Agreement of Merger") with VT Dutch Services, also a subsidiary of VCC, pursuant to which VT Dutch Services merged with and into us. Pursuant to the merger, holders of shares of common stock of VT Dutch Services received the identical number and class of our stock as they held in VT Dutch Services, and holders of warrants of VT Dutch Services received the identical number and class of our warrants as they held in VT Dutch Services. In connection with the Plan and Agreement of Merger, VT Dutch Services also changed its name to "Bay Peak 5 Acquisition Corp." All shares of common stock of BP5 held prior to the consummation of the transactions contemplated by the Plan and Agreement of Merger were cancelled. The sole purpose of the merger was to change the corporate domicile of VT Dutch Services from Arizona to Nevada and to effect a name change of VT Dutch Services.

In February 2010 we entered into the Share Exchange Agreement with Trunkbow BVI and the shareholders of Trunkbow BVI (the "Shareholders"), who together owned shares constituting 100% of the issued and outstanding ordinary shares of Trunkbow BVI (the "Trunkbow BVI Shares"), and Bay Peak, our former principal shareholder. Pursuant to the terms of the Share Exchange Agreement, the Shareholders transferred to us all of the Trunkbow BVI Shares in exchange for the issuance of 19,562,888 (the "Shares") shares of our common stock (the "Share Exchange"). As a result of the Share Exchange, Trunkbow BVI became our wholly owned subsidiary. After giving effect to the Share Exchange, the sale of common stock in the February 2010 Offering and the BP5 Warrant Financing (as defined below) (i) existing shareholders of Trunkbow BVI owned approximately 60.25% of our outstanding common stock, (ii) purchasers of common stock in the February 2010 Offering owned approximately 26.01% of our outstanding common stock (including 7.7% owned by VeriFone, Inc.), (iii) the holders of BP5 warrants owned approximately 8.54% of our outstanding common stock and (iv) the pre-existing shareholders of BP5 owned approximately 5.2% of our outstanding common stock.

We were founded in 2001 by former Silicon Valley engineers with extensive experience in the telecom industry. We have been able to develop first to market application platforms that enable telecom operators to generate significant new revenue streams by leveraging our extensive knowledge of the mobile network technology. Since our inception, we have invested significant time and resources to develop cutting edge technology solutions for our customers. We were the first to create and develop a Color Ring Back Tone ("CRBT") application platform for Shandong Unicom in 2003. Since then, this innovative service solution has become the third largest revenue contributor for China Mobile after voice and Short Message Service ("SMS").

Concurrent with the Share Exchange, (i) we entered into a securities purchase agreement (the "Purchase Agreement") with certain investors (the "Investors") for the sale of an aggregate of 8,447,575 shares (the "Investor Shares") and 1,689,515 warrants (the "Investor Warrants"), for aggregate gross proceeds equal to $16,895,150 (the "February 2010 Offering") and (ii) certain holders of our outstanding warrants issued to creditors and claimants of Visitalk.com, in accordance with the Visitalk Plan, referred to herein as the "BP5 Warrant Investors" exercised the 2,774,500 warrants owned by them for an aggregate exercise price of $5.5 million and received warrants to purchase an aggregate of 554,900 shares of common stock ("BP5 Warrant Financing").

We believe that we have a competitive advantage over our primary competitors by our proven track record of innovation. We believe Chinese telecom operators continue to utilize our technology platforms because of our superior technological solutions and unique product offerings.

Our organizational structure is as follows:

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(1) Trunkbow International Holdings Limited ("Trunkbow BVI") was established in the British Virgin Islands ("BVI") on July 17, 2009. Trunkbow BVI itself has no significant business operations and assets other than holding of equity interests in its subsidiaries through a series of reorganization activities described below (the "Reorganization").

(2) Trunkbow (Asia Pacific) Investment Holdings Limited ("Trunkbow Hong Kong") was established as an Investment Holding Company in Hong Kong Special Administrative Region of the People's Republic of China (the "PRC") on July 9, 2004. As part of the reorganization, on September 16, 2009, the entire issued share capital Trunkbow Hong Kong was transferred to Trunkbow BVI.

(3) Trunkbow Asia Pacific (Shandong) Company, Limited ("Trunkbow Shandong") was established as a wholly foreign owned enterprise on December 10, 2007 in Jinan, Shandong Province, the PRC by Trunkbow Hong Kong. It is principally engaged in research and development of application platforms for mobile operators in the PRC.

(4) Trunkbow Asia Pacific (Shenzhen) Company, Limited ("Trunkbow Shenzhen") was established as a wholly foreign owned enterprise on June 7, 2007 in Shenzhen, Guangdong Province, the PRC by Trunkbow Hong Kong. It is principally engaged in research and development of application platforms for mobile operators in the PRC.

