U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
/X/QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE PERIOD ENDED JUNE 30, 2004
/ /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 small business issuer in its charter)
DELAWARE 91-2118007
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
UNIT 2710, HONG KONG PLAZA, N/A
188 CONNAUGHT ROAD WEST, (Zip Code)
HONG KONG
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER: 011-852-2876-2900
--------------------------------------------------------------------------------
(Former Name and Address)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 / /
There were 7,036,168 shares of the Company's common stock outstanding on August
11, 2004.
TABLE OF CONTENTS
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PAGE
----
PART I - FINANCIAL INFORMATION.................................................2
ITEM 1. FINANCIAL
STATEMENTS...................................................2
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............. 13
ITEM 3. CONTROLS AND PROCEDURES.....................................18
PART II - OTHER INFORMATION...................................................19
ITEM 1. LEGAL PROCEEDINGS...........................................19
ITEM 2. CHANGES IN SECURITIES AND ISSUER PURCHASES
OF EQUITY SECURITIES........................................19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.............................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.....................................................19
ITEM 5. OTHER INFORMATION...........................................19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................20
i
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except par values and share numbers)
DECEMBER 31,
JUNE 30, 2003
2004 (AUDITED)
--------- ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 3,201 $ 3,823
Restricted cash - pledged bank deposit 212 212
Accounts Receivables (net of allowance
for doubtful accounts of $0 as of
June 30, 2004 and $0 as of December 31, 2003 3,709 1,890
Inventories 1,051 76
Other Current Assets 1,273 286
--------- ---------
Total Current Assets 9,446 6,287
Property and Equipment, net 604 466
Goodwill 6,108 420
Investment - at equity 518 --
--------- ---------
TOTAL ASSETS $ 16,676 $ 7,173
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank Line of Credit $ 190 $ 1,199
Bank Loans - current portion 1,485 1,405
Capital Lease Obligations - current portion 61 152
Accounts Payable 1,892 1,007
Accrued Expenses 597 360
Subscription Payable -- 722
--------- ---------
Total Current Liabilities 4,225 4,845
--------- ---------
Long-term liabilities:
Bank Loans - non current portion 384 377
Capital Lease Obligations - non current portion 147 149
Shareholders' Loan 116 --
--------- ---------
Total Long-Term Liabilities 647 526
--------- ---------
Minority Interest in Consolidated Subsidiaries 1,093 (110)
2
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:
June 30, 2004 - 8,370,762 issued; 7,036,168
outstanding
December 31, 2003 -
6,163,977 issued; 5,363,977
outstanding 1 1
Treasury Stock, at cost
June 30, 2004 - 834,594 shares;
December 31, 2003 - 800,000 shares (101) (5)
Additional Paid-In Capital 40,493 31,790
Cumulative Other Comprehensive Loss (24) (24)
Accumulated Deficit (29,658) (29,850)
--------- ---------
Total Stockholders' Equity 10,711 1,912
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,676 $ 7,173
========= =========
See condensed notes to consolidated financial statements.
3
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited. In thousands of United States dollars, except
profit/(loss) per share and share amounts)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Revenues $ 8,084 $ 123 $ 11,586 $ 220
--------- --------- --------- ---------
Cost of Revenues (6,789) (47) (9,042) (83)
--------- --------- --------- ---------
Gross Margin 1,295 76 2,544 137
Selling, General and Administrative expenses (875) (321) (1,652) (740)
Depreciation and amortization (73) (2) (140) (3)
Provision for written off of fixed assets -- -- -- (91)
--------- --------- --------- ---------
PROFIT/(LOSS) FROM OPERATIONS 347 (247) 752 (697)
Interest Income 7 8 10 15
Sundry income 3 -- 64 --
Equity earnings in undistributed earnings
of investee company 17 -- 17 --
--------- --------- --------- ---------
PROFIT/(LOSS) BEFORE INCOME TAXES, MINORITY
INTEREST AND DISCONTINUED OPERATIONS 374 (239) 843 (682)
Provision for income taxes -- -- -- --
Minority Interest (323) 7 (651) 21
--------- --------- --------- ---------
PROFIT/(LOSS) BEFORE DISCONTINUED OPERATIONS 51 (232) 192 (661)
--------- --------- --------- ---------
LOSS FROM DISCONTINUED OPERATIONS -- -- -- (185)
NET PROFIT/(LOSS) AVAILABLE TO COMMON
STOCKHOLDERS $ 51 $ (232) $ 192 $ (846)
========= ========= ========= =========
4
BASIC AND DILUTED PROFIT/(LOSS) PER COMMON
SHARE:
Profit/(Loss) from continuing operations $ 0.01 $ (0.04) $ 0.03 $ (0.13)
Profit/(Loss) from discontinued operations $ -- $ -- $ -- $ (0.04)
--------- --------- --------- ---------
Net Profit/(Loss) $ 0.01 $ (0.04) $ 0.03 $ (0.17)
========= ========= ========= =========
See condensed notes to consolidated financial statements.
5
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars, except loss per share and share amounts)
SIX MONTHS ENDED JUNE 30,
-------------------------
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net profit/(loss) $ 192 $ (846)
Adjustment to reconcile net profit/(loss)
to net cash used in operating activities:
Expenses settled by issuance of warrants -- 15
Expenses settled by issuance of common shares -- 12
Equity earnings of investee company (17) --
Provision for written off of fixed assets -- 91
Loss from discontinued operations -- 185
Minority Interest 1,203 (20)
Depreciation and amortization 140 1
Accounts receivable and other current assets (2,804) 94
Inventories (975) --
Accounts payable and accrued expenses 1,122 (67)
-------- --------
Net cash used in operating activities (1,139) (535)
-------- --------
CASH FLOWS FROM INVESTMENT ACTIVITIES
Acquisition of property and equipment (278) --
Acquisition of subsidiaries (1,160) --
Acquisition of investee company (385) --
-------- --------
Net cash used in investing activities (1,823) --
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
(Repayments)/advances under bank line of credit (1,009) 305
Repayment of amount borrowed under bank loans
and capital lease obligations (1,919) --
Proceeds from sale of common stock 2,813 --
Post acquisition of share capital - subsidiaries 564 --
Repurchase of treasury shares (96) --
Proceeds from exercise of stock options 74 210
Advances under bank loans 1,913 --
-------- --------
Net cash provided by financing activities 2,340 515
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (622) (20)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,823 3,694
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,201 $ 3,674
======== ========
6
CASH PAID FOR:
Interest $ 109 $ 19
Income taxes -- --
NONCASH INVESTING AND FINANCING ACTIVITIES:
Investment in subsidiaries and associated company
acquired through issuance of common stock $ 5,250 $ --
Common stock issued to satisfy certain liabilities
and to settle expenses $ -- $ 27
Common stock issued as a result of exercise
of stock options $ 2 $ --
See condensed notes to consolidated financial statements.
7
PACIFICNET INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in United States dollars unless otherwise stated)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-QSB. Accordingly, they do not include all the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows for
all periods presented have been made. Preparing financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue, and expenses. Examples include provisions for
returns and impairment losses, accounting for income taxes, bad debts, and
property, plant and equipment lives for depreciation purposes. Actual results
may differ from these estimates. The results of operations for the six-month
period ended June 30, 2004 are not necessarily indicative of the operating
results that may be expected for the entire year ending December 31, 2004. These
financial statements should be read in conjunction with the Management's
Discussion and Analysis and financial statements and notes thereto included in
the Company's financial statements and accompanying notes thereto as of and for
the year ended December 31, 2003, filed with the Company's Annual Report on Form
10-KSB.
2. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share are based on the weighted average number of
shares of common stock outstanding. Diluted earnings or loss per share is based
on the weighted average number of shares of common stock outstanding and
dilutive common stock equivalents. All earnings per share amounts in these
financial statements are basic earnings (loss) per share as defined by SFAS No.
128, "Earnings Per Share." Diluted weighted average shares outstanding for both
periods in 2003 exclude the potential issuances of common stock upon exercise of
options and warrants because to do so would be antidilutive. Total potential
common shares not included in the computation of dilutive EPS for both periods
in 2004 was 154,320 warrants to purchase common stock because their impact would
be antidilutive based on current market prices.
The computation of basic and diluted profit/(loss) per share is as follows:
(IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------ ------------------------------
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
------------- ------------- ------------- -------------
Numerator-net profit /(loss) $ 51 $ (232) $ 192 $ (846)
============ ============ ============ =============
Denominator:
Weighted average number of shares used in
computed basic EPS 6,880,329 5,227,310 6,757,307 5,106,010
Net effect of dilutive common shares 969,427 -- 604,364 --
------------ ------------ ------------ -------------
Weighted average shares used in computed
diluted EPS 7,849,756 5,227,310 7,361,671 5,106,010
============ ============ ============ =============
Basic profit/(loss) per share $ 0.01 $ (0.04) $ 0.03 $ (0.17)
Diluted profit/(loss) per share $ 0.01 $ (0.04) $ 0.03 $ (0.17)
8
3. BUSINESS ACQUISITIONS AND DISPOSITIONS
BUSINESS ACQUISITIONS.
----------------------
GUANGZHOU YUESHEN TAIYANG TECHNOLOGY LIMITED
--------------------------------------------
On April 12, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of a 51% controlling
interest (the "Acquisition") in Guangzhou YueShen TaiYang Technology Limited, a
newly formed company incorporated in the People's Republic of China ("YueShen").
YueShen is engaged in the business of distributing telecom services, including
calling cards, mobile SIM cards, prepaid stored-value cards, VoIP, IDD calling
cards, bundled insurance cards and customer loyalty membership cards in China.
The Company acquired the controlling interest in YueShen through the purchase of
85 shares (representing 100% of the issued and outstanding shares, the "Shanghai
Shares") of Shanghai Classic Group Limited, the beneficial owner of the 51%
controlling interest in YueShen. The consideration for the Acquisition was an
aggregate value of approximately USD$1,196,143, 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) approximately USD$616,195 by delivery of 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.
The cash portion of the purchase price for the Acquisition was from working
capital of the Company.
CHEER ERA LIMITED
-----------------
On April 7, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of 300 shares (the
"Shares"), representing 30% of the issued and outstanding shares of Cheer Era
Limited, a newly formed company incorporated in Hong Kong SAR ("Cheer Era").
Cheer Era is engaged in the business of designing, developing and manufacturing
multimedia entertainment and communication kiosk products, including photo and
video entertainment kiosks, digital camera photo development stations, MMS,
ring-tone and mobile content download, payment and delivery stations for mobile
phones, and other coin-operated kiosks and kiosk consumables. The consideration
for the Shares was an aggregate value of approximately USD$1,156,812, which was
paid in cash and shares of Common Stock, and a warrant to purchase up to 80,000
shares of Common Stock. The consideration was paid as follows:
(i) approximately USD$771,208 by delivery of 149,459 shares of Common
Stock as consideration for the purchase of 100 of the Shares from Apex Legend
Limited, a company incorporated in the British Virgin Islands ("Apex") within
9
thirty (30) days of the signing of the agreement for the purchase of the Shares.
All of the Common Stock deliverable to Apex 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 purchase and sale of the Shares, provided, that Cheer Era attains certain
net income milestones during such period. In the event there is a shortfall in
the net income during the period, Apex shall return to the Company shares of the
Common Stock equivalent to the dollar amount of such shortfall divided by $6.00;
and
(ii) approximately USD$385,604 in cash directly to Cheer Era within
thirty (30) days of the closing of the purchase and sale of the Shares for the
Company's subscription to purchase 200 of the Shares. The cash used to pay for
the Shares was from working capital of the Company.
BUSINESS DISPOSITIONS.
----------------------
In May 2003, the Company decided not to further invest in the Customer Service
Support Center in the U.S. As of June 30, 2003, all activities have
significantly slowed down due to the economic slowdown in the U.S. During the
six months ended June 30, 2003, the Company wrote off property and equipment of
$150,000. Revenues and net loss information related to Customer Service Support
Center operations are as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------------------------------------------
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
(UNAUDITED) (AUDITED) (UNAUDITED) (AUDITED)
---------------- --------------- ---------------- -------------
Revenues $ -- $ -- $ -- $ 4
Net Loss $ -- $ -- $ -- $ (185)
Total Net assets of the Customer Service Support Center were comprised primarily
of property and equipment.
4. JOINT VENTURE OPERATIONS
The Company ceased its participation with International Elite Limited (IEL) in
the joint venture company, PacificNet Communications Limited - Macao Commercial
Offshore (the "Joint Venture"). Pursuant to the terms of the Equity Joint
Venture Agreement, signed on December 21, 2002, the Company was required to
obtain the requisite regulatory and shareholder approval to issue 34 million
shares of the Company's common stock in connection with the Joint Venture
transaction. The Company did not receive the necessary regulatory and
shareholder approval to issue the shares. Since the Company was unable to obtain
the appropriate approvals, the board of directors of the Company determined that
it was in the best interest of the Company to terminate its interest in the
Joint Venture. Since the Company did not obtain regulatory and shareholder
approval of the joint venture transaction and the Company does not control the
operating and financing decisions of the joint venture, the Company does not
consolidate the assets, liabilities, revenues and expenses of the joint venture.
The original 800,000 deposit shares held in escrow were canceled and returned to
the Company's treasury. The termination agreement was signed on March 30, 2004.
As such, the results of operations for the six months ended June 30, 2003, do
not include the activity for the joint venture as previously reported in its
June 30, 2003 quarterly filing.
5. STOCKHOLDERS' EQUITY
Common stock issued.
For the period ended June 30, 2004, the Company issued (i) 1,050,000 shares with
total consideration of $5,250,000 to acquire subsidiaries representing (a)
100,000 deposit shares of common stock plus 300,000 shares as a result of
achievement of certain earnings criteria to Epro; b) 350,000 deposit shares of
10
common stock plus 300,000 shares as a result of achievement of certain earnings
criteria to Linkhead; (ii) 617,285 shares with cash consideration of $3,000,000
pursuant to a private placement, including warrants to purchase up to an
aggregate of 154,320 common shares of the Company issued to a group of
institutional investors; (iii) 39,500 shares as a result of exercise of stock
options with cash consideration of $74,000 and noncash consideration of $2,000;
(iv) post-acquisition of share capital from subsidiaries of $564,000; and (v)
reduced by repurchase of 27,000 shares with cash consideration of $96,000 by the
Company.
Common Stock Repurchase Program.
--------------------------------
The Company's Board of Directors has approved a Corporate Stock Repurchase
Program to purchase up to US$800,000 worth of outstanding shares of its common
stock in open market transactions, from time to time, in compliance with Rule
10b-18 of the Securities Exchange Act of 1934 and all other applicable
securities regulations. The purpose of the repurchase program is to enhance
shareholder value. During the six months ended June 30, 2004, the Company
repurchased 26,784 shares at an average price of $3.56 per share for
approximately $96,000.
6. STOCK-BASED COMPENSATION
Stock options.
During the period ended June 30, 2003, the Company granted stock options to
purchase the Company's common stock at $1.75 and $2.20 per share, which expire
on January 10, 2006 and June 23, 2006, respectively. No options were granted
during the first quarter and second quarters of 2004. During the period ended
June 30, 2004, no options were canceled or forfeited, and 39,500 options were
exercised for cash proceeds of $74,000 and noncash consideration of $2,000. As
of June 30, 2004, there were 886,100 stock options outstanding and 303,600
options exercisable. The weighted average exercise price of the options
outstanding and exercisable is $3.07 and $2.04, respectively, and the weighted
average remaining contractual life is 1.66 and 1.61 and years, respectively.
The Company accounts for stock-based compensation using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," under which no compensation cost for stock options
is recognized for stock option awards granted at or above fair market value. Had
compensation expense for the Company's stock-based compensation plans been
determined under FASB No. 123, based on the fair market value at the grant
dates, the Company's pro forma net loss and pro forma net loss per share would
have been reflected as follows at June 30:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
------------- ------------- ------------- -------------
Net profit (loss)
As reported $ 51 $ (232) $ 192 $ (614)
Stock-based employee
compensation cost,
net of tax -- (819) -- (1,133)
------------- ------------- ------------- -------------
Pro forma $ 51 $ (1,051) $ 192 $ (1,747)
============= ============= ============= =============
Profit (loss) per share
As reported $ 0.01 $ (0.04) $ 0.03 $ (0.12)
============= ============= ============= =============
Pro forma $ 0.01 $ (0.20) $ 0.03 $ (0.34)
============= ============= ============= =============
The fair values of options granted during the three and six months period ended
June 30, 2003, were $1.62 and $2.04, respectively, and were estimated on the
date of grant using the Black-Scholes option pricing model with the following
11
weighted-average assumptions: dividend yield of 0%, expected volatility of 266%,
risk-free interest rate of 2.5%, and an expected life of 3 years.
Warrants.
During the period ended June 30, 2003, no warrants were granted to purchase the
Company's common stock. 154,320 warrants were granted at $7.15 per share during
the second quarter of 2004, and no warrants were exercised, canceled or
forfeited. As of June 30, 2004, there were 954,320 warrants outstanding. The
weighted average exercise price of the warrants outstanding is $2.43 and the
weighted average remaining contractual life is 1.57 years.
7. SEGMENT INFORMATION
The Company's reportable segments are operating units, which represent the
operations of the Company's significant subsidiaries. The significant accounting
policies of the Company's subsidiaries are the same as those of the Company. No
information has been presented for the comparative prior period as the
acquisitions of the Company's current significant subsidiaries had not occurred
as of those dates. The operations for the six months ended June 30, 2003
primarily represent the operations of our subsidiary PacificNet Solutions
Limited. ("PacSo"), which specializes in systems integration, software
application, and e-business solutions services in Hong Kong and Greater China
Summarized financial information concerning the Company's reportable segments is
shown in the following table. The "Other" column includes the Company's other
insignificant subsidiaries and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable segments
(in thousands).
FOR THE SIX MONTHS
ENDED JUNE 30, 2004 LINKHEAD EPRO YUESHEN OTHER TOTAL
------------------- -------- ---- ------- ----- -----
Revenues $ 2,781 $ 4,302 $ 3,805 $ 698 $11,586
Operating gain/(loss) $ 753 $ 451 $ 52 $ (413) $ 843
Total assets $ 3,364 $ 3,733 $ 271 $ 9,308 $16,676
FOR THE THREE MONTHS
ENDED JUNE 30, 2004 LINKHEAD EPRO YUESHEN OTHER TOTAL
------------------- -------- ---- ------- ----- -----
Revenues $ 1,624 $ 2,250 $ 3,805 $ 405 $ 8,084
Operating gain/(loss) $ 381 $ 241 $ 52 $ (300) $ 374
Total assets $ 3,364 $ 3,733 $ 271 $ 9,308 $16,676
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE INFORMATION
CONTAINED IN THE FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO
APPEARING ELSEWHERE HEREIN AND IN CONJUNCTION WITH THE MANAGEMENT'S DISCUSSION
AND ANALYSIS SET FORTH IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED DECEMBER 31, 2003.
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The statements contained in this Form 10-QSB that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These include statements about the Company's expectations, beliefs,
intentions or strategies for the future, which are indicated by words or phrases
such as "anticipate," "expect," "intend," "plan," "will," "the Company
believes," "management believes" and similar words or phrases. The
forward-looking statements are based on the Company's current expectations and
are subject to certain risks, uncertainties and assumptions. The Company's
actual results could differ materially from results anticipated in these
forward-looking statements. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis or plan of operations are 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 estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to accounts receivable
reserves, provisions for impairment losses of affiliated companies and other
intangible assets, income taxes and contingencies. We base our estimates on
historical experience and on various other assumptions that are believed 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.
We believe the following critical accounting policies reflect our more
significant estimates and assumptions used in the preparation of our
consolidated financial statements:
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We evaluate the collectibility 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 bad debt to reduce the related receivable to the amount we
reasonably believe is collectible. The allowances are calculated based on
detailed review of certain individual customer accounts, historical rates and an
estimation of the overall economic conditions affecting our customer base. We
review a customer's credit history before extending credit. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
INCOME TAXES
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, and prudent and feasible tax
13
planning strategies in determining the need for a valuation allowance. We
currently have recorded a full valuation allowance against net deferred tax
assets as we currently believe it is more likely than not that the deferred tax
assets will not be realized.
CONTINGENCIES
We may be subject to certain asserted and unasserted claims encountered in the
normal course of business. It is our belief that the resolution of these matters
will not have a material adverse effect on our financial position or results of
operations, however, we cannot provide assurance that damages that result in a
material adverse effect on our financial position or results of operations will
not be imposed in these matters. We account for contingent liabilities when it
is probable that future expenditures will be made and such expenditures can be
reasonably estimated.
LONG-LIVED ASSETS
We periodically assesses the need to record impairment losses on long-lived
assets, such as property, plant and equipment, goodwill 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 an 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 will be 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.
COMPANY OVERVIEW.
PacificNet Inc. (referred to herein as "PacificNet" or the "Company") was
incorporated in the state of Delaware in 1999. The Company is focused on
providing value-added telecom services and products, customer relationship
management (CRM) solutions, systems integration, network communications,
information technology solutions and telecommunications in Asia. Through its
subsidiaries, the Company invests, operates and provides value-added telecom
services (VAS) in Greater China. The Company's VAS includes operating call
centers, providing telemarketing services, customer relationship management
services (CRM), interactive voice response systems (IVR), short messaging
services (SMS), multimedia messaging services (MMS), voice over internet
protocol (VoIP) services, mobile applications and calling cards. In addition,
the Company sells and distributes telecom services. The Company intends to
continue to grow by acquiring and managing growing technology and network
communications businesses with established products and customers in Asia. The
Company employs over 800 staff in various subsidiaries throughout Greater China.
The Company's goal is to take a leading role in providing value-added telecom
services and products, information technology services and network
communications in Asia and Greater China. The Company's business can be
classified into the following operating units:
I. Beijing Linkhead Technologies Co., Limited ("Linkhead"), subsidiary, a
private PRC company. Linkhead is a leading provider of VAS, IVR
systems, mobile chatting, and voice-portal services in greater China.
Linkhead is in the business of providing VAS, IVR system development
14
and integration, voice internet portals, computer telephony integration
(CTI), VoIP, internet and mobile application development and CRM
services for China's telecom operators. Linkhead also provides telecom
related management and consulting services, mobile consumer analytics,
mobile data-mining, internet e-commerce and mobile commerce, mobile
applications based on WAP, K-Java, BREW, EMS, SMS, MMS, outsourced
software development, and other mobile VAS in greater China. Linkhead's
major clients and profit-sharing partners include some of the leading
telecom operators such as China Telecom (NYSE: CHA), China Mobile
(NYSE: CHL), China Unicom (NYSE: CHU), UTStarcom (Nasdaq: UTSI).
Linkhead is also channel partner, or a master reseller, of NMS
Communications (Nasdaq: NMSS), a leading provider of communications
technologies and solutions.
II. Epro Telecom Holdings Limited ("Epro"), subsidiary, one of the largest
providers of value-added telecom services (VAS), interactive voice
response (IVR), mobile chatting, and voice-portal services in Greater
China with over 500 employees, 1,000 call center seats and processes
over 100,000 calls daily. Epro is in the business of providing VAS,
such as call center services, CRM, mobile marketing and promotion
services, call center training, management and consulting services,
call center software, IVR systems, mobile payment and mobile point of
sale (POS) solutions, internet e-commerce and mobile commerce, mobile
applications based on SMS, MMS, outsourced telemarketing and customer
support services, and other mobile VAS for Hong Kong and PRC's telecom
operators, banks, insurance, and other financial services companies in
China. Epro's clients include major telecom operators, banks, insurance
and financial services companies in greater China, such as China
Telecom (NYSE: CHA), China Unicom (NYSE: CHU), PCCW (NYSE: PCW), CSL,
SmarTone Telecom, Sunday Communications (Nasdaq: SDAY), Hutchison
Whampoa Limited (HKSE:0013.HK), Swire Coca-Cola, Samsung, Dun &
Bradstreet, DBS, Dao Heng Insurance, Shenzhen Development Bank, Hong
Kong Government Housing Authority and Hongkong Post.
III. Guangzhou YueShen TaiYang Technology Limited ("YueShen"), subsidiary, a
newly formed company incorporated in the People's Republic of China.
YueShen is engaged in the business of distributing telecom services,
including calling cards, mobile SIM cards, prepaid stored-value cards,
VoIP, IDD calling cards, bundled insurance cards and customer loyalty
membership cards in China.
IV. Cheer Era Limited ("Cheer Era"), investee company, a newly formed
company incorporated in Hong Kong SAR. Cheer Era is engaged in the
business of designing, developing and manufacturing multimedia
entertainment and communication kiosk products, including photo and
video entertainment kiosks, digital camera photo development stations,
MMS, ring-tone and mobile content download, payment and delivery
stations for mobile phones, and other coin-operated kiosks and kiosk
consumables.
V. PacificNet Communications Limited. ("PacComm") and PacificNet Strategic
Investment Holdings Limited ("PSI"), subsidiaries, are holding
companies. In December 2003, PacComm and PSI completed agreements to
acquire a 50% controlling interest in Epro and 51% of the shares of
Linkhead, respectively. In April 2004, PSI completed agreements to
acquire a 30% interest in Cheer Era and a 51% controlling interest in
YueShen.
VI. PacificNet Limited ("PNL") and PacificNet Solutions Limited. ("PacSo"),
subsidiaries, distributors and resellers of telecommunication,
networking and computer equipment, which complements our
telecommunication services. They specialize in systems integration,
software application, and e-business solutions services in Hong Kong
and Greater China. The scope of products and services includes smart
card solutions, web based user applications and web based connections
to remote or fixed database services, which are also referred to as
backend enterprise planning systems.
15
VII. PacificNet Tech (SZ) Limited ("SZ"), is a subsidiary located in
Shenzhen. SZ was established to expand the Company's research,
development, marketing and distribution opportunities in Greater China.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
REVENUES. Revenues for the three months ended June 30, 2004 were $8,084,000, an
increase of $7,961,000 from $123,000 for the three months ended June 30, 2003.
The significant increase in this quarter is mainly due to the recent acquisition
of YueShen, which is engaged in the business of distributing telecom services,
including calling cards in Greater China. YueShen contributes 47% of total
revenues while the Company's other newly acquired subsidiaries, Epro and
Linkhead, in the aggregate contribute 48% of total revenues. These three
subsidiaries make up in the aggregate 95% of the Company's total revenues.
COST OF REVENUES. Cost of revenues for the three months ended June 30, 2004 was
$6,789,000, an increase of $6,742,000 from $47,000 for the three months ended
June 30, 2003. This significant increase in cost of revenues is directly
associated with the increase in revenues. Our three newly acquired subsidiaries
generated in the aggregate, 94% of the total cost of revenues.
GROSS MARGIN AND GROSS MARGIN RATIO. Gross margin for the three months ended
June 30, 2004 was $1,295,000, an increase of $1,219,000 from $76,000 for the
three months ended June 30, 2003. Gross margins for the three months ended June
30, 2004, comprised 16% of revenues. The significant decrease in gross margin
ratio in this quarter is mainly due to the low gross margin ratio, which is one
of the characteristics of YueShen's calling card distribution business. We
expect both our gross margin and gross margin ratio to increase gradually as a
result of cost reduction and efficient utilization of assets.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $875,000 for the three months ended June 30,
2004, an increase of $554,000, from $321,000 for the three months ended June 30,
2003. This increase resulted from increasing the size of our operations, which
included increased premises costs and staff costs, mainly attributable to the
operations of Epro and Linkhead.
INTEREST INCOME. Interest income was $7,000 for the three months ended June 30,
2004, as compared to $8,000 for the three months ended June 30, 2003. The
decrease is due to a lower average outstanding bank balance in 2004 than 2003.
EQUITY EARNINGS IN UNDISTRIBUTED EARNINGS OF INVESTEE COMPANY. The Company
recorded $17,000 in equity earnings in its investee company for the three month
period ended June 30, 2004 compared with nil for the same period in the prior
year representing the Company's 30% ownership interest in its recent acquisition
of Cheer Era Limited in April 2004.
INCOME TAXES. No tax provision has been recorded for the three months ended June
30, 2004, as a result of the cumulative operating losses generated by the
Company. Interim income tax provisions are based upon management's estimate of
taxable income and the resulting consolidated effective income tax rate for the
full year. As a result, such interim estimates are subject to change as the year
progresses and more information becomes available.
MINORITY INTEREST. Minority interest for the three months ended June 30, 2004
totaled $323,000, compared with $(7,000) for the same period in the prior year,
which represents the Company's existing interest in its subsidiary PacSo of
$(7,000), and its interest in newly acquired subsidiaries, Epro of $116,000,
Linkhead of $189,000 and YueShen of $25,000 respectively.
16
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
REVENUES. Revenues for the six months ended June 30, 2004 were $11,586,000, an
increase of $11,366,000 from $220,000 for the six months ended June 30, 2003.
For the six months ended June 30, 2004, revenues derived from the value-added
telecom services rendered by the Company's newly acquired subsidiaries, YueShen,
Epro and Linkhead, in the aggregate, contributed to 94% of total revenues.
COST OF REVENUES. Cost of revenues for the six months ended June 30, 2004 was
$9,042,000, an increase of $8,959,000 from $83,000 for the six months ended June
30, 2003. This significant increase is directly associated with the increase in
revenues. Our three newly acquired subsidiaries, in the aggregate, comprise 93%
of total cost of revenues.
GROSS MARGIN AND GROSS MARGIN RATIO. Gross margin for the six months ended June
30, 2004 was $2,544,000, an increase of $2,407,000 from $137,000 for the six
months ended June 30, 2003. Gross margins for the six months ended June 30, 2004
were comprised of 22% in revenues compared to 62% for the same period in the
prior year. The significant decrease in gross margin ratio is attributable to
the change in our mode of operations from systems integration and software
application in 2003 to value-added telecom services and products providers in
2004. We expect both our gross margin and gross margin ratio to increase
gradually as a result of cost reduction and efficient utilization of assets.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $1,652,000 for the six months ended June 30,
2004, an increase of $912,000, from $740,000 for the six months ended June 30,
2003. This increase resulted from increasing the size of our operations, which
included increased premises costs and staff costs, mainly attributable to the
operations of Epro and Linkhead.
INTEREST INCOME. Interest income was $10,000 for the six months ended June 30,
2004, as compared to $15,000 for the six months ended June 30, 2003. The
decrease is due to a lower average outstanding bank balance in 2004 than 2003.
EQUITY EARNINGS IN UNDISTRIBUTED EARNINGS OF INVESTEE COMPANY. The Company
recorded $17,000 in equity earnings in its investee company for the six month
ended June 30, 2004 compared with nil for the same period in the prior year
representing the Company's 30% ownership interest in its recent acquisition of
Cheer Era Limited in April 2004.
INCOME TAXES. No tax provision has been recorded for the six months ended June
30, 2004, as a result of the cumulative operating losses generated by the
Company. Interim income tax provisions are based upon management's estimate of
taxable income and the resulting consolidated effective income tax rate for the
full year. As a result, such interim estimates are subject to change as the year
progresses and more information becomes available.
MINORITY INTEREST. Minority interest for the three months ended June 30, 2004
totaled $651,000, compared with $(21,000) for the same period in the prior year,
which represents the Company's existing interest in its subsidiary PacSo of
$(4,000), and its interest in newly acquired subsidiaries, Epro of $258,000,
Linkhead of $372,000 and YueShen of $25,000 respectively.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL. The Company's working capital increased to $5,221,000 at June
30, 2004 as compared to $1,442,000 at December 31, 2003. When compared to
balances at December 31, 2003, the increase in working capital at June 30, 2004
reflects an increase in current assets primarily resulting from the Company's
completion of a $3,000,000 private placement and a decrease in current
liabilities of $3,159,000 and $620,000, respectively.
17
NET CASH USED IN OPERATING ACTIVITIES. Net cash used in operating activities was
$1,139,000 for the six months ended June 30, 2004. Net cash used in operating
activities in the six months ended June 30, 2004 was primarily the result of a
net profit of $192,000, increased by noncash items totaling $1,326,000 and
decreased by changes in operating assets of $2,657,000.
NET CASH USED IN INVESTING ACTIVITIES. Net cash used in investing activities for
the six months ended June 30, 2004 was $1,823,000 representing the acquisition
of subsidiary companies, interest in investee company, and property and
equipment of $1,160,000, $385,000 and $278,000, respectively. The additions to
property and equipment were for the expansion of the CRM and call centre
business in Hong Kong.
NET CASH PROVIDED BY FINANCING ACTIVITIES. Net cash provided by financing
activities for the six months ended June 30, 2004 was $2,340,000 representing
net proceeds from issuance of common stock of $2,813,000, net proceeds from post
acquisition of share capital - subsidiaries of $564,000, net cash proceeds
received from the exercise of stock options of $74,000 and advances under bank
loans of $1,913,000, and reduced by repayments on debt of $2,928,000 and
repurchase of treasury shares of $96,000.
ISSUANCE OF COMMON STOCK. For the period ended June 30, 2004, we issued (i)
1,050,000 shares with total consideration of $5,250,000 to acquire subsidiaries
and associated company, (ii) 617,285 shares with cash consideration of
$3,000,000 pursuant to a private placement, (iii) 39,500 shares as a result of
exercise of share options with cash consideration of $74,000 and noncash
consideration of $2,000.
CURRENCY EXCHANGE FLUCTUATIONS. All of the Company's revenues are denominated
either in United States dollars or Hong Kong dollars, while its expenses are
denominated primarily in Hong Kong dollars and Renminbi ("RMB"), the currency of
the People's Republic of China. There can be no assurance that RMB-to-United
States dollar or Hong Kong dollar-to-United States dollar exchange rates will
remain stable. Although a devaluation of the Hong Kong dollar or RMB 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 RMB 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. The Company has never
engaged in currency hedging operations and has no present intention to do so.
CONCENTRATION OF CREDIT RISK. All of the Company's revenues are derived in Asia
and Greater China. The Company does not have any single customer that accounts
for more than 10% of its revenues or 10% of its purchases. If the Company was
unable to derive any revenue from Asia and Greater China, it would cause a
significant, financially disruptive effect on the normal operations of the
Company. Based on the current economic environment in China, the Company does
not expect any material adverse impact to its business, financial condition and
results of operations.
ITEM 3. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management,
including our principal executive officer and the principal accounting officer,
the Company conducted an evaluation of the effectiveness of the design and
operation of its disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end
of the period covered by this report (the "Evaluation Date"). Based on this
evaluation, the Company's principal executive officer and principal accounting
officer concluded as of the Evaluation Date that the Company's disclosure
controls and procedures were effective such that the material information
required to be included in our Securities and Exchange Commission ("SEC")
reports is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms relating to the Company, including our
consolidating subsidiaries, and was made known to them by others within those
entities, particularly during the period when this report was being prepared.
Additionally, there were no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the Evaluation Date. We have not identified any significant
deficiencies or material weaknesses in our internal controls, and therefore
there were no corrective actions taken.
18
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES AND ISSUER PURCHASES OF EQUITY SECURITIES
(d) MAXIMUM
NUMBER (OR
APPROXIMATE
(c) TOTAL NUMBER OF DOLLAR VALUE) OF
SHARES PURCHASED AS SHARES THAT MAY
(a) TOTAL NUMBER PART OF PUBLICLY YET BE PURCHASED
OF SHARES (b) AVERAGE PRICE ANNOUNCED PLANS UNDER THE PLANS
PERIOD PURCHASED PAID PER SHARE OR PROGRAMS (1) OR PROGRAMS
-----------------------------------------------------------------------------------------------------
April 1 - April 30 -0- N/A N/A N/A
-----------------------------------------------------------------------------------------------------
May 1 - May 31 21,084 $ 3.66 21,084 $722,804
-----------------------------------------------------------------------------------------------------
June 1 - June 30 5,700 $ 3.16 5,700 $704,777
-----------------------------------------------------------------------------------------------------
Total 26,784 $ 3.56 26,784 $704,777
-----------------------------------------------------------------------------------------------------
(1) The Company's Corporate Stock Repurchase Program was announced to the public
on May 4, 2004. The Company is authorized to purchase up to USD$800,000 of its
outstanding shares of common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION
None.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
theSarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
None.
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: AUGUST 13, 2004 /S/ TONY TONG
-----------------------------
TONY TONG
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
DATE: AUGUST 13, 2004 /S/ WANG SHAO JIAN
-----------------------------
WANG SHAO JIAN
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
20