U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-KSB/A
(Amendment
No. 3)
x
ANNUAL
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR
THE FISCAL YEAR ENDED DECEMBER
31, 2005
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 NUMBER: 000-24985
PACIFICNET
INC.
(Exact
name of registrant in its charter)
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DELAWARE
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91-2118007
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(State
or other jurisdiction of incorporation or
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(I.R.S.
Employer Identification Number)
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organization)
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23/F,
TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,
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CHAOYANG
DISTRICT, BEIJING, CHINA 100028
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N/A
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant's
Telephone Number: 0086-10-59225000
601
New
Bright Building, 11 Sheung Yuet Road, Kowloon Bay, Kowloon, Hong
Kong.
(Former
Name and Address)
Securities
Registered under Section 12(b) of the Exchange Act: NONE
Securities
Registered under Section 12(g) of the Exchange Act: Common Stock, par value
$0.0001
1
Check
whether the issuer is not required to file reports pursuant to Section 13
or
15(d)
of the Exchange Act [ ]
Check
whether the issuer (1) filed all reports required to be filed by Section
13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter
period
that the registrant was required to file such reports), and (2) has been
subject
to such filing requirements for the past 90 days.
YES
[X] NO [ ]
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation
S-B contained in this form, and will not be contained, to the best of
the
registrant's knowledge, in definitive proxy or information statements
incorporated
by reference in Part III of this Form 10-KSB or any amendment to this
Form
10-KSB. [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule
12(b) of the Exchange Act).
Yes
[
] No [X]
Issuer's
revenue for its most recent fiscal year: $44,341,000. The aggregate
market value of the common stock held by non-affiliates of the registrant
as of March 31, 2006 was approximately $66,627,235 based upon the closing
sale price of $7.39 per share as reported by The NASDAQ National Market on
such
date. There were 13,238,497 shares of the Company's common stock outstanding
on March 31, 2006.
Transitional
Small Business Disclosure Format (check
one): Yes [
] No [X]
DOCUMENTS
INCORPORATED BY REFERENCE - NONE
Explanatory
Note:
This
Annual Report on Form 10-KSB/A ("Form 10-KSB/A") is being filed as Amendment
No.
3 to our Annual Report on Form 10-KSB for the year ended December 31, 2005,
which was originally filed with the Securities and Exchange Commission (the
"SEC") on April 28, 2006. We are amending and restating the following items
in
this amendment:
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(i)
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Part
II. Item 6. Management's Discussion and Analysis
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(ii)
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Part
II. Item 7. Financial Statements
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(iii)
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Part
III. Item 9. Directors, Executive Officers, Promoters and Control
Persons:
Compliance with Section 16(a) of the Exchange Act to update officer
information for our new Chief Financial Officer who will be signing
the
certifications in Exhibits 31 and 32.
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(iv)
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Part
III. Item 13. Exhibits and Reports on Form 8-K to reflect the inclusion
of
updated officer certifications in Exhibits 31 and 32 for this amended
filing.
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(v)
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Part
III. Item 14. Principal Accountant Fees and Services, to reflect
the fees
of our new auditor in connection with the re-audits of the fiscal
years
ended December 31, 2005 and 2004.
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2
TABLE
OF
CONTENTS
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PART
II
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ITEM
6.
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MANAGEMENT'S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
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ITEM
7.
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FINANCIAL
STATEMENTS-RESTATED
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ITEM
8A.
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CONTROLS
AND PROCEDURES
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PART
III
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ITEM
9.
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DIRECTORS,
EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
SECTION
16(A) OF THE EXCHANGE ACT
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ITEM
13.
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EXHIBITS
AND REPORTS ON FORM 8-K
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ITEM
14.
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PRINCIPAL
ACCOUNTANT FEES AND SERVICES
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This
annual report contains forward-looking statements within the meaning of the
federal
securities laws. These include statements about our expectations, beliefs,
intentions or strategies for the future, which we indicate by words or
phrases
such as "anticipate," "expect," "intend," "plan," "will," "we believe,"
"the
Company believes," "management believes" and similar language. The forward-looking
statements are based on our current expectations and are subject to
certain risks, uncertainties and assumptions, including those set forth in
the
discussion under "Description of Business," including the "Risk Factors"
described
in that section, and "Management's Discussion and Analysis or Plan of
Operation."
Our actual results may differ materially from results anticipated in
these
forward-looking statements. We base our forward-looking statements on
information
currently available to us, and we assume no obligation to update
them.
3
PART II
ITEM
6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
FORWARD-LOOKING
STATEMENTS This annual report on Form 10-KSB, as amended, contains
forward-looking statements within the meaning of the federal securities
laws.
These include statements about our expectations, beliefs, intentions or
strategies
for the future, which we indicate by words or phrases such as "anticipate,"
"expect," "intend," "plan," "will," "we believe," "management believes"
and similar language. The forward-looking statements are based on our
current
expectations and are subject to certain risks, uncertainties and assumptions,
including those set forth in the discussion under "Description of Business,"
including the "Risk Factors" described in that section, and "Management's
Discussion and Analysis or Plan of Operation." Our actual results may
differ materially from results anticipated in these forward-looking statements.
FACTORS
THAT COULD AFFECT FUTURE RESULTS
Factors
that might cause actual results, performance or achievements to differ
materially
from those projected or implied in such forward-looking statements include,
among other things:
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·
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the
impact of competitive products
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·
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changes
in laws and regulations
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·
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adequacy
and availability of insurance
coverage
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·
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limitations
on future financing
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·
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increases
in the cost of borrowings and unavailability of debt or equity
capital
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·
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the
inability of the Company to gain and/or hold market
share
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·
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exposure
to and expense of resolving and defending liability claims and
other
litigation
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·
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consumer
acceptance of the Company's
products
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·
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managing
and maintaining growth
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·
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customer
demands
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·
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market
and industry conditions
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·
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the
success of product development and new product introductions into
the
marketplace
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·
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the
departure of key members of
management
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·
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the
effect of the United States War on Terrorism, as well as other
risks and
uncertainties that are described from time to time in the Company's
filings with the Securities and Exchange
Commission
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Regarding
one of our subsidiaries, for example,
Epro is engaged in the business of providing outsourced call center services
with over 13 years of field experience in China. The factors that could
affect
current and future results are as follows:
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·
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insufficient
sales forces for business development & account
servicing
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·
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lack
of PRC management team in operation o less familiarity on partners'
product knowledge
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·
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deployment
costs of a new HR application and the costs to upgrade the call
center
computer system o increasing operations costs (cost of salaries,
rent,
interest rates & inflation) under rising economy in Hong
Kong
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·
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insufficient
brand awareness initiatives in the
market
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·
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salary
increases due to an active labor market in Hong Kong and GuangZhou;
and
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·
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increasing
competition of call center solutions in the Hong Kong and PRC
markets.
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4
CRITICAL ACCOUNTING POLICIES
Our
discussion and analysis is based upon our consolidated 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 certain estimates and judgments that affect the reported amount
of
assets, liabilities, revenue and expenses, and related disclosure of
contingent
assets and liabilities. On an on-going basis, we evaluate our estimates,
including those related to research and development, long-lived assets
including goodwill and purchased intangible assets, allowance for doubtful
accounts, inventories, income taxes and contingencies. We base our estimates
on historical experience and on various other assumptions that we believe
to be reasonable under the circumstances, the results of which form the
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.
Management
believes the following critical accounting policies reflect the most
significant
estimates and assumptions used in the preparation of its consolidated
financial statements.
RESEARCH
AND DEVELOPMENT
We
evaluate research and development costs to identify any research and
development
activities that could be objectively measured and recognized as an asset
for
accounting purposes at the time they are acquired or at the time they
have
developed future economic benefits. Some costs and expenses are recognized
as
costs
and expenses incurred during the period, provided that (a) there are no
discernible
future benefits, (b) costs recorded as assets in prior periods no longer
provide discernible benefits, and (c) allocating costs either on the
basis
of
association with revenue or among several accounting periods is considered
to serve no useful purpose.
VALUATION
OF LONG-LIVED ASSETS INCLUDING GOODWILL AND PURCHASED INTANGIBLE
ASSETS
We
review
property, plant and equipment, goodwill and purchased intangible assets for
impairment whenever events or changes in circumstances indicate the carrying
value of an asset may not be recoverable. Our asset impairment review assesses
the fair value of the assets based on the future cash flows the assets are
expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset
plus
net proceeds expected from the disposition of the asset (if any) are less
than
the carrying value of the asset. This approach uses our estimates of future
market growth, forecasted revenue and costs, expected periods the assets
will be
utilized and appropriate discount rates. Such evaluations of impairment of
long-lived assets including goodwill arising on a business combination and
purchased intangible assets are an integral part of, but not limited to,
our
strategic reviews of our business and operations performed in conjunction
with
restructuring actions. When impairment is identified, the carrying amount
of the
asset is reduced to its estimated fair value. Deterioration of our business
in a
geographic region or within a business segment in the future could also lead
to
impairment adjustments as such issues are identified. The accounting effect
of
an impairment loss would be a charge to income, thereby reducing our net
profit.
We
evaluate the collected ability of our trade receivables based on a combination
of factors. We regularly analyze our significant customer accounts, and,
when
we become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration
in the customer's operating results or financial position, we record
a
specific reserve for doubtful accounts to reduce the related receivable
to
the
amount we reasonably believe is collectible. We also record reserves for
doubtful
accounts for all other customers based on a variety of factors including
the length of time the receivables are past due, the financial health
of
the
customer, macroeconomic considerations and historical experience. If
circumstances
related to specific customers change, our estimates of the recoverability
of receivables could be further adjusted. In the event that our trade
receivables become uncollectible, we would be forced to record additional
adjustments
to receivables to reflect the amounts at net realizable value. The accounting
effect of this entry would be a charge to income, thereby reducing our
net
profit. Although we consider the likelihood of this occurrence to be
remote
based on past history and the current status of our accounts, there is a
possibility
of this occurrence.
TAXES
ON EARNING
We
record
a valuation allowance to reduce our deferred tax assets to the amount
that
is
more likely than not to be realized. We have considered future market
growth,
forecasted earnings, future taxable income, the mix of earnings in the
jurisdictions
in which we operate and prudent and feasible tax planning strategies
in determining the need for a valuation allowance. In the event we determine
that we would not be able to realize all or part of our net deferred
tax
assets in the future, an adjustment to the deferred tax assets would be
charged
to earnings in the period such determination is made. Likewise, if we
later
determine that it is more likely than not that the net deferred tax assets
would
be
realized, the previously provided valuation allowance would be reversed.
5
RECENT
ACCOUNTING PRONOUNCEMENTS
The
Financial Accounting Standards Board issued the following accounting
pronouncements:
In
May
2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections".
SFAS No. 154 replaces APB Opinion No. 20 "Accounting Changes" and SFAS
No.
3, "Reporting Accounting Changes in Interim Financial Statements". SFAS
No.
154
requires retrospective application to prior periods' financial statements
of changes in accounting principle, unless it is impracticable to determine
either the period-specific effects or the cumulative effect of the change.
The adoption of SFAS No. 154 did have an impact on the Company's consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 123R (revised 2004) "Share-Based Payment" which amends FASB Statement No. 123 and will be effective for public companies (small business issuers) for interim or annual periods beginning after December 15, 2005. SFAS 123R requires that compensation cost related to share-based payment transactions be recognized in the financial statements. Share-based payment transactions within the scope of SFAS 123R include stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee share purchase plans. The Company adopted the new standard as of January 1, 2006. Based on the Company's evaluation of the adoption of the new standard, the Company believes that it could have a significant impact to the Company's financial position and overall results of operations depending on the number of stock options granted in a given year.
In
February 2007, FASB issued FASB Statement No. 159, The Fair Value Option for
Financial
Assets and Financial Liabilities. FAS159 is effective for fiscal years
beginning
after November 15, 2007. Early adoption is permitted subject to specific
requirements outlined in the new Statement. Therefore, calendar-year
companies
may be able to adopt FAS 159 for their second quarter 2007 financial
statements.
The
new
Statement allows entities to choose, at specified election dates, to
measure
eligible financial assets and liabilities at fair value that are not
otherwise
required to be measured at fair value. If a company elects the fair value
option for an eligible item, changes in that item's fair value in subsequent
reporting periods must be recognized in current earnings. FAS 159 also
establishes presentation and disclosure requirements designed to draw
comparison
between entities that elect different measurement attributes for similar
assets and liabilities. The management is currently evaluating the effect
of
this pronouncement on financial statements.
In
September 2006, FASB issued SFAS 158 `Employers' Accounting for Defined
Benefit
Pension and Other Postretirement Plans--an amendment of FASB Statements
No.
87,
88, 106, and 132(R)' This Statement improves financial reporting by requiring
an employer to recognize the over funded or underfunded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset
or
liability in its statement of financial position and to recognize changes
in that funded status in the year in which the changes occur through
comprehensive
income of a business entity or changes in unrestricted net assets of
a
not-for-profit organization. The requirement to measure plan assets and
benefit
obligations as of the date of the employer's fiscal year-end statement
of
financial position is effective for fiscal years ending after December 15,
2008.
The
Company currently does not have any defined benefit plan and so FAS 158
will
not affect the financial statements.
In
September 2006, FASB issued SFAS 157 `Fair Value Measurements'. This
Statement
defines fair value, establishes a framework for measuring fair value
in
generally accepted accounting principles (GAAP), and expands disclosures
about
fair value measurements. This Statement applies under other accounting
pronouncements
that require or permit fair value measurements, the Board having previously
concluded in those accounting pronouncements that fair value is the relevant
measurement attribute. Accordingly, this Statement does not require any
new
fair
value measurements. However, for some entities, the application of this
Statement
will change current practice. This Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007,
and
interim periods within those fiscal years. The management is currently
evaluating
the effect of this pronouncement on financial statements.
In
March
2007, the Emerging Issues Task Force ("EITF") reached a consensus on issue
number 06-10, "Accounting for Deferred Compensation and Postretirement Benefit
Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements,"
("EITF 06-10"). EITF 06-10 provides guidance to help companies determine whether
a liability for the postretirement benefit associated with a collateral
assignment split-dollar life insurance arrangement should be recorded in
accordance with either SFAS No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions" (if, in substance, a postretirement benefit plan
exists), or Accounting Principles Board Opinion No. 12 (if the arrangement
is,
in substance, an individual deferred compensation contract). EITF 06-10 also
provides guidance on how a company should recognize and measure the asset in
a
collateral assignment split-dollar life insurance contract. EITF 06-10 is
effective for fiscal years beginning after December 15, 2007, though early
adoption is permitted. The management is currently evaluating the effect of
this
pronouncement on financial statements.
6
RESULTS OF OPERATIONS (RESTATED)
The
following table sets forth selected statement of operations data as a
percentage
of revenue for the periods indicated.
|
YEAR
ENDED DECEMBER 31,
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||
|
2005
(%)
|
2004
(%)
|
|
|
Restated
|
Restated
|
|
|
Revenues
|
100
|
100
|
|
Cost
of Revenues
|
(66.5)
|
(72.5)
|
|
Gross
Margin
|
33.5
|
27.5
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|
Selling,
general and administrative expense
|
(33.5)
|
(31.1)
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|
Depreciation
and amortization
|
(1.1)
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(0.6)
|
|
Loss
from operations
|
(13.9)
|
(27.1)
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|
Interest
(expenses) income, net
|
(0.3)
|
(0.4)
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|
Sundry
income
|
2.1
|
3.1
|
|
Provision
for income taxes
|
(0.9)
|
(0.6)
|
|
Share
of profit of associated companies
|
2.8
|
0.5
|
|
Minority
interest
|
(6.9)
|
(7.5)
|
|
Discontinued
operations
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0.0
|
0.0
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|
NET
LOSS
|
(16.6)
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(32.0)
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RESTATEMENT
On
March
19, 2007 the Company's predecessor auditor, Clancy and Co. P.L.L.C., withdrew
its opinion on our previously
filed financial statements for the years ended December 31, 2005 and
2004
due
to uncertainties around certain option grants during the said period.
Despite
independent investigation in this connection commissioned by our Audit
Committee
resulting in extra stock-based compensation charges of approximately
$0.3
million, $1.2 million and $0.1 million to each of the years ended December
31,
2005,
2004 and 2003, respectively, the predecessor auditor did not re-instate its
opinion.
The
Company engaged the incumbent auditors to conduct a reaudit of the
financial statements for the years ended December 31, 2005 and 2004. In the
course of the reaudit, management determined that the Company had never had
control over Yueshen, a 51% owned subsidiary in the context of FAS 94. As
a
result of excluding Yueshen from the Company's consolidated
statement operations, net revenues of the Company for each of the years
ended December 31, 2005 and 2004 were reduced by $13.3 million and $12.5
million, respectively. Accordingly, gross profit of the Company for each
of the
years ended December 31, 2005 and 2004 were reduced by $0.5 million and $1
million, respectively.
Due to time lapse and the lack of cooperation on the part of current management of certain former subsidiaries that the Company disposed of during 2006, extra provisions for doubtful accounts of approximately $3.5 million and $281,000 were charged to the restated operating expenses for the years ended December 31, 2005 and 2004 to compensate for the lack of audit evidence for certain deposits, prepayments and receivables alike.
Further,
extra goodwill impairment amounting to approximately $3.7 million and
$2.6
million, respectively, have been moved forward from fiscal year 2006 for
charging
to the restated Selling, General and Administrative expenses for the
years
ended December 31, 2005 and 2004 with the benefit of the hindsight of
knowing
the corporate restructure that took place in fiscal year 2006. In the
course
of
the reaudit, the Company has also increased the restated Selling, General
and Administrative expenses for the year ended December 31, 2005 to account
for approximately $600,000 of previously unaccrued 2005 bonus paid by a
former
subsidiary (ChinaGoHi) in 2006.
In
summary, the above, combined with others, has a net effect of reducing the
net
profits (FY2005: $2.6M; FY2004: $774,000) as reported in previous form
10-KSB
into deficits (FY2005: -$5.1M; FY2004: -$5.4M) as restated in this Form
10-KSB.
Further
details of the effects of the restatement are found below in Note 16 -
Restatement
to the audited financial statements contained in this form 10-KSB.
7
REVENUES
Revenues
for the year ended December 31, 2005 were amounted to $31,086,000, which
represented a year-over-year increase of 83% as compared to $16,942,000
for
the
year ended December 31, 2004. The increase in revenues was mainly due to
revenues
derived from the value-added telecom services rendered by the Company's
newly
acquired subsidiaries, Guangzhou3G ($5,141,000), Clickcom ($660,000) and
Lion
Zone
($1,190,000). In the aggregate, the three newly acquired subsidiaries
contributed
to22 % of the total revenues. Revenues from the VAS and IVR segment can
vary
from quarter to quarter due to new product launches and the seasonality
of
certain product lines. Segmented financial information of the four business
operating
groups is set out below followed by a brief discussion of each business
group.
YEAR
ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31,
2004.
| For the year ended December 31, 2005 (in thousands of US Dollars, except percentages |
Group
1.
Outsourcing
Business
|
Group
2.
Value-Added
Telecom
Business
|
Group
3.
Communication
Products
Distribution
Business
|
Group
4.
Other
Business
|
Total
|
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
|
|
Revenues
|
13,568
|
13,779
|
2,880
|
859
|
31,086
|
|
(%
of Total
|
|||||
|
Revenues)
|
44%
|
44%
|
9%
|
3%
|
100%
|
|
Earnings
/ (Loss) from
Operations
|
686
|
1,274
|
(106)
|
(6,187)
|
(4,333)
|
| For the year ended December 31, 2004 (in thousands of US Dollars, except percentages |
Group
1.
Outsourcing
Business
|
Group
2.
Value-Added
Telecom
Business
|
Group
3.
Communication
Products
Distribution
Business
|
Group
4.
Other
Business
|
Total
|
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
($)
Restated
|
|
Revenues
|
9,821
|
6,084
|
849
|
188
|
16,942
|
|
(%
of Total
|
|||||
|
Revenues)
|
58%
|
36%
|
5%
|
1%
|
100%
|
|
Earnings
/ (Loss)
|
|||||
|
from
Operations
|
862
|
1,655
|
(286)
|
(6,819)
|
(4,588)
|
(1)
OUTSOURCING SERVICES
Revenues
for the year ended December 31, 2005 were $13,568,000, a year-over-year
increase
of 39% as compared to $9,821,000 for the year ended December 31, 2004.
Outsourcing
services revenues accounted for 44% of the Company's total revenues for
FY
2005 due to its subsidiary being selected by China's State Administration
of
Taxation to provide integrated call center services training for the tax
bureau's
"123661" customer services center in Shenzhen and it is believed that
the
contact center expansion in Guangzhou will lead to over 40% annual revenue
growth
in
the coming years.
One
of
the reasons the revenues increased is the continuous rapid growth on
computer
software product from which the revenues amounted to $3,678,000, representing
27% of total outsourcing revenues in FY2005, a year-over-year increase
of 337% as compared to $841,000 for the same periods of prior year.
8
Besides,
providing a seamless solution and multi-media channels for clients to
communicate
with their customers for building better customer relationship generated
more sales revenues. The combination of its innovative infomercials along
with our growing call center operations generated about $8,118,000 revenues
in FY2005,
accounted for 60% of total outsourcing revenues, It is a strong vote of
confidence
in our future development in China's growing CRM call center market due
to
our expansion from B2B outsourced call center services into B2C infomercial
services market for vertical industries which a growing number of domestic
and multinational companies across a number of industries are selecting
us
to
enhance customer services. This demand for CRM services reflects the
increasingly
competitive nature of the Chinese marketplace where customers choose
a
provider not solely based upon price, but also on customer services. We
believe
that our CRM contact center has emerged as the new competitive advantage
for
the
market leaders in China and we are well positioned to benefit from this
trend.
(2)
VALUE-ADDED TELECOM SERVICES (VAS)
Revenues
for the year ended December 31, 2005 was $13,779,000 a significant year-over-year
increase of 126% as compared to $6,084,000 for the year ended December
31, 2004. Revenues from 3G, Clikcom and Lion Zone in 2005 contributed
to
the
increase in revenues for this business segment, which amounted to $5,141,000,
$660,000 and $1,190,000 respectively, accounted for 37%, 5% and 9% of
total
VAS revenues, and helped us enter the mobile Internet market in
China.
VAS
revenues accounted for 44% of the Company's total revenues for FY 2005.
Presently,
approximately 80% of mobile phone users use VAS in China.
Based
on
CPCT industry control machines and Media Server which supports access
from
both
PSTN and VoIP, soft switch and 3G networks, the Company's revenue in
the
sales
of voice cards continued to grow and amounted to $6,453,000 in FY 2005,
a
year-over-year increase of 23% compared to $5,230,000 in FY 2004. These
phone
cards sold through the VAS segment differ from the calling cards sales in
the
Communication Distribution Business as described below in that those phone
cards
are
geared towards the end user and include prepaid calling cards, IDD long
distance calling cards, internet access cards, bundled cross-selling
insurance
cards, shopping discount cards, travel and hotel reservation cards, entertainment
cards, and customer loyalty membership cards. For example, the Bank
of
China Shanghai selected PacificNet Epro to provide CRM and call center
management
training, to enhance agent productivity, to improve call center service
quality, and to revise the strategic market positioning for the
bank.
On
the
other hand, revenues from providing telecom information services to customers
under partner with China Mobile, China Telecom and other communication
service
providers for the year ended December 31, 2005 increased to $5,741,000,
accounted
for 42% of the total VAS revenues and 18% of the total Revenues in FY
2005.
(3)
COMMUNICATION
PRODUCTS DISTRIBUTION
Revenues
from Communication Products Distribution for the year ended December
31,
2005
were $2,880,000, a year-over-year increase of 242% as compared to $841,000
for the year ended December 31, 2004. Communication products distribution
revenues made up 9% of the Company's total revenues for the year ended
December 31, 2005. The increased Distribution revenue was mainly due to
the
expanding of market promotion activities to meet the increasing market
growth
in
communication products distribution services.
(4)
OTHER BUSINESS
Revenues
for the year ended December 31, 2005 were $860,000, a significant year-over-year
increase of 357% as compared to $188,000 for the year ended December
31, 2004. This increased revenue was mainly due to the web maintenance
service
by PacificNet Limited which generated revenues of $523,000 in FY 2005,
an
increase of 179% as compared to $188,000 in FY2004. Moreover the incorporation
of PacificNet Power on Jan 2005 increased the revenues ($336,000) in
FY
2005.
COST
OF REVENUES AND GROSS MARGIN
Cost
of
revenues for the year ended December 31, 2005 was $20,678,000, an increase
of 68% from $12,286,000 for the year ended December 31, 2004. The slight
increase in the cost of revenues was directly associated with the increase
in revenue. Cost of revenue, as a percentage of revenue, was 67% for
the
year
ended December 31, 2005 as compared with 73% for the year ended December
31, 2004. The decrease in cost as a percentage of revenues was attributable
to the changes in operations, from supplying systems integration and
software applications in 2004 to becoming value-added telecom services and
product
providers in 2005.
Gross
profit for the year ended December 31, 2005 was $10,408,000 an increase of
124%
as
compared to $4,656,000 for the year ended December 31, 2004, resulting
from
gross margin contributions from our newly acquired subsidiaries in 2005:
Guangzhou3G
($3,000,000), Clickcom ($597,000) and Lion Zone ($1,190,000), which accounted
for 29%, 6% and 11% of total Gross Profit.
Our
gross
margin overall was 33% in the year ended December 31, 2005 (2004:27%)
and
approximated the industry standards. The slight increase in gross margin
came
primarily from providing telecom information services which had generated
Gross
profit of $8,499,000 and Gross margins of 40%.
9
(1)
OUTSOURCING SERVICES
As
compared to prior year, cost of revenues for outsourcing services increased
to
$10,366,000, 48% higher at $6,984,000 in FY 2004. Gross profit was 13% higher
at
$3,202,000 (2004: $2,837,000).The increase in Gross profit was mainly due to
the
increasing demand for outsourcing contact center services, especially from
the
industries of telecom, banking, market research and fast-moving consumer
goods,
among others. From the perspective of high-margin IT Solutions, EPRO
enjoyed
growth in FY2005 from its self-developed Contact Center System - WISE-xb
Contact
Center System and TNT Hong Kong selected this contact center solution
with
customer management capabilities to improve efficiency and enhance customer
satisfaction.
