U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-KSB
[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
[ ] 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.)
23/F, TOWER A, TIMECOURT, NO.6 SHUGUANG XILI, N/A
CHAOYANG DISTRICT, BEIJING, CHINA 100028 (Zip Code)
(Address of principal executive offices)
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
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
TABLE OF CONTENTS
PART I
ITEM 1. DESCRIPTION OF BUSINESS........................................... 2
ITEM 2. DESCRIPTION OF PROPERTY...........................................30
ITEM 3. LEGAL PROCEEDINGS.................................................31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............31
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........32
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.........34
ITEM 7. FINANCIAL STATEMENTS..............................................43
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................44
ITEM 8A. CONTROLS AND PROCEDURES...........................................44
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT...............45
ITEM 10. EXECUTIVE COMPENSATION............................................51
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....53
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................54
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K..................................54
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES............................56
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.
1
ITEM 1. DESCRIPTION OF BUSINESS
As used in this report, "we", "us," "our," "Company", "PacificNet" or "PACT"
refers to PacificNet Inc., a Delaware corporation.
OVERVIEW
We were incorporated in the state of Delaware in 1987. Our business consists of
four groups, all of which operate within the outsourcing and telecommunications
industries in Asia, primarily Greater China, which includes the People's
Republic of China (PRC), or mainland China, Hong Kong Special Administrative
Region (HKSAR), Macau Special Administrative Region, and Taiwan. Through our
subsidiaries we invest in and operate companies that 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 comprises 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). Our communication products distribution
services include the wholesale and retail sale and distribution of calling cards
in China, multimedia interactive self-service kiosk distribution and online
mobile phone distribution. We also have a number of subsidiaries that we use
primarily for administration, internal control and acquisition purposes. We
intend to continue to grow our business by acquiring and managing growing
technology and network communications businesses with established products and
customers in Asia.
Our business process outsourcing services generate revenue from call center
services, call center management software sales, and training and consulting. We
invoice our call center clients monthly at per seat monthly rates, a base price
plus commission per call, or a per hour charge rate, depending on the client's
preference. Our call center software clients pay per license, for which there is
usually a one-time charge on sale of the software and annual maintenance fees
for service. We charge per project for our consulting and training services and
for our telecom VAS, which are invoiced throughout the project. Our telecom VAS
often includes a post-sale service contract for systems integration and
consulting services for which we bill separately. Our communication products
such as calling cards, kiosks and cell phones are sold cash-on-delivery.
Our clients include the leading telecom operators, banks, insurance, travel,
marketing, and service companies, as well as telecom consumers, in Greater
China. Clients include China Telecom, China Netcom, China Mobile, China Unicom,
PCCW, Hutchison Telecom, CSL, SmarTone, Sunday, Swire Travel, Coca-Cola, SONY,
Samsung, Motorola, Nokia, TNT Express, Huawei, TCL, Dun & Bradstreet, American
Express, Bank of China, DBS, Hong Kong Government, and Hongkong Post. PacificNet
employs over 2,000 staff in our various subsidiaries in China with offices in
Hong Kong, Beijing, Shanghai, Shenzhen, and Guangzhou.
PacificNet's operations include the following four groups:
(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).
(3) Communication Products Distribution Services: including calling
cards, GSM/ CDMA/ XiaoLingTong products, and multimedia self-service
kiosks.
(4) Other Business: including internal administrative matters and other
related corporate items.
2
CORPORATE STRUCTURE
The chart attached herein as Exhibit 99.1, sets forth our corporate and share
ownership structure as of the date of this annual report.
We conduct our business operations through the following business units and
subsidiaries:
(I) OUTSOURCING SERVICES GROUP
------------------------------
1) PACIFICNET EPRO HOLDINGS LIMITED (FORMERLY KNOWN AS: EPRO TELECOM
HOLDINGS LIMITED)
PacificNet Epro Holdings Limited (referred to herein as "Epro"), a
company incorporated in the Hong Kong Special Administrative Region of
the PRC, is engaged in the business of providing call center and
customer relationship management (CRM) services, 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 short messaging services (SMS),
multimedia messaging services (MMS), outsourced telemarketing and
customer support services, and other mobile value-added services (VAS).
Epro's business serves Hong Kong and the PRC's telecom operators,
banks, insurance, and other financial services companies in the PRC.
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 Hong Kong Post.
2) PACIFIC SMARTIME SOLUTIONS LIMITED / PACIFIC SOLUTIONS TECHNOLOGY
(SHENZHEN) CO. LTD.
Pacific Smartime Solutions Limited (referred to herein as "Smartime")
is an IT outsourcing company incorporated in Hong Kong that operates
through its China subsidiary Pacific Solutions Technology ( Shenzhen )
Co. Ltd. (referred to herein as: Soluteck Shenzhen), which is a leading
provider of outsourcing services including software development, R&D,
and project management services in China. Smartime employs over 280
staff and provides outsourcing services to the leading telecom, banking
and financial services companies in China, including Huawei, IBM, Bank
of East Asia. In December 2004, Smartime launched a new software
development outsourcing center in Shenzhen, located in a Grade A office
building, currently occupying two floors (total 26,000 square feet)
with the capacity to expand to two additional floors. Each of the two
floors will have the capacity to house about 200 employees. The new
outsourcing development center will serve its existing clients, which
includes some of the world's leading telecom and IT companies.
3) PACIFICNET SOLUTIONS LIMITED (Incorporated in Hong Kong)
PacificNet Solutions Ltd. (referred to herein as "PacSo"), incorporated
in Hong Kong, is a subsidiary that specializes in systems integration,
software application, and e-business solutions services in Hong Kong
and Greater China. The scope of PacSo's products and services includes
smart card solutions, web based front-end applications and web based
connections to backend enterprise planning systems.
3
(II) VALUE-ADDED TELECOM SERVICES (VAS) GROUP
---------------------------------------------
CONTENT PROVIDER COMPANY
CHINAGOHI/LION ZONE (SPECIAL PURPOSE VEHICLE (SPV)), HOLDING COMPANY
FOR CHINAGOHI
In December, 2005, we acquired a controlling interest in Shenzhen
GuHaiGuanChao Investment Consultant Company Limited ("ChinaGoHi"), a
wholly owned foreign enterprise (WOFE) registered in China, through the
purchase of a 51% interest of ChinaGoHi's parent, GoHi Holdings Limited
(referred to herein as "Lion Zone"), a British Virgin Islands company.