(5) Trunkbow Technologies (Shenzhen) Company, Limited ("Trunkbow Technologies") was established as a limited liability company on December 4, 2001 in Shenzhen, Guangdong Province, the PRC. Trunkbow Technologies was formerly engaged in research and development of application platforms for mobile operators in China as well as wireless application systems for the international market. Trunkbow Technologies no longer accounts for any of our new business, currently represents less than 10% of our current revenues and is being operationally wound down.

(6) We entered into a series of contractual arrangements with Beijing Delixunda Technology Co., Ltd. ("Delixunda") and its shareholders on March 10, 2011. Delixunda is a telecom value-added service licensed company and was established as a limited liability company on December 1, 2009 in Beijing, the PRC. Delixunda has no operations prior to February 10th, 2011. As a result of the contractual arrangements with Delixunda, we indirectly own the telecom value-added service license, which would enble us to offer telecom wireless value-added conten service to individual clients.

How We Generate Revenue

We develop wireless enablement platforms targeted at cellular carriers and provide them with constantly improving interactive delivery vehicles to improve cellular performance and end-user functionality. We leverage our patented technology platforms to help telecom operators in China to increase their per subscriber revenue and reduce subscriber churn. We generate revenues through direct and indirect revenue sharing agreements with the relevant provincial branch of the telecom operators, one-time service and product sales, and maintenance fees. We charge a one time licensing fee and an annual maintenance fee of approximately 5 - 10% of the initial system purchasing amount. We also have monthly revenue sharing contracts in place with resellers and directly with the relevant provincial branch of the telecom providers for up to a 50% share in the revenue generated through our proprietary applications platforms. In addition to one-time sales and revenue sharing, we also generate revenue through transaction fees for our Mobile Payment System solution.

Our current MVAS Application Platform solutions generate revenue through one time sales and recurring revenues. For our Caller Color Ring Back Tone ("Caller CRBT") and Color Numbering solution, we have revenue sharing agreements with resellers and directly with telecom providers to receive up to 50% of the subscription revenues generated for up to 5 years and then renewable upon expiration. For our Number Change Notification ("NCN") solution, we receive revenues from one-time system sales and maintenance fees.

For our Mobile Payment System solution, we generate both one-time and recurring revenues.

We generate non-recurring revenues in the following ways:

• System sales to telecom providers which enables the mobile payment function on their network;

• System sales to telecom providers that enables various MPS compatible SIM and mobile payment functions for their corporate clients; and

• Revenue share on the MPS compatible SIM cards that are sold to the telecom providers.

We generate recurring revenues in the following ways:

• Up to a 50% share of the monthly function fee charged by the telecom providers;

• 0.1 - 0.5% of total transaction cost on purchases made through the mobile payment application; and

• Monthly rental revenues on POS (Point of Sales) machines deployed by Trunkbow.

We operate under exclusive patent licensing and revenue sharing agreements for Caller CRBT in three provinces with local branches of China Telecom, two provinces with local branches of China Mobile and two provinces with local branches of China Unicom, Number Change Notification in two provinces with local branches of China Unicom and two provinces with local branches of China Telecom, and Mobile Payment System in four provinces with local branches of China Telecom. These agreements typically have a one to five year term. In addition, we have sold over 10 different other platform services to the mobile operators over the past years.

In determining development priorities, we conduct research efforts which include client input, market analysis, economic considerations, revenue potential and technical feasibility. Only when these factors each rise above a predefined threshold will a true development undertaking ensue. As an ISO 9000 certified business entity, which is a family of standards for quality management systems that is maintained by the International Organization for Standardization, and in keeping with this practice, all projects must adhere to a pre-defined regimen of development and only ends when acceptance by the client is gained.

Our business has grown rapidly since inception and we anticipate that our business will continue to grow at a rapid pace in the next three to five years. We expect that our growth will be driven by the broad adoption of our Caller CRBT and Mobile Payment services, geographic expansion and the introduction of new products and services.

Our customers are primarily telecom service providers in the PRC, including local branches of China's three major cellular carriers, China Telecom, China Unicom and China Mobile. Collectively, these carriers provide services to greater than 700 million cellular subscribers. For the fiscal years ended December 31, 2009 and 2008, revenues generated directly by sales to China Telecom, China Unicom and China Mobile accounted for approximately 3%, 6% and nil, and 4%, 95% and nil, respectively, of our total revenues, and 7%, 5% and nil, and 3%, 6% and nil, respectively, for the year ended December 31, 2010 and 2009. When we include resales of our products to these carriers through intermediaries (i.e., direct and indirect sales to these carriers), then revenues generated from sales to these three carriers for the fiscal years ended December 31, 2009 and 2008 accounted for approximately 42%, 15% and 42%, and 4%, 95% and nil, respectively, of our total revenues, and 16%, 47% and 28%, and 42%, 15% and 42%, respectively, for the year ended December 31, 2010 and 2009. The significant increase in revenues generated from sales to China Mobile for 2009 as compared to 2008 is attributable to the sale in 2009 of two platforms to two resellers that provided an air-charge system to China Mobile in two provinces. The large variations in revenues attributable to China Unicom and China Mobile during 2008 and 2009 are mainly attributable to a reorganization of China Unicom which resulted in that company's CDMA segment being spun-off into China Telecom and the remaining company being merged with China Netcom. Even though our relationship with these three continues to expand, it is important to understand the complexity of these relationships. The significant increase in revenues generated from sales to China Unicom for 2010 as compared to 2009 is contributed from the sale in 2010 of the deployment of our systems including Caller CRBT, Color Numbering, Mobile Business Card and Mobile Payment.

To be accepted as an approved vendor of services to any of these carriers, a company must first gain approval at a corporate level by successfully completing a series of tests of its technology. Once completed, the next step is to gain contracted business from each operating unit. Each of the 30 provinces, municipalities and autonomous regions contains its own self sufficient cellular operating unit with separate P&L responsibility. In other words, with 30 regions, there are 30 separate operating companies per cellular carrier. This model is replicated in each of the three major carriers, resulting in a total of ninety potential clients within China.

The PRC government has mandated that these mobile payment services and MVAS functions must be available to all provinces over the next five years. With such services currently available in 13 provinces, the 17 remaining provinces will be seeking them from the market with Trunkbow being a major incumbent; fully vetted at a corporate level and with patented technology.

While we were initially focused exclusively on the PRC market, we have built a product set for the global sector. To this end, we are now actively positioning our product sets with carriers in the US and Europe, and we are entering the global market with a well accepted product set and excellent credentials.

Seasonality

Our quarterly operating results have varied significantly in the past and are likely to continue to vary significantly in the future. Historically, we have generally experienced a slowdown or decrease in generating revenues in the first and fourth quarter of the year due to the Chinese Lunar New Year as a majority of the businesses in the PRC shut down for a month long holiday and slow down for a month prior to the New Year celebration. We believe that this fluctuation will gradually subside as we increase our recurring revenue streams.

Results of Operations

Fiscal Years Ended December 31, 2010 versus 2009

Net Revenues: Net revenues increased $10.96 million, or 81.6%, from $13.43 million for the year ended December 31, 2009 to $24.39 million for the year ended December 31, 2010. Software sales increased $10.69 million, or 252.6%, from $4.23 million for the year ended December 31, 2009 to $14.92 million for the year ended December 31, 2010, mainly due to increased sales in Mobile Payment by $8.85 million and MVAS software of Caller CRBT, NCN and Color Numbering by $2.52 million in additional provinces. Our net revenues shifted to more software sales and less system integration sales during 2010. System integration revenues increased $0.87 million, from $8.5 million for the year ended December 31, 2009 to $9.37 million for the year ended December 31, 2010, due to the change in demand of our customers for the various components of our services. And our company's competitive edge is in R&D. So the increase in Software sales is more than System integration revenues.

We started to deploy MPS platforms with our customers from the third quarter of 2009. We generated revenues of $12.66 million and $12.18 million, $10.14 million and $3.33 million, from MVAS and MPS solutions for the year ended December 31, 2010 and 2009. MPS solutions have become a significant revenue segment, representing 49% and 25% for the year ended December 31, 2010 and 2009.

Gross Margin: Gross margin increased $8.25 million, or 73.6%, from $11.21 million for the year ended December 31, 2009 to $19.46 million for the year ended December 31, 2010. The increase in gross margin was due to revenue growth associated with the software sales. Gross margin rate decreased by 3.7% from 83.5% for the year ended December 31, 2009 to 79.8% for the year ended December 31, 2010. The decrease in gross margin rate was due to the sale of point of sale system, of which gross margin rate was 23.6%. The increase in business tax and surcharges in line with the increase of revenues also cut down the gross margin.

The gross margin or the gross margin rate for the MVAS and MPS was $11.2 million or 90.9% and $8.27 million or 68.5%, respectively, for the year ended December 31, 2010, and $8.64 million or 85.5% and $2.57 million or 77.2%, respectively, for the year ended December 31, 2009.

Operating expenses: Operating expenses, including selling, general and administrative expenses and R&D increased $2.84 million, or 99.9%, from $2.85 million for the year ended December 31, 2009 to $5.69 million for the year ended December 31, 2010. The increase in operating expenses was related to the expansion of administrative and R&D departments with recruitment of more employees, related office expenses, as well as the addition of public company related expenses.

Interest expenses: Interest expenses increased $0.15 million, or 234.26%, from $0.07 million for the year ended December 31, 2009 to $0.22 million for the year ended December 31, 2010 due to an increase in interest expenses from the notes payable with an annual interest rate of 12% and short-term loans with an annual interest rate of 6.6375%.

Research and Development:For the year ended December 31, 2010 and 2009, we spent $1.2 million and $0.44 million on research and development expenses, of which $0.61 million and $0.34 million was attributable to MVAS and $0.59 million and $0.1 million was attributable to MPS.

Income from Operations:Income from operations increased $5.4 million, or 64.6%, from $8.36 million for the year ended December 31, 2009 to $13.76 million for the year ended December 31, 2010, principally due to revenue growth associated with our geographic expansion into additional provinces. Income from operations margin rate decreased 5.8% from 62.2% for the year ended December 31, 2009 to 56.4% for the year ended December 31, 2010, mainly caused by the excessive increase of cost and expenses over the growth of revenue.

Critical Accounting Policies and Estimates. We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect our reporting of, among other things, assets and liabilities, contingent assets and liabilities and revenues and expenses. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and other factors that we believe to be relevant under the circumstances. Since our financial reporting process inherently relies on the use of estimates and assumptions, our actual results could differ from what we expect. This is especially true with some accounting policies that require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our audited consolidated financial statements because they involve the greatest reliance on our management's judgment.

Revenue Recognition. We derive revenues from our MVAS Technology Platforms and Mobile Payment Solutions in the form of providing system integration, sales of software, patent licensing and maintenance services. With respect to the system integration, we sign contracts with telecommunication and mobile operators and system integrators to install and integrate the Group's software with the hardware and software purchased from third-party suppliers. Deliverables of system integration include: software, hardware, integration, installation and training. No Post-Contract Customer Support (PCS) arrangement is included in system integration. Revenue is recognized when the last deliverable in the arrangement is delivered and when all of the following criteria have been met:
(1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the vendor's fee is fixed or determinable; and (4) collectability is probable.

With respect to the sales of software, revenue is recognized when the last deliverable in the arrangement is delivered and when all of the following criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the vendor's fee is fixed or determinable; and (4) collectability is probable.

With respect to patent licensing, we enter into contracts with local system integrators who further contract with telecommunication and mobile operators, and provide these system integrators with our patents which permit the system integrators to use our patents. The system integrators pay the Group a one-time license fee for obtaining the programs and technologies. Patent licensing revenues are recognized when all revenue recognition criteria according to ASC 985-605 have been met.

Revenue derived from technical support contracts primarily includes telephone consulting, on-site support, product updates, and releases of new versions of products previously purchased by the customers, as well as error reporting and correction services. Maintenance contracts are typically sold for a separate fee with initial contractual period of one year with renewal for additional periods thereafter. Technical support service revenue is recognized ratably over the term of the service agreement.

Accounts Receivable. We sell our products and services to telecommunication and mobile operators directly or through resellers. We do not require collateral from our customers.

We perform ongoing credit evaluations of our customers and review the composition of accounts receivable, analyze historical bad debts, customer concentration, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate if allowance for doubtful accounts is needed.

Recently issued accounting pronouncements

The FASB issued ASU 2010-13, Compensation - Stock Compensation (ACS 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. The ASU codifies the consensus reached in Emerging Issues Task Force (EITF) Issue No. 09-J. The amendments to the Codification clarify that an employee 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 shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.

The amendments in the ASU are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. Earlier adoption is permitted. The amendments are to be applied by recording a cumulative-effect adjustment to beginning retained earnings. We are currently evaluating the impact of adopting this update on our consolidated financial statements.

Foreign Currency Translation

The functional currency of the Company is United States dollars ("US$"), and the functional currency of Trunkbow Hong Kong is Hong Kong dollars ("HK$"). The functional currency of the Company's PRC subsidiaries and VIE is the Renminbi ("RMB"), and the PRC is the primary economic environment in which the Company operates.

For financial reporting purposes, the financial statements of the Company's PRC subsidiaries and VIE, which are prepared using the RMB, are translated into the Company's reporting currency, the United States Dollar. Assets and liabilities are translated using the exchange rate at each balance sheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and shareholders' equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income in shareholders' equity.

For financial reporting purposes, our financial statements, which are prepared using the functional currency, have been translated into U.S. dollars. Assets . . .