(2)
VALUE-ADDED TELECOM SERVICES (VAS)
As
compared to prior year, cost of revenues for VAS increased to $7,457,000 in
FY
2005,
an increase of 70% as compared to $4,399,000 in FY 2004. The increased
cost
of
VAS revenues was mainly derived from our newly acquired subsidiaries in
the
year
of 2005, Guangzhou3G, Clickcom and Lion Zone, the cost of revenues form
which
amounted to $2,141,000, $63,000 and $0 respectively. In the aggregate, the
cost
of
VAS revenues from the three newly acquired subsidiaries contributed to
30
% of
the total cost of VAS revenues in FY 2005.
The
Gross
profit amounted to $6,322,000 for the year ended December 31, 2005, a
significant increase of 275% as compared to $1,686,000 for the same periods
of
2004. The increased gross profit was mainly due to the new acquisitions in
the
year of 2005, Guangzhou3G, Clickcom and Lion Zone, from which the Gross profit
amounted to $3,000,000, $597 and $1,190,000 respectively. The acquisitions
for
the newly companies helped our company moved our strategic consolidation
in
China's CRM and VAS market, and increased our customer base and improved
our
gross margin. the continued profitability in the sale of phone cards.
Furthermore, our company increased market share in the voice/IVR supplier
market.
(3)
COMMUNICATION PRODUCTS DISTRIBUTION
Cost
of
revenues from communication products distribution for the year ended
year
ended December 31, 2005 amounted to $2,572,000, a significant year-over-year
increase of 206% as compared to $841,000 for the same periods of 2004.
The
increased cost of revenue was associated with the increased revenues
from
communication products distribution as the expanding of promotion market
activities.
Gross profit was 4,001% higher at $307,000 (2004: $7,000).
(4)
OTHER BUSINESS
Cost
of
revenues and Gross profit for PacificNet Power for the year ended December
31, 2005 was $283,000 and $577,000, a significant increase of 356% and
358%
compared to $62,000 and $126,000 respectively for the year ended December
31,
2004.
This was mainly due to the incorporation of PacificNet Power on Jan 2005,
which generated about $269,000 cost of revenues and $67,000 Gross
Profit.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
Selling,
General and Administrative expenses ("SG&A") totaled $10,420,000 for
the
year
ended December 31, 2005, which represents a year-over-year increase of
98%
as
compared to $5,267,000 for the year ended December 31, 2004. The significant
increase in selling, general and administrative expenses reflected the
expansion of our operations of which expenses were incurred by our newly
acquired
subsidiaries: Guangzhou3G ($922,000), Clickcom ($611,000) and Lion Zone
($3,097,000),
and the expansion of the management team. In addition to making several
key acquisitions in 2005, we laid the foundation for a strong future, by
hiring
additional personnel in key areas to support our accounting and back-office
functions, as well as implemented the systems to allow the Company to
better
measure the performance of each of its units.
(1)
OUTSOURCING SERVICES
Selling,
General and Administrative expenses for outsourcing services were $2,261,000
for the year ended December 31, 2005, an increase of 19% from $1,907,000
for the year ended December 31, 2004. For the increase in the demand
for
telemarketing and call center services, PacificNet Epro purchased a new
250-seat
call center facility in China to support the rapidly growing business
of
the
company, which caused an increase of 8% from $1,618,000 for the year
ended
December 31, 2004 to $1,752,000 for the year ended December 31, 2005,
accounted
for 78% of the total SG&A from outsourcing services. However, a wide
array
of
supporting services are provided, including professional inbound services,
outbound services, facilities management and IVRS support services, to
meet
clients' diversified needs.
10
(2)
VALUE-ADDED TELECOM SERVICES (VAS)
Selling,
General and Administrative expenses for VAS increased from $22,000 for
the
year
ended December 31, 2004 to $4,973,000 for the year ended December 31,
2005.The
increase of SG&A expense resulted from the increasing size of our
operations
which included premises cost and staff costs from the three new acquisitions,
Guangzhou3G, Clickcom and LionZone, of which SG&A amounted to $922,000,
$611,000and $3,097,000 respectively, and accounted for 30%, 20% and 38%
of
the total SG&A from VAS.
(3)
COMMUNICATION PRODUCTS DISTRIBUTION
Selling,
General and Administrative expenses for this group were $413,000 for
the
year
ended December 31, 2005, a significant year-over-year increase of 57 %
as compared
to $263,000 for the year ended December 31, 2004. The increased SG&A
was
mainly derived from bad debts ($223,000), and Sunday expenses ($11,000) by
PacificNet
Communications as the expanding of Market share.
(4)
OTHER BUSINESS
Selling,
General and Administrative expenses were $2,773,000 for the year ended
December
31, 2005, a year-over-year decrease of 9.8% as compared to $3,075,000
for
the
same periods of FY 2004.
DEPRECIATION
AND AMORTIZATION EXPENSES
Depreciation
and amortization expenses were $351,000 for the year ended December 31,
2005,
which represented an increase of 241% as compared to $103,000 for the
year
ended December 31, 2004.
OPERATING
LOSS
Operating
Loss of $4,333,000 for the year ended December 31, 2005, a decrease of
6%
as
compared to $4,588,000 from the year ended December 31, 2004. Operating
Loss
margins for the year ended December 31, 2005 was14% as compared to 27% in
the
previous year. Annual operating loss of $(686,000), $(1,274,000) and
$106,000
generated from the Company's three business units: (1) CRM Outsourcing
Services,
(2) Value-Added Services (VAS) and (3) Telecom Distribution Services,
as
compared to $(862,000), $(1,655,000), and $287,000 for the same periods of
prior
year.
INTEREST INCOME / (EXPENSES), NET
Interest
income was $226,000 for the year ended December 31, 2005, an increase
of
304%as
compared to $56,000 for the year ended December 31, 2004. Interest income
was mainly due to $152,000 (67% of total interest income) of PacificNet
Communications
from lending and fixed-rate bank deposits ($2,039,000), to $45,000
of PacificNet Strategic Investment Holdings Limited from bank deposits
($362,000).
Interest
expense was $144,000 for the year ended December 31, 2005, an increase
of
16% as
compared to $124,000 for the year ended December 31, 2004. Interest expenses
were greatly derived from bank loans ($108,000) and bank overdraft ($943,000)
by Epro which generated $97,000 interest expense, as a percentage of
67%
of
the total interest expense.
SUNDRY
INCOME/EXPENSE
Sundry
income known as non-operating income is defined as the external income
(miscellaneous
income) that results from factors outside of our operating subsidiaries'
control and such income does not related to each subsidiaries' core
operating business. Income from the sale of various investments is one of
the
typical examples. (See Note 11 for details)
For
the
year ended December 31, 2004,
the
non-operating income or sundry income was $521,000 included in Statement
of Operations was mainly derived from Linkhead's consulting services
income
from system integration services totaling $345,000, from PacificNet Communications'
Investment income totaling $55,000, from leasehold income totaling
$104,000 and from others totaling $17,000.
For
the
year ended December 31, 2005, the non-operating income or sundry income
was
$655,000 included in Statement of Operations was mainly derived from the
consulting
services income of $368,000, investment income of $260,000, leasehold
income
of
$6,000 and various others totaling $(21,000).
11
INCOME
TAXES
The
income taxes expenses for the Company's subsidiaries were $272,000 and
$106,000
for the years ended December 31, 2005 and 2004 respectively. The provision
of income taxes was the result of the operating profit generated by Epro
($631,899), Smartime ($53,243) and ChinaGoHi ($648,266), from which the
income
taxes amounted to $27,000, $15,000 and $195,000 respectively. Pursuant to
the
PRC
Income Tax Laws, the Company's subsidiaries and VIEs are generally subject
to Enterprise Income Taxes ("EIT") at a statutory rate of 33%, which
comprises
30% national income tax and 3% local income tax. Some of these subsidiaries
and VIEs are qualified new technology enterprises and under PRC Income
Tax Laws, they are subjected to a preferential tax rate of 15%. Guangzhou3G-DE
as software enterprise comprises 15% tax rate for one year during 2005
and
it can continue to apply 15% tax rate after this is expired. In addition,
Guangzhou 3G-WOFE, as a new High Technology Foreign Investment Enterprises
and under PRC Income Tax Laws, is entitled to a two-year tax exemption
in 2005 and 2006. In order to improve the technology market in China,
another
of our high-tech subsidiaries, Linkhead, is entitled a three-year tax
exemption
followed by three years with a 50% reduction in the tax rate, commencing
the first operating year. Therefore, Linkhead's taxes have been remitted
during January 1, 2003 to December 31, 2005 but it pays taxes at 7.5%
from
January 1, 2006 to December 31, 2008.
MINORITY
INTERESTS
Minority
interests for the years ended December 31, 2005 and 2004 totaled $2,132,000
and $1,271,000 respectively. Minority interests represented the interests
of third parties in our subsidiaries' results.
NET
LOSS
Net
loss
for the year ended December 31, 2005 was $5,145,000 as compared to net
loss
of
$5,425,000 for the year ended December 31, 2004. Net loss of $(585,000),
$(1,440,000)
and $113,000 was generated from the Company's three business units:
(1)
CRM
Outsourcing Services, (2) Value-Added Services (VAS) and (3) Telecom
Distribution
Services, represented a decrease of 17 %, 28 % and (76) % respectively
as compared to $(705,000), $(1,988,000) and $480,000 respectively for
the
year ended December 31, 2004.
12
CONTRACTUAL
OBLIGATIONS
CONTRACTUAL
OBLIGATIONS
We
have
significant cash resources to meet our contractual obligations as of
December
31, 2005, as detailed bellows (in thousands of US Dollars):
Payments
Due by Period
|
Contractual
Obligations
|
||||||||||||||||
|
(in
thousands)
|
Less
than 1 year
|
1-5
years
|
After
5 years
|
Total
|
||||||||||||
|
Restated
|
Restated
|
Restated
|
Restated
|
|||||||||||||
|
Line
of credit
|
$ |
1,059
|
0
|
0
|
$ |
1,059
|
||||||||||
|
Bank
Loans
|
$ |
188
|
$ |
6
|
0
|
$ |
194
|
|||||||||
|
Operating
leases
|
$ |
571
|
$ |
1,444
|
0
|
$ |
2,015
|
|||||||||
|
Capital
leases
|
$ |
126
|
$ |
78
|
0
|
$ |
204
|
|||||||||
|
Total
cash contractual
|
||||||||||||||||
|
obligations
|
$ |
1,944
|
1,528
|
0
|
$ |
3,472
|
||||||||||
OFF-BALANCE
SHEET ARRANGEMENTS
We
had no
outstanding derivative financial instruments, off-balance sheet guarantees,
interest rate swap transactions or foreign currency forward contracts.
We did not engage in trading activities involving non-exchange
traded
contracts
during 2005.
LIQUIDITY
AND CAPITAL RESOURCES
WORKING
CAPITAL
The
Company's working capital increased by 9% to $17,109,000 for the year ended
December
31, 2005 as compared to $15,646 at December 31, 2004. The increase in
working
capital primarily resulted from proceeds (shown net of offering costs)
from
our
private placement activities that resulted in an increase of
$1,105,000in
cash
balance and time deposit, net of cash expenditures for operations and
acquisitions.
ISSUANCE OF COMMON STOCK
During
the year ended December 31, 2005, the Company issued shares of common stock
as
follows: (i) 676,000 shares of common stock were issued as a result of the
exercise of stock options and warrants with cash consideration of $966,000
in
the aggregate;; (ii) 515,900 for the acquisition of subsidiaries with market
value of $3,971,000; and (iii) 20,000 shares of common stock were issued
to our
investor relations firm for services rendered with a market value of
$63,000.
FUTURE LIQUIDITY NEEDS
As
of
December 31, 2005, we had approximately $10,639,000 in cash. We regularly
review
our cash funding requirements and attempt to meet those requirements
through
a
combination of cash on hand; cash provided by operations, available borrowings
under bank lines of credit and possible future public or private equity
offerings. We evaluate possible acquisitions of, or investments in, businesses
that are complementary to ours, which transactions may require the use
of
cash. We believe that our cash, other liquid assets, operating cash flows,
credit arrangements, access to equity capital markets, taken together,
provide
adequate resources to fund ongoing operating expenditures. In the event
that
they
do not, we may require additional funds in the future to support our
working
capital requirements or for other purposes and may seek to raise such
additional
funds through the sale of public or private equity as well as from other
sources.
INFLATION
Inflation
has not had a material impact on the Company's business in recent years.
13
CURRENCY
EXCHANGE FLUCTUATIONS
All
of
the Company's revenues are denominated either in U.S. dollars or Hong
Kong
dollars, while its expenses are denominated primarily in Hong Kong dollars
and
Chinese renminbi ("RMB"). The value of the RMB-to-U.S. dollar or Hong Kong
dollar-to-United
States dollar and other currencies may fluctuate and is affected
by, among other things, changes in political and economic conditions.
Since
1994, the conversion of renminbi into foreign currencies, including U.S.
dollars,
has been based on rates set by the People's Bank of China, which are
set
daily
based on the previous day's inter-bank foreign exchange market rates
and
current exchange rates on the world financial markets. Since 1994, the
official
exchange rate generally has been stable. Since October 2004, the renminbi
has been pegged to the US dollar at the rate of one dollar for 8.2765
Yuan,
which was scrapped when the renminbi reform was launched on July 21 and
since
then the Yuan was fixed at a market basket of currencies. Recently there
has
been
increased political pressure on the Chinese government to decouple the
renminbi
from the United States dollar. At the recent quarterly regular meeting
of
People's Bank of China, its Currency Policy Committee affirmed the effects
of
the
reform on Chinese renminbi exchange rate, regarding that in the past two
months
(February and March 2006) when the new currency rate system has been
operating,
the currency rate of renminbi has become more flexible while basically
maintaining stable and the expectation for a larger appreciation range
is
shrinking. Although a devaluation of the Hong Kong dollar or renminbi
relative
to the United States dollar would likely reduce the Company's expenses
(
as
expressed in United States dollars), any material increase in the value of
the
Hong
Kong dollar or renminbi relative to the United States dollar would increase
the Company's expenses, and could have a material adverse effect on the
Company's
business, financial condition and results of operations. For fluctuations
in period to period exchange rates, the translation adjustment is required
to translate from local functional currency to the USD reporting currency
(not RMB to HKD to USD). The Company has never engaged in currency hedging
operations and has no present intention to do so.
CONCENTRATION
OF CREDIT RISK
Credit
risk represents the accounting loss that would be recognized at the reporting
date if counterparties failed completely to perform as contracted. Concentrations
of credit risk (whether on or off balance sheet) that arise from financial
instruments exist for groups of customers or counterparties when they
have
similar economic characteristics that would cause their ability to meet
contractual
obligations to be similarly affected by changes in economic or other
conditions
as described below:
|
|
·
|
The
Company's business is characterized by rapid technological change,
new
product and service development, and evolving industry standards
and
regulations. Inherent in the Company's business are various risks
and
uncertainties, including the impact from the volatility of the
stock
market, limited operating history, uncertain profitability and
the ability
to raise additional capital.
|
|
|
·
|
All
of the Company's revenue is derived from Asia and Greater China.
Changes
in laws and regulations, or their interpretation, or the imposition
of
confiscatory taxation, restrictions on currency conversion, devaluations
of currency or the nationalization or other expropriation of private
enterprises could have a material adverse effect on our business,
results
of operations and financial
condition.
|
|
|
·
|
If
the Company is unable to derive any revenues from Greater China,
it would
have a significant, financially disruptive effect on the normal
operations
of the Company.
|
* A substantial portion of the operations of business operations depend on mobile telecommunications operators (operators) in China and any loss or deterioration of such relationship may result in severe disruptions to their business operations and the loss of a significant portion of the Company's revenue. The VIEs rely entirely on the networks and gateways of these operators to provide its wireless value-added services. Specifically these operators are the only entities in China that have platforms for wireless value-added services. The Company's agreements with these operators are generally for a period of less than one year and generally do not have automatic renewal provisions. If neither of them is willing to continue to cooperate with the Company, it would severely affect the Company's ability to conduct its existing wireless value-added services business.
COMPREHENSIVE
INCOME (LOSS)
Comprehensive
income (loss) consists of net earnings and other gains (losses) affecting
stockholders' equity that, under generally accepted accounting principles
are excluded from net earnings in accordance with Statement of Financial
Accounting Standards ("SFAS") 130, Reporting Comprehensive Income. Additionally,
the translation adjustment is recorded as component of comprehensive
income (loss) in stockholders' equity section of balance sheet.
SEASONALITY
AND QUARTERLY FLUCTUATIONS
Several
of our businesses experience fluctuations in quarterly performance. Traditionally,
the first quarter from January to March is a low season for our call
center business due to the long Lunar New Year holidays in China. Revenues
and
income from operations for the call center and telecom value-added
services tend
to
be higher in the fourth quarter due to special holiday promotions. Internet/Direct
Commerce revenues also tend to be higher in the fourth quarter due
to
increased consumer spending during that period. Revenues from
the VAS
and
IVR segment can vary from quarter to quarter due to new product launches and
the
seasonality
of certain product lines.
14
ITEM
7. FINANCIAL STATEMENTS
The
consolidated financial statements and the report and notes, are attached
hereto
following the signature page beginning on Page F-1.
INDEX
TO
FINANCIAL STATEMENTS
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
Consolidated
Balance Sheets-Restated
|
F-2
|
|
-
As of December 31, 2005 and 2004
|
|
|
Consolidated
Statements of Operations-Restated
|
|
|
-
For the Years Ended December 31, 2005, December 31, 2004
|
F-3
|
|
Consolidated
Statements of Changes in Stockholders' Equity-Restated
|
|
|
-
For the Years Ended December 31, 2005 and December 31,
2004
|
F-4
|
|
Consolidated Statements
of Cash Flows-Restated - For the Years Ended December 31, 2005
and
December 31, 2004
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
ITEM
8A. CONTROLS AND PROCEDURES
We
maintain controls and procedures designed to ensure that information required
to
be
disclosed in the reports that we file or submit under the Securities
Exchange
Act of 1934 is recorded, processed, summarized and reported within the
time
periods specified in the rules and forms of the Securities and Exchange
Commission.
Certain internal audit tests performed at the fiscal year-end of 2006
revealed that there were weaknesses inherent in the Company's internal
control
system. Among which it was noted that there were insufficient checks and
balances
in place for controlling the company's non-routine transactions, namely:
accuracy and completeness of stock option expense calculation. Such weaknesses
in our controls eventually led to prior period option expense restatements
being charged to the Company's financial statements for the years ended
December 31, 2003, 2004, and 2005 respectively. As a result, our chief
executive
officer and our former chief financial officer concluded that there was
a
material weakness in our disclosure controls and procedures.
As
of the
end of the period covered by this report, the company had taken
various
steps to maintain the accuracy of our financial disclosures, and improve
company
internal control. An internal control SOX implementation team led by
senior
managers had been set up to uncover potential significant deficiencies
inherent
in the internal control systems of the company, including but not limited
to risk identification, control procedure setup, staff training,segregation
of incompatible job duties, design of management reporting system, definition
and delegation of signing authority, establishment of documentation system
and implementation of a company-wide SOX compliant ERP system. Based on
the
current schedule, the Company is expected to be substantially SOX compliant
by
the
end of FY2007.
15
PART
III
ITEM
9.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(A) OF THE EXCHANGE
ACT
Set
forth
below are the names of the directors, executive officers and significant
employees of the Company as of October 24, 2007:
|
Name
|
Age
|
Title
|
|
Tony
Tong
|
38
|
Chairman
and Chief Executive Officer
|
|
Victor
Tong
|
36
|
President,
Secretary, and Director
|
|
Daniel
Lui
|
43
|
Chief
Financial Officer
|
|
ShaoJian
(Sean) Wang
|
41
|
Director
|
|
Michael
Ha
|
36
|
Independent
Director (2) (3)
|
|
Jeremy
Goodwin
|
33
|
Independent
Director (1) (3)
|
|
Tao
Jin
|
38
|
Independent
Director (1) (2) (3)
|
|
Mike
Fei
|
38
|
Company
Secretary and General Counsel
|
| Ho-Man Poon |
34
|
Independent Director |
___________
(1)
Member of Audit Committee
(2)
Member of Nominating Committee
(3)
Member of Compensation Committee
Our
executive officers are appointed at the discretion of our board of
directors with no fixed term. There are no family relationships between
or among any of our executive officers or our directors other than
the relationship between
Mr. Tony Tong and Mr. Victor Tong.
The
following is a brief description of each board of director, key positions
and
brief biography:
MR.
TONY TONG, age 38, is the Chairman, CEO, Executive Director,
and co-founder of PacificNet since 1999. From 1995 to 1997, Mr. Tong
served
as
the Chief Information Officer of DDS Inc., a leading SAP-ERP consulting
company in the USA, which was later acquired by CIBER, Inc. (NYSE: CBR).
From 1993 to 1994, Mr. Tong worked for Information Advantage, Inc. (NASDAQ:IACO),
a leading business intelligence, Data-Mining and CRM technology provider
serving Fortune 500 clients. IACO consummated an IPO on NASDAQ in 1997
and
was
later acquired by Sterling Software and Computer Associates (NYSE:CA).
From
1992
to 1993, Mr. Tong worked as a Business Process Re-engineering Consultant
at Andersen Consulting (now Accenture, NYSE:ACN). From 1990 to 1991,
Mr.
Tong
worked for ADC Telecommunications (NASDAQ:ADCT), a global supplier of
telecom
equipment. Mr. Tong's R&D achievements include being the inventor and
patent
holder of US Patent Number 6,012,066 (granted by US Patent and Trademark
Office)
titled "Computerized Work Flow System, an Internet-based workflow management
system for automated web creation and process management." Mr. Tong also
serves on the board of advisors of Fortune Telecom (listed on Hong Kong
Stock
Exchange: 0110.HK), a leading distributor of mobile phones, PDAs, telecom
services,
and accessories in China and Hong Kong. Mr. Tong is a frequent speaker
on
technology investment in China, and was invited to present at the Fourth APEC
International
Finance & Technology Summit in 2001. Mr. Tong is the Vice Chairman
(PRC)
of
Hong Kong Call Centre Association, a Fellow of Hong Kong Institute of
Directors,
a consultant on privatization and securitization for China's State-owned
Assets Supervision and Administration Commission (SASAC), and a frequent
speaker for LexisNexis, a licensed Continued Professional Development
(CPD)
trainer, on China investment. Mr. Tong graduated with Bachelor of Mechanical/Industrial
Engineering Degree from the University of Minnesota and served
on
the Computer Engineering Department Advisory Board and was an Adjunct
Professor
at the University of Minnesota, USA. Tony Tong is the brother of Victor
Tong.
16
MR.
VICTOR TONG, age 36, is the President, Secretary, and Director of
PacificNet, and has served on our board as an Executive Director since 2002.
Mr.
Victor Tong gained his consulting, systems integration, and technical expertise
through his experience at Andersen Consulting (now Accenture, NYSE:ACN),
American Express Financial Advisors (IDS), 3M, and the Superconductivity
Center
at the University of Minnesota. In 1994, Victor co-founded Talent Information
Management ("TIM"), a leading internet application development and consulting
company in Minnesota. PacificNet.com was originally founded as an operating
division of TIM. In 1997, Mr. Tong successfully sold GoWeb internet consulting
division of TIM to Key Investment, a leading technology and media investment
company owned by Vance Opperman, a billionaire in Minnesota who founded West
Publishing. Mr. Tong became the President of KeyTech, a leading information
technology consulting company based in Minnesota. In 1999, he was recognized
in
"City Business 40 Under 40" as one of the future business and community leaders
in Minnesota. Mr. Tong won the Student Commencement Speaker Award and graduated
with honors with a Bachelor of Science in Physics from the University of
Minnesota. Mr. Tong was an adjunct professor at the College of Software of
Beihang University, one of the top software colleges in China. Victor Tong
is
the brother of Tony Tong.
MR.
DANIEL LUI, age 43, has served as Chief Financial Officer since March
1, 2007. Mr. Lui joined PacificNet with over 17 years of professional and
commercial accounting experience, 7 years of which was in Mainland China.
He
carries the credentials of Chartered Accountant (Alberta, Canada) and
CPA-inactive (Washington, USA). Mr. Lui was Vice President of Finance and
Company Secretary of Fiberxon Inc., a leading communications subsystem maker,
where he was in charge of Fiberxon’s Finance, Company Secretarial, and
Information Technology departments from 2002 to 2007. Prior to joining Fiberxon,
Mr. Lui was Chief Financial Officer of China Motion NetCom Ltd., a wholly
owned
subsidiary of China Motion Telecom International Limited, a Hong Kong Exchange
listed company, engaged in long distance call resale business from 2000 to
2001.
Prior to that, Mr. Lui was Financial Advisory Services Manager of
PricewaterhouseCoopers and Auditor at KPMG. Mr. Lui received his Bachelors
of
Business Administration degree from the University of Hawaii at Manoa in
1987
and Masters of Business Administration from University of Alberta in Canada
in
1994.
MR.
SHAOJIAN (SEAN) WANG, age 41, has served on our board as a Director
since 2002. From 2002 to May 2006, Mr. Wang also served as Chief Financial
Officer of PacificNet. Mr. Wang is now President and Chief Operating Officer
of
Hurray! Holding Co., Ltd. (NASDAQ:HRAY), a NASDAQ-listed Chinese VAS company.
Previously, Mr. Sean Wang was COO and acting Chief Financial Officer (CFO)
at
GoVideo and Opta Corporation, a public listed consumer Electronics Company
in
the US controlled by TCL, a leading consumer electronics maker in China.
From
1987 to 2002, he served as a country manager at Ecolab, Inc. and as the managing
director at Thian Bing Investments PTE, Ltd. From 1993 to 2002, Mr. Wang
served
as managing director of Thian Bing Investments PTE, Ltd. where he managed
the
Singapore-based company's multi-million dollar investment operations and
identified strategic and investment opportunities. Mr. Sean Wang attended
Peking
University and received a BS in Economics from Hamline University and an
MBA
from Carlson School of Management, University of
Minnesota.
MR.
MICHAEL CHUN HA, age 36, has served on our board as an Independent
Director since
December 24, 2003. Mr. Ha graduated from the Faculty of Law, University of
Hong
Kong
in 1994 with a bachelor degree in law
and
was admitted as a solicitor of the High Court of the Hong Kong Special
Administrative
Region in 1997 and a solicitor of the Supreme Court of England and
Wales
in 1998. From 1995 to 2002, Mr. Ha worked as lawyer in a number of international
and Hong Kong prestigious law firms, specializing in the areas of corporate
finance, securities offerings, takeovers, cross-border mergers and acquisitions,
venture capital, corporate restructuring, regulatory and compliance
issues, project finance, and general commercial transactions and services
in Hong Kong and the People's Republic of Hong Kong. In 2002, Mr. Ha
commenced
his own practice in the trade name of "Ha and Ho Solicitors" and the
firm
specializes in the areas of general commercial transactions, corporate
finance
and civil and criminal litigations. Mr. Ha is also the company secretary
of,
Shanxi Central Pharmaceutical International Company Limited, a Hong Kong
main
board listed company from year 2000 and a director of a private investment
company,
Metro Concord Investment Limited, from year 2002.
17
MR.
JEREMY GOODWIN, age 33, has served on our board as an Independent
Director since
December 24, 2004. Jeremy Goodwin is founder of China Diligizer and Managing
Partner of 3G Capital Partners. He began his career in 1995 at Mees Pierson
Investment Finance S.A. in Geneva, Switzerland where he supported the
fund's
private placement/private equity finance team. Noteworthy transactions
executed
by the group included assistance on the placements of the $1.2 Billion
Carlyle
Partners II Limited Partnership. In 1997 he went to work for the then
parent
institution, ABN Amro, in Beijing, China. In 1999, Mr. Goodwin was employed
with ING Barings in London as an International Associate. Mr. Goodwin
received
his BS from Cornell University in 1996 in conjunction with the Institute
of Higher International Studies in Geneva, Switzerland. He later pursued
his advanced degree with Princeton University with a concentration in
Chinese
affairs which he completed at the prestigious Nanjing Chinese Studies
Center
of
the Johns Hopkins School of Advanced International Studies. Jeremy is
fluent
in
written and spoken Mandarin Chinese, French and has working knowledge
of
Dutch.
MR.
TAO JIN, age 38, has served on our board as an Independent Director
since January
6, 2005. Mr. Jin is a resident partner at Jun He Law Offices (www.JunHe.com),
a leading Chinese law firm specializing in commercial legal practice
with over 160 lawyers and offices in Beijing, Shanghai, Shenzhen,
Dalian,
Haikou and New York. Founded in April 1989, Jun He was one of the first
private
law firms formed in China, and has been a pioneer in the re-established
Chinese
legal profession with a focus in representing foreign clients in business
activities throughout China. Over the past few years, Jun He has been
honored
a
number of times as one of the best law firms in China by the Ministry
of
Justice of China. With a team of more than 160 well-trained lawyers, Jun He
is
one of
the largest and most established law firms in China. Prior to joining
Jun
He,
Mr. Jin served as Vice President and Assistant General Counsel of J.P.
Morgan
Chase Bank, as the head legal counsel for capital markets transactions in
Asia,
and
for JPMorgan's M&A transactions in China. Mr. Jin joined Jun He as a
partner
in 2005. From 1999 to 2002, Mr. Jin served as a Senior New York Qualified
Lawyer for Sullivan & Cromwell, which represented China Unicom, PetroChina
and China Telecom in their IPO's and dual listings in New York and Hong
Kong. From 1996 to 1999, Mr. Jin served as Associate Lawyer for Cleary,
Gottlieb
Steen & Hamilton, which represented various Fortune 500 companies and
investment
banks in public and private securities offerings and M&A activities.
Mr.
Jin
received his Juris Doctor in 1996 with high honors from Columbia University,
and received B.S. in Psychology in 1990 from Beijing University.
MR. MIKE FEI, age 38, is the Company Secretary and General Counsel for PacificNet. Mr. Fei joined PacificNet in 2004 as in-house PRC Chief Legal Counsel for PacificNet's China Operations. Mr. Fei is a Member of the All-China Bar Association and holds a Master of Law degree from the University of New South Wales of Australia. Mr. Fei has 8 years of experience in the legal profession and dealt with more than 200 cases of litigation and arbitration which related to the issues of foreign investment, bankruptcy, merging, commercial contract and debt disputes.
MR.
HO-MAN (MIKE) POON, is a nominee for independent director of
PacificNet. Mr. Poon is a Chartered Financial Analyst (CFA). He is the first
session graduate of the EMBA course of the Tsinghua University and holds
a
Bachelor degree from the University of Hong Kong. He has been registered
as
dealing director and investment advisor since 2002. He has over 11 years
experience in the equity and capital markets of the Greater China Region,
ranging from direct investment, fund management, securities brokerage and
financial advisory. He is experienced in deal structuring, especially in
relation to transactions of the listed companies in Hong Kong. Since 2002,
he
has served as the Chairman and the Chief Executive Officer of the
Friedmann Pacific group of companies, which is a private financial groups
covering investment, securities brokerage and financial services. He is a
member
of the Hong Kong Society of Financial Analyst and the member of the Hong
Kong
Institute of Directors.
COMPLIANCE WITH SECTION 16(A) OF EXCHANGE ACT
Section
16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"),
requires our executive officers, directors and persons who beneficially
own
more
than 10% of a registered class of our equity securities to file with
the
Securities and Exchange Commission initial reports of ownership and reports
of
changes in ownership of our common stock and other equity securities. Such
executive
officers, directors, and greater than 10% beneficial owners are required
by SEC regulation to furnish us with copies of all Section 16(a) forms
filed
by
such reporting persons.
Based
solely on our review of such forms furnished to us and written representations
from certain reporting persons, we believe that the following executive
officers and directors failed to timely file Form 4's and 5's: Tony Tong
failed to timely file Form 4's, one Form 4 reporting the exercise of a
stock
option and three Form 4's each reporting the grant of stock options;
Victor
Tong failed to timely file Form 4's, one Form 4 reporting the exercise of
a
stock
option and four Form 4's each reporting the grant of stock options; Shaojian
Wang failed to timely file Form 4's, two Form 4's each reporting the
exercise
of stock options and three Form 4's each reporting the grant of stock
options;
Michael Chun Ha failed to timely file Form 4's, one Form 4 reporting
the
exercise of an option and three Form 4's each reporting the grant of stock
options;
Peter Wang failed to timely file three Form 4's each reporting the grant
of
stock options; Jeremy Goodwin failed to timely file three Form 4's each
reporting
the grant of stock options and Tao Jin failed to timely file three Form
4's
each reporting the grant of stock options.
18
AUDIT
COMMITTEE OF THE BOARD OF DIRECTORS
The
Audit
Committee is responsible for nominating the Company's independent auditors
and reviewing any matters that might impact the auditors' independence
from
the
Company; reviewing plans for audits and related services; reviewing audit
results and financial statements; reviewing with management the adequacy
of
the
Company's system of internal accounting controls, including obtaining
from
independent auditors management letters or summaries on such internal
accounting
controls; determining the necessity and overseeing the effectiveness
of
the
internal audit function; reviewing compliance with the U.S. Foreign Corrupt
Practices Act and the Company's internal policy prohibiting insider trading
in its Common Stock; reviewing compliance with the SEC requirements for
financial
reporting and disclosure of auditors' services and audit committee members
and activities; reviewing related-party transactions for potential conflicts
of interest; and reviewing with corporate management and internal and
independent
auditors the policies and procedures with respect to corporate officers'
expense accounts and perquisites, including their use of corporate assets.
The
board
of directors has established an audit committee in accordance with Section
3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The members
of the Audit Committee are Messrs. Jeremy Goodwin and Tao Jin,
each
of whom are considered "independent" under the NASDAQ National Market
listing
standards currently in effect.
The board of directors has determined that each of the members of the audit committee qualify as an "audit committee financial expert" under the Securities and Exchange Commission's definition.
19
ITEM
13. EXHIBITS AND REPORTS ON FORM 8-K.
EXHIBITS
The
following exhibits are filed as part of this report:
|
EXHIBIT
NUMBER
|
DESCRIPTION
|
|
2.1
|
Share
Exchange Agreement by and among Davin Enterprises, Inc., Carl Tong,
Leo
Kwok and Acma trategic Holdings Limited dated December 15, 1997.
(1)
|
|
2.2
|
Share
Exchange Agreement dated February 17, 2000, between Registrant and
holders
of embership interests in PacificNet.com LLC.(2)
|
|
2.3
|
Supplement
to Share Exchange Agreement dated April 29, 2000, between Registrant
and
holders of membership interests in PacificNet.com LLC.
(2)
|
|
2.4
|
Agreement
dated September 30, 2000, among the Company and the "Purchasers"
named
therein. (3)
|
|
2.5
|
Supplemental
Agreement dated October 3, 2000, among the Company and the "Purchasers"
named therein. (3)
|
|
2.6
|
Deed
of Waiver, dated October 3, 2000, by Creative Master Limited in favor
of
the Company. (3)
|
|
3.1
|
Certificate
of Incorporation, as amended. (4)
|
|
3.2
|
Form
of Amended By Laws of the Company. (4) Specimen Stock Certificate
of the
Company.
|
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet
Inc.
and the purchasers identified therein (5)
|
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(5)
|
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated December
9, 2004 (10)
|
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated November
17, 2004 (10)
|
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc.
and the
Holders identified therein (12)
|
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to each
of
the Holders (12)
|
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(12)
|
|
4.8
|
Form
of Registration Rights Agreement, dated February 28, 2006
(17)
|
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(1)
|
|
10.2
|
Amendment
to 1998 Stock Option Plan. (8)
|
|
10.3
|
Form
of Notice of Stock Option Grant and Stock Option Agreement under
the 1998
Stock Option Plan. (2)
|
|
10.4
|
Amendment
dated January 31, 2002 to the Subscription Agreement by and between
the
Company and Sino Mart Management Ltd., dated as of December 9,
2001 (6)
|
|
10.6
|
Sub-Lease
Agreement dated August 30, 2002.(8)
|
|
10.7
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription
of
Shares in Epro Telecom Holdings Limited (9)
|
|
10.8
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares in
Beijing
Linkhead
|
|
Technologies
Co., Ltd. (9)
|
|
|
10.9
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet
Inc.
and the purchasers identified therein (10)
|
|
10.10
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet
Inc.
and the purchasers identified therein (10)
|
|
10.11
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
|
10.12
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(11)
|
|
10.13
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science and Technology Ltd. (16)
|
|
10.15
|
PacificNet
Inc. 2005 Stock Option Plan (15)
|
|
10.16
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information Technology
Co.,Ltd. (16)
|
|
10.17
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(14)
|
|
10.18
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(13)
|
|
10.19
|
Form
of Lock-Up Agreement, dated March 13, 2006 (17)
|
|
10.20
|
Form
of Voting Agreement, dated March 13, 2006 (17)
|
|
14
|
Code
of Ethics (9)
|
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
|
31.1
+
|
Rule
13a-14(a) Certification of Chief Executive Officer (Principal Executive
Officer)
|
| 31.2 + |
Rule
13a-14(a) Certification of Chief Financial Officer (Principal Financial
Officer)
|
| 32 + | 18 U.S. C. Section 1350 Certifications. |
|
99.1
|
Corporate
structure chart of our corporate and share ownership structure
(14)
|
|
99.2
|
Subscription
Agreement by and between the Company and Sino Mart Management Ltd.,
dated
as of December 9, 2001 (6)
|
|
99.3
|
19.9%
Private Placement Agreement and Amendments between Ho Shu-Jen and
PacificNet.com Inc. (7)
|
20
+
Filed
herewith.
|
(1)
|
Incorporated
by reference to the Company's Form SB-2 filed on October 21, 1998.
|
|
(2)
|
Incorporated
by reference to the Company's Form 8-K filed on August 11,
2000.
|
|
(3)
|
Incorporated
by reference to the Company's Form 8-K filed on October
17, 2000.
|
|
(4)
|
Incorporated
by reference to the Amendment to Registration Statement
on Form S-3 on Form SB-2/A (Registration No. 333-113209) filed on
April
21, 2004.
|
|
(5)
|
Incorporated
by reference to the Registration Statement on Form S-3 filed on
March
2, 2004.
|
|
(6)
|
Incorporated
by reference to the Company's Form 8-K filed on March
20, 2002.
|
|
(7)
|
Incorporated
by reference to the Company's Form 10-KSB filed on
April 16, 2002.
|
|
(8)
|
Incorporated
by reference to the Company's 10-KSB filed on
March 31, 2003.
|
|
(9)
|
Incorporated
by referenced to the Company's Form 10-KSB filed
on April 2, 2004.
|
|
(10)
|
Previously
filed as an exhibit to the Form SB-2 Registration
Statement filed on December 30,
2004.
|
|
(11)
|
Incorporated
by reference
to the Company's Form 8-K filed on April 19,
2004.
|
|
(12)
|
Incorporated
by
reference to the Company's Form 8-K filed on March 6,
2006.
|
|
(13)
|
Incorporated
by
reference to the Company's Form 8-K filed on December 20, 2005.
|
|
(14)
|
Incorporated
by reference to the Company's Form 10-KSB filed on April 28,
2006.
|
|
(15)
|
Incorporated
by reference to the Company's Definitive Proxy Statement filed
on
November 19, 2004.
|
|
(16)
|
Incorporated
by reference to the Company's Form 10-KSB
filed on April 19, 2005.
|
| (17) | Incorporated by reference to the Company's Form 10-KSB/A filed on November 3, 2006. |
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
For
fiscal years ended December 31, 2005 and 2004, and for the review of the
financial
statements included in the Company's Quarterly Reports on Form 10-QSB
for
fiscal years 2005 and 2004, the aggregate fees billed by our predecessor
independent
auditor Clancy and Co., P.L.L.C. and its Hong Kong affiliate HLB Hodgson
Impey Cheng to us were $182,400 and 82,060, respectively.
AUDIT
FEES
The
aggregate fees paid to Kabani & Company, Inc for professional services
rendered
for the reaudit of the Company's annual financial statements for the
fiscal
years ended December 31, 2005 and 2004.
AUDIT
RELATED FEES
NONE.
TAX
FEES
NONE.
ALL
OTHER FEES
NONE.
PRE-APPROVAL
OF SERVICES
The
Audit
Committee pre-approves all services, including both audit and non-audit
services, provided by our independent accountants. For audit services,
each
year
the independent auditor provides the Audit Committee with an engagement
letter outlining the scope of the audit services proposed to be performed
during the year, which must be formally accepted by the audit commences.
The independent auditor also submits an audit services fee
proposal,
which
also must be approved by the audit commences.
21
SIGNATURES
In
accordance with the requirements of the Securities Exchange Act of 1934, as
amended,
the Registrant has duly caused this report to be signed on its
behalf by
the
undersigned, thereunto duly authorized.
|
PACIFICNET
INC.
|
|
|
Date:
October 24, 2007
|
BY:
/S/ TONY TONG
Tony
Tong
|
|
Chief
Executive Officer (Principal Executive Officer)
|
|
|
Date:
October 24, 2007
|
BY:
/S/ DANIEL LUI
|
|
Daniel
Lui
|
|
|
Chief
Financial Officer (Principal Financial
Officer)
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report
has
been
signed below by the following persons on behalf of the registrant and
in
the
capacities and on the dates indicated.
|
Name
|
Title
|
Date
|
||
|
/s/
TONY
TONG
|
Director,
Chairman and CEO
|
October
24,
2007
|
||
|
Tony
Tong
|
||||
|
/s/
VICTOR
TONG
|
Director,
President and
|
October
24,
2007
|
||
|
Victor
Tong
|
||||
|
/s/
DANIEL
LUI
|
Chief
Financial
Officer
|
October
24,
2007
|
||
|
Daniel
Lui
|
|
/s/
SHAO JIAN WANG
|
Director
|
October
24,
2007
|
||
|
Shao
Jian Wang
|
||||
|
/s/
MICHAEL CHUN HA
|
Director
|
October
24,
2007
|
||
|
Michael
Chun Ha
|
||||
|
/s/ TAO
JIN
|
Director
|
October
24,
2007
|
||
|
Tao
Jin
|
||||
| /s/ JEREMY GOODWIN | Director |
October
24,
2007
|
||
| Jeremy Goodwin | ||||
| /s/ HO-MAN POON | Director |
October
24,
2007
|
||
| Ho-Man Poon |
22
|
EXHIBIT
NUMBER
|
DESCRIPTION
|
|
2.1
|
Share
Exchange Agreement by and among Davin Enterprises, Inc., Carl Tong,
Leo
Kwok and Acma Strategic Holdings Limited dated December 15, 1997.
(1)
|
|
2.2
|
Share
Exchange Agreement dated February 17, 2000, between Registrant
and holders
of membership interests in PacificNet.com LLC.(2)
|
|
2.3
|
Supplement
to Share Exchange Agreement dated April 29, 2000, between Registrant
and
holders of membership interests in PacificNet.com LLC.
(2)
|
|
2.4
|
Agreement
dated September 30, 2000, among the Company and the "Purchasers"
named
therein. (3)
|
|
2.5
|
Supplemental
Agreement dated October 3, 2000, among the Company and the "Purchasers"
named therein. (3)
|
|
2.6
|
Deed
of Waiver, dated October 3, 2000, by Creative Master Limited in
favor of
the Company. (3)
|
|
3.1
|
Certificate
of Incorporation, as amended. (4)
|
|
3.2
|
Form
of Amended By Laws of the Company. (4) Specimen Stock Certificate
of the
Company.
|
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet
Inc.
and the purchasers identified therein (5)
|
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(5)
|
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated
December
9, 2004 (10)
|
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated
November
17, 2004 (10)
|
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc.
and the
Holders identified therein (12)
|
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to
each of
the Holders (12)
|
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(12)
|
|
4.8
|
Form
of Registration Rights Agreement, dated February 28, 2006
(17)
|
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(1)
|
|
10.2
|
Amendment
to 1998 Stock Option Plan. (8)
|
|
10.3
|
Form
of Notice of Stock Option Grant and Stock Option Agreement under
the 1998
Stock Option Plan. (2)
|
|
10.4
|
Amendment
dated January 31, 2002 to the Subscription Agreement by and between
the
Company and Sino Mart Management Ltd., dated as of December 9,
2001 (6)
|
|
10.6
|
Sub-Lease
Agreement dated August 30, 2002.(8)
|
|
10.7
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription
of
Shares in Epro Telecom Holdings Limited (9)
|
|
10.8
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares
in Beijing
Linkhead Technologies Co., Ltd. (9)
|
|
10.9
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet
Inc.
and the purchasers identified therein (10)
|
|
10.10
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet
Inc.
and the purchasers identified therein (10)
|
|
10.11
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
|
10.12
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(11)
|
|
10.13
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science andTechnology Ltd. (16)
|
|
10.15
|
PacificNet
Inc. 2005 Stock Option Plan (15)
|
|
10.16
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information
Technology
Co.,Ltd. (16)
|
|
10.17
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(14)
|
|
10.18
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(13)
|
|
10.19
|
Form
of Lock-Up Agreement, dated March 13, 2006 (17)
|
|
10.20
|
Form
of Voting Agreement, dated March 13, 2006 (17)
|
|
14
|
Code
of Ethics (9)
|
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
|
31.1
+
|
Rule
13a-14(a) Certification of Chief Executive Officer (Principal Executive
Officer)
|
|
31.2
+
|
Rule
13a-14(a) Certification of Chief Financial Officer (Principal Financial
Officer)
|
|
32
+
|
18 U.S.C Section 1350 Certifications |
|
99.1
|
Corporate
structure chart of our corporate and share ownership structure
(14)
|
|
99.2
|
Subscription
Agreement by and between the Company and Sino Mart Management Ltd.,
dated
as of December 9, 2001 (6)
|
|
99.3
|
19.9%
Private Placement Agreement and Amendments between Ho Shu-Jen and
PacificNet.com Inc. (7)
|
|
+
|
Filed
herewith.
|
|
(1)
|
Incorporated
by reference to the Company's Form SB-2 filed on October 21, 1998.
|
|
(2)
|
Incorporated
by reference to the Company's Form 8-K filed on August 11,
2000.
|
|
(3)
|
Incorporated
by reference to the Company's Form 8-K filed on October
17, 2000.
|
|
(4)
|
Incorporated
by reference to the Amendment to Registration Statement
on Form S-3 on Form SB-2/A (Registration No. 333-113209) filed on
April
21, 2004.
|
|
(5)
|
Incorporated
by reference to the Registration Statement on Form S-3 filed on
March
2, 2004.
|
|
(6)
|
Incorporated
by reference to the Company's Form 8-K filed on March
20, 2002.
|
|
(7)
|
Incorporated
by reference to the Company's Form 10-KSB filed on
April 16, 2002.
|
|
(8)
|
Incorporated
by reference to the Company's 10-KSB filed on
March 31, 2003.
|
|
(9)
|
Incorporated
by referenced to the Company's Form 10-KSB filed
on April 2, 2004.
|
|
(10)
|
Previously
filed as an exhibit to the Form SB-2 Registration
Statement filed on December 30, 2004.
|
|
(11)
|
Incorporated
by reference
to the Company's Form 8-K filed on April 19, 2004.
|
|
(12)
|
Incorporated
by
reference to the Company's Form 8-K filed on March 6,
2006.
|
|
(13)
|
Incorporated
by
reference to the Company's Form 8-K filed on December 20,
2005.
|
|
(14)
|
Incorporated
by reference to the Company's Form 10-KSB filed on April 28,
2006.
|
|
(15)
|
Incorporated
by reference to the Company's Definitive Proxy Statement filed
on
November 19, 2004.
|
| (16) | Incorporated by reference to the Company's Form 10-KSB filed on April 19, 2005. |
| (17) | Incorporated by reference to the Company's Form 10-KSB/A filed on November 3, 2006. |
23
INDEX
TO
FINANCIAL STATEMENTS
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
Consolidated
Balance Sheets-Restated - As of December 31, 2005 and 2004
|
F-2
|
|
Consolidated
Statements of Operations-Restated - For the Years Ended December
31, 2005,
and December 31, 2004
|
F-3
|
|
Consolidated
Statements of Changes in Stockholders' Equity-Restated - For the
Years
Ended December 31, 2005, and December 31, 2004
|
F-4
|
|
Consolidated
Statements of Cash Flows-Restated - For the Years Ended December
31, 2005,
and December 31, 2004
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
24
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of Pacific Net Inc.
We
have
audited the accompanying consolidated balance sheets of PacificNet Inc. (a
Delaware Corporation) and Subsidiaries as of December 31, 2005 and 2004,
and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is
to
express an opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards established by the
Public
Company Accounting Oversight Board (United States). Those standards require
that
we plan and perform the audit to obtain reasonable assurance about whether
the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of PacificNet Inc. and
Subsidiaries as of December 31, 2005 and 2004, and the results of their
consolidated operations and cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of
America.
As
disclosed in note 15 to the consolidated financial statements, subsequent
to December 31, 2005, the Company acquired and disposed off several significant
subsidiaries and also, is subject to several lawsuits. As disclosed in note
15
to the consolidated financial statements, subsequent to the year ended December
31, 2005, the Company suspended use of the prospectus contained in its
Registration Statement on Form S-1 that was declared effective on December
8,
2006. The suspension of the use of the prospectus after April 17, 2007,
triggered an event of default under the registration rights agreement and
the
convertible debentures.
As
discussed in Note 16, the financial statements for the two years ended December
31, 2005 and 2004 have been restated.
/s/
KABANI & COMPANY, INC.
LOS
ANGELES, CA
September
23, 2007.
F-1
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS--RESTATED
AS
AT DECEMBER 31, 2005 AND 2004
(In
thousands of United States dollars, except par values and share
numbers)
|
2005
|
2004
|
|||||||
|
ASSETS
|
||||||||
|
Current
Assets:
|
||||||||
|
Cash
and cash equivalents
|
$ |
10,639
|
$ |
9,534
|
||||
|
Restricted
cash - pledged bank deposit
|
163
|
212
|
||||||
|
Accounts
receivables, net of allowances for doubtful accounts
|
6,869
|
5,575
|
||||||
|
Inventories
|
1,987
|
1,250
|
||||||
|
Loan
receivable from related parties
|
2,328
|
1,460
|
||||||
|
Loan
receivable from third parties
|
1,062
|
38
|
||||||
|
Marketable
equity securities - available for sale
|
539
|
29
|
||||||
|
Other
current assets
|
5,197
|
1,609
|
||||||
|
Total
Current Assets
|
28,784
|
19,707
|
||||||
|
Property
and equipment, net
|
3,687
|
721
|
||||||
|
Investments
in affiliated companies and subsidiaries
|
1,161
|
1,933
|
||||||
|
Goodwill
|
9,129
|
7,636
|
||||||
|
Other
assets
|
235
|
-
|
||||||
|
TOTAL
ASSETS
|
$ |
42,996
|
$ |
29,997
|
||||
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
|
Current
Liabilities:
|
||||||||
|
Bank
line of Credit
|
$ |
1,059
|
$ |
196
|
||||
|
Bank
loans-current portion
|
188
|
1,577
|
||||||
|
Capital
lease obligations - current portion
|
126
|
99
|
||||||
|
Accounts
payable
|
1,146
|
1,054
|
||||||
|
Accrued
expenses and other payables
|
8,007
|
951
|
||||||
|
Income
tax payable
|
390
|
-
|
||||||
|
Loan
payable to related party
|
759
|
184
|
||||||
|
Total
Current Liabilities
|
11,675
|
4,061
|
||||||
|
Bank
loans - noncurrent portion
|
6
|
70
|
||||||
|
Capital
lease obligations - noncurrent portion
|
78
|
110
|
||||||
|
Total
long-term liabilities
|
84
|
180
|
||||||
|
Total
liabilities
|
11,759
|
4,241
|
||||||
|
Minority
interest in consolidated subsidiaries
|
8,033
|
1,648
|
||||||
|
Commitments
and contingencies
|
-
|
-
|
||||||
|
Stockholders'
Equity:
|
||||||||
|
Preferred
stock, par value $0.0001, Authorized 5,000,000 shares Issued and
outstanding - none
|
-
|
-
|
||||||
|
Common
stock, par value $0.0001, Authorized 125,000,000 shares
|
||||||||
|
Issued
and outstanding:
|
||||||||
|
December
31, 2005: 12,000,687 issued, 10,809,562 outstanding
|
||||||||
|
December
31, 2004: 10,627,737 issued, 9,794,121 outstanding
|
1
|
1
|
||||||
|
Treasury
stock, at cost (2005: 1,191,125 shares; 2004: 833,616
shares)
|
(134 | ) | (119 | ) | ||||
|
Additional
paid-in capital
|
61,979
|
57,730
|
||||||
|
Cumulative
other comprehensive income
|
(15 | ) | (22 | ) | ||||
|
Accumulated
deficit
|
(38,627 | ) | (33,482 | ) | ||||
|
Total
Stockholders' Equity
|
23,204
|
24,108
|
||||||
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$ |
42,996
|
$ |
29,997
|
||||
The
accompanying notes form an integral part of these consolidated financial
statements
F-2
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS - RESTATED
FOR
THE YEARS ENDED DECEMBER 31, 2005 AND 2004
(In
thousands of United States dollars, except loss per share and share
amounts)
|
2005
|
2004
|
|||||||
|
Net
Revenues
|
||||||||
|
Services
|
$ |
21,082
|
$ |
10,008
|
||||
|
Product
sales
|
10,004
|
6,934
|
||||||
|
Total
net revenue
|
31,086
|
16,942
|
||||||
|
Cost
of Revenues
|
||||||||
|
Services
|
12,584
|
7,046
|
||||||
|
Product
sales
|
8,094
|
5,240
|
||||||
|
Total
cost of revenue
|
20,678
|
12,286
|
||||||
|
Gross
Profit
|
10,408
|
4,656
|
||||||
|
Operating
expenses:
|
||||||||
|
Selling,
General and Administrative expenses
|
(10,419 | ) | (5,267 | ) | ||||
|
Stock-based
compensation expenses
|
(282 | ) | (1,246 | ) | ||||
|
Depreciation
and amortization
|
(351 | ) | (103 | ) | ||||
|
Impairment
of Goodwill
|
(3,689 | ) | (2,628 | ) | ||||
|
Total
Operating expenses
|
(14,741 | ) | (9,244 | ) | ||||
|
Loss
from operations
|
(4,333 | ) | (4,588 | ) | ||||
|
Other
income (expenses):
|
||||||||
|
Interest
income/(expense), net
|
82
|
(68 | ) | |||||
|
Sundry
income, net
|
655
|
521
|
||||||
|
Total
other income
|
737
|
453
|
||||||
|
Loss
from operations before Income Taxes and Minority
Interests
|
(3,596 | ) | (4,135 | ) | ||||
|
Provision
for income taxes
|
(272 | ) | (106 | ) | ||||
|
Share
of earnings from investment on equity method
|
855
|
87
|
||||||
|
Minority
Interests
|
(2,132 | ) | (1,271 | ) | ||||
|
NET
LOSS
|
(5,145 | ) | (5,425 | ) | ||||
|
Other
comprehensive income (loss):
|
||||||||
|
Foreign
exchange gain (loss)
|
7 | (22 | ) | |||||
|
Net
comprehensive loss
|
$ | (5,138 | ) | $ | (5,447 | ) | ||
|
BASIC
& DILUTED LOSS PER COMMON SHARE:
|
||||||||
|
Loss
per common share – basic & diluted
|
$ | (0.51 | ) | $ | (0.78 | ) | ||
|
*Weighted
average number of shares - basic & diluted
|
10,156,809
|
7,015,907
|
||||||
*Weighted
average number of shares used to calculate basic and diluted loss per share
are
considered same as the effect of dilutive shares is anti-dilutive.
The
accompanying notes are an integral part of these consolidated financial
statements
F-3
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS
OF CHANGES IN STOCKHOLDERS' EQUITY--RESTATED
(In
thousands of United States dollars, except number of shares)
|
Common
Stock
(Outstanding)
|
Additional
Paid-in
Capital
|
Cumulative
Other
Comprehensive
Income/(loss)
|
Accumulated
Deficit
(Restated)
|
Treasury
Stock
|
Total
Stockholders'
Equity
(Restated)
|
|||||||||||||||||||||||||||
|
Shares
|
Amount
|
Shares
|
Amount
|
|||||||||||||||||||||||||||||
|
Balance
at December 31, 2003, as restated
|
5,363,977
|
$ |
1
|
$ |
31,790
|
$ | (24 | ) | $ | (28,056 | ) |
800,000
|
$ | (5 | ) | $ |
3,706
|
|||||||||||||||
|
Issuance
of common stock for acquisition of subsidiaries
|
1,756,240
|
-
|
9,938
|
-
|
-
|
-
|
-
|
9,938
|
||||||||||||||||||||||||
|
Proceeds
from the sale of common stock, net of related costs
|
2,205,697
|
-
|
12,330
|
-
|
-
|
-
|
-
|
12,330
|
||||||||||||||||||||||||
|
PIPE
related Expenses
|
-
|
-
|
(205 | ) |
-
|
-
|
-
|
-
|
(205 | ) | ||||||||||||||||||||||
|
Issuance
of common stock for acquisition of affiliate
|
149,459
|
-
|
1,547
|
-
|
-
|
-
|
-
|
1,547
|
||||||||||||||||||||||||
|
Repurchase
of common stock
|
(33,616 | ) |
-
|
-
|
-
|
-
|
33,616
|
(114 | ) | (114 | ) | |||||||||||||||||||||
|
Stock
issued for services
|
50,000
|
-
|
132
|
-
|
-
|
-
|
132
|
|||||||||||||||||||||||||
|
Stock
issued in error
|
83,000
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||||||||||
|
Stock
options expense
|
-
|
-
|
1,246
|
-
|
-
|
-
|
-
|
1,246
|
||||||||||||||||||||||||
|
Exercise
of stock options and warrants for cash
|
219,364
|
-
|
606
|
-
|
-
|
-
|
-
|
606
|
||||||||||||||||||||||||
|
Foreign
currency translation gain
|
-
|
-
|
-
|
2
|
-
|
-
|
-
|
2
|
||||||||||||||||||||||||
|
Excess
finders fee charged adjusted
|
-
|
-
|
345
|
-
|
-
|
-
|
-
|
345
|
||||||||||||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
-
|
(5,425 | ) |
-
|
-
|
(5,425 | ) | ||||||||||||||||||||||
|
Balance
at December 31, 2004
|
9,794,121
|
1
|
57,730
|
(22 | ) | (33,482 | ) |
833,616
|
(119 | ) |
24,108
|
|||||||||||||||||||||
|
Issuance
of common stock for acquisition of subsidiaries
|
515,900
|
-
|
3,971
|
-
|
-
|
-
|
-
|
3,971
|
||||||||||||||||||||||||
|
Stock
issued for services
|
20,000
|
-
|
63
|
-
|
-
|
-
|
-
|
63
|
||||||||||||||||||||||||
|
Repurchase
of common stock for acquisition of affiliate
|
(149,459 | ) |
-
|
(1,547 | ) |
-
|
-
|
149,459
|
-
|
(1,547 | ) | |||||||||||||||||||||
|
Cancellation
of common stock
|
(45,000 | ) |
-
|
-
|
-
|
-
|
45,000
|
-
|
-
|
|||||||||||||||||||||||
|
Repurchase
of common shares
|
(2,000 | ) |
-
|
-
|
-
|
-
|
2,000
|
(15 | ) | (15 | ) | |||||||||||||||||||||
|
Stock
options expense
|
-
|
-
|
282
|
-
|
-
|
-
|
-
|
282
|
||||||||||||||||||||||||
|
Exercise
of stock options and warrants for cash
|
676,000
|
-
|
966
|
-
|
-
|
- |
-
|
966
|
||||||||||||||||||||||||
|
Holdback
shares as contingent consideration due to performance targets not
yet
met
|
-
|
-
|
-
|
-
|
-
|
298,550
|
-
|
-
|
||||||||||||||||||||||||
|
Share
consideration for acquisition of subsidiary deemed issued under
S&P
|
-
|
-
|
-
|
-
|
-
|
(137,500 | ) |
-
|
-
|
|||||||||||||||||||||||
|
Excess
finders fee charged adjusted
|
-
|
-
|
455
|
-
|
-
|
-
|
-
|
455
|
||||||||||||||||||||||||
|
Option
exercise price adjusted
|
-
|
-
|
60
|
-
|
-
|
-
|
-
|
60
|
||||||||||||||||||||||||
|
Foreign
currency translation gain
|
-
|
-
|
-
|
7
|
-
|
-
|
-
|
7
|
||||||||||||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
(5,145 | ) |
-
|
-
|
(5,145 | ) | |||||||||||||||||||||||
|
BALANCE
AT DECEMBER 31, 2005
|
10,809,562
|
$ |
1
|
$ |
61,979
|
$ | (15 | ) | $ | (38,627 | ) |
1,191,125
|
$ | (134 | ) | $ |
23,204
|
|||||||||||||||
The
accompanying notes form an integral part of these consolidated financial
statements
F-4
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS --RESTATED
(In
thousands of United States dollars)
|
For
the Years Ended December 31,
|
||||||||
|
2005
|
2004
|
|||||||
|
Cash
Flows from operating activities
|
Restated
|
Restated
|
||||||
|
Net
loss
|
$ | (5,145 | ) | $ | (5,425 | ) | ||
|
Adjustment
to reconcile net loss to net cash provided by (used in) operating
activities:
|
||||||||
|
Provision
for allowance for doubtful accounts
|
3,425
|
777
|
||||||
|
Minority
Interest
|
2,132
|
1,271
|
||||||
|
Depreciation
and amortization
|
2,109
|
139
|
||||||
|
Goodwill
impairment
|
3,689
|
2,628
|
||||||
|
Stock-based
compensation
|
282
|
1,246
|
||||||
|
Issuance
of shares for services
|
63
|
132
|
||||||
|
Realized
income (loss) on marketable securities
|
||||||||
|
Changes
in current assets & liabilities net of effects from purchase of
subsidiaries:
|
||||||||
|
Accounts
receivable and other current assets
|
1,243
|
(4,842 | ) | |||||
|
Inventories
|
(737 | ) | (1,174 | ) | ||||
|
Accounts
payable and accrued expenses
|
(4,782 | ) | 2,491 | |||||
|
Net
cash provided by (used in) operating
activities
|
11,843
|
(2,757 | ) | |||||
|
Cash
flows from investing activities
|
||||||||
|
Increase
in restricted cash
|
49
|
-
|
||||||
|
Increase
in purchase of marketable securities
|
(510 | ) | (29 | ) | ||||
|
Acquisition
of property and equipment
|
(5,365 | ) | (477 | ) | ||||
|
Acquisition
of subsidiaries and affiliated companies
|
(3,958
|
) | (991 | ) | ||||
|
Repurchase
of treasury shares
|
(15 | ) | (114 | ) | ||||
|
Net
cash used in investing activities
|
(9,799 | ) | (1,611 | ) | ||||
|
CASH
FLOWS PROVIDED BY FINANCING ACTIVITIES:
|
||||||||
|
Loans
receivable from third parties
|
(1,024 | ) | (38 | ) | ||||
|
Loans
receivable from related parties
|
(868 | ) | (1,460 | ) | ||||
|
Loans
payable to related party
|
575
|
184
|
||||||
|
Advances
(repayments) under bank line of credit
|
863
|
(1,003 | ) | |||||
|
Repayment
of amount borrowed under capital lease obligations
|
(5 | ) | (92 | ) | ||||
|
Proceeds
from exercise of stock options and warrants
|
966
|
496
|
||||||
|
Advances
under bank loans
|
(1,453 | ) | (135 | ) | ||||
|
Payment
of certain PIPE related expenses
|
-
|
(205 | ) | |||||
|
Proceeds
from sale of common stock for cash
|
-
|
12,330
|
||||||
|
Net
cash provided by (used in) financing
activities
|
(946 | ) |
10,077
|
|||||
|
Effect
of exchange rate change on cash and cash equivalents
|
7
|
2
|
||||||
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
1,105
|
5,710
|
||||||
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
9,534
|
3,823
|
||||||
|
CASH
AND CASH EQUIVALENTS, END OF PERIOD
|
$ |
10,639
|
$ |
9,534
|
||||
|
SUPPLEMENTAL
CASH FLOW INFORMATION:
|
||||||||
|
Interest
paid
|
$ |
229
|
$ |
178
|
||||
|
Income
taxes paid
|
$ | (53 | ) | $ |
3
|
|||
|
NONCASH
INVESTING AND FINANCING ACTIVITIES:
|
||||||||
|
Investment
in subsidiaries and affiliate through issuance of common
stock
|
$ |
3,971
|
$ |
9,938
|
||||
The
accompanying notes form an integral part of these consolidated financial
statements
F-5
PACIFICNET
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS--RESTATED
(Amounts
expressed in United States dollars unless otherwise stated)
1.
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
NATURE
OF OPERATIONS
PacificNet
Inc. (referred to herein as "PacificNet" or the "Company") was originally
incorporated in the State of Delaware on April 8, 1987. Through our subsidiaries
we provide outsourcing services, value-added telecom services (VAS) and
communication products distribution services. Our business process outsourcing
(BPO) services include call centers, providing customer relationship management
(CRM), and telemarketing services, and our information technology outsourcing
(ITO) includes software programming and development. We are value-added
resellers and providers of telecom VAS, which is comprised of interactive
voice
response (IVR) systems, call center management systems, and voice over Internet
protocol (VOIP), as well as mobile phone VAS, such as short messaging services
(SMS) and multimedia messaging services (MMS). The Company's operations are
primarily targeted in the China and Hong Kong market.
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES
OF CONSOLIDATION AND BASIS OF PRESENTATION
The
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America and present
the
financial statements of the Company and its wholly owned and majority-owned
subsidiaries including variable interest entities ("VIEs") for which the
Company
is the primary beneficiary. All significant inter-company accounts and
transactions have been eliminated. Investments in entities in which the Company
can exercise significant influence, but which are less than majority owned
and
not otherwise controlled by the Company, are accounted for under the equity
method.
The
Company has adopted FASB Interpretation No. 46R "Consolidation of Variable
Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research
Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
consolidated by a company if that company is subject to a majority of the
risk
of loss for the VIE or is entitled to receive a majority of the VIE's residual
returns. VIEs are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the company is the primary
beneficiary of these entities. Acquisitions of subsidiaries or variable interest
entities are accounted for using the purchase method of accounting. The results
of subsidiaries or variable interest entities acquired during the year are
included in the consolidated income statements from the effective date of
acquisition.
INITIAL
MEASUREMENT OF VIE- The Company initially measures the assets, liabilities,
and
non-controlling interests of the VIEs at their fair values at the date of
the
acquisitions. Goodwill is recorded for the excess of the fair value of the
newly
consolidated assets and the reported amount of assets transferred by the
primary
beneficiary to the VIE over the sum of the fair value of the consideration
paid,
the reported amount of any previously held interests, and the fair value
of the
newly consolidated liabilities and non-controlling interests are allocated
and
reported as a pro rata adjustment of the amounts that would have been assigned
to all of the newly consolidated assets as if the initial consolidation had
resulted from a business combination
F-6
ACCOUNTING
AFTER INITIAL MEASUREMENT OF VIE - Subsequent accounting for the assets,
liabilities, and non-controlling interest of a consolidated variable interest
entity are accounted for as if the entity were consolidated based on voting
interests and the usual accounting rules for which the VIE operates are applied
as they would to a consolidated subsidiary as follows:
|
|
·
|
Carrying
amounts of the VIE are consolidated into the financial statements
of
PacificNet as the primary beneficiary (referred as "Primary Beneficiary"
or "PB")
|
|
|
·
|
Inter-company
transactions and balances, such as revenues and costs, receivables
and
payables between or among the Primary Beneficiary and the VIE(s)
are
eliminated in their entirety
|
|
|
·
|
There
is no direct ownership interest by the Primary Beneficiary in the
VIE,
equity of the VIE is eliminated with an offsetting credit to minority
interest
|
PRC
laws
and regulations restrict us, as a foreign entity, from having a direct
controlling interest in entities such as Guangzhou Dianxun Co., Ltd.(Dianxun-DE)
and Guangzhou Sunroom Information Industry Co., Ltd.(Sunroom-DE) that
hold operating licenses to engage in domestic telecom value-added services
and
online ecommerce in China. As a result, we conduct substantially all of our
operations through Guangzhou Clickcom Digit-net Science(WOFE)and Technology
Ltd.
and Guangzhou 3G Information Technology Co., Ltd.(WOFE). We own 51% of the
shares in each of the WOFEs and each WOFE signed Consulting and Services
Agreements with Dianxun-DE and Sunroom-DE (the entities that actually carry
out
the operating activities). These agreements provide that all of the DE profits
will flow through to the respective WOFEs. Pursuant to these agreements,
the
Company guarantees any obligations undertaken by these companies under their
contractual agreements with third parties, and the Company is entitled to
receive service fees in an amount equal to 51% of the net income of these
companies. Accordingly, we bear the risks of, and enjoy the rewards associated
with, the investments in the WOFEs.
The
operations of DEs are managed by their original management teams, however,
the
Company has the power to appoint or change directors and senior management
because it indirectly ultimately controls the voting power of the shareholders
of each DE through the Power of Attorney given to PacificNet's President
according to the operating agreements between the DEs and WOFEs. Pursuant
to the
Consulting and Service Agreements signed between each WOFE and their respective
DE, the WOFE ("Party A") agrees to be the exclusive provider of telecom
consulting services to the DE ("Party B"). During the term of the agreement,
Party B shall not accept technical and consulting services provided by any
third
party. Party B agrees to pay a fee to Party A equal to 100% of its monthly
net
income for the services provided. Payment of the service fees has been secured
through a share pledge agreement with the shareholders of each of the DEs,
whereby they pledged all of their shares to the respective WOFE.
Further,
(1)
Each
of the DEs, by design, is thinly capitalized because a substantial portion
of
PacificNet's invested amounts or consideration were paid or payable directly
to
previous owners of Sunroom-DE and Dianxun-DE for entering into the acquisition
transactions while none of the investment consideration was injected into
the
DEs. Therefore, additional funding from PacificNet is needed to support the
DEs'
business development and working capital.
(2)
Fees
from Service Contracts are substantial, but are not commensurate with the
level
of service provided by the WOFEs to the DEs. The contractual and funding
arrangements with the DEs evidence that PacificNet has closely participated
in
the majority of the DEs' economics. PacificNet is the primary beneficiary
through its WOFE subsidiaries since PacificNet is the only enterprise with
a
sufficiently large interest in the VIEs. In compliance with PRC's foreign
investment restrictions on Internet Content Provider and Value Added Telecom
Services Provider's laws and regulations, the Company conducts all of its
value-added services for telecom in China via the following significant domestic
VIEs below. The respective management agreements between the VIE's and WOFE's
create a variable interest and accordingly, these two Vies are consolidated
as
VIE through their respective WOFEs from the date of acquisition.
F-7
The
following is a summary of all the VIEs of the Company:
GuangZhou
DianXun Company Limited (the "Dianxun-VIE"), a China company controlled through
business agreement. Through Dianxun-VIE, a variable interest entity, PacificNet
is able to provide indirectly to China's telecom operators, a wide variety
of
wireless Internet services for mobile phones, such as SMS, Wireless Application
Protocol, or WAP, which allows users to access information instantly via
handheld wireless devices, and Java mobile applications. The business of
the VIE
is managed by their original management teams. Clickcom VIE is owned by Zhang
Ming, CEO 60%, Lai Jinnan, COO 30%, Liu Dong, CTO 10% of the Company. The
adjusted registered capital of the VIE is $125,000 (the original registered
capital of Dianxun-VIE was approx. US$1.25m but was adjusted down to reflect
the
fair value of NAV at time of acquisition. (See Note 5) The VIE's board of
directors has the power to appoint the General Manager of the VIE who in
turn
has the power to appoint other members of the management. PacificNet does
not
directly participate in the daily operation of the VIE. It however has the
power
to change the management, if needed, because PacificNet is directly or
indirectly controlling the board of this VIE. As at the December 31, 2005,
Dianxun-VIE's revenues and net earnings accounted for approximately 2% and
3% of
our consolidated revenues and net earnings before minority interests
respectively.
Guangzhou
Sunroom Information Industrial Co., Ltd. ("Sunroom-VIE"), a PRC registered
domestic enterprise, controlled by PacificNet through a series of contractual
agreements. It is responsible for VAS in China under its ICP and VAS licenses.
It is 31% owned by Mr. Wang Yongchao (CEO), 41.4% owned by Mr. Liao Mengjiang
(COO) and 27.6% owned by non-participating shareholder, Mr. Sun Zhengquan.
The
registered capital of the VIE Company is $4.0 million. Sunroom-VIE is required
to transfer their ownership in these entities to our subsidiaries when permitted
by PRC laws and regulations and all voting rights are assigned to us. As
at
December 31, 2005, Sunroom-VIE's revenues and net loss accounted for
approximately 17% and (96)% of our consolidated revenues and net earnings
before
minority interests, respectively.
The
initial capital investments in these VIEs were not funded by us but we have
provided loans to these VIEs to fund their R&D and expansion plans. As of
December 31, 2005, the amount of loans to Clickcom VIE and Sunroom VIE were
approximately US$262,695 (low interest at 2%) and US$246,216 (interest free)
respectively. None of the VIEs' assets were collateralized for our loans.
Given
the fact that we do not have direct ownership interests in these VIEs, the
creditors of these VIEs will not have recourse to the general credit of our
group being the primary beneficiary.
Under
various contractual agreements, employee shareholders of the VIEs are required
to transfer their ownership in these entities to our subsidiaries in China
when
permitted by PRC laws and regulations or to our designees at any time for
the
amount of the outstanding loans. All voting rights of the VIEs are then assigned
to us. We have the power to appoint all directors and senior management
personnel of the VIEs. Through our wholly owned subsidiaries in China, we
have
also entered into exclusive technical agreements and other service agreements
with the VIEs, under which these subsidiaries provide technical
services.
BUSINESS
COMBINATIONS
The
Company accounts for its business combinations using the purchase method
of
accounting. This method requires that the acquisition cost to be allocated
to
the assets and liabilities the Company acquired based on their fair values.
The
Company makes estimates and judgments in determining the fair value of the
acquired assets and liabilities, based on valuations using management's
estimates and assumptions including its experience with similar assets and
liabilities in similar industries. If different judgments or assumptions
were
used, the amounts assigned to the individual acquired assets or liabilities
could be materially different.
F-8
GOODWILL
AND PURCHASED INTANGIBLE ASSETS
Goodwill
represents the excess of the purchase price over the fair value of the
identifiable assets and liabilities acquired as a result of the Company's
acquisitions of interests in its subsidiaries and VIEs. Under Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets ("SFAS 142")," goodwill is no longer amortized, but tested for impairment
upon first adoption and annually, thereafter, or more frequently if events
or
changes in circumstances indicate that it might be impaired. The Company
assesses goodwill for impairment periodically in accordance with SFAS
142.
The
Company applies the criteria specified in SFAS No. 141, "Business Combinations"
to determine whether an intangible asset should be recognized separately
from
goodwill. Intangible assets acquired through business acquisitions are
recognized as assets separate from goodwill if they satisfy either the
"contractual-legal" or "separability" criterion. Per SFAS 142, intangible
assets
with definite lives are amortized over their estimated useful life and reviewed
for impairment in accordance with SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-lived Assets." Intangible assets, such as purchased
technology, trademark, customer list, user base and non-compete agreements,
arising from the acquisitions of subsidiaries and variable interest entities
are
recognized and measured at fair value upon acquisition. Intangible assets
are
amortized over their estimated useful lives from one to ten years. The Company
reviews the amortization methods and estimated useful lives of intangible
assets
at least annually or when events or changes in circumstances indicate that
it
might be impaired. The recoverability of an intangible asset to be held and
used
is evaluated by comparing the carrying amount of the intangible asset to
its
future net undiscounted cash flows. If the intangible asset is considered
to be
impaired, the impairment loss is measured as the amount by which the carrying
amount of the intangible asset exceeds the fair value of the intangible asset,
calculated using a discounted future cash flow analysis. The Company uses
estimates and judgments in its impairment tests, and if different estimates
or
judgments had been utilized, the timing or the amount of the impairment charges
could be
different.
We
currently have seven reporting units: Lion Zone, Linkhead, EPRO,
Smartime/Soluteck, Clickcom-WOFE, and Guangzhou 3G-WOFE for the purpose of
goodwill assessment. We determined our reporting units if the entity constituted
a business, financial information was available, and segment management can
regularly review the operating results of that component. Excluding investment
holding vehicles and self-developed units, reporting units only include those
operating units that PacificNet holds 51% or more through acquisition and
maintain effective control. Units such as PacificNet Solution, PacificNet
Limited, and PacificNet Communication are 100% owned by PacificNet through
self
development and not through acquisition. Therefore, there is no goodwill
allocation to these self-developed units.
We
allocated goodwill amongst the reporting units based on the consideration
paid
in shares and cash minus the proportional share of the fair value of net
assets
and liabilities at the time of acquisition specific to each reporting unit.
The
fair value of each reporting unit represents the amount at which the unit
as a
whole could be bought or sold in a current transaction between willing parties
in an open marketplace. At the time of acquisition, the fair value of assets
and
liabilities was determined based on book value minus any potential write-down,
if any, to reflect the fair value of the assets and liabilities acquired
in the
transaction.
The
Company has one class of goodwill arising from business combination resulting
from the acquisitions of our subsidiaries. Goodwill has been revised to reflect
certain expenses that should have been written off prior to certain
acquisitions, not subsequent to the acquisitions, to better reflect the assets
acquired and liabilities assumed in certain business combinations during
2003 in
accordance with SFAS No. 141, "Business Combinations”.
F-9
The
changes in the carrying amount of goodwill for the following reporting periods
are summarized below:
|
Group
1.
|
Group
2.
|
Group
3.
|
||||||||||||||
|
(US$000s)
|
Outsourcing
Services
|
Telecom
Value-Added
Services
|
Products
(Gaming
and
Technology)
|
Total
goodwill
on
the restated
balance
sheet
|
||||||||||||
|
Balance
as of December 31, 2003
|
$ |
420
|
$ |
-
|
$ |
-
|
$ |
420
|
||||||||
|
Goodwill
acquired during the year
|
3,575
|
4,831
|
1,438
|
9,844
|
||||||||||||
|
Goodwill
impaired during the year
|
(31
|
) |
(1,159
|
) |
(1,438
|
) |
(2,628
|
) | ||||||||
|
Balance
as of December 31, 2004-Restated
|
3,964
|
3,672
|
-
|
7,636
|
||||||||||||
|
Goodwill
acquired during the year
|
-
|
5,183
|
-
|
5,183
|
||||||||||||
|
Goodwill
impaired during the year
|
-
|
(3,689
|
) |
-
|
(3,689
|
) | ||||||||||
|
Balance
as of December 31, 2005-Restated
|
$ |
3,964
|
$ |
5,165
|
$ |
-
|
$ |
9,129
|
||||||||
The
Company assesses the need to record impairment losses on our goodwill assets
at
least annually or when an event occurs or circumstances change that would
more
likely than not reduce the fair value of a reporting unit below its carrying
amount. The assessment includes using a combination of qualitative and
quantitative analyses such as DCF/PE multiples based on 5 year profit forecasts,
and published comparables, where applicable. The Company concluded that there
have been no material adverse changes on the operating environments during
the
reporting periods that would have otherwise affected the carrying value of
the
goodwill. In addition, there has been no disposal of any reporting subsidiaries
and, as a result, no gain or loss is recognized during those reporting
periods
The
following table summarizes goodwill from the Company's acquisitions during
2005
and 2004:
|
Year
December 31,
|
||||||||
|
(US$'000s)
|
2005
|
2004
|
||||||
|
Restated
|
Restated
|
|||||||
|
Epro
|
$ |
3,949
|
$ |
3,949
|
||||
|
Linkhead
|
249
|
3,672
|
||||||
|
Smartime
(Soluteck)
|
15
|
15
|
||||||
|
Clickom
|
268
|
-
|
||||||
|
GZ3G(Sunroom)
|
3,900
|
-
|
||||||
|
Lion
Zone(ChinaGoHi)
|
748
|
-
|
||||||
|
Total
|
$ |
9,129
|
$ |
7,636
|
||||
F-10
IMPAIRMENT
OF LONG-LIVED ASSETS
The
Company periodically assesses the need to record impairment losses on long-lived
assets, such as property, plant and equipment, and purchased intangible assets,
used in operations and its investments when indicators of impairment are
present
indicating the carrying value may not be recoverable. An impairment loss
is
recognized when estimated undiscounted future cash flows expected to result
from
the use of the asset plus net proceeds expected from disposition of the asset
(if any) are less than the carrying value of the asset. When impairment is
identified, the carrying amount of the asset is reduced to its estimated
fair
value. All goodwill will no longer be amortized and potential impairment
of
goodwill and purchased intangible assets with indefinite useful lives will
be
evaluated using the specific guidance provided by SFAS No. 142 and SFAS No.
144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."
This
impairment analysis is performed at least annually. For investments in
affiliated companies that are not majority-owned or controlled, indicators
or
value generally include revenue growth, operating results, cash flows and
other
measures. Management then determines whether there has been a permanent
impairment of value based upon events and circumstances that have occurred
since
acquisition. It is reasonably possible that the impairment factors evaluated
by
management will change in subsequent periods, given that the Company operates
in
a volatile environment. This could result in material impairment charges
in
future periods.
INVESTMENTS
IN AFFILIATED COMPANIES
The
Company's investments in affiliated companies for which its ownership exceeds
20%, but is not majority-owned or controlled, are accounted for using the
equity
method. The Company's investments in affiliated companies for which its
ownership is less than 20% are accounted for using the cost method.
COMPREHENSIVE
INCOME (LOSS)
Comprehensive
income (loss) consists of net earnings and other gains (losses) affecting
stockholders' equity that, under generally accepted accounting principles
are
excluded from net earnings in accordance with Statement of Financial Accounting
Standards ("SFAS") 130, Reporting Comprehensive Income.
REVENUE
RECOGNITION
Revenues
are derived from the following categories as classified by our operating
segments (see Note 15): (1) outsourcing services including Business Process
Outsourcing (BPO), call center, IT Outsourcing (ITO) and software development
services; (2) Value-Added Telecom Services (VAS) including Content Providing
(CP), Interactive Voice Response (IVR), Platform Providing (PP) and Service
Providing (SP); and (3) Communication Products Distribution Services, including
calling cards, GSM/ CDMA/ XiaoLingTong products, and multimedia self-service
kiosks.
Revenues
from outsourcing services are recognized when the services are rendered.
Revenues from license agreements are recognized when a signed non-cancelable
software license exists, delivery has occurred, the Company's fee is fixed
or
determinable, and collectibility is probable at the date of sale. Revenues
from
software development services are recognized when the customer accepts the
installation and no significant modification or customization work is involved,
in accordance with SOP 97-2 "Software Revenue Recognition." Revenues from
support services such as consulting, implementation and training services
are
recognized when the services are performed, collectibility is probable and
such
revenues are contractually nonrefundable.
Revenues
from value-added telecom services are derived principally from providing
mobile
phone users with short messaging service ("SMS"), multimedia messaging service
("MMS"), color ring back tone ("CRBT"), wireless application protocol ("WAP")
and interactive voice response system ("IVR"). These services include news
and
other content subscriptions, mobile dating service, picture and logo download,
ring tones, ring back tones, mobile games, chat rooms and access to music
files.
These revenues from are charged on a monthly or per-usage basis and are
recognized in the period in which the service is performed, provided that
no
significant Company obligations remain, collection of the receivables is
reasonably assured and the amounts can be accurately estimated. In accordance
with EITF No. 99-19, "Reporting Revenues Gross as a Principal Versus Net
as an
Agent," revenues are recorded on a gross basis when the Company is considered
the primary obligor to the VAS users. Under the gross method, the amounts
billed
to VAS users are recognized as revenues and the fees charged or retained
by the
third-party operators are recognized as cost of revenues.
Revenues
from the sale of products and systems are recognized when the product and
system
is completed, shipped, and the risks and rewards of ownership have
transferred.
Revenues
from the distribution of all types of calling cards and product sales is
recognized in accordance with EITF No. 99-19, "Reporting Revenues Gross as
a
Principal Versus Net as an Agent," where revenues are recorded on a gross
basis
when the Company is considered the primary obligor to the users, maintains
an
inventory of products before the products are ordered by customers, has latitude
in establishing the pricing power of products, is subject to physical inventory
loss risk, and has credit risk as it is responsible for collecting the sales
price from the customer and is responsible for paying the supplier regardless
of
whether or not the sales price is fully collectible.
The
effect of post-shipment/delivery obligations, such as customer acceptance,
product returns, etc. on our revenue recognition policy is as follows: (a)
there
is no effect on outsourcing services as revenue is recognized as the services
are performed; however product sale revenue is recognized when contracts
are
approximately 80% completed for revenue recognition and fully when the customer
signs the UAF, (i.e., "User Acceptance Form"); (b) there is no effect on
value-added services revenue as the product sales mainly involve IVR hardware
that are from mature and stable products of multi-national vendors and there
have been minimal returns historically; and (c) there is no effect on
communication products distribution since the transactions are conducted
on cash
basis and revenue is recognized at the time the sale is transacted.
F-11
ALLOWANCE
FOR DOUBTFUL ACCOUNTS
The
Company presents accounts receivable, net of allowances for doubtful accounts
and returns. The allowances are calculated based on a detailed review of
certain
individual customer accounts, historical rates and an estimate of the overall
economic conditions affecting the Company's customer base. The Company
frequently monitors its customers' financial condition and credit worthiness
and
only sells products, licenses or services to customers where, at the time
of the
sale, collection is reasonably assured. If the financial condition of its
customers were to deteriorate, resulting in an impairment of their ability
to
make payments, additional allowances may be required. The Company also records
reserves for bad debt for all other customers based on a variety of factors
including the length of time the receivables are past due, the financial
health
of the customer, macroeconomic considerations and historical experience.
If
circumstances related to specific customers change, the Company's estimates
of
the recoverability of receivables could be further
adjusted. Allowance for doubtful accounts for the years ended
December 31, 2005 and 2004 amounted to $168,000 and $559,000
respectively.
PROPERTY
AND EQUIPMENT
Property
and equipment is stated at cost and depreciated using the straight-line method
over the shorter of the estimated useful life of the asset or the lease term,
ranging from three to five years. Significant improvements and betterments
are
capitalized. Routine repairs and maintenance are expensed when incurred.
When
property and equipment is sold or otherwise disposed of, the asset account
and
related accumulated depreciation account are relieved, and any gain or loss
is
included in operations.
INVENTORIES
Inventories
consist of finished goods and are stated at the lower of cost or market value.
Cost is computed using the first-in, first-out method and includes all costs
of
purchase and other costs incurred in bringing the inventories to their present
location and condition. Market value is determined by reference to the sales
proceeds of items sold in the ordinary course of business after the balance
sheet date or management estimates based on prevailing market conditions.
The
inventories consist of finished goods and represent telecommunication products
such as mobile phone, rechargeable phone cards, smart chip, and interactive
voice response cards.
INCOME
TAXES
Income
taxes are accounted for using an asset and liability approach, which requires
the recognition of income taxes payable or refundable for the current year
and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in the Company's consolidated financial statements
or
tax returns. The measurement of current and deferred tax liabilities and
assets
is based on provisions of the enacted tax laws; the effects of future changes
in
tax laws or rates are not anticipated. The measurement of deferred tax assets
is
reduced, if necessary, by the amount of any tax benefits that, based on
available evidence assessed using the criteria in SFAS No. 109, "Accounting
for
Income Taxes," will not more-likely-than-not be realized.
The
Company records a valuation allowance for deferred tax assets, if any, based
on
estimates of its future taxable income as well as its tax planning strategies
when it is more likely than not that a portion or all of its deferred tax
assets
will not be realized. If the Company is able to utilize more of its deferred
tax
assets than the net amount previously recorded when unanticipated events
occur,
an adjustment to deferred tax assets would be reflected in income when those
events occur.
For
the
year ended December 31, 2005, income taxes of $43,000, $217,000 and $0 and
$12,000 was incurred from the Company's four business units: (1) CRM Outsourcing
Services, (2) Value Added Services (VAS), (3) Telecom Distribution
Services and (4) Other Business.
For
the
year ended December 31, 2004, income taxes of $70,636, $25,913 and $9,665
from
Smartime, Perpetual growth and Epro respectively.
RESEARCH
AND DEVELOPMENT COSTS AND CAPITALIZED SOFTWARE COSTS
Expenditures
related to the research and development of new products and processes, including
significant improvements and refinements to existing products are expensed
as
incurred, unless they are required to be capitalized.
Software
development costs are required to be capitalized when a product's technological
feasibility has been established by completion of a detailed program design
or
working model of the product, and ending when a product is available for
release
to customers. For the years ended December 31, 2005 and 2004, the Company
did
not capitalize any costs related to the purchase of software and related
technologies and content. There was no research and development costs charged
to
operations for the year ended December 31, 2005 and 2004.
F-12
EARNINGS
PER SHARE (EPS)
Basic
and
diluted earnings or loss per share (EPS) amounts in the financial statements
are
computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS
is
based on the weighted average number of common shares outstanding. Diluted
EPS
is based on the weighted average number of common shares outstanding and
dilutive common stock equivalents. Basic EPS is computed by dividing net
income/loss available to common stockholders (numerator) by the weighted
average
number of common shares outstanding (denominator) during the period. Weighted
average number of shares used to calculate basic and diluted loss per share
is
considered same as the effect of dilutive shares is anti-dilutive.
The
reconciliation of the numerators and denominators of the basic and diluted
EPS
calculations was as follows:
|
Year
December 31,
|
||||||||
|
(In
thousands of US Dollars, except weighted shares and per share
amounts.)
|
2005
|
2004
|
||||||
|
Restated
|
Restated
|
|||||||
|
Numerator:
Net loss
|
$ | (5,145 | ) | $ | (5,425 | ) | ||
|
Denominator:
|
||||||||
|
Weighted-average
shares used to compute basic & diluted loss per share
|
10,156,809
|
7,015,907
|
||||||
|
Basic
& diluted loss per common share:
|
$ | (0.51 | ) | $ | (0.78 | ) | ||
STOCK-BASED
COMPENSATION PLANS
The
Company has adopted SFAS No. 123, "Accounting for Stock Based Compensation".
As
permitted by SFAS No. 123, the Company measures compensation cost in accordance
with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock
Issued to Employees" and related interpretations. Compensation cost for stock
options, if any, is measured as the excess of the quoted market price of
the
Company's stock at the date of grant over the amount an employee must pay
to
acquire the stock. Accordingly, no accounting recognition is given to stock
option granted at fair market value until they are exercised. Upon exercise,
net
proceeds including tax benefits realized, are credited to equity. Details
regarding a description and status of the Company's stock option plans can
be
found in Note 12.
The
Company's net earnings (loss) and net earnings (loss) per common share would
have changed to the pro forma amounts indicated below if compensation cost
for
the Company's stock option had been determined based on fair value at the
grant
date for awards in accordance with SFAS No. 123, (in thousands, except per
share
amounts):
|
FY
2005
|
FY
2004
|
|||||||
|
Net
earnings/ (loss):
|
||||||||
|
As
reported
|
$ | (5,145 | ) | $ | (5,425 | ) | ||
|
Stock-based
compensation cost APB 25
|
282
|
1,246
|
||||||
|
Stock-based
compensation cost FAS 123R
|
(364 | ) | (1,905 | ) | ||||
|
Pro
forma
|
$ | (5,227 | ) | $ | (6,084 | ) | ||
|
Basic
& diluted loss per share:
|
||||||||
|
As
reported
|
$ | (0.51 | ) | $ | (0.78 | ) | ||
|
Pro
forma
|
$ | (0.51 | ) | $ | (0.87 | ) | ||
The
fair
value of options granted during 2005 and 2004, respectively was approximately
$1.41 and $1.78 per option respectively based on the Black-Scholes option
pricing model using valuation assumptions of: a) average remaining contractual
life of two years and three years; b) expected volatility of 148% and 61.33%,
c)
dividend yield of 0% for both years; and d) a risk free interest rate of
2.75%
and 2.75%.
ADVERTISING
EXPENSES
Advertising
expenses consist primarily of costs of promotion for corporate image and
product
marketing and costs of direct advertising. The Company expenses all advertising
costs as incurred and classify these costs under selling, general and
administrative expenses, which amounted to$129,000 in 2005 (2004:
$55,000).
F-13
CASH
EQUIVALENTS
Cash
and
cash equivalents comprise cash at bank and on hand, demand deposits with
banks
and other financial institutions, and short-term, highly liquid investments
that
are readily convertible to known amounts of cash and which are subject to
an
insignificant risk of changes in value. Bank overdrafts that are repayable
on
demand and form an integral part of the PacificNet's cash management are
also
included as a component of cash and cash equivalents for the purpose of the
cash
flow statement. Highly liquid investments with original maturities of three
months or less are considered cash equivalents.
RELATED
PARTY TRANSACTIONS
A
related
party is generally defined as (i) any person that holds 10% or more of the
Company's securities including such person's immediate families, (ii) the
Company's management, (iii) someone that directly or indirectly controls,
is
controlled by or is under common control with the Company, or (iv) anyone
who
can significantly influence the financial and operating decisions of the
Company. A transaction is considered to be a related party transaction when
there is a transfer of resources or obligations between related parties.
(See
Note 12)
RECLASSIFICATION
Certain
prior period amounts have been reclassified to conform to the current year
presentation. These changes had no effect on previously reported results
of
operations or total stockholders' equity.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
Fair
value is described as the amount at which the instrument could be exchanged
in a
current transaction between informed willing parties, other than a forced
liquidation. Cash and cash equivalents, accounts receivable and payable,
accrued
expenses and other current liabilities are reported on the consolidated balance
sheets at carrying value which approximates fair value due to the short-term
maturities of these instruments. The Company does not have any off balance
sheet
financial instruments.
CONCENTRATION
OF CREDIT RISK
CASH
HELD
IN BANKS: For those financial institutions that the Company maintains cash
balances in the United States, the amounts are insured by the Federal Deposit
Insurance Corporation up to $2,182,000.
GEOGRAPHIC
RISK: All of the Company's revenues are derived in Asia and Greater China
and
its operations are governed by Chinese laws and regulations. The operations
in
China are carried out by the subsidiaries and VIEs. If the Company was unable
to
derive any revenue from Asia and Greater China, it would have a significant,
financially disruptive effect on the normal operations of the
Company.
SIGNIFICANT
RELATIONSHIPS: A substantial portion of the operations of the Company's VIEs
(Dianxun-DE and Sunroom-DE) business operations depend on mobile
telecommunications operators (operators) in China and any loss or deterioration
of such relationship may result in severe disruptions to their business
operations and the loss of a significant portion of the Company's revenue.
The
VIEs rely entirely on the networks and gateways of these operators to provide
its wireless value-added services. Specifically these operators are the only
entities in China that have platforms for wireless value-added services.
The
Company's agreements with these operators are generally for a period of less
than one year and generally do not have automatic renewal provisions. If
neither
of them is willing to continue to cooperate with the Company, it would severely
affect the Company's ability to conduct its existing wireless value-added
services business.
MARKETABLE
EQUITY SECURITIES
Marketable
equity securities are classified as available-for-sale and are recorded at
fair
value in other assets on the balance sheet, with the change in fair value
during
the period excluded from earnings and recorded net of tax as a component
of
other comprehensive income. Realized gains or losses are charged to the income
statement during the period in which the gain or loss is realized. Investments
classified as available-for-sale securities include marketable equity securities
of Unit Trust Funds and are based primarily on quoted market prices at December
31, 2005. The component costs of these securities are summarized as follows:
cost of $586,000, gross unrealized losses of $47,000 and estimated fair value
of
$539,000 as at December 31, 2005 and cost of $46,000, gross unrealized losses
of
$17,000 and estimated fair value of $29,000 as at December 31, 2004. The
acquisition of marketable securities and unrealized losses on marketable
equity
securities are recorded on consolidated statements of cash flows.
F-14
FOREIGN
CURRENCY
The
Company's reporting currency is the U.S. dollar. The Company's operations
in
China and Hong Kong use their respective currencies as their functional
currencies. The financial statements of these subsidiaries are translated
into
U.S. dollars using period-end rates of exchange for assets and liabilities
and
average rates of exchange in the period for revenue and expenses. Translation
gains and losses are recorded in accumulated other comprehensive income or
loss
as a component of shareholders' equity. Net gains resulting from foreign
exchange transactions are included in General and Administrative Expenses
an
amount to $27,000 and $(22,000) for the years ended December 31, 2005 and
2004.
SEGMENT
INFORMATION
The
Company determines and classified its operating segments in accordance with
SFAS
No. 131 "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION"
based on the following considerations: (a) each of the Company's operating
segments is a discrete business unit that earns revenues and incurs expenses;
(b) the operating results are regularly reviewed by PacificNet's chief operating
decision makers for the purposes of fine-tuning its strategies going forward,
making resource allocation decisions such as whether further working capital
advances are required and assessing individual performance; and (c) discrete
financial information for each subsidiary within each operating segment is
available. The chief operating decision makers are the Company's President
and
CEO and its Chairman, and their decisions are based on discussions with each
segment's senior management and financial controllers regarding non-financial
indicators such as customer satisfaction, loyalty and new marketplace
competition as well as financial indicators such as internally generated
financial statements, to assess overall financial performance.
GOING
CONCERN
As
shown
in the accompanying consolidated financial statements, the Company incurred
accumulated losses of $38.6 million and $33.5 million as of December 31,
2005
and 2004, respectively. Net loss for the years ended December 31, 2005 and
2004
is $5.15 million and $5.43 million respectively. In addition, the Company
is in
default on its convertible debenture obligation (See note 15). These matters
raise substantial doubt about the Company’s ability to continue as a going
concern.
In
view
of the matters described in the preceding paragraph, recoverability of a
major
portion of the recorded asset amounts shown in the accompanying Restated
balance
sheet is dependent upon continued operations of the Company, which in turn
is
dependent upon the Company’s ability to raise additional capital, obtain
financing and to succeed in its future operations. The financial statements
do
not include any adjustments relating to the recoverability and classification
of
recorded asset amounts or amounts and classification of liabilities that
might
be necessary should the Company be unable to continue as a going
concern.
The
Company has taken certain restructuring steps to provide the necessary capital
to continue its operations. These steps included, but not limited to: 1)
accelerate disposal and spin-off of unprofitable or unfavorable
return-on-investment non-gaming operations. On April 30, 2007, the Company
entered into a sale and purchase agreement to dispose of its interest in
Guangzhou3G for a consideration of US$6 million. On May 5, 2007, the Company
also entered into a sale and purchase agreement to dispose of the real estate
in
HK for approximately US$1 million; 2) focus on execution of the new high
potential gaming business initiatives; 3) acquisition of profitable and/or
strategic operations through issuance of equity instruments; 4) formation
of
strategic relationship with key gaming operators in Asia; 5) issuance and/or
restructure of new long-term convertible debentures.
RECENT
PRONOUNCEMENTS
The
Financial Accounting Standards Board issued the following recent accounting
pronouncements:
In
February 2007, FASB issued FASB Statement No. 159, The Fair Value Option
for
Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal
years beginning after November 15, 2007. Early adoption is permitted subject
to
specific requirements outlined in the new Statement. Therefore, calendar-year
companies may be able to adopt FAS 159 for their first quarter 2007 financial
statements.
The
new
Statement allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value
option
for an eligible item, changes in that item's fair value in subsequent reporting
periods must be recognized in current earnings. FAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. The management is currently evaluating the effect of this
pronouncement on financial statements.
F-15
In
September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
employer to recognize the over funded or under funded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset
or
liability in its statement of financial position and to recognize changes
in
that funded status in the year in which the changes occur through comprehensive
income of a business entity or changes in unrestricted net assets of a
not-for-profit organization. The Company currently does not have any defined
benefit plan and so FAS 158 will not affect the financial
statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures
about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board
having
previously concluded in those accounting pronouncements that fair value is
the
relevant measurement attribute. Accordingly, this Statement does not require
any
new fair value measurements. However, for some entities, the application
of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15,
2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
In
July
2006, the FASB released FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48) FIN
48
clarifies the accounting and reporting for uncertainties in income tax law.
This
interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions
taken or expected to be taken in income tax returns. This statement is effective
for fiscal years beginning after December 15, 2006. The management is currently
evaluating the effect of the adoption of FIN 48.
In
March
2006 FASB issued SFAS 156 “Accounting for Servicing of Financial Assets.” This
Statement amends FASB Statement No. 140, “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,” with respect to the
accounting for separately recognized servicing assets and servicing liabilities.
The Company does not have any servicing assets and therefore the statement
will
not have any impact on the financial statements.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments.” SFAS No. 155 amends SFAS No 133, “Accounting for
Derivative Instruments and Hedging Activities,” and SFAF No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.” SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise
would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. The management is currently evaluating the effect of this
pronouncement on financial statements.
In
May
2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections".
SFAS No. 154 replaces APB Opinion No. 20 "Accounting Changes" and SFAS No.
3,
"Reporting Accounting Changes in Interim Financial Statements". SFAS No.
154
requires retrospective application to prior periods' financial statements
of
changes in accounting principle, unless it is impracticable to determine
either
the period-specific effects or the cumulative effect of the change. The adoption
of SFAS No. 154 did not impact the Company's consolidated financial
statements.
In
December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of Nonmonetary
Assets." The Statement is an amendment of APB Opinion No. 29 to eliminate
the
exception for nonmonetary exchanges of similar productive assets and replaces
it
with a general exception for exchanges of nonmonetary assets that do not
have
commercial substance. The Company believes that the adoption of this standard
will have no material impact on its financial statements.
In
December 2004, the FASB issued SFAS No. 123R (revised 2004) "Share-Based
Payment" which amends FASB Statement No. 123 and will be effective for public
companies (small business issuers) for interim or annual periods beginning
after
December 15, 2005. SFAS 123R requires that compensation cost related to
share-based payment transactions be recognized in the financial statements.
Share-based payment transactions within the scope of SFAS 123R include stock
options, restricted stock plans, performance-based awards, stock appreciation
rights, and employee share purchase plans. The Company adopted the new standard
as of January 1, 2006. Based on the Company's evaluation of the adoption
of the
new standard, the Company believes that it could have a significant impact
to
the Company's financial position and overall results of operations depending
on
the number of stock options granted in a given year.
F-16
In
March
2004, the Emerging Issues Task Force ("EITF") reached a consensus on Issue
No.
03-1, "The Meaning of Other-Than-Temporary Impairment and its Application
to
Certain Investments." The EITF reached a consensus about the criteria that
should be used to determine when an investment is considered impaired, whether
that impairment is other-than-temporary, and the measurement of an impairment
loss and how that criteria should be applied to investments accounted for
under
SFAS No. 115, "ACCOUNTING IN CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES."
EITF 03-01 also included accounting considerations subsequent to the recognition
of other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. Additionally, EITF 03-01 includes new disclosure requirements
for
investments that are deemed to be temporarily impaired. In September 2004,
the
Financial Accounting Standards Board (FASB) delayed the accounting provisions
of
EITF 03-01; however the disclosure
2.
BUSINESS ACQUISITIONS
During
2005 and 2004, PacificNet acquired various entities in accordance with the
Company's strategy to grow via mergers and acquisitions. The entities acquired
met various PacificNet acquisition criteria, which include reasonable
expectations for positive earnings and cash flow within two years of acquisition
and reputation for high quality and performance in the customer relationship
management, brand name recognition, and well-established relationships with
clients. Several factors contributed to the determination of the negotiated
purchase price and deal structure. Among them were the value of assets acquired
and liabilities assumed, historical EBITDA and projected EBITDA. The assets
acquired and liabilities assumed were recorded at estimated fair values as
determined by the Company's management based on information currently available
and on current assumptions as to future operations
A
summary
of business acquisitions for the periods presented follows:
SHANGHAI
CLASSIC GROUP LIMITED ("YUESHEN")
On
April
12, 2004, the Company, through its subsidiary PacificNet Strategic Investment
Holdings Limited, consummated the acquisition of a 100% controlling interest
(the "Acquisition") in Shanghai Classic Group Limited, which owns 51% of
Guangzhou YueShen TaiYang Technology Limited, a newly formed telecommunication
company located and incorporated in the People's Republic of China ("Yueshen").
The Company acquired the 100% controlling interest in Shanghai Classic through
the purchase of 85 shares (representing 100% of the issued and outstanding
shares, the "Shanghai Shares") of Shanghai Classic Group Limited, which is
also
the beneficial owner of the 51% controlling interest in Yueshen. The
consideration for the Acquisition was an aggregate value of approximately
USD$1,679,532, which was paid in cash and shares of common stock of the Company
(the "Common Stock"), and a warrant to purchase up to 50,000 shares of Common
Stock. The consideration was paid as follows:
(i)
106,240 shares of Common Stock as consideration for the purchase of 51% of
the
Shanghai Shares from Yan Kuan Li ("Ms. Li") within thirty (30) days of the
signing of the agreement for the Acquisition. All of the Common Stock
deliverable to Ms. Li is being held in escrow pursuant to the terms of an
escrow
agreement, which provides that the Common Stock will be released in installments
over the twelve month period following the consummation of the Acquisition,
provided, that Yueshen attains certain net income milestones during such
period.
In the event there is a shortfall in the net income during the period Ms.
Li
shall return to the Company shares of Common Stock equivalent to the dollar
amount of such shortfall divided by $5.80; and
(ii)
approximately USD$338,303 in cash as consideration for the purchase of 34
of the
Shanghai Shares from Avatar Trading, Ltd. ("Avatar") within thirty (30) days
of
the closing of the Acquisition; and
(iii)
approximately USD$241,645 in cash directly to Yueshen within thirty (30)
days of
the closing of the Acquisition, as consideration for the purchase of the
Yueshen
shares by Shanghai Classic.
(iv)
A
common stock purchase warrant to purchase 50,000 shares of PacificNet common
stock, par value $0.0001 per share. The exercise price under this warrant
shall
be the 5-Day volume weighted average price of the common stock of PacificNet
before the signing date of this Agreement, exercisable within 3 years from
the
date of issuance. The warrants are considered contingent consideration and
have
not been valued as the contingency has not been met. (See Note 5)
The
cash
portion of the purchase price for the Acquisition was paid from working capital
of the Company. The value of the common shares issued was determined based
on
the average market price of PacificNet's common shares over a reasonable
period
before and after the terms of the acquisition were agreed to and
announced.
F-17
The
company accounted for the acquisition using the equity method of accounting
due
to the following reasons.
The
usual
condition for a controlling financial interest is ownership of a majority
voting
interest, and, therefore, as a general rule ownership by one company, directly
or indirectly, of over fifty percent of the outstanding voting shares of
another
company is a condition pointing toward consolidation. However, there are
exceptions to this general rule. FAS 94, that amended ARB No. 51,
Consolidated Financial Statements, stipulates that a majority-owned subsidiary
shall not be consolidated if control is likely to be temporary or if it does
not
rest with the majority owner.
It
follows that Yueshen has been excluded from consolidation to the Company’s
consolidated financial statements for the years ended December 31, 2004 and
2005
on the grounds that the control of Yueshen was temporary for two main
reasons. First, the Company had never been given full access to
detailed financial information of Yueshen by its legal representative. .Second,
since the legal representative of Yueshen refused to cooperate, the Company,
despite of its 51% ownership, never managed to obtain board control through
nominating new directors to the board of Yueshen.
Accordingly,
operating results of Yueshen have been accounted for using equity method
for the
years ended December 31, 2004 and 2005.
Following
is the summary of investment as of December 31, 2005 and 2004.
|
(In
thousands of U.S Dollars)
|
2005
|
2004
|
||||||
|
Initial
investment
|
n/a
|
$ |
1,680
|
|||||
|
Net
income
|
n/a
|
(242 | ) | |||||
|
Total
|
n/a
|
1,438
|
||||||
|
Impairment
of investment
|
n/a
|
(1,438 | ) | |||||
|
Net
|
n/a
|
$ |
-
|
|||||
As
of
December 31, 2004 the Company impaired $1,438,909 in investment as the
recoverability of the investment is uncertain due to the litigation between
the
Company and Yueshen (See note 15).
PACIFIC
SMARTIME SOLUTIONS LIMITED ("SMARTIME")
On
September 15, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of a 51% controlling
interest (the "Acquisition") in Soluteck Technology (Shenzhen) Company Limited,
a corporation incorporated in Shenzhen, China ("Soluteck"). The Company acquired
the controlling interest in Soluteck through the purchase of 630 shares (the
"Shares") or 63% ownership interest of Pacific Smartime Solutions Limited
("Smartime"), the beneficial owner of an 81% controlling interest in Soluteck,
from the shareholders of Smartime. The consideration for the Acquisition
was
payable as follows:
(i)
100,000 shares of common stock of the Company (the "Common Stock"), deliverable
within 30 days of signing the Agreement. All of the Shares deliverable to
the
Shareholders are being held in escrow pursuant to the terms of an escrow
agreement, which provides that the Common Stock will be released in installments
over the twelve month period ending on September 30, 2005; provided that
Soluteck meets certain net income milestones during such period. If at the
end
of the second twelve month period ending on September 30, 2006, there is
a
shortfall in Soluteck's net income, the Shareholders shall return to the
Company
Shares equivalent to the dollar amount of such shortfall divided by $5.00;
and
(ii)
warrants to purchase up to 50,000 shares of common stock at an exercise price
equal to the 5 day volume weighted average price of the Company's common
stock
before the signing of the Agreement. The warrants are exercisable for a period
of 3 years from the date of issuance. The warrants are considered contingent
consideration and have not been valued as the contingency has not been met.
(See
Note 5).
In
connection with the Acquisition, the Company's subsidiary has agreed to provide
Soluteck with an operating loan of RMB 3,000,000; provided that Soluteck
secures
certain contracts with Huawei. The loan would mature within 3 years with
interest at a rate of 4% per year.
F-18
A
summary
of the assets acquired and liabilities assumed in the acquisition follows
(In
thousands of US Dollars):
|
Estimated
fair values:
|
Restated
|
|||
|
Current
Assets
|
$ |
460,957
|
||
|
Property
Plan and equipment
|
61,067
|
|||
|
Current
Liabilities assumed
|
(255,024 | ) | ||
|
Net
asset acquired
|
267,000
|
|||
|
Consideration
paid:
|
||||
|
Shares
|
282,000
|
|||
|
Goodwill
|
$ |
$15,000
|
||
The
Company recorded the shares at the fair market value at the date of consummation
and recorded goodwill of $15,000.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. There is no change in the value of goodwill as of December
31, 2005 and 2004.
The
purchase price allocation for Smartime acquisition is based on a management's
estimates and overall industry experience. Immediately after the signing
of the
definitive agreement, the Company obtained effective control over Smartime.
Accordingly, the operating results of Smartime have been consolidated with
those
of the Company starting September 15, 2004.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2005 AND 2004
The
following unaudited pro forma consolidated financial information for the
years
ended December 31, 2004 and 2005, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1,
2004
and 2005 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would
have
been had the acquisitions actually taken place on January 1, 2004 and 2005
respectively, and may not be indicative of future operating
results.
|
Smartime
|
Year
ended December 31
|
|||||||
|
(In
thousands of U.S Dollars except for earnings per
share)
|
2005
Restated
(Unaudited)
|
2004
Restated
(Unaudited)
|
||||||
|
Revenues
|
$ |
31,086
|
$ |
18,623
|
||||
|
Operating
Loss
|
(4,333 | ) | (4,588 | ) | ||||
|
Net
loss attributable to shareholders
|
(5,145 | ) | (5,549 | ) | ||||
|
Loss
per share-basic & diluted
|
$ | (0.51 | ) | $ | (0.79 | ) | ||
PacificNet
included the financial results of Smartime in its consolidated 2005 financial
results and from the date of the purchase, September 15, 2004 through December
31, 2004.
PACIFICNET
CLICKOM LIMITED
On
December 16, 2004, we entered into an agreement to acquire a controlling
interest in Guangzhou Clickcom Digit-net Science and Technology Ltd.
("Clickcom-WOFE") through the purchase of a 51% interest of Clickcom-WOFE's
parent company, PacificNet Clickcom Limited, a British Virgin Islands Company
("Clickcom-BVI") from three shareholders, Mr. Jinnan Lai, Mr. Ming Zhang
and Mr.
Dong Liu who are majority shareholders of GuangZhou DianXun Company Limited
("Dianxun-DE"), a PRC registered Domestic Enterprise (DE) either. The
acquisition was completed on March 28, 2005 upon receipt of the required
business license and approval from the local government.
The
total
purchase consideration for 51% of Clickcom is payable 30% in cash and 70%
in
restricted shares of PACT. The purchase price is payable upon achievement
of
certain quarterly earn-out targets based on net profits, through the issuance
of
130,000 restricted shares of common stock of PacificNet. As of December 31,
2005, cash consideration of $268,000 and stock consideration of $402,480,
representing 52,000 restricted shares of PACT common stock valued at$7.65
per
share for 26,000 shares issued at the time of completion of acquisition and
at
$7.83 per share for 26,000 shares issued on achievement of net earnings target,
were recorded as the cost of acquisition. Total unearned purchase consideration
in the form of common stock to be distributed based on the achievement of
earnings was 78,000 restricted shares (See Note 12). PacificNet will also
issue
warrants to purchase 50,000 shares of PacificNet's common stock. The warrants
are considered contingent consideration and have not been valued as the
contingency has not been met. (See Note 5).
F-19
The
cash
portion of the purchase price for the Acquisition was paid from working capital
of the Company. The value of the common shares issued was determined based
on
the average market price of PacificNet's common shares over a reasonable
period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities assumed at the time of acquisition
as
follows (In thousands of US Dollars):
|
Estimated
fair values:
|
Restated
|
|||
|
Current
Assets
|
$ |
136,474
|
||
|
Net
asset acquired
|
136,474
|
|||
|
Consideration
paid:
|
||||
|
Shares
|
198,900
|
|||
|
Cash
paid
|
268,004
|
|||
|
Goodwill
|
$ |
330,430
|
||
The
Company recorded goodwill of $267,786 and 330,430 as at December 31, 2005
and
2004 respectively.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. As at December 31, 2005 the Company impaired goodwill
by
$266,096.
Following
is the summary of goodwill as at December 31, 2005 and 2004.
|
Goodwill
|
||||
|
As
at 12-31-04
|
$ |
330,430
|
||
|
Additional
issuance of shares during 2005
|
203,452
|
|||
|
Impairment
|
(266,096 | ) | ||
|
As
at 12-31-05
|
$ |
267,786
|
||
The
purchase price allocation for the Clickcom acquisition was based on a
management's estimates and overall industry experience. Immediately after
the
signing of the definitive agreement, the Company obtained effective control
over
Clickcom. Accordingly, the operating results of Clickcom have been consolidated
with those of the Company starting March 28, 2005. Pursuant to SFAS 141
"Business Combinations", the earn-out consideration is considered contingent
consideration, which will not become certain until the audited combined
after-tax profit of US$600,000 for 12 months ended December 31, 2005 is
available. Accordingly, the contingent consideration of 78,000 restricted
shares
has not been reflected in the consolidated financial statements of the Company
as of December 31, 2005 due to the performance target not being
met.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2005 AND 2004
The
following unaudited pro forma consolidated financial information for the
years
ended December 31, 2004 and 2005, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1,
2004
and 2005 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would
have
been had the acquisitions actually taken place on January 1, 2004 and 2005
respectively, and may not be indicative of future operating
results.
|
Clickcom
|
Year
ended December 31
|
|||||||
|
(In
thousands of U.S Dollars)
|
2005
Restated
(Unaudited)
|
2004
Restated
(Unaudited)
|
||||||
|
Revenues
|
$ |
31,086
|
$ |
16,942
|
||||
|
Operating
income
|
(4,333 | ) | (4,588 | ) | ||||
|
Net
profit
|
(5,145 | ) | (5,425 | ) | ||||
|
Loss per
share-basic & diluted
|
$ | (0.51 | ) | $ | (0.77 | ) | ||
PacificNet
included the financial results of Clickcom in its consolidated 2005 financial
results from the date of the purchase, March 28, 2005 through December 31,
2005.
F-20
GUANGZHOU
3G INFORMATION TECHNOLOGY CO. LTD
On
March
30, 2005 we entered into an agreement to acquire a controlling interest in
Guangzhou 3G Information Technology Co. Ltd. ("Guangzhou3G-WOFE"), a PRC
registered wholly owned foreign enterprise (WOFE), through the purchase of
a 51%
interest of Guangzhou 3G's parent company, Pacific 3G Information &
Technology Co. Limited, a British Virgin Islands Company ("Guangzhou3G-BVI")
from three shareholders, ASIAFAME INTERNATIONAL LIMITED, STARGAIN INTERNATIONAL
LIMITED, and TRILOGIC INVESTMENTS LIMITED. All of above three shareholders
are
incorporated in BVI. Guangzhou3G-WOFE conducts it VAS operations with Guangzhou
Sunroom Information Industrial Co., Ltd. ("Sunroom-DE"), a PRC registered
Domestic Enterprise (DE), through a series of contractual
agreements.
The
details of the acquisition are as follows:
The
purchase price for 51% controlling interest which is payable 29% in cash
and 71%
in restricted shares of PacificNet. The purchase price includes $500,000
cash
payable to Guangzhou 3G, and the remaining amount payable to the selling
shareholders through the issuance of restricted shares of common stock of
PacificNet plus $1.18 million cash payable to the sellers upon achievement
by
Guangzhou 3G of certain quarterly earn-out targets based on net profits.
As of
December 31, 2005, cash consideration of $1,683,000 and stock consideration
of
$2,470,453, representing 326,400 restricted shares of PACT common stock valued
at $7.65 per share for 130,050 shares, $7.83 per share for 98,175 shares
and
$7.20 per share for 98,175 shares were recorded as the cost of the acquisition.
Total unearned purchase consideration in the form of common stock to be
distributed based on the achievement of earnings was 196,350 restricted shares
(See Note 12). PacificNet also issue warrants to purchase 100,000 shares
of
PacificNet's common stock. The warrants have never been issued since it is
contingent upon a certain earning milestone which has not been met (See Note
5).
The
cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities for Guangzhou 3G WOFE assumed in the
acquisition follows (In thousands of US Dollars):
|
Estimated
fair values:
|
Restated
|
|||
|
Current
Assets
|
$ |
253,000
|
||
|
Net
asset acquired
|
253,000
|
|||
|
Consideration
paid:
|
||||
|
Shares
|
2,470,453
|
|||
|
Cash
paid
|
1,683,000
|
|||
|
Goodwill
|
$ |
3,900,453
|
||
The
Company recorded goodwill of $3,900,453 as at December 31, 2005.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for Guangzhou3G acquisition
is
based on a management's estimates and overall industry experience. Immediately
after the signing of the definitive agreement, the Company obtained effective
control over Guangzhou3G. Accordingly, the operating results of Guangzhou
3G
have been consolidated with those of the Company starting March 30, 2005.
Pursuant to SFAS 141 "Business Combinations", the earn-out consideration
is
considered contingent consideration, which will not become certain until
the
audited combined after-tax profit of US$2,000,000 for the 12 months ended
December 31, 2005 is available. Accordingly, the contingent consideration
of
196,350 shares has not been reflected in the consolidated financial statements
of the Company as of December 31, 2005.
F-21
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2005 AND 2004
The
following unaudited pro forma consolidated financial information for the
years
ended December 31, 2004 and 2005, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1,
2004
and 2005 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would
have
been had the acquisitions actually taken place on January 1, 2004 and 2005
respectively, and may not be indicative of future operating
results.
|
GZ
3G
|
Year
ended December 31
|
|||||||
|
(In
thousands of U.S Dollars)
|
2005
Restated
(Unaudited)
|
2004
Restated
(Unaudited)
|
||||||
|
Revenues
|
$ |
46,509
|
$ |
n/a
|
||||
|
Operating
income
|
1,851
|
n/a
|
||||||
|
Net
profit
|
1,136
|
n/a
|
||||||
|
Earnings
per share-basic&diluted
|
$ |
0.11
|
$ |
n/a
|
||||
PacificNet
included the financial results of 3G in its consolidated 2005 financial results
from the date of the purchase, March 30, 2005 through December 31,
2005.
SHENZHEN
GUHAIGUANCHAO INVESTMENT CONSULTANT COMPANY LIMITED
("CHINAGOHI")
On
December 19, 2005, we closed an agreement to purchase a 51% interest in Shenzhen
GuHaiGuanChao Investment Consultant Company Limited ("ChinaGoHi"), a wholly
owned foreign enterprise (WOFE) registered in China and a provider of DRTV
infomercial marketing company for financial advisory services in China. On
October 3, 2005 we announced that we had signed an agreement dated as of
September 30, 2005 to acquire 51% of the outstanding shares of ChinaGoHi
from
Hitching International Corporation ("HIC"), the former majority owner of
ChinaGoHi to be closed upon the completion of due diligence and the approval
of
the WOFE structure by China's Industry and Commerce Department.
As
a
result of the due diligence process and receipt of the Chinese government's
WOFE
approval, we and HIC agreed to amend the Sale and Purchase Agreement and
entered
into a Supplementary Agreement dated as of December 1, 2005 (the "Supplementary
Sale and Purchase Agreement") and permitted us to have direct ownership of
ChinaGoHi through the acquisition of 51% of the outstanding shares from Lion
Zone Holdings Limited instead of HIC.
We
agreed
to purchase 12,850 existing ordinary shares (the "Sale Shares") of ChinaGoHi
from Lion Zone Holdings Limited (the "Seller") and to subscribe 5,000 newly
issued ordinary shares (the "Subscription Shares") from the Seller, which
together with the Sale Shares, being 17,850 or 51% of the 35,000 entire
outstanding shares of ChinaGoHi. The purchase price for 51% of the outstanding
shares of ChinaGoHi was payable as follows: US$2.1 million payable in cash
to
the Seller and 825,000 shares of our common stock valued. The purchase price
is
payable upon achievement of certain quarterly earn-out targets based on net
profits, through the issuance of our 825,000 shares. As at December 31, 2005
the
Company paid $775,000 for seller shares and $1,500,000 for subscription shares
and issued 137,500 shares valued at $7.03 per share at the date of consummation
of agreement.
The
cash
portion of the acquisition consideration was for the working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities assumed in the acquisition follows
(In
thousands of US Dollars):
|
Estimated
fair values:
|
Restated
|
|||
|
Current
Assets
|
$ |
4,785,924
|
||
|
Property
Plan and equipment
|
157,376
|
|||
|
Current
Liabilities assumed
|
(2,449,981 | ) | ||
|
Net
asset acquired
|
2,493,319
|
|||
|
Consideration
paid:
|
||||
|
Shares
|
966,625
|
|||
|
Cash
paid
|
2,275,000
|
|||
|
Goodwill
|
$ |
748,306
|
||
F-22
The
Company recorded goodwill of $748,306 as at December 31, 2005.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for ChinaGohi acquisition
is
based on management's estimates and overall industry experience. Immediately
after the signing of the definitive agreement, the Company obtained effective
control over ChinaGohi. Accordingly, the operating results of ChinaGohi have
been consolidated with those of the Company starting December 19, 2005. Pursuant
to SFAS 141 "Business Combinations", the earn-out consideration is considered
contingent consideration, which will not become certain until the audited
combined after-tax profit of US$4,500,000 for 15 months ending December 31,
2006
is available. Accordingly, the contingent consideration of 687,500 restricted
shares and cash of US$1,325,000 have not been reflected in the consolidated
financial statements of the Company as of December 31, 2005.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2005 AND 2004
The
following unaudited pro forma consolidated financial information for the
years
ended December 31, 2004 and 2005, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1,
2004
and 2005 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would
have
been had the acquisitions actually taken place on January 1, 2004 and 2005
respectively, and may not be indicative of future operating
results.
|
Lion
Zone
|
Year
ended December 31
|
|||||||
|
(In
thousands of U.S Dollars)
|
2005
Restated
(Unaudited)
|
2004
Restated
(Unaudited)
|
||||||
|
Revenues
|
$ |
44,177
|
$ |
n/a
|
||||
|
Operating
income
|
(25,563 | ) |
n/a
|
|||||
|
Net
profit
|
(28,344 | ) |
n/a
|
|||||
|
Loss
per share-basic&diluted
|
$ | (2.79 | ) | $ |
n/a
|
|||
PacificNet
included the financial results of Lion Zone in its consolidated 2005 financial
results from the date of the purchase, December 19, 2005 through December
31,
2005.
3.
INVESTMENT IN AFFILIATED COMPANIES
Investments
Investments
in affiliated companies and subsidiaries consist of the following as of December
31, 2005 and 2004 (in thousands):
|
(USD000s)
|
2005
|
2004
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
||
|
INVESTMENTS
IN AFFILIATED COMPANIES:
|
|||||
|
Take1
(Cheer Era Limited) [1]
|
$
1,161
|
$1,933
|
20%
ownership interest in 2005 (30% in 2004); trader of vending machine
located in Hong Kong
|
||
|
Shanghai
Classic (Yueshen)
|
$1,438
|
$1,438
|
51%
ownership interest in Yueshen thru Shanghai Classic (See note
2)
|
||
|
Ximedia
Holdings Inc
|
95
|
95
|
25%
ownership interest; provides new media business development and
marketing
to advertisers.
|
||
|
Less:
Provisions for Impairment
|
(1,533)
|
(1,533)
|
|||
|
Total
|
$
1,161
|
$1,933
|
F-23
TAKE
1 TECHNOLOGIES GROUP LIMITED (FORMERLY KNOWN AS: CHEER ERA LIMITED
"CHEERERA")
The
investment in 30% of Take 1 Technologies Group Limited ("Take 1"), a trader
of
vending machine located in Hong Kong, was originally made in April 2004 with
details as follows:
In
April
2004 the Company, through its subsidiary PacificNet Strategic Investment
Holdings Limited, acquired 30% equity interest in Take 1. The aggregate
consideration was $385,604 in cash and 149,459 PacificNet shares , and warrants
within a duration of three years to purchase up to 50,000 PacificNet shares
at
5-Day volume weighted average price immediately prior to the transaction.
The
warrants have been cancelled in the year 2005 because the warranted profit
was
not met. (See Note 5)
In
2005
both the Company and Take 1 have mutually agreed to a change to the original
investment structure pursuant to the Securities Repurchase Agreements entered.
Summarized below are the effects of these repurchase arrangements:
(i)
PacificNet 's interest in Take 1 was reduced to 20% in the year 2005 from
30% in
the prior year;
(ii)
PacificNet repurchased 149,459 shares in PacificNet previously issued to
the
majority owner of Take 1 at nominal value;
(iii)
In
addition to PacificNet 's existing loan of $769,000 (or HKD$6,000,000),
PacificNet will advance a new loan of $256,000 (or HKD$2,000,000) to Take
1
(collectively called `Convertible Loan'). The Convertible Loan is guaranteed
personally and jointly by the two majority owners of Take 1. The term of
the
Convertible Loan shall be three years expiring on October 17, 2008 (referred
as
"Term") with 8% interest per annum or HK Six-Month Prime Rate, whichever
is
higher.
(iv)
Conversion terms of the Convertible Loan provide PacificNet an option at
any
time during the Term to convert in part or in whole of the then outstanding
loan
principal up toS$1,794,000 (or HKD$8,000,000) into shares of Take 1 to reach
51%
ownership of Take 1.
As
a
result, the original investment of Take 1 was reduced at cost to $385,604
as of
December 31, 2005 due to the PacificNet shares repurchased under item (ii)
above. As of December 31, 2005, the outstanding loan amount due to Take 1
was
US$769,000.
4.
PROPERTY AND EQUIPMENT, NET
Property
and equipment consists of the following as of December 31 (in thousands of
US
dollars)
|
FY2005
|
FY2004
|
|||||||
|
Restated
|
Restated
|
|||||||
|
Office
furniture, fixtures and leasehold improvements
|
$ |
1,173
|
$ |
1,005
|
||||
|
Computers
and office equipment
|
5,623
|
2,371
|
||||||
|
Motor
Vehicles
|
354
|
58
|
||||||
|
Software
|
755
|
613
|
||||||
|
Electronic
Equipment
|
2,143
|
1,178
|
||||||
|
Land
and buildings
|
68
|
|||||||
|
Other
|
233
|
68
|
||||||
|
Less:
Accumulated depreciation
|
(6,662 | ) | (4,572 | ) | ||||
|
Net
Property and Equipment
|
$ |
3,687
|
$ |
721
|
||||
For
the
years ended December 31, 2005 and 2004, the total depreciation and amortization
expenses were $351,000 and $103,000 respectively, which were all included
in the
cost of revenue.
F-24
5.
COMMITMENTS AND CONTINGENCIES
OPERATING
LEASES - The Company leases warehouse and office space under operating leases
for two years with fixed monthly rentals that expire through 2005. None of
the
leases included contingent rentals. Lease expense charged to operations for
2005
amounted to $516,000 (2004: $383,000). Future minimum lease payments under
non-cancelable operating leases are 2006: $571,000 and 2007: $680,000. 2008-2009
$764,000
RESTRICTED
CASH –The Company has a $163,000 and 212,000 pledged bank deposit for Epro which
represents overdraft protections with certain financial institutions for
the
years ended December 31, 2005 and 2004 respectively.
BANK
LINE
OF CREDIT (2005): As of December 31, 2005, the Company utilized $1,059,000
of
the banking facility including $944,000 from Epro and $115,000 from Smartime.
Epro has an overdraft banking facility with certain major financial institutions
in the aggregate amount of $1,218,000, which is secured by a pledge of its
fixed
deposits of $163,000, pursuant to the following terms: interest will be charged
at the Hong Kong Prime Rate per annum and payable at the end of each calendar
month or the date of settlement, whichever is earlier. For Smartime, there
is no
due date payment stipulated by Hong Kong Hang Seng Bank because its overdraft
banking facility was borrowed directly from one of its directors personal
fixed
deposit account as a mortgage. The detailed payment period is based on its
funding condition.
As
at
December 31, 2004 the Company utilized 196,000 of the banking facility including
$78,000 from Epro and $118,000 from Smartime, Epro is secured by a pledge
of the
Company's fixed deposits of $212,000, pursuant to the following terms: interest
will be charged at the Hong Kong Prime Rate per annum and payable at the
end of
each calendar month or the date of settlement, whichever is earlier. For
Smartime, there is no due date payment stipulated by Hong Kong Hang Seng
Bank
because its overdraft banking facility was borrowed directly from one of
its
directors personal fixed deposit account as a mortgage. The detailed payment
period is based on its funding condition.
CONTINGENT
CONSIDERATION: Warrants have not been included as part of the acquisition
price
of various S&P Agreements (Note 2) and are no longer considered as part of
the purchase consideration due to (i) the ambiguity of the S&P Agreements
with respect to the issuance of the warrants and (ii) the lack of actual
instruments to transfer the warrants, such as a warrant agreement that is
signed
and sealed by the Company and property registered at the Company Registrar
of
securities in Hong Kong, and accordingly, there is no irrevocable obligation
by
the Company to issue the warrants. Furthermore, the net income milestones
were
not achieved as required under the S&P Agreements according to Hong Kong
law. Based on the opinion of the Company's legal counsel in Hong Kong, the
Company does not have an irrevocable obligation to issue the warrants and
therefore the warrants are not considered issued and outstanding. The offer
to
issue the warrants is no longer part of the purchase price in the S&P
Agreements due to the failure by the Sellers to satisfy their warranties
in the
S&P Agreements. Accordingly, the warrants have not been valued.
MINIMUM
STATED CAPITAL REQUIREMENTS. Guangzhou Dianxun Co, Limited (DE) ("Dianxun"),
a
subsidiary of the Group, is carrying on business as a telecommunication value
added service provider in the People's Republic of China ("PRC"). Initially,
Dianxun obtained a certificate (the "Certificate") from the PRC authority
to
transact business and according to the PRC Telecommunication Rules, all
telecommunication value added service providers can only carry on business
if
the Certificate is granted and if the Company maintains a minimum capital
requirement of at least RMB10,000,000
In
order
to satisfy the capital requirement of RMB 10,000,000, the shareholders of
Dianxun had contributed relevant asset equivalent to RMB9,000,000 on behalf
of
Dianxun and such assets were verified by an independent professional accountant.
Subsequently, such assets were returned back to the shareholders. In the
opinion
of the directors, even though the capital requirement is not fulfilled, Dianxun
can continue to carry on business. No provision for any loss arising from
the
consequential actions that may be taken by the authority in the PRC and any
potential penalties or claims for the Company not maintaining the minimum
stated
capital requirements of the PRC have been made in these financial
statements.
Dianxun's
contribution to consolidated revenues and net profit for 2005 was approximately
2% and 0%, respectively. Upon demand by the PRC authorities, PacificNet has
agreed to loan Clickcom the remaining balance of the registration capital
to
provide the stated capital in accordance with PRC laws.
F-25
6.
OTHER CURRENT ASSETS
Other
current assets are represented in Consolidated Balance Sheets which include
the
following as at December 31 (in thousands of US Dollars):
|
2005
|
2004
|
|||||||
|
Other
current assets
|
Restated
|
Restated
|
||||||
|
Prepayment
|
$ |
1,108
|
$ |
211
|
||||
|
Utilities
deposit
|
12
|
-
|
||||||
|
Prepaid
expenses
|
1,059
|
142
|
||||||
|
Income
tax refunds
|
-
|
22
|
||||||
|
Others
receivable
|
4,049
|
1,590
|
||||||
|
Provision
for doubtful account of other receivables
|
(1,031 | ) | (356 | ) | ||||
|
Total
|
$ |
5,197
|
$ |
1,609
|
||||
7.
BANK LOANS
Bank
loans represent the following at December 31 (in thousands of US
Dollars):
|
2005
|
2004
|
|||||||
|
Bank
loans
|
Restated
|
Restated
|
||||||
|
Secured
[1]
|
$ |
108
|
$ |
757
|
||||
|
Unsecured
|
86
|
890
|
||||||
|
Less:
current portion
|
(188 | ) | (1,577 | ) | ||||
|
Non
current portion
|
$ |
6
|
$ |
70
|
||||
Bank
Loans are generated by one of the Company's subsidiaries, PacificNet Epro
Holdings Limited, a company incorporated in the Hong Kong Special Administrative
Region of the PRC, primarily engaged in the business of providing call center
and customer relationship management (CRM) services as well as other business
outsourcing services.
[1]
The
loans were secured by the following: joint and several personal guarantees
executed by certain directors of the subsidiary of the Company; corporate
guarantee executed by a subsidiary of the Company; second legal charge over
a
property owned by a subsidiary of the Company; and pledged bank deposits
of
$163,000 (2004: $212,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as follows: (2006:
$188,000, 2007: $6,000)
8.
CAPITAL LEASE OBLIGATIONS
The
Company leases various equipments under capital leases expiring in various
years
through 2008. The assets and liabilities under capital leases are recorded
at
the lower of the present value of the minimum lease payments or the fair
value
of the asset. The assets are depreciated over the lesser of their related
lease
terms or their estimated productive lives and are secured by the assets
themselves. Depreciation of assets under capital leases is included in
depreciation expense for 2005 and 2004.
Aggregate
minimum future lease payments under capital leases as of December 31, 2005
for
each of the next five years are as follows: (2006: $126,000; 2007: $57,000;
and
2008: $21,000)
F-26
Capital
lease obligations represent the following at December 31 (in thousands of
US
Dollars):
|
2005
|
2004
|
|||||||
|
Capital
lease obligations
|
Restated
|
Restated
|
||||||
|
Total
minimum lease payments
|
$ |
216
|
$ |
225
|
||||
|
Interest
expense relating to future periods
|
(12 | ) | (16 | ) | ||||
|
Present
value of the minimum lease payments
|
204
|
209
|
||||||
|
Less:
current portion
|
(126 | ) | (99 | ) | ||||
|
Non
current portion
|
$ |
78
|
$ |
110
|
||||
Following
is a summary of fixed assets held under capital leases at December 31 (in
thousands of US Dollars):
|
2005
|
2004
|
|||||||
|
Restated
|
Restated
|
|||||||
|
Computers
and office equipment
|
$ |
636
|
$ |
571
|
||||
|
Less:
accumulated depreciation
|
(475 | ) | (359 | ) | ||||
|
Net
|
$ |
161
|
$ |
212
|
||||
9.
ACCRUED EXPENSES& OTHER PAYABLES
Accrued
expenses consist of the following at December 31 (in thousands of US
Dollars):
|
2005
|
2004
|
|||||||
|
Accrued
expenses & other payables
|
Restated
|
Restated
|
||||||
|
Deposit
received from customers
|
$ |
5,280
|
$ |
318
|
||||
|
Accrued
expenses
|
1,249
|
377
|
||||||
|
Salaries
and benefit payable
|
1,267
|
149
|
||||||
|
Others
|
211
|
107
|
||||||
|
Total
|
$ |
8,007
|
$ |
951
|
||||
10.
SUNDRY INCOME
Sundry
income for the years ended December 31, 2005 and 2004 was comprised of the
following on the consolidated income statements (in thousands of US
dollars).
|
2005
|
2004
|
|||||||
|
Sundry
income
|
Restated
|
Restated
|
||||||
|
Consulting
service income
|
$ | (368 | ) | $ | (345 | ) | ||
|
Investment
income
|
(260 | ) | (55 | ) | ||||
|
Leasehold
income
|
(6 | ) | (104 | ) | ||||
|
Others
|
(21 | ) | (17 | ) | ||||
|
TOTAL
|
$ | (655 | ) | $ | (521 | ) | ||
F-27
11.
STOCKHOLDERS' EQUITY
a)
COMMON
STOCK
For
the
year ended December 31, 2005, the Company had the following equity transactions
(i) 700,000 shares as a result of exercise of stock options and warrants
with
cash consideration of $966,000; (ii) 515,900 shares for acquisition of
subsidiaries valued at $3,971,000;(iii) 20,000 shares at $63,000 for investor
relations services rendered based on the fair market value of the services
rendered; (iv) repurchase of 45,000 shares fraudulently issued by the former
financial controller of the company in 2004 to herself at par
value; and (v) repurchase of 149,459 shares with a market value of
$1,547,000 related to affiliated company (see Note 3 for details).
For
the
year ended December 31, 2004, the Company had the following equity transactions
(i) 219,364 shares as a result of exercise of stock options and warrants
with
cash consideration of $606,000; (ii) 1,756,240 shares for acquisition of
subsidiaries valued at $9,938,000; and (iii) 2,205,697 shares for cash proceeds
of $12,330,000 (net of offering costs); (iv) 50,000 shares at $2.64 per share,
or $132,000 for investor relations services rendered; (v) 83,000 shares were
fraudulently issued by the former financial controller of the company to
herself
out of which 38,000 could not be cancelled as they had been resold and the
balance were cancelled in 2005 by the company; and (vi) 149,459 shares with
a
market value of $1,547,000 for acquisition of affiliated company (see Note
3 for
details)
b)
STOCK
OPTION PLAN
On
December 23, 2003, stockholders of the Company adopted an amendment to the
Stock
Option Plan (the "Plan") to increase the number of shares reserved under
the
Plan from 1,666,667 to 2,000,000. On December 30, 2004, stockholders of the
Company approved the new 2005 Stock Option Plan (the "2005 Option Plan").
The
2005 Option Plan provide for the grant to directors, officers, employees
and
consultants of the Company (including its subsidiaries) of options to purchase
up to an aggregate of 2,000,000 shares of Common Stock. The 2005 Plan is
administered by the Board of Directors or a committee of the Board of Directors
(in either case, the "Committee"), which has complete discretion to select
the
optionees and to establish the terms and conditions of each option, subject
to
the provisions of the 2005 Option Plan. Options granted under the 2005 Plan
are
"incentive stock options" as defined in Section 422 of the Internal Revenue
Code
of 1986, as amended (the "Code"), or nonqualified options.
The
purpose of the Plan is to attract and retain the best available personnel
for
positions of responsibility and to provide incentives to such personnel to
promote the success of the business. The Plan provides for the grant to
directors, officers, employees and consultants of the Company (including
its
subsidiaries) of options to purchase shares of common stock. Options granted
under the Plan may be "incentive stock options" as defined in Section 422
of the
Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified
options. To date, all options granted have been nonqualified options. The
exercise price of incentive stock options may not be less than 100% of the
fair
market value of the common stock as of the date of grant. The number of options
outstanding and the exercise price thereof are subject to adjustment in the
case
of certain transactions such as mergers, recapitalizations, stock splits
or
stock dividends. Options granted under the Plan fully vest through June
2006.
The
status of the Stock Option Plan as of December 31, 2005, is as
follows:
|
OPTIONS
|
WEIGHTED
AVERAGE EXERCISE PRICE
|
|||||||
|
OUTSTANDING,
DECEMBER 31, 2003
|
550,600
|
$ |
2.87
|
|||||
|
Granted
|
870,000
|
$ |
3.03
|
|||||
|
Cancelled
|
(400,000 | ) |
4.25
|
|||||
|
Exercised
|
(188,500 | ) | $ |
2.04
|
||||
|
OUTSTANDING,
DECEMBER 31, 2004
|
832,100
|
$ |
1.90
|
|||||
|
Granted
|
680,000
|
$ |
6.57
|
|||||
|
Cancelled
|
(680,000 | ) | $ |
6.57
|
||||
|
Exercised
|
(76,000 | ) | $ |
2.05
|
||||
|
OUTSTANDING,
DECEMBER 31, 2005
|
756,100
|
$ |
3.99
|
|||||
F-28
Additional
information on options outstanding as of December 31, 2005 is as
follows:
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
OPTIONS
|
AVERAGE
REMAINING
CONTRACTUAL
LIFE
|
|
|
Options
outstanding
|
$3.99
|
756,100
|
3.50
years
|
|
Options
exercisable
|
$2.06
|
529,000
|
1.50
years
|
c)
WARRANTS
At
December 31, 2005, the Company had outstanding and exercisable warrants to
purchase an aggregate of 591,138 shares of common stock. The weighted average
remaining life is 3.74 years and the weighted average price per share is
$9.50
per share as follows:
The
status of the warrants as of December 31, 2005, is as follows:
|
WARRANTS
|
WEIGHTED
AVERAGE EXERCISE PRICE
|
|||||||
|
OUTSTANDING,
DECEMBER 31, 2003
|
800,000
|
$ |
1.53
|
|||||
|
Granted
|
622,002
|
$ |
9.38
|
|||||
|
Expired
|
-
|
-
|
||||||
|
Exercised
|
(30,864 | ) | $ |
7.15
|
||||
|
OUTSTANDING,
DECEMBER 31, 2004
|
1,391,138
|
$ |
4.93
|
|||||
|
Granted
|
-
|
-
|
||||||
|
Expired
|
(200,000 | ) | $ |
1.75
|
||||
|
Exercised
|
(600,000 | ) | $ |
1.45
|
||||
|
OUTSTANDING,
DECEMBER 31, 2005
|
591,138
|
$ |
9.5
|
|||||
Following
is the details of warrants outstanding as of December 31, 2005
|
Grant
Date
|
Total
warrants Outstanding
|
Weighted
Average
Remaining
Life (Years)
|
Total
Weighted Average Exercise Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
|
January
15, 2004
|
123,456
|
3.04
|
$7.15
|
123,456
|
$7.15
|
|
November
17, 2004
|
117,682
|
3.88
|
$3.89
|
117,682
|
$3.89
|
|
December
9, 2004
|
350,000
|
3.94
|
$12.21
|
350,000
|
$12.21
|
|
Total
|
591,138
|
3.74
|
$9.50
|
591,138
|
$9.50
|
The
Company believes 330,000 warrants issued in connection with certain acquisition
agreements (Note 2) with the following subsidiaries, Yueshen: 50,000, Cheer
Era:
80,000, Smartime: 50,000, Clickcom: 50,000, and Guangzhou3G:100,000 were
no
longer part of the purchase consideration as more fully described in Note
5 and
therefore are not considered outstanding.
During
2005, 200,000 unexercised warrants (Excel Harbour warrants) expired, and
600,000
warrants were exercised by Sino Mart Management Ltd, a related party, at
an
exercise price of $1.45 per share for total proceeds of $870,000. For the
year
ended December 31, 2004, 30,864 warrants were exercised at an exercise price
of
$7.15 per share for total proceeds of $220,678.
F-29
d)
TREASURY STOCK
The
following is a summary of the movement of the Company's shares held as treasury
stock for the years ended December 31:
|
Number
of shares
|
Remarks
|
|||
|
Balance,
December 31, 2003
|
800,000
|
|||
|
Repurchase
in the open market
|
33,616
|
|||
|
Balance,
December 31, 2004
|
833,616
|
|||
|
Repurchase
in the open market
|
2,000
|
|||
|
Repurchase
of shares from Take1
|
149,459
|
See
note 3 to the F/S
|
||
|
Cancellation
of former employee shares
|
45,000
|
|||
|
Holdback
shares as contingent consideration due to performance targets not
yet
met
|
298,550
|
Including
24,000 shares relating to options exercised but neither money received
nor
shares issued, 196,350 shares to 3G and 78,000 shares to Clickcom,
200
other shares
|
||
|
Share
consideration for acqusition of ChinaGoHi deemed issued under Sale
and
Purchase Agreement
|
(137,500)
|
Due
to share issuance in progress; actual share certificate delivered
after
the year end
|
||
|
Balance,
December 31, 2005
|
1,191,125
|
|||
|
Shares
outstanding at December 31, 2005
|
10,809,562
|
|||
|
Shares
issued at December 31, 2005
|
12,000,687
|
12.
INCOME TAXES
The
Company is registered in the State of Delaware and has operations in primarily
three tax jurisdictions - the PRC, Hong Kong and the United States.
United
States of America
For
operations in the USA, the Company is subject to United States federal income
tax at a rate of 34%. The Company has incurred net accumulated operating
losses
for income tax purposes and there is no provision for U.S. federal income
tax
for 2005 and 2004 due to the Company's loss position. The Company believes
that
it is more likely than not that these net accumulated operating losses will
not
be utilized in the future because the Parent company is a holding company
with
foreign subsidiaries and does not generate income. Therefore, the Company
has
provided full valuation allowance for the deferred tax assets arising from
the
losses as of December 31, 2005 and 2004.
The
following table sets forth the significant components of the deferred tax
assets
for operation in the United States of America as of December 31, 2005 and
2004.
|
2005
|
2004
|
|||||||
|
Deferred
tax asset credit:
|
||||||||
|
Federal
|
34% | 34% | ||||||
|
State
|
6% | 6% | ||||||
|
Valuation
allowance
|
(40)% | (40)% | ||||||
| 0% | 0% | |||||||
The
following is a reconciliation of the provision for income taxes at the U.S.
federal income tax rate to the income taxes reflected in the Statement of
Operations:
|
2005
|
2004
|
|||||||
|
U.S
federal tax rate
|
34% | 34% | ||||||
|
State
tax rate
|
6% | 6% | ||||||
|
Valuation
allowance
|
(40)% | (40)% | ||||||
| 0% | 0% | |||||||
F-30
The
Company generates substantially all of its net income from its Hong Kong
and PRC
operations and the Company has recorded income tax provisions for the years
ended December 31, 2005 and 2004. The tax laws for these jurisdictions are
summarized as follows:
Hong
Kong
Hong
Kong
profits tax has been provided at a rate of 17.5% on the estimated assessable
profits arising in Hong Kong for each of the years ended December 31, 2005
and
2004. Provision for Hong Kong profits tax for 2005 was approximately $40,000
(2004 $36,000).
PEOPLE'S
REPUBLIC OF CHINA (PRC)
Pursuant
to the PRC Income Tax Laws, the Company's subsidiaries and VIEs are generally
subject to Enterprise Income Taxes ("EIT") at a statutory rate of 33%, which
comprises 30% national income tax and 3% local income tax. Some of these
subsidiaries and VIEs are qualified new technology enterprises and under
PRC
Income Tax Laws, they are subject to a preferential tax rate of 15%. In
addition, some of the Company's subsidiaries are Foreign Investment Enterprises
and under PRC Income Tax Laws, they are entitled to either a three-year tax
exemption followed by three years with a 50% reduction in the tax rate,
commencing the first operating year, or a two-year tax exemption followed
by
three years with a 50% reduction in the tax rate, commencing the first
profitable year. Provision for PRC business tax expense for 2005 was $232,000
(2004: $70,000).
No
provision for deferred tax liabilities has been made, since the Company had
no
material temporary differences between the tax bases of assets and liabilities
and their carrying amounts.
13.
RELATED PARTY TRANSACTIONS
Employment
Agreement
The
Company has an employment agreement with its Chief Executive Officer (CEO)
and
President. The employment agreement with the CEO provides for $100,000 cash
compensation plus $60,000 annual share compensation until April 1, 2005.
The CEO
is also eligible for an annual bonus for each fiscal year of the Company
during
the term based on performance standards as the Board or compensation committee
designates. The CEO is entitled to receive a monthly housing allowance of
$2,500, monthly automobile allowance of $500, Tax Preparation expenses of
$2,000
per year, and Cash Bonus based on net profit of the Company. During 2004,
under
the Company’s stock option plan, the CEO was granted an option to acquire 65,000
shares at an exercise price per share of $2.00 (at market price) which has
not
been exercised. During 2004, under the Company’s stock option plan, the
President was granted an option to acquire 73,000 shares at an exercise price
per share of $2.00 (at market price) which has not been exercised.
Lease
Agreement
In
November 2004, the Company entered a lease agreement with EPRO for rental
space
in the amount of $1,923 per month. The term of the lease was one year and
renewable by either party.
LOAN
DUE TO AND FROM RELATED PARTIES
As
at
December 31, 2005 and 2004, there was a total loan receivable of approximately
$2,328,000 and $1,460,000 respectively due from related parties while the
loan
due to related party was $759,000 and $184,000.
As
at
December 31, 2005 the related party loans receivable included $769,000 due
from
Take 1, an affiliated company that is 20% owned by PacificNet Strategic Limited.
The loans receivable from shareholders and directors of PacificNet’s
subsidiaries comprised of $1,559,000 due from a shareholder of Smartim and
Yueshen.
As
at
December 31, 2004, the related party loans receivable included $320,000 due
from
Take 1, an affiliated company that is 20% owned by PacificNet Strategic Limited.
The loans receivable from shareholders and directors of PacificNet’s
subsidiaries comprised of $1,140,000 due from a shareholder of
Yueshen.
F-31
The
terms
of these three related party loans receivable and payable are summarized
below:
LOAN
TO TAKE 1
Please
refer to Note 3 of the Consolidated Financial Statements for detailed discussion
on the change of investment structure of this affiliated company which is
now
20% owned by PacificNet Strategic Limited. As at years ended December 31,
2005
and 2004, there was a Convertible Loan of $769,000 and $320,000 respectively
outstanding from Take 1. The purpose of the Convertible Loan was a working
capital loan to finance the expansion of Take 1’s business in Europe and North
America.
LOAN
TO SMARTIME’S SHAREHOLDER
As
at
December 31, 2005, there was $192,000 loan receivable due from the shareholder
of PacificNet Smartime.
LOAN
TO SHAREHOLDER OF YUESHEN
As
at
December 31, 2005 and 2004, there was an unsecured loan of $1,367,000 and
$1,140,000 respectively due from Ms. Li Yan-Kuan, shareholder of
Yueshen.
LOAN
PAYABLE TO RELATED PARTY
As
at
December 31, 2005, a loan of $513,000 was payable to a shareholder of EPRO.
The
loan was advanced to Epro for working capital purpose expiring by August
4, 2010
at Hong Kong Prime lending rate approximately 6.5% interest per annum prevailing
in the year 2005.
As
at
years ended December 31, 2005 and 2004, a loan of $246,000 and $184,000
respectively was payable to a shareholder of Yueshen.
14.
SEGMENT INFORMATION
SFAS
No.
131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION (“SFAS
131”), establishes standards for reporting information about operating segments
and for related disclosures about products, services and geographic areas.
Operating segments are identified as components of an enterprise about which
separate discrete financial information is available for evaluation by the
chief
operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance. PacificNet’s chief
decision-makers, as defined under SFAS 131, is the Chief Executive Officer
and
Chairman. During 2005 and 2004, PacificNet had four operating
segments.
F-32
The
Company’s reportable segments are operating units, which represent the
operations of the Company’s significant business operations. Summarized
financial information concerning the Company’s reportable segments is shown in
the following table. The “Other” column includes the Company’s other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable
segments.
|
For
the year ended December 31, 2005
(in
thousands of US Dollars, except percentages)
|
Group
1.
Outsourcing
Business
($)
|
Group
2.
Value-Added
Telecom
Business
($)
|
Group
3.
Communication
Products
Distribution
Business
($)
|
Group
4.
Other
Business
($)
|
Total
($)
|
|||||||||||||||
|
Restated
|
Restated
|
Restated
|
Restated
|
Restated
|
||||||||||||||||
|
Revenues
|
13,568
|
13,779
|
2,880
|
859
|
31,086
|
|||||||||||||||
|
(%
of Total Revenues)
|
44% | 44% | 9% | 3% | 100% | |||||||||||||||
|
Earnings
/ (Loss) from Operations
|
686
|
1,274
|
(106) | (6,187) | (4,333) | |||||||||||||||
|
(%
of Total Profit)
|
(16)% | (29)% | 2% | 143% | 100% | |||||||||||||||
|
Total
Assets
|
8,100
|
18,783
|
7,036
|
12,432
|
46,351
|
|||||||||||||||
|
(%
of Total Assets)
|
17% | 41% | 15% | 27% | 100% | |||||||||||||||
|
Goodwill
|
3,964
|
5,165
|
9,129
|
|||||||||||||||||
|
Geographic
Area
|
HK,PRC
|
HK,
PRC
|
HK,PRC,Macau
|
HK,PRC
|
||||||||||||||||
|
For
the year ended December 31, 2004
(in
thousands of US Dollars, except percentages)
|
Group
1.
Outsourcing
Business
($)
|
Group
2.
Value-Added
Telecom
Business
($)
|
Group
3.
Communication
Products
Distribution
Business
($)
|
Group
4.
Other
Business
($)
|
Total
($)
|
|||||||||||||||
|
Restated
|
Restated
|
Restated
|
Restated
|
Restated
|
||||||||||||||||
|
Revenues
|
9,821
|
6,084
|
849
|
188
|
16,942
|
|||||||||||||||
|
(%
of Total Revenues)
|
58% | 36% | 5% | 1% | 100% | |||||||||||||||
|
Earnings
/ (Loss) from Operations
|
862
|
1,655
|
(287) | (6,818) | (4,588) | |||||||||||||||
|
(%
of Total Profit)
|
(19%) | (36%) | 6% | 149% | 100% | |||||||||||||||
|
Total
Assets
|
4,671
|
3,684
|
6,725
|
14,917
|
29,997
|
|||||||||||||||
|
(%
of Total Assets)
|
16% | 12% | 22% | 50% | 100% | |||||||||||||||
|
Goodwill
|
3,964
|
3,672
|
7,636
|
|||||||||||||||||
|
Geographic
Area
|
HK,PRC
|
HK,
PRC
|
HK,PRC,Macau
|
HK,PRC
|
||||||||||||||||
The
Company identifies and classifies its operating segments based on reporting
entities that exhibit similar long-term financial performance based on the
nature of the products and services with similar economic characteristics
such
as margins, business practices and target market. The operating segments
are
classified into four major segments which are summarized as
follows:
(1)
Outsourcing Services – involves human voice services such as Business Process
Outsourcing, CRM, call center, IT Outsourcing and software development services.
These types of services are conducted through our subsidiaries EPRO,
Smartime/Soluteck and PacificNet Solution Ltd.
(2)
Value-Added Telecom Ser vices (VAS) – primarily involves machine voice services
such as Interactive Voice Response, SMS and related VAS, which are conducted
through our subsidiaries such as ChinaGoHi, Linkhead, Clickcom and Guangzhou
3G/Sunroom. For example, Linkhead is a master reseller of NMS hardware and
software platforms in China, and its voice cards are used as an integral
part of
voice hardware using CPCI industry control machines, and also by Media Servers
to support access from PSTN and VoIP, softswitch and 3G networks.
F-33
(3)
Communication and Gaming Products Group – primarily involves voice products
distribution such as distribution of calling cards and Gaming products. These
calling cards differ from the phone cards in the VAS business as these cards
are
geared towards the end user, and include prepaid calling cards, IDD long
distance calling cards, internet access cards, bundled cross-selling insurance
cards, and shopping discount cards.
(4)
Other
Business –other administrative, financial and investment services and non-core
businesses such as PacificNet Power Limited (PacPower), Pacific Financial
Services Limited, PacificNet Games, etc.
Product
and service revenues classified by major geographic areas are as follows
(in
thousands):
|
For
the year ended December 31, 2005
|
Hong
Kong
|
PRC
|
Macau
|
United
States
|
Total
|
|
Product
revenues-Restated
|
3,216
|
6,788
|
10,004
|
||
|
Service
revenues-Restated
|
10,413
|
10,669
|
21,082
|
|
For
the year ended December 31, 2004
|
Hong
Kong
|
PRC
|
Macau
|
United
States
|
Total
|
|
Product
revenues-Restated
|
849
|
6,085
|
6,933
|
||
|
Service
revenues-Restated
|
9,168
|
841
|
10,008
|
15.
EVENTS SUBSEQUENT TO DECEMBER 31, 2005 (UNAUDITED)
1) SALE
OF CONVERTIBLE DEBENTURES
On
March
13, 2006, the Registrant consummated a private offering of $8,000,000 principal
amount variable debentures due March 2009 (the Debentures) at an initial
fixed
conversion price of $10.00, and warrants to purchase up to 400,000 shares
of the
Registrants common stock exercisable for a period of 5 years at an exercise
price of $12.20 per share (the Warrants) with several institutional investors,
which included Whalehaven Capital Fund Limited, DKR Soundshore Oasis Holding
Fund Ltd., Basso Fund Ltd., Basso Multi-Strategy Holding Fund Ltd., Basso
Private Opportunities Holding Fund Ltd., Iroquois Master Fund Ltd., C.E.
Unterberg, Towbin Capital Partners I, LP and Alpha Capital AG. C.E. Unterberg,
Towbin advised the Registrant and acted as lead placement agent.
The
Registrant has agreed to file a registration statement covering the resale
of
the shares underlying the Debentures and the Warrants under the Securities
Act
of 1933, as amended, on the earlier of (i) April 30, 2006, or (ii) the 30th
calendar day following the date the Registrant files its Form 10-KSB with
the
Securities and Exchange Commission.
The
Debentures and Warrants were sold in a transaction not involving a public
offering and were issued without registration in reliance upon the exemption
from registration afforded by Section 4(2) of the Securities Act of 1933,
as
amended and Regulation D promulgated there under.
Under
the
terms of a registration rights agreement entered into at the time of the
private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April
30,
2006, and have the registration statement declared effective by the SEC no
later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to the investors
at the rate of 2% of the principal amount of the debenture each month beginning
on June 28, 2006 until the effectiveness of the registration statement, which
was equal to $1,120,000, in the aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of accrued
liquidated damages, the Company signed a Settlement and Release Agreement
with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding
Fund
Ltd. and Basso Private Opportunities Holding Fund Ltd. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
in cash, with the remaining liquidated damages in the amount of $105,000
paid in
the form of a new convertible debenture due February 2009, on substantially
the
same terms as the original debentures, except that interest only is paid
on the
new debentures until October 2008 and beginning in November 2008 until February
2009, when the new debentures are due, the monthly redemption amount under
the
new debentures shall be equal to $315,000. The remaining investors also agreed
to accept the aggregate $840,000 in liquidated damages owed to them in the
form
of the new convertible debentures for the amount of their respective portion
of
the liquidated damages. The Company also agreed to amend the original debentures
to shorten the term for payment of the original principal amount to a 22
month
term. As a result the monthly redemption amount for the original debenture
increased from $320,000 to $ 363,638. All other terms and conditions of the
original debenture remains in full force and effect.
F-34
EVENT
OF
DEFAULT
On
March
16, 2007 the predecessor auditor withdrew their opinion on our previously
filed
financial statements for the years ended December 31, 2005, December 31,
2004
and December 31, 2003. As a result, on March 27, 2007, we notified the holders
of the outstanding convertible debenture that we suspended use of the prospectus
contained in our Registration Statement on Form S-1 (File No. 333-134127)
that
was declared effective on December 8, 2006, due to the lack of fiscal year
end
2005 and 2004 audited financial statements and that they must cease selling
under the prospectus. The suspension of the use of the prospectus after April
17, 2007, triggered an event of default under the registration rights agreement
and the convertible debentures, and if any of the holders so elect, they
could
accelerate and demand payment under the debentures, in accordance with the
registration rights agreement.
2) SALE
OF CONVERTIBLE DEBENTURES BY OUR SUBSIDIARY PACIFICNET GAMES
LIMITED
On
February 9, 2007, the Company through its subsidiary, PacificNet Games Limited
(PacGames) entered into a definitive agreement for a $5 million financing
in the
form of a convertible secured note from Pope Asset Management, LLC (Pope),
an
institutional investor. Proceeds from the financing will be used to provide
PacGames with additional working capital to expand its gaming technology
operations, to make further synergistic acquisitions in China and for general
corporate purposes.
The
$5
million financing, evidenced by a convertible secured note issued by PacGames
to
Pope, matures on February 6, 2010, and may be converted into 26% to 32%
ownership interest in PacGames based on reaching certain net income milestones
during fiscal year 2007. The interest rate on the convertible debenture isl
initially set at 8%, and shall increase to 15% if the note is not
converted prior to maturity.
3) SALE
OF GUANGZHOU YUESHEN TAIYANG NETWORK SCIENCE AND TECHNOLOGY LIMITED
(“Yueshen”)
Operations
of Yuenshen were discontinued during the year. Accordingly, the Company had
recorded a charge to loss on disposal of $0.5 million at December 31, 2006.On
12
August, 2006, to recover the loan advanced to Yueshen, we commenced a law
suit
in the High Court of the Hong Kong Special Administrative Region ("HKSAR")
against i) Guangzhou Yueshen Taiyang Network Science and Technology Limited
as
borrower and both ii) Ms. Li Yan Kuan and iii) Mr. Yi Wen as guarantors for
the
loan sum of RMB 2,000,000 ("Debt Sum") together with the agreed interest
rate
calculated at 6% per annum all due on 15 November, 2005 according to the
promissory note and guarantee entered into by the three defendants on 15
May,
2005.
4) SALE
OF GUANGZHOU CLICKOM DIGIT-NET
SCIENCE AND TECHNOLOGY LTD. (“Clickcom”)
Operations
of Clickcom were discontinued and became dormant during the year as a result
of
poor business and market prospects. Former staffs of Clickcom have been
reassigned to MOABC. Nominal amount of fixed assets are subject to disposition.
Accordingly, Clickcom has been classified as Asset Held for Disposition in
2006.
5) SALE
OF CHINAGOHAI (“Lion Zone”)
On
November 20, 2006, PacificNet executed an agreement ("Termination Agreement")
to
terminate the Sale and Purchase Agreement with Lion Zone, ChinaGoHi and Mr.
Wang
Wenming (collectively, the "Sellers"). The Termination Agreement was effective
as of November 1, 2006. In the Termination Agreement, the Sellers agreed
to pay
an aggregate of HKD$3,000,000, comprising: USD$100,000 in cash and 275,000
in
restricted shares of PACT, in exchange for 51% interest of Lion Zone, holding
company of ChinaGoHi. Additionally, the Sellers agreed to waive PacificNet's
obligations under the Sale and Purchase Agreement entered into between
PacificNet and the Sellers in December 2005 to issue restricted shares and
to
provide certain loans to the Sellers. PacificNet, however, reserves the rights
to re-purchase the said 51% interest of Lion Zone within 2 years of the date
of
signing the Termination Agreement for a consideration of 5 times audited
net
profit under US GAAP for the 12-month period subsequent to the year of
signing.
6) SALE
OF BEIJING LINKHEAD TECHNOLOGIES COMPANY LIMITED (“Linkhead”)
Due
to
bleak industry prospects, board of directors of Linkhead had resolved a special
board resolution in January 2007 to direct management to engage in active
search
for willing buyers to acquire or prepare to enter into liquidation process.
Accordingly, Linkhead has been classified as Asset Held for Disposition in
2006.
Approximately $4 million of goodwill carried for Linkhead has been charged
to
impairment by the Company at the year end of 2006.
F-35
7) SALE
OF GUANGZHOU 3G (“GZ3G”)
As
part
of our strategy to move away from telecom VAS, on April 30,2007 our wholly-owned
subsidiary, PacificNet Strategic Investment Holdings Limited, entered into
a
stock purchase and sale agreement with Heyspace International Limited to
sell
its 51% interest in Guangzhou 3G's parent company, Pacific 3G Information
&
Technology Co. Limited. The purchase price is $6,000,000 payable in installments
over a six month period or earlier if Heyspace completes its initial public
offering prior to October 31, 2007.
8)
SALE OF PACIFICNET TELECOM SOLUTIONS INC. ("PacTelso")
On
May
20, 2007, the Company entered into a definitive agreement to sell its 36%
equity
interest in PacTelso, an intermediate holding company registered under the
laws
of British Virgin Islands, to Mr. Mu Yingliang, a resident of People’s Republic
of China. Consideration for the 36% interest of PacTelso was RMB10,000 (or
US$1,295), to be paid within 90 days after signing of the agreement The
Company’s interest in PacTelso decreased from 51% to 15% after the
transaction.
9)
SALE OF PACIFICNET SOLUTIONS LIMITED ("PacSo")
On
May
18, 2007, the Company entered into a definitive agreement to sell its 45%
equity
interest in PacSo, a company registered under the laws of Hong Kong SAR,
China
and engaged in systems integration, software application, and e-business
solutions services, to Mr. Alex Au, a resident of Hong Kong SAR, China.
Consideration for the 45% interest of PacSo was HK$4,500 (or US$583), to
be paid
within 90 days after signing of the agreement. The Company’s interest in PacSo
decreased from 60% to 15% after the transaction.
10)
SALE OF PACIFICNET POWER LIMITED ("PacPower")
On
May
18, 2007, the Company entered into a definitive agreement to sell its 36%
equity
interest in PacPower, a company registered under the laws of Hong Kong SAR,
China and engaged in air-conditioning contracting and consulting businesses,
to
Mr. Alex Au, a resident of Hong Kong SAR, China. Consideration for the 36%
interest of PacPower was HK$3,600 (or US$466), to be paid within 90 days
after
signing of the agreement. The Company’s interest in PacPower decreased from 51%
to 15% after the transaction.
11)
SALE OF MOABC.com ("MOABC")
On
May
20, 2007, the Company entered into a definitive agreement to sell its 5%
equity
interest in MOABC, a PRC limited liability corporation engaged in the business
of value-added services platform providing, to Mr. Jack Ou, a resident of
People’s Republic of China. Consideration for the 5% interest of MOABC was
RMB5,000 (or US$647), to be paid within 90 days after signing of the agreement.
The Company’s interest in MOABC decreased from 20% to 15% after the
transaction.
12)
ACQUISITION OF PACIFICNET IMOBILE (BEIJING) TECHNOLOGY CO.LTD
("IMOBILE")
On
February 26, 2006, entered into an agreement to acquire a 51% majority interest
in PacificNet iMobile (Beijing) Technology Co., Ltd ("iMobile"), one of the
leading Internet information portal and e-commerce distributors for mobile
phone
a and accessories and mobile related value-added service providers in China.
iMobile operates its e-commerce business via two Internet portals,
"http://www.iMobile.com.cn" and "http://www.18900.com" and one WAP portal
"17wap.com" for mobile phone browsing. In addition, iMobile's 18900.com
operation is the designated Internet distributor for Motorola, Nokia, and
NEC's
mobile products in China.
The
purchase consideration for 51% of the equity interest of iMobile is
approximately US$1.8 million, which represents approximately seven times
the
anticipated future annual net income of iMobile. The purchase consideration
is
payable 14% in cash and 86% in restricted shares of PacificNet valued at
$8 per
share, or about 191,875 restricted shares. Under the purchase agreement,
iMobile
has committed to generate US$500,000 in annual net income. In the event of
a
shortfall, the purchase price will be adjusted accordingly. PacificNet will
also
invest approximately RMB2 million (about US$250,000) in iMobile for general
corporate and working capital purposes to support growth. The purchase price
is
payable upon achievement of certain quarterly earn-out targets based on net
income.
13)
ACQUISITION OF GUANGZHOU WANRONG INFORMATION TECHNOLOGY CO.LTD (GUANGZHOU
WANRONG)
On
Jan
31, 2006, the Company, through its subsidiary PacificNet Strategic Investment
Holdings Limited, consummated the acquisition of a 51% controlling interest
in
Guangzhou Wanrong Information Technology Co. Limited (Guangzhou Wanrong),
one of
the leading value-added telecom service providers in China, located in PRC
Guangzhou, The purchase consideration for 51% of the equity interest of
Guangzhou Wanrong was approximately US$1.75million, payable 21% in cash and
79%
in restricted shares of PacificNet common stock valued at $8 per share, or
about
173,000 restricted shares. Under the purchase agreement, Guangzhou Wanrong
has
made a guarantee to generate US$500,000 in annual net income. In the event of a
shortfall, the purchase price will be adjusted accordingly. PacificNet will
also
invest approximately RMB 3 million (or about US$370,000) in Guangzhou Wanrong
for general corporate purposes. The purchase price is payable upon achievement
of certain quarterly earn-out targets based on net income.
F-36
14) ACQUISITION
OF PACIFICNET GAMES LIMITED (PACGAMES)
On
August
3, 2006, PacificNet’s wholly owned subsidiary PacificNet Games Limited
(“PacGames”, [_____________]) completed the acquisition of 100% of Able
Entertainment Technology Ltd., a leading gaming technology provider based
in the
Macau Special Administrative Region of China. Upon completion of this
transaction, the Company owned 35% of PacificNet Games Limited. Under the
purchase agreement, Able Entertainment Technology Ltd represented that is
expects to generate an annual profit of USD $1,600,000 and will provide for
an
adjustment to the purchase price if PacGames does not achieve an annual net
profit of USD $1,600,000 during the first 12-month period ended June 30,
2007,
and USD $3,000,000 during the second 12-month period ended June 30,
2008.
The
purchase price consideration is 200,000 restricted PACT shares in exchange
for
100% of the issued and outstanding shares of Able Entertainment Technology
Ltd.
or a 35% ownership interest in PacGames. As of December 31, 2006, 40,000
total
restricted shares of PacificNet had been issued for the acquisition and 160,000
shares were held back as contingent consideration payable upon completion
of
certain earnings criteria pursuant to the purchase agreement.
On
September 22, 2006, PACT acquired another 10% of PacGames in exchange for
57,100
restricted shares of the Company’s common stock. Those shares have been issued
out according to sale and purchase agreement.
On
November 9, 2006, we acquired an additional 6% interest in PacificNet Games
Limited (PacGames) for a consideration of $504,000 (paid entirely with shares
of
PacificNet: 90,000 PACT Shares, valued at $5.60 per share, price on the day
of
transaction). Those shares have been issued out according to sale and purchase
agreement. The company currently owns 51% of PacGames.
15) ACQUISITION
OF TAKE1 TECHNOLOGIES LIMITED (“TAKE1”)
On
January 05, 2007, we entered into an agreement for PacificNet to exercise
the
option to acquire an additional 31% interest in Take1 Technologies Limited
(“Take1”) (formerly known as “CHEER ERA LIMITED”). The completion date for the
new Securities Subscription Agreement was March 5, 2007, with a consideration
of
$721,887 (paid entirely with shares of PacificNet: 149,459 PACT Shares, valued
at $4.83 per share). As a result, PacificNet has become the majority and
controlling shareholder of Take1 with our ownership percentage increased
from
20% to 51%.
16)
LEGAL PROCEEDINGS
1.
Legal Proceeding and Judgment Against Guangzhou Yueshen Taiyang Network Science
and Technology Limited, Ms. Li Yan Kuan, and Mr.Wu Yi
Wen
On
August
12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
Science and Technology Limited, Ms. Li Yan Kuan, (PRC ID:
440112195706120967, Residential Address: Room G6-305, West Garden,
FuLiHuanShi, HuanShi West Road, LiWan District, Guangzhou, Guangdong,
China) and Mr.Wu Yi Wen, (PRC ID: 440106196412220919, Residential
Address: Room 906, Number 15, SiHeng Road Number 2, TianHe YuanChun, Guangzhou,
Guangdong, China) for failure to pay amounts owed under a promissory
note. On May 15, 2005, we loaned RMB2,000,000 ("Debt Sum") to Yueshen
to cover operating costs, evidenced by a promissory note due on November
15,
2005. Ms. Kuan and Mr. Wen guaranteed repayment of the note by
Yueshen. The Debt Sum together with the agreed interest rate
calculated at 6% per annum was due on November 15, 2005.
On
March
28, 2007, the High Court of HKSAR had adjudged that the three defendants
should
pay us the Debt Sum together with interest sum at the rate of 6% per annum
from May 15, 2005 to March 28, 2007, and additional
interest charged at the rate of 5% per annum for the Debt Sum and accrued
interest within 90 days overdue and thereafter at the judgment rate until
payment and fixed costs of HK$3,405.
2.
Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
(JCHKL), a subsidiary of Johnson Controls Inc. (NYSE:JCI)
(www.jci.com )
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
Court of the Hong Kong Special Administrative Region seeking HK$4,800,000
as
payment for services rendered to replace 3 sets of trane water-cooled chillers,
together with energy saving performance (the "Chiller System"), at the Fortress
Tower in Hong Kong.
F-37
In
connection with the claim, PacificNet Power reviewed a letter from its client,
China Weal Property Management Ltd., dated January 22, 2007 stating that
the
construction work by JCHKL had not been completed as of the date of the letter,
and that certain violations itemized in a letter issued by the Hong
Kong Environment Protection Department (EPD) (Noise Abatement Notice
No. N806030) addressed to JCHKL with respect to acoustic problems with JCHKL’s
equipment had not been abated. Further, JCHKL was to pay penalties
between HK$100,000 and HK$200,000 assessed by the JCHKL for failing to fix
the
noise problem on the roof of Fortress Tower.
The
board
of directors of PacificNet Power Limited has reviewed the case with its client,
China Weal Property Management Ltd., and our Hong Kong legal counsel and
it is
our belief that the project work undertaken JCHKL is defective in numerous
aspects, as evidenced by the letter from government letter issued by
EPD. As a result, we believe the construction work was not been
completed by JCHKL, and therefore, JCHKL is not entitled to payment for its
services.
On
February 7, 2007, we instructed our Hong Kong legal counsel to issue a Defense
and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's construction
work
has not complied with the applicable rules and regulations of various government
authorities in Hong Kong; (ii) the Chiller System provided by JCHKL was
defective and merchantable unfit and JCHKL has failed and/or refused to rectify
such defective works; and (iii) JCHKL shall return the work deposit in the
amount of HK$1,500,000 to PacificNet Power Limited and shall
compensate and keep PacificNet Power Limited indemnified against all the
loss
and damages suffered as a result of any claims from the China Weal Property
Management Ltd, the employer and the potential tenants of Fortress
Tower.
The
case
is under review by Hong Kong High Court and we have not received any judgment
from the High Court of the Hong Kong Special Administrative Region as of
date of
this report. We are currently proceeding with discovery and counter-claims,
and
we intend to vigorously defend ourselves against the allegations. We are
unable
to predict the outcome of these actions, or a reasonable estimate of the
range
of possible loss, if any.
3.
Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
(JCHKL), a subsidiary of Johnson Controls Inc. (NYSE:JCI) (www.jci.com
)
On
or
about December, 2005, Johnson Controls Hong Kong Limited approached PacificNet
Power Limited (a 51% owned subsidiary of PacificNet) and made a representation
that they had submitted a tender to “The Incorporated Owners of Nan Fung Centre,
Tsuen Wan (“the Employer”) for the “construction and replacement works of
existing air-cooled chiller plant by new water-cooled chiller plant for Tsuen
Wan Nan Fung Centre and energy saving performance contract” (“the Construction
and Replacement Works Contract”). JCHKL invited and induced PacificNet Power
Limited to act as the main contractor for the Contract and it would then
act as
a sub-contractor.
PacificNet
Power also expressly made known to JCHKL that the said construction and
replacement works and the guaranteed energy saving should meet all the tender
requirements if PacificNet Power accepted the invitation to act as the main
contractor for the Contract, and PacificNet Power further said that if there
should be any quality defects with the system and/ or the construction work,
the
Employer and/ or their prospective tenants would claim against JCHKL and
JCHKL
should compensate.
PacificNet
Power however received some correspondences and complaints from the Employer
and/ or their representatives about the poor and/ or sub-standard works done
by
JCHKL. PacificNet Power, after separate investigation, discovered the poor
workmanship and sub-standard works done by JCHKL. Accordingly, the Employer
and/
or their representatives have delayed the monthly installments payment to
PacificNet Power.
On
April
23, 2007, we instructed our lawyers issued a letter to the Defendant requesting
and demanding them, being the sub-contractor of the Construction and Replacement
Works Contract, to take immediate rectification action within seven days
from
the date of the said letter to (i) rectify and complete all outstanding
defective works of the Construction and Replacement Works Contract; (ii)
replace
the water-cooled chiller plant and/or equipments which are not conformed
with
the requirements of the tender documents previously submitted by the Defendant
to the Employer; and (iii) improve the poor performance of energy saving
of the
new water-cooled chiller plant so that it would conform with their guarantee
made on 21 December, 2005 to PKL and the employer.
Despite
the said letter, JCHKL had failed and/ or refused to rectify and complete
all
outstanding works and/ or replace the defective system. And therefore PacificNet
Power claims against JCHKL for: (i) refund HK$6,414,300.00, being the Contract
Price paid by PacificNet Power to JCHKL; (ii) costs and expenses incurred
by
Power to rectify all defective works of the Contract; (iii) all damage and
loss
suffered by PacificNet Power, and further and other relief.
On
July
25, 2007, JCHKL issued a Defense and Counterclaim to PacificNet Power to
counter-claim that: (i) a concrete base was discovered after the existing
dismantled radiators was not indicated in tender drawings nor could it be
revealed by site visit; (ii) JCHKL could not have carried out the works under
the Contract without first demolishing the said concrete base; (iii) by a
letter
from JCHKL to PacificNet Power dated 22 May, 2007, PacificNet Power was informed
additional works had been carried out by JCHKL; (iv) a sum of HK$30,000 is
still
due and owing by PacificNet Power to JCHKL.
The
case
is now proceeding to the stage of fixing a date for trial in the High Court
of
Hong Kong. We are unable to predict the outcome of these actions, or a
reasonable estimate of the range of possible loss, if any.
F-38
4.
PacificNet Inc., v/s Iroquois Master Fund, Ltd.
On
October 3, 2007 Iroquois Master Fund, Ltd. filed a complaint in the Supreme
Court of the State of New York against PacificNet Inc., complaining against
non-payment of mandatory default amount on convertible debentures of $3,000,000
and $420,000.
As
of
October 2, 2007, the outstanding principal amount of the $3,000,000 debenture
is
$2,045,452 and accrued but unpaid interest amount is $30,682.
The
mandatory default amount due to Iroquois Master Fund, Ltd. pursuant to amended
debenture (as amended in February 2007) is $2,698,974 on $3,000,000 convertible
debenture.
As
of
October 2, 2007, the outstanding principal amount of the $420,000 debenture
is
$420,000 and accrued but unpaid interest amount is $6,300.
The
mandatory default amount due to Iroquois Master Fund, Ltd. is $554,190 on
$420,000 convertible debenture.
Iroquois
Master Fund, Ltd. also demanded for the reimbursement of its attorney fees
and
other costs and expenses incurred together with costs and disbursements of
this
action and such other and further relief as to the court seems just and
proper.
16.
RESTATEMENT
On
March
19, 2007 the predecessor auditor withdrew their opinion on our previously
filed
financial statements for the years ended December 31, 2005 and 2004 due to
uncertainties around certain option grants during the said
period. Independent investigation in this connection commissioned by
our Audit Committee resulted in extra stock-based compensation charges of
approximately $0.3 million, $1.2 million and $0.1 million to each of the
years
ended December 31, 2005, 2004 and 2003, respectively,. The Company determined
that its allowance for bad debts on the accounts receivable was understated
by
$3.5 Million and $0.28 million in the years ended December 31, 2005 and 2006,
respectively. The Company also restated impairment of goodwill for certain
subsidiaries ($3.7 million and $2.6 million in the years ended December 31,
2005
and 2004, respectively) and accrued certain 2005 bonus payable in 2006 amounting
to $600,000. Also, the Company concluded that the consolidation of
certain entity (Yueshen) was wrongly reflected as the Company did not have
control over the management of the entity.
Below
is
the detailed effect of the restatement:
|
(In
thousands of US Dollars)
|
2005
As
reported
|
2005
As
restated
|
2004
As
reported
|
2004
As
reported
|
||||||||||||
|
Consolidated
Balance Sheets:
|
||||||||||||||||
|
ASSETS:
|
||||||||||||||||
|
Current
assets
|
$ |
31,130
|
$ |
28,784
|
$ |
21,531
|
$ |
19,707
|
||||||||
|
Non-current
assets
|
20,073
|
14,212
|
11,719
|
10,290
|
||||||||||||
|
Total
assets
|
$ |
51,203
|
$ |
42,996
|
$ |
33,250
|
$ |
29,997
|
||||||||
|
LIABILITIES
|
||||||||||||||||
|
Current
liabilities
|
$ |
10,620
|
$ |
11,675
|
$ |
5,346
|
$ |
4,061
|
||||||||
|
Non-current
liabilities
|
84
|
84
|
198
|
180
|
||||||||||||
|
Total
liabilities
|
10,704
|
11,759
|
5,544
|
4,241
|
||||||||||||
|
STOCKHOLDERS' EQUITY
|
||||||||||||||||
|
Additional
paid-in capital
|
$ |
57,690
|
$ |
61,979
|
$ |
53,916
|
$ |
57,730
|
||||||||
|
Accumulated
deficit
|
(25,990 | ) | (38,627 | ) | (28,479 | ) | (33,482 | ) | ||||||||
|
TOTAL
STOCKHOLDERS' EQUITY
|
31,785
|
23,204
|
25,310
|
24,108
|
||||||||||||
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$ |
51,203
|
$ |
42,996
|
$ |
33,250
|
$ |
29,997
|
||||||||
|
Consolidated
Statements of Operations:
|
||||||||||||||||
|
Net
revenue
|
$ |
44,341
|
$ |
31,086
|
$ |
29,709
|
$ |
16,942
|
||||||||
|
Cost
of sales
|
(33,439 | ) | (20,678 | ) | (24,704 | ) | (12,286 | ) | ||||||||
|
Gross
profit
|
10,902
|
10,408
|
5,635
|
4,656
|
||||||||||||
|
Selling,
General and Administrative expenses
|
(6,333 | ) | (10,419 | ) | (3,698 | ) | (5,267 | ) | ||||||||
|
Stock-based
compensation expenses
|
-
|
(282 | ) |
-
|
-1,246
|
|||||||||||
|
Income/(loss)
from operations
|
4,569
|
(4,333 | ) |
1,937
|
(4,588 | ) | ||||||||||
|
Income/(loss)
before income taxes, minority interest and discontinued
operations
|
5,645
|
(3,596 | ) |
2,438
|
(4,135 | ) | ||||||||||
|
Income/(loss)
before discontinued operations
|
2,498
|
(5,145 | ) |
817
|
(5,425 | ) | ||||||||||
|
Net
income available to common stockholders
|
$ |
2,489
|
$ | (5,145 | ) | $ |
774
|
$ | (5,425 | ) | ||||||
|
Earnings/(loss)
per common share:
|
||||||||||||||||
|
Basic
|
$ |
0.25
|
$ | (0.51 | ) | $ |
0.11
|
$ | (0.78 | ) | ||||||
|
Diluted
|
$ |
0.23
|
$ | (0.51 | ) | $ |
0.09
|
$ | (0.78 | ) | ||||||
|
Shares
used in computing earnings per share:
|
||||||||||||||||
|
Basic
|
10,154,271
|
10,156,809
|
7,268,374
|
7,015,907
|
||||||||||||
|
Diluted
|
10,701,211
|
10,156,809
|
8,241,996
|
7,015,907
|
||||||||||||
|
Consolidated
Statements of Cash Flows
|
||||||||||||||||
|
Net
income (loss)
|
$ |
2,489
|
$ | (5,145 | ) | $ |
774
|
$ | (5,425 | ) | ||||||
|
Stock-based
compensation
|
-
|
282
|
-
|
1,246
|
||||||||||||
|
Net
cash provided by (used in) operating activities
|
9,250
|
11,843
|
(4,431 | ) | (2,757 | ) | ||||||||||
|
Net
cash used in investing activities
|
(6,199 | ) | (9,799 | ) | (4,265 | ) | (1,611 | ) | ||||||||
|
Net
cash provided by (used in) financing activities
|
24
|
(946 | ) |
11,620
|
10,077
|
|||||||||||
|
Effect
of exchange rate on cash & cash equivalent
|
(260 | ) |
7
|
17
|
2
|
|||||||||||
|
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
$ |
2,815
|
$ |
1,105
|
$ |
2,941
|
$ |
5,711
|
||||||||
F-39