Lion Zone is an investment holding company principally engaged in
providing investment advisory consulting services and direct response
television (DRTV) telemarketing services. Through ChinaGoHi, we provide
infomercial marketing services and telemarketing services and financial
advisory services in China, including Direct Response Television (DRTV)
infomercials through satellite and cable TV broadcasting, web portals,
and subscription-based value-added services including Internet email,
short message services (SMS), mobile WAP services, and interactive
voice response (IVR) services via fixed and mobile phones. ChinaGoHi
("ChinaGoHi", http://www.ChinaGoHi.cn) is a leading information content
provider of Chinese stock market information, analysis, and investment
advisory services via DRTV infomercials through satellite and cable TV
broadcasting, IVR, SMS and WAP based mobile value-added services, web
portals and subscription based audio-video streaming via the Internet.
PLATFORM PROVIDING COMPANY
BEIJING LINKHEAD TECHNOLOGIES COMPANY LIMITED (Incorporated in the PRC)
Beijing Linkhead Technologies Company Limited, (referred to herein as
"Linkhead"), a PRC limited liability corporation, is engaged in the
business of providing value-added services (VAS), interactive voice
response (IVR) system development and integration, voice Internet
portals, computer telephony integration (CTI), VoIP, Internet and
mobile application development, telecom customer relationship
management (CRM) services for China's telecom operators, 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, short messaging services
(SMS), multimedia messaging services (MMS), outsourced software
development, and other mobile value-added services (VAS) in the PRC.
Linkhead's major clients and profit-sharing partners include some of
the leading telecom operators such as China Telecom, China Mobile,
China Unicom. Linkhead is also channel partner, or a master reseller,
of NMS Communications (NASDAQ: NMSS), a leading provider of
communications technologies and solutions which enable new enhanced
services and efficient networks that help customers grow their profits
and revenue.
SERVICE PROVIDER COMPANIES
1) PACIFICNET CLICKCOM LIMITED (INCORPORATED IN THE PRC)
In December 16, 2004, we entered 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"). The deal has been completed on
March 28, 2005. Clickcom-WOFE conducts its VAS operations with
GuangZhou DianXun Company Limited ("Dianxun-DE"), a PRC registered
Domestic Enterprise (DE)., through a series of contractual agreements.
Under these agreements, the shareholders of Dianxun-DE are 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. Through Clickcom-WOFE, we have also entered into a
consulting and services agreements with Dianxun-DE, under which
Clickcom-WOFE provides technical services and other services to
Dianxun-DE in exchange for all of the net income of Dianxun-DE. In
addition, the shareholders of Dianxun-DE have pledged their shares in
Dianxun-DE as collateral for non-payment of fees for the services we
provide. Through Clickcom-WOFE we provide directly to China's telecom
operators a wide variety of wireless Internet services for mobile
phones, such as SMS, Wireless Application Protocol (WAP), which allows
users to access information instantly via handheld wireless devices and
Java mobile applications. The acquisition of Clickcom-WOFE is our first
step in entering the VAS service provider market in which we will be
able to design our own mobile phone VAS for distribution directly to
telecom operators.
4
2) GUANGZHOU 3G INFORMATION TECHNOLOGY CO. LIMITED (Incorporated in the
PRC)
In March 2005 we entered 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 in Guangzhou 3G's parent company, Pacific 3G
Information & Technology Co. Limited, a British Virgin Islands Company
("Guangzhou3G-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. Under these agreements, the shareholders of
Sunroom-DE are 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. Through Guangzhou3G-WOFE, we have
also entered into a consulting and services agreements with Sunroom-DE,
under which Guangzhou3G-WOFE provides technical services and other
services to Sunroom-DE in exchange for all of the net income of
Sunroom-DE. In addition, the shareholders of Sunroom-DE have pledged
their shares in Sunroom DE as collateral for non-payment of fees for
the services we provide. Sunroom-DE is one of the largest value-added
telecom and information services providers in China with both voice
(IVR and call center) and data (SMS, MMS, WAP, JAVA, GPRS) connection
to the four major telecom operators in Asia, China Mobile, China
Unicom, China Telecom, and China Netcom, covering both mobile and
fixed-line networks. Guangzhou 3G-DE also offers a wide variety of IVR
and other wireless and fixed-line, value-added telecom services
including color ring back tone (CRBT) services, background music (BGM)
services, video ICQ (VICQ) mobile instant messaging services, sports
and soccer news, weather forecasts, stock prices, jokes, short stories,
dramas, songs and mobile karaoke, mobile TV, games, entertainment, as
well as community-oriented services, such as chatline and dating
services. Mobile and fixed-line phone users can access Guangzhou
3G-DE's IVR services through one of the four major telecom operators'
networks. Guangzhou 3G-DE currently employs 280 staff, and has offices
in 26 provinces in China including Guangdong, Guangxi, Hubei, Hunan,
Jiangsu, Zhejiang, Shanghai, Henan, Anhui, Yunnan, Gansu, Ningxia,
Inner Mongolia, Guizhou, Tianjin, Qinghai, Hainan, Heilongjiang,
Shanxi, Shandong, Chongqing, Jiangxi, Beijing, Hebei, Liaoning, and
Jilin. Guangzhou 3G's market covers all the major regions of China with
over 3 million accumulated fee paying customers.
3) GUANGZHOU WANRONG INFORMATION TECHNOLOGY CO., LIMITED (Incorporated
in the PRC)
On January 31, 2006, we consummated an agreement to acquire a 51%
majority interest in Guangzhou Wanrong Information Technology Co., Ltd.
("Guangzhou Wanrong,), one of the leading value-added telecom service
providers in China. Since its inception in 2003, Guangzhou Wanrong has
achieved strong growth in its VAS including SMS, WAP, JAVA, MMS, IVR,
multimedia entertainment download services, media interactive products,
mobile email services, life, sports, entertainment, and business
information services. Guangzhou Wanrong was granted nationwide SMS
service numbers "2388" for China Mobile and "9928" for China Unicom.
4) IPACT INTERNATIONAL INVESTMENT LIMITED (Incorporated in the BVI)
Our subsidiary, PacificNet Strategic Investment Holdings Limited holds
an 80% equity interest in IPACT International Investment Limited
("IPACT"). IPACT is a newly formed business entity in October 2005. Its
primary business will be to sign up qualified Voice-VAS and IVR service
providers as profit sharing members in China under a unified brand
"iPACT". We will provide to qualified VAS-Alliance partners, on a
profit sharing basis, all of the hardware, software, application, and
content for VAS, including a variety of IVR and other wireless and
fixed-line VAS content, including color ring back tone (CRBT) services,
background music (BGM) services, VICQ mobile instant messaging
services, sports news, weather forecasts, stock market, humor, songs
and mobile karaoke, mobile TV, games, entertainment, as well as
community-oriented services, such as chatline and dating services.
Mobile and fixed-line phone users can access PacificNet's VAS-Alliance
services through Guangzhou 3G presence in 26 provinces in China.
5) PACIFICNET AD. LIMITED (Incorporated in Hong Kong)
PacificNet Ad. Limited was incorporated in Hong Kong in December 2005
and 68% of its outstanding equity shares are held by PacificNet
Limited. Its principle business is advertising and media services.
5
(III) COMMUNICATION PRODUCTS DISTRIBUTION GROUP
-----------------------------------------------
1) GUANGZHOU YUESHEN TAIYANG NETWORK TECHNOLOGY CO. LTD. (Incorporated
in the PRC)
Guangzhou YueShen TaiYang Network Technology Co. Ltd. (referred to
herein as "YueShen"), a PRC registered sino-foreign equity joint
venture, is a subsidiary of PacificNet. YueShen is a leading
distributor of telecom services including phone cards, mobile SIM
cards, prepaid stored-value cards, re-chargeable phone cards, VoIP and
IDD calling cards, Internet access cards, and bundled cross-selling
insurance cards, travel and hotel reservation cards and customer
loyalty membership cards in China. YueShen is a leading top-level
distributor for the major telecom operators in China, including China
Mobile, China Unicom, China Telecom, China Netcom and China Railcom.
2) PACIFICNET IMOBILE (BEIJING) TECHNOLOGY CO., LIMITED (Incorporated
in the PRC)
On February 06, 2006, we 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 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. 18900.com is the
leading Internet e-commerce distributor of mobile products in China,
and provides Internet, email, customer service centers, pre-sale and
post-sale services, logistics and cash-on-delivery (COD) services to
mobile related products in China. iMobile's 18900.com e-commerce
operations combines both online Internet services with its offline
customer services network composed of a nationwide chain of logistic
and customer centers covering 22 provinces and 40 major cities in
China, including Beijing, Shanghai, Chongqing, Tianjin, Chengdu,
Dalian, Qingdao, Guangzhou, Shenzhen, Zhuhai, Dongguan, Hangzhou,
Suzhou, Ningbo, Wenzhou, Nanjing, Wuhan, Xi'an, Harbin, Qiqihaer, Hunan
and Changsha. iIMobile's Internet portal has been one of the top ranked
traffic sites and has achieved about 2.3 million registered online
users and over 400,000 active users, with 5 million daily page views
and 20,000 blog postings per day, which makes iMobile the top ranked
site in its category in China. It is expected this acquisition was
structured in the same manner as our other acquisitions, with operation
and services agreements between Beijing Xing Chang Xin Science and
Technology Development Co. Limited Incorporated DE and PacificNet
Imobile (Beijing) Technology, Co. Ltd. WOFE.
3) PACIFICNET COMMUNICATIONS LIMITED
PacificNet Communications Limited (referred to herein as "PacCom"),
incorporated in Hong Kong, is a wholly owned subsidiary of PacificNet
that specializes in telecom related services in Hong Kong and Greater
China.
4) TAKE1 TECHNOLOGIES GROUP LIMITED ("TAKE1" , FORMERLY KNOWN AS: CHEER
ERA LIMITED)
Take1 (http://www.take1technologies.com/) is a leading designer,
developer and manufacturer of multimedia entertainment and
communication kiosk products including photo and video entertainment
kiosks, digital camera photo development stations, multimedia messaging
services (MMS) and mobile content download, payment and delivery
stations for mobile phones, and other coin-operated kiosks and kiosk
consumables. Take1 markets and distributes its multimedia communication
stations around the world including the USA, Canada, Mexico, Europe,
Korea, China, India and SE Asia. Take1 is headquartered in Hong Kong
with operations in China, Canada, and USA.
6
(IV) OTHER BUSINESS ENTITIES
----------------------------
1) PACIFICNET LIMITED (INCORPORATED IN HONG KONG)
PacificNet Limited is incorporated in Hong Kong as a wholly owned
subsidiary of PacificNet Inc. Its primary purpose is to handle the
general administrative operations of PacificNet in Hong Kong.
2) PACIFICNET STRATEGIC INVESTMENT HOLDINGS LIMITED (Incorporated in
the BVI)
PacificNet Strategic Investment Holdings Limited (referred to herein as
"PacInvest"), incorporated in the British Virgin Islands (BVI), is a
wholly owned subsidiary of PacificNet that specializes in strategic
investment, direct investment, mergers and acquisitions, joint venture
development, and other financial and investment services in Hong Kong
and Greater China. Its primary purpose is to help PacificNet identify
strategic investment opportunities, process deal flow, conduct due
diligence, negotiate terms and valuation, monitor investment
performance and conduct synergy development, with a focus in Chinese
investment opportunities related to PacificNet's business.
3) PACIFICNET POWER LIMITED (Incorporated in Hong Kong)
PacificNet Power Ltd. (referred to herein as "PacPower"), incorporated
in Hong Kong, is a subsidiary that specializes in information
technology (IT) solutions, systems integration, software application,
energy saving and electric power management systems and solutions in
Hong Kong and Greater China. PacificNet Power was registered in Hong
Kong in January 2005 as a subsidiary of PacificNet Limited with 51%
controlling ownership by PacificNet.
4) PERPETUAL GROWTH INVESTMENTS LIMITED (Incorporated in the BVI)
Perpetual Growth Investments Limited incorporated in the British Virgin
Islands (BVI), is a wholly owned subsidiary of PacificNet
Communications Limited.
5) PACIFIC FINANCIAL SERVICES LIMITED (Incorporated in Hong Kong)
Pacific Financial Services Limited incorporated in Hong Kong in
November 2005, is a wholly owned subsidiary of PacificNet Inc. Its
primary purpose is to provide financial services in Hong Kong.
6) PACIFICNET GAMES LIMITED(Incorporated in the BVI)
PacificNet Games Limited incorporated in the British Virgin Islands
(BVI), is a wholly owned subsidiary of PacificNet Strategic Investment
Holdings Limited. Its primary purpose is to design and distribute
Internet online games and offline gaming machines.
7) PACIFICNET TECHNOLOGY (SHENZHEN) LIMITED (Incorporated in the PRC)
PacificNet Technology (Shenzhen) Limited (referred to herein as
"PacSZ") is incorporated in the PRC as a wholly owned foreign
enterprise (WOFE) , is a wholly owned subsidiary of PacificNet Limited
Hong Kong. Its primary purpose is to provide administrative support
back-office, IT support and software development services, to support
PacificNet's operations in China, and to conduct the general
administrative operations of PacificNet in China.
8) PACIFICNET BEIJING LIMITED (Incorporated in the PRC)
PacificNet Beijing Limited (referred to herein as "PacBJ") incorporated
in the PRC as a wholly owned foreign enterprise (WOFE) is a wholly
owned subsidiary of PacificNet Limited Hong Kong. Its primary purpose
is toprovide administrative back-office support, IT support and
software development services, to support PacificNet's operations in
China, and to conduct the administrative operations of PacificNet in
China.
7
OUR ACQUISITION MODEL FOR TELECOM VALUE- ADDED SERVICES COMPANIES IN CHINA
CORPORATE OWNERSHIP STRUCTURE
Set forth below is an illustration of our acquisition model using
Clickcom as an example.
===================================
| PacificNet Inc. |
| Incorporated in Delaware, USA |
| (listed on Nasdaq) |
===================================
|
| 100%
\/
----------------------------------- --------------------------------
| PacificNet Strategic Investment | | The shareholders of Guangzhou |
| Holdings Limited | | Dianxun Co., Ltd. |
| Incorporated in BVI | | |
----------------------------------- --------------------------------
| |
| 51% | 49%
\/ \/
-------------------------------
--------------->| PacificNet Clickcom Limited |
| | Incorporated in BVI |
| -------------------------------
Power | |
| | 100%
of | \/
| -------------------------------
Attorney | | Guangzhou Clickcom Digit-net |
| | Science and Technology Ltd. |
| | WOFE |
| -------------------------------
| Operation agreement /\ /\ |
| Share pledge agreement | | | Service agreement
| | | \/
| -------------------------------
| | Guangzhou Dianxun Co., Ltd. |
|---------------| Incorporated in PRC |
| DE |
-------------------------------
PRC laws and regulations restrict us, as a foreign entity, from having a direct
controlling interest in entities such as Dianxun-DE Sunroom-DE Wanrong-DE and
Imobile-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 Clickcom-WOFE, Guangzhou3G-WOFE,
Wanrong-WOFE and Imobile-WOFE. We own 51% of the shares in each of the WOFEs.
Clickcom-WOFE, Guangzhou3G-WOFE, Wanrong-WOFE and Imobile-WOFE each
signed Consulting and Services Agreements respectively with Dianxun-DE
Sunroom-DE Wanrong-DE and Imobile-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, we guarantee
any obligations undertaken by these companies under their contractual agreements
with third parties, and we are 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
Clickcom-WOFE, Guangzhou3G-WOFE, Wanrong-WOFE and Imobile-WOFE . The operations
of DEs are managed by their original management teams. We do not put our own
management in place, nor do we integrate current management of the DEs with
management from other subsidiaries. According to the operating agreements
between the DEs and WOFEs, each DEs board of directors has the power to appoint
the General Manager of the DE who in turn has the power to appoint other members
of the management. We do not directly participate in the daily operations DE,
however, we have the power to appoint or change directors and senior management
because PacificNet indirectly ultimately controls the voting power of the
shareholders of each DE through the Power of Attorney given to our
President, Mr. Victor Tong.
8
In the opinion of our internal PRC legal counsel, the ownership structures of,
and contractual agreements between Clickcom-WOFE, Guangzhou3G-WOFE, Wanrong-WOFE
and Imobile-WOFE with Dianxun-DE Sunroom-DE Wanrong-DE and Imobile-DE,
respectively, and their shareholders, and the businesses and operations of the
DEs as, respectively, described in this Annual Report, comply with all existing
PRC laws, rules and regulations and are fully enforceable in accordance with
their terms and conditions. In addition, our internal PRC legal counsel is of
the opinion that no consent, approval or license, other than those already
obtained, is required under any of the existing PRC laws, rules and regulations
for the effectiveness and enforceability of the ownership structures,
contractual agreements and businesses and operations of the WOFEs and those
DE's. However, there may be uncertainties regarding the interpretation and
implementation of current PRC laws and regulations. See "Risk Factors -- Risks
Relating to Our Business."
BUSINESS OPERATIONS OF THE WOFES
The business of each of Clickcom, Guangzhou3G, Wanrong and Imobile WOFE's are
conducted through a series of contractual agreements with their affiliated
PRC-incorporated Domestic Enterprise (DE) value-added service (VAS) or ecommerce
providers, Dianxun-DE, Sunroom-DE, Wanrong-DE and Imobile-DE, respectively, and
their respective shareholders. We do not have any ownership interests in
Dianxun-DE, Sunroom-DE, Wanrong-DE and Imobile-DE.
WIRELESS DATA SERVICES
----------------------
Dianxun-DE, Sunroom-DE and Wanrong-DE have established cooperation arrangements
with mobile telecommunications operators, mobile phone producers and other
wireless data service providers in the wireless VAS business. They provide
wireless data services through China Mobile's Monternet and China Unicom's
UNI-Info platforms pursuant to revenue sharing agreements that they have entered
into with these mobile telecommunications operators. These services include
color ring back tone (CRBT) services, background music (BGM) services, VICQ
mobile instant messaging services, sports and soccer news, weather forecasts,
stock prices, jokes, short stories, dramas, songs and mobile karaoke, mobile TV,
games and entertainment.
China Mobile and China Unicom control the two mobile telecommunications networks
through which all wireless data services are currently provided to mobile phone
users in China. Close working relationships with China Mobile and China Unicom
are critical to the operation and continued development of wireless data
services business. See "Risk Factors -- Risks Relating to Our Business." A
substantial portion of Dianxun-DE, Sunroom-DE and Wanrong-DE business depends on
mobile telecommunications 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 our revenue. As of the end of 2005,
Dianxun-DE, Sunroom-DE and Wanrong-DE had entered into approximately 25
cooperation and revenue sharing agreements with various provincial subsidiaries
of China Mobile, as well as China Unicom, to provide wireless data services to
mobile phone users, to research and develop new wireless data technologies and
to promote the use of wireless data services in China.
Dianxun-DE, Sunroom-DE and Wanrong-DE established the fees for data services in
consultation with telecommunications operators in China. They share the revenue
from these fees with the telecommunications operators, content providers and
mobile phone producers. They also pay a transmission fee to the appropriate
telecommunications operator with respect to messages that they send through its
value-added services platform.
The mobile telecommunications operators establish standards within which
wireless data services providers are able to set the fees for their services.
These standards are filed with the Ministry of Information Industry by the
mobile telecommunications operators. In accordance with these standards, they
charge the users content fees on either a per-message or a monthly subscription
basis. Both per-message and monthly subscription content fees vary for the
different wireless data products and services.
WIRELESS INTERACTIVE VOICE RESPONSE (IVR) SERVICES
--------------------------------------------------
In May 2003, China Mobile launched its wireless IVR services nationwide. Mobile
phone users access Sunroom-DE's wireless IVR services through China Mobile's
network. Sunroom-DE's wireless IVR services include weather forecasts, stock
prices, jokes, short stories, dramas, songs and other entertainment topics, as
well as community-oriented services, such as chat and dating services.
9
We believe that demand for wireless IVR services in China, like demand for other
wireless value-added services, has been driven by the rapid increase in mobile
phone ownership, the rise in average income and the emergence of a youth culture
that rapidly adopts new modes of affordable entertainment.
CONSULTING AND SERVICE AGREEMENTS
The Consulting and Service Agreement signed between each WOFE and their
respective DE is similar. Pursuant to the terms of the agreement, 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. In addition, each of the
shareholders of the DEs has granted to our President, Mr. Victor Tong, a Power
of Attorney which gives him the full power and authority to exercise all of the
rights of the shareholders of the DEs.
(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 - Fees from these 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. Accordingly, we conclude that going forward PacificNet should consolidate
the DEs' financial interests.
BUSINESS OPERATION HIGHLIGHTS OF 2005
During the three months ended December 31, 2005, we continued to win business
from high-profile Chinese and multinational companies conducting business in
China such as China Mobile, China Unicom, China Telecom, Bank of China, Ping An
Insurance, TCL, TNT Express, Watsons, Hutchison. All of our business units
remain strong, and we continue to focus on penetrating the CRM and VAS/IVR
markets through organic growth and by acquisition. With the launch of the
'iPACT' IVR-Alliance program, we hope to sign up new local IVR service providers
to join our unified brand and strong IVR content and service offerings, under a
chain of unified service standard under the iPACT brand. We look forward to
revenue growth, market share improvement, and stronger partnerships with all the
major telecom operators and local IVR service providers in China. With business
activity increasing across all of our units, we are excited about the prospects
for the Company in the coming quarters. We believe that our fundamentals are
stronger than ever and that market opportunities for sustainable growth and
profitability in China's CRM and VAS sector are vast. The following are some of
the highlights of 2005:
o In January, Watsons Water selected PacificNet Epro's WISE-xb
Multimedia Contact Center System as its customer services initiative for its
customer services center.
o In January, PacificNet Linkhead, a leading provider of interactive
voice response (IVR), voice chatline, mobile QQ, and other voice based
value-added services in China, launched the Color Ring-back Tone (CRBT) services
for China Unicom (NYSE:CHU) in Shandong and Henan. We partnered with North Tech,
a leading system integrator and channel partner, in deploying the customized
Color Ring-back Tone (CRBT) service for China Unicom Henan Province, with over
200,000 users based on both CDMA and GSM networks. With the CRBT service
("Cai-Ling"), subscribers can customize the ring tone from a wide selection of
commercial music, personalized messages, celebrity greetings, or voice
advertisements to replace the monotonous ring connecting tone that the caller
would hear.
o In February, we successfully deployed WISE-xb Interactive Voice
Response System (IVRS) Contact Center Solution for TNT Hong Kong, a division of
TPG NV and the world's leading business to business express delivery company, as
TNT's key customer relationship management (CRM) initiative to enhance its
customer services.
10
o In March, we expanded our operations by acquiring entities that
operate as service providers in the VAS & IVR industries, which have grown
rapidly in China in recent years and to further develop products and services
organically. On the acquisition front, the purchase of Guangzhou 3G Information
Technology Co. Ltd. in April was a significant event. We purchased a 51%
controlling interest, which is expected to help expand PacificNet's value-added
service coverage to all of China through Guangzhou 3G's experienced operation
team of 280 staff and sales offices in 26 provinces in China. Guangzhou 3G is
one of the largest value-added telecom and information services providers in
China with both voice and data connections to the four major telecom operators
(China Mobile, China Unicom, China Telecom, and ChinaNetcom), covering both
mobile and fixed-line networks.
o In April, we were selected by Ping An Insurance ("Ping An"), the
second largest life insurance company in China, to provide CRM consulting and
call center training services to Ping An's main customer service center located
in Suzhou with 300 seats and 500 customer service representatives.
o In April, we have formed an alliance with the largest Call Center in
Japan, under which we became designated agent for Bellsystem24, Inc. in China
and Hong Kong. Bellsystem24 is Japan's largest telemarketing, call center and
CRM services company with over 4,300 clients, 22,135 communication service
representatives, 9,500 workstations, 160 system engineers, and 31 offices in
Japan.
o In June, we formed a partnership with Epicor Software Corporation
(NASDAQ:EPIC), a recognized global leader of software solutions for
middle-market companies, to provide Customer Relationship Management (CRM) for
Chinese companies.
o In July, we announced the launch of a new IVR-Alliance program called
"iPACT" at the 2005 Voice Value-Added Service (VAS) Conference. Under this iPACT
program, PacificNet plans to sign up qualified Voice-VAS and IVR service
providers as profit sharing members in China under a unified brand "iPACT".
PacificNet will provide to qualified VAS-Alliance partners, on a profit sharing
basis, all of the hardware, software, application, and content for VAS,
including a variety of IVR and other wireless and fixed-line VAS content. Mobile
and fixed-line phone users can access PacificNet's VAS-Alliance services through
Guangzhou 3G presence in 26 provinces in China.
o In August, PacificNet Clickcom, reached an agreement with China
Unicom's Guangdong Branch to launch a new Mobile Mailbox Service called "UMAIL"
for Unicom's CDMA users on its WAP Portal website. Guangdong is one of the
largest and most affluent provinces in China and represents a significant
opportunity for PacificNet to offer value-added telecom services. As of June
2005, China Unicom has 30.47 million CDMA users and 8.5 million WAP users
nationwide. China Unicom's CDMA users in Guangdong may go to its WAP Portal,
enter UMAIL service, and be able to send and receive e-mail by mobile phone.
o In October, PacificNet Epro acquired a 70% ownership interest in
Guangzhou JunFeng Network Technology Co. Ltd. (JunFeng). The acquisition is
expected to be additive to Epro's 2006 earnings.
o In November, PacificNet Linkhead was awarded an open project tender
by Industrial and Commercial Bank of China ("ICBC"), the largest commercial bank
in China with over 21,000 domestic branches, to develop its integrated IVR
telephone banking system.
o In December, we continued to win high-profile government and private
sector projects. We won a project tender by the City of Guangzhou, one of the
largest and most affluent cities in China, to develop an Internet and intranet
based e-business platform for Guangzhou Metro.
RECENT DEVELOPMENTS
Recently, we expanded our operations by acquiring entities that operate as
Internet e-commerce providers and service providers in the wireless VAS & IVR
industries, which have grown rapidly in China in recent years.
11
ACQUISITION OF GUANGZHOU WANRONG
In January 2006, we completed the acquisition of a 51% interest in Guangzhou
Wanrong Information Technology Co., Ltd. ("Guangzhou Wanrong",
http://www.my2388.com), one of the leading value-added telecom service providers
in China. The acquisition is expected to be accretive to the Company's earnings
in 2006. Since its inception in 2003, Guangzhou Wanrong has achieved strong
growth in its VAS including SMS, WAP, JAVA, MMS, IVR, multimedia entertainment
download services, media interactive products, mobile email services, life,
sports, entertainment, and business information services. Guangzhou Wanrong was
granted nationwide SMS service numbers "2388" for China Mobile and "9928" for
China Unicom. Wanrong's integrated value-added mobile services system is
valuable for the implementation of PacificNet's "iPACT program", a standard
service-mark for PacificNet's VAS profit-sharing alliance partnership program.
See "Product and Service Offerings: Value-Added Telecom Services" above for a
detailed description of the iPACT program.
We paid approximately US$1.75million for the equity interest in Guangzhou
Wanrong, which payable 21% in cash and 79% in restricted shares of PacificNet
common stock payable in restricted shares of PacificNet valued at $8 per share,
or about 173,000 restricted shares. The purchase price is payable upon
achievement of certain quarterly earn-out targets based on net income Under the
purchase agreement, Guangzhou Wanrong is obligated to generate $500,000 in
annual net income. In the event of a shortfall, the purchase price will be
adjusted accordingly. PacificNet will also invest approximately $370,000 (or
about RMB 3 million) in Guangzhou Wanrong for general corporate purposes.
ACQUISITION OF IMOBILE IN Q1 2006
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. 18900.com is the leading Internet e-commerce
distributor of mobile products in China, and provides Internet, email, customer
service centers, pre-sale and post-sale services, logistics and cash-on-delivery
(COD) services to mobile related products in China. iMobile's 18900.com
e-commerce operations combines both online Internet services with its offline
customer services network composed of a nationwide chain of logistic and
customer centers covering 21 provinces and 40 major cities in China, including
Beijing, Shanghai, Chongqing, Tianjin, Chengdu, Dalian, Qingdao, Guangzhou,
Shenzhen, Zhuhai, Dongguang, Hanzhou, Suzhou, Ningbo, Wenzhou, Nanjing, Wuhan,
Xian, Harbin, Qiqihaer, Hunan and Changsha.
iMobile's Internet portal has been one of the top ranked traffic sites and has
achieved about 2.3 million registered online users and over 400,000 active
users, with 5 million daily page views and 20,000 blog postings per day, which
makes iMobile the top ranked site in its category 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. The purchase price is payable upon achievement of
certain quarterly earn-out targets based on net income. Under the purchase
agreement, iMobile has committed to generate $500,000 in annual net income. In
the event of a shortfall, the purchase price will be adjusted accordingly.
PacificNet will also invest approximately $250,000 (about RMB 2 million) in
iMobile for general corporate and working capital purposes to support growth.
PRODUCTS AND SERVICES OFFERED
Our goal is to take a leading role in providing information technology services
and network communications, which are rapidly expanding business sectors in
Asia. The services offered by each of our subsidiaries can be classified within
one of the following three business groups:
1. OUTSOURCING SERVICES
BUSINESS PROCESS OUTSOURCING (BPO)
----------------------------------
PACIFICNET EPRO HOLDINGS Limited ("Epro") operates our call center offering 24
hour staff-answering and automatic-answering service hotlines in our service
areas, handling customer inquiries regarding services, billing, and technical
support, as well as customer complaints. We offer services targeted at
high-value and corporate customers. We provide them with dedicated account
executives, on-site visits, and systems for collecting comments and handling
complaints.
12
Epro is a leading provider of outsourced call-center services with over 15 years
of field experience in greater China. Epro's business consists of the following
three major categories:
(1) OUTSOURCED CALL CENTER SERVICES Epro's ISO 9001 certified
outsourcing contact center hosts over 1,000 workstations and 1,200
agents, processing over 100,000 calls daily and provides multi-lingual
inbound and outbound CRM services. The call center is the largest
outsourced call center in Hong Kong. Epro permits its clients to
recruit and hire their own personnel to work in its call center, for
which Epro provides managerial services, call center seats, and
equipment. Our inbound call center services include sales inquiry
hotline, telephone orders, technical helpdesk, and customer service.
Certain of our clients also engage us to provide telemarketing and
telesales for their products and for promotions, to conduct market
surveys, and to provide administrative functions, such as appointment
setting.
(2) TRAINING AND CONSULTING SERVICES The Epro Call Center Training
Institute (ECCTI) is a leading provider of Contact Center Management
Consulting and Training services, which helps clients to maximize the
return on investment of their CRM operations. Through ECCTI, we provide
on-site training and consulting services, and we offer courses and
seminars for call center managers and professionals, sales
representatives, customer service representatives and telemarketing
service representatives and in-house trainers.
(3) CALL CENTER MANAGEMENT SOFTWARE PRODUCTS AND SOLUTIONS WISE-xb Call
Center agent performance management and reporting software is Epro's
proprietary call center management software. Wise-xb has been installed
in over 60 customer sites in the PRC. Epro's products also include
Automatic Call Distribution (ACD) System, Unified Messaging System
(UMS), SMS, and VAS.
INFORMATION TECHNOLOGY OUTSOURCING (ITO)
----------------------------------------
PACIFIC SMARTIME SOLUTIONS LIMITED ("Smartime") - Through Pacific Solutions
Technology (Shenzhen) Company Limited, its operating subsidiary in Shenzhen,
China, Smartime provides outsourced consulting services and programming
services, including software development, R&D, and project management to leading
telecom, banking and financial services companies including Huawei, IBM, Bank of
East Asia and others.
PACIFICNET SOLUTIONS LIMITED ("PacSo") - PacSo specializes in systems
integration, software application, and e-business solutions services in Hong
Kong and Greater China. The scope of PacSo's products and services includes
smart card solutions, web based front-end applications and web based connections
to backend enterprise planning systems.
2. VALUE-ADDED TELECOM SERVICES (VAS)
CHINAGOHI - Through our subsidiary, ChinaGoHi, we provide China with
telemarketing services, financial advisory services, and infomercial marketing
services, including Direct Response Television (DRTV) infomercials through
satellite, cable tv broadcasting, and web portals. We also offer
subscription-based value-added services including Internet email, short message
services (SMS), mobile WAP services, and interactive voice response (IVR)
services via fixed-line and mobile phones.
LINKHEAD - Linkhead is a value-added reseller and provider of VAS, such as IVR
system development and integration, SMS, and voice-portal services. Linkhead is
also a channel partner, or a master reseller, of NMS Communications system
hardware, a leading provider of communications technologies. Linkhead also acts
as a mobile phone systems integrator for service providers in China, providing
the hardware, know-how, and software for mobile phone VAS, such as mobile chat,
mobile karaoke, and color ring back tone. The service providers ultimately
provide the Linkhead systems to telecom operators, such as China Unicom and
China Netcom.
CLICKCOM-WOFE - Through Clickcom-WOFE and its affiliated company Dianxun-DE we
can offer, directly to China's telecom operators, a wide variety of wireless
Internet services for mobile phones, such as SMS, Wireless Application Protocol
(WAP), which allows users to access information instantly via handheld wireless
devices, and Java mobile applications. The acquisition of Clickcom-WOFE was our
first step in entering the VAS service provider market where we anticipate
designing our own mobile phone VAS for distribution directly to telecom
operators.
13
GUANGZHOU3G-WOFE - Guangzhou3G-WOFE is one of the largest value-added telecom
and information services providers in China with both voice (IVR and call
center) and data (SMS, MMS, WAP, JAVA, GPRS) connections to the four major
telecom operators: China Mobile, China Unicom, China Telecom, and China Netcom,
covering both mobile and fixed-line networks. Guangzhou 3G also offers a wide
variety of IVR and other wireless and fixed-line, value-added telecom services
including color ring back tone (CRBT) services, background music (BGM) services,
VICQ mobile instant messaging services, sports and soccer news, weather
forecasts, stock prices, jokes, short stories, dramas, songs and mobile karaoke,
mobile TV, games, entertainment, as well as community-oriented services, such as
chatline and dating services. Mobile and fixed-line phone users can access
Guangzhou 3G IVR services through one of the four major telecom operators'
networks.
IPACT INTERNATIONAL INVESTMENT LIMITED - IPACT plans to sign up qualified
Voice-VAS and IVR service providers as profit sharing members in China under a
unified brand "iPACT." We will provide to qualified VAS-Alliance partners, on a
profit sharing basis, all of the hardware, software, application, and content
for VAS, including a variety of IVR and other wireless and fixed-line VAS
content, including color ring back tone (CRBT) services, background music (BGM)
services, VICQ mobile instant messaging services, sports news, weather
forecasts, stock market, humor, songs and mobile karaoke, mobile TV, games,
entertainment, as well as community-oriented services, such as chatline and
dating services. Mobile and fixed-line phone users can access PacificNet's
VAS-Alliance services through Guangzhou 3G presence in 26 provinces in China.
PACIFICNET AD. LIMITED - PacificNet Ad. Limited was newly formed in December
2005 in Hong Kong and provides advertising and media services.
3. COMMUNICATION PRODUCTS DISTRIBUTION
YUESHEN - Yueshen distributes telecom services for mobile phones, such as
calling cards, mobile SIM cards, prepaid stored-value cards, wireless broadband
and Internet services for mobile phones. We sell calling cards wholesale to
distributors who in turn sell to retail shops, such as newsstands. We have
entered the retail calling card market and have established nine retail stores
in the Guangzhou Metro. Yueshen is the designated distributor of China Netcom's
XiaoLingTone/PHS mobile phone products, prepaid calling cards, wireless
broadband and Internet services.
IMOBILE - iMobile's Internet portal has been one of the top ranked traffic sites
and has achieved about 2.3 million registered online users and over 400,000
active users, with 5 million daily page views and 20,000 blog postings per day,
which makes iMobile the top ranked site in its category in China.
PACIFICNET COMMUNICATIONS LIMITED - PacificNet communication (referred to herein
as "PacCom"), was incorporated in Hong Kong,and is a wholly owned subsidiary of
PacificNet that specializes in telecom related services in Hong Kong and Greater
China.
PRINCIPAL CUSTOMERS
Our principal customers in each of our business groups are located in Hong Kong,
mainland China and other regions of Asia. Our key clients consist of leading
telecom operators, banks, insurance, travel, marketing, government, services
companies and telecom consumers.
1. OUTSOURCING SERVICES (INCLUDING BPO, ITO, CALL CENTER SERVICES) CUSTOMERS
The following is a brief description of some of the Company's customers in the
outsourcing services group:
HUTCHISON TELECOM - A subsidiary of Hutchison Whampoa Ltd, is one of the world's
leading owners and operators of telecommunications, offering a wide range of
communication services in Hong Kong and around the globe including mobile
telephony (voice and multimedia), paging, trunked radio, fixed-line services,
Internet services, fiber optic broadband networks and radio broadcasting.
14
PCCW LIMITED - A leading telecommunications carrier and service provider in Hong
Kong.
SUNDAY COMMUNICATIONS LIMITED - One of the six mobile operators in Hong Kong,
SUNDAY was granted a mobile carrier license in Hong Kong to construct and
operate a 3G network. SUNDAY offers its mobile subscribers basic airtime
services, value-added services, enhanced services, short messaging services,
wireless data services, roaming services and international long distance calling
services, and sells accessories.
BANK OF CHINA GROUP INSURANCE COMPANY (BOCGI) - BOCGI owns 6 branches and one
wholly owned subsidiary life insurance company (Bank of China Group Life
Assurance Company Ltd.) in Hong Kong and Mainland China.
AMERICAN EXPRESS BANK (HONG KONG) - A diversified worldwide travel, financial
and network services company founded in 1850. It is a world leader in charge and
credit cards, Travelers Cheques, financial planning, business services,
insurance and international banking.
ACNIELSEN (CHINA) LTD. - The world's leading provider of market research,
information and analysis to the consumer products and services industries,
primarily in retail measurement, consumer panel research, customized research
and media measurement, as well as to government and social services.
HSBC - One of the largest banking and financial services organizations in the
world. HSBC's international network comprises over 9,500 offices in 76 countries
and territories in Europe, the Asia-Pacific region, the Americas, the Middle
East and Africa.
SO-NET, HONG KONG - A wholly owned subsidiary of Sony Corporation of Hong Kong
Limited. So-net was granted a sub-license from Sony Communication Network
Corporation (SCN) to create a broadband service under the So-net brand. So-net
has become the third largest Internet Service Provider in Japan with a
subscriber base of 1.7 million. Sony is a leading manufacturer of audio, video,
game, communications and information technology products for the consumer and
professional markets
TCL CORPORATION - A leading consumer electronics brand in China that runs its
business from multimedia to mobile phones, from personal computers to home
appliances, from electric lighting to digital products.
HONG KONG GOVERNMENT - Hong Kong Housing Authority - The Hong Kong Housing
Authority (HA) was established as a statutory body in April 1973 under Hong
Kong's Housing Ordinance. Within the Government's overall housing policy
framework, the HA determines and implements public housing programs.
2. VALUE-ADDED TELECOM SERVICES (VAS) CUSTOMERS
CHINA TELECOM - The largest fixed service telecommunications provider in China,
which includes data, Internet, and the XiaoLingTong PAS wireless system.
CHINA NETCOM - One of the four major telecom carriers in China, which includes
fixed line, data, Internet, and the XiaoLingTong wireless system.
CHINA MOBILE - The largest mobile operator in China.
CHINA UNICOM - One of the major mobile operators in China operating both GSM and
CDMA mobile networks, long-distance call, local call, data communication
including Internet service and IP phone, value-added telecom service, wireless
paging and a variety of relevant services.
3. COMMUNICATION PRODUCTS DISTRIBUTION CUSTOMERS
China Telecom, China Netcom, China Mobile and China Unicom are our primary
customers.
MOTOROLA - A world leader in wireless and broadband communications.
15
NOKIA - Nokia is a world leader in mobile communications, with products like
mobile phones, devices and solutions for imaging, games, media and businesses.
Nokia provides equipment, solutions and services for network operators and
corporations.
SALES AND MARKETING
We do not engage in any significant marketing activities. We advertise our
services by attending various CRM and VAS trade shows and conferences in China.
There are a limited number of competitors in our industry; accordingly, new
business opportunities are generated mainly through business contacts and by
word of mouth. We rely on our reputation for quality and efficiency among our
customers and leveraging our strategic investors to obtain new business.
GOVERNMENT REGULATION
We operate our business in China under a legal regime that consists of the State
Council, which is the highest authority of the executive branch of the PRC
central government, and several ministries and agencies under its leadership,
including:
o the Ministry of Information Industry (MII);
o the China Securities Regulatory Commission (CSRC);
o the Ministry of Culture;
o the General Administration of Press and Publication of the
P.R. China;
o the State Copyright Bureau;
o the State Administration of Industry and Commerce (SAIC);
o the Ministry of Public Security; and
o the Ministry of Commerce.
The State Council and these ministries and agencies have issued a series of
rules that regulate a number of different substantive areas of our business,
which are discussed below.
FOREIGN OWNERSHIP RESTRICTION ON BUSINESSES ENGAGED IN PROVIDING INTERNET
CONTENT
PRC regulations currently limit foreign ownership of companies that provide
Internet content services to 50%. This limitation extends to our IVR, call
center and telecom VAS and to our business of providing financial information
and data to Internet users. To comply with this foreign ownership restriction,
with respect to our Internet content services, we operate our website in China
through Shenzhen DongFang Digital Port Technology Development Company Limited
("DongFang Digital"), which is 59% owned by Mr. Wang Wen Ming, the Chairman and
CEO of ChinaGoHi, who is a PRC citizen. Under PRC law, we cannot hold the
licenses and obtain the approvals necessary to operate the website because those
licenses and approvals can not be held by foreign entities or majority
foreign-owned entities. Furthermore, because Lion Zone and ChinaGoHi are wholly
owned foreign enterprises, they cannot hold such licenses or obtain the
approvals.
There are substantial uncertainties regarding the interpretation and application
of current or future PRC laws and regulations with respect to our acquisition
model. In the opinion of our in-house PRC legal counsel, our current ownership
structure, the contractual arrangements among our wholly owned subsidiaries and
the operating company and their shareholders comply with all existing applicable
PRC laws, rules and regulations. We cannot assure that the PRC regulatory
authorities will not ultimately take a view that is contrary to the opinion of
our PRC legal counsel. If the PRC government finds that the agreements that
establish the structure of our operations in China do not comply with PRC
government restrictions on foreign investment in our industry, we could be
subject to severe penalties.
LICENSES AND PERMITS
There are a number of aspects of our business which require us to obtain
licenses from a variety of PRC regulatory authorities. For example, in order to
host our website, DongFang Digital is required to hold an Internet content
provider, or ICP, license issued by the Ministry of Information Industry or its
local offices. DongFang Digital currently holds an ICP license issued by
Ministry of Information Industry Guangdong department. Each ICP license holder
that provides analysis and research information relating to stocks and other
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securities must obtain a securities advisory permit from China Securities
Regulatory Commission, or the CSRC. Our subsidiary ChinaGoHi currently holds a
securities advisory permit, which allows it to operate in securities investment
consultancy service. We also receive securities analysis and research
information from other licensed securities advisors that hold securities
advisory permits, and we have disclosed on our websites, reports, and in our
software the sources of such information as required by the CSRC.
A recent regulation issued by the Ministry of Information Industry requires
short message, or SMS, content providers to obtain an SMS license from the
Ministry of Information Industry or its local offices. DongFang Digital has
obtained the required SMS license for the delivery of our financial short
message content. Furthermore, the Ministry of Information Industry has
promulgated rules requiring ICP license holders that provide online bulletin
board services to register with, or obtain an approval from, the relevant
telecommunications authorities. DongFang Digital has obtained such approval from
Guangdong Communications Administration, the government agency in charge of this
matter in Guangdong and Shenzhen.
REGULATION OF INTERNET CONTENT
The PRC government has promulgated measures relating to Internet content through
a number of ministries and agencies, including the Ministry of Information
Industry, the Ministry of Culture and the State Press and Publications
Administration. These measures specifically prohibit Internet activities that
result in the publication of any content which is found to, among other things,
propagate obscenity, gambling or violence, instigate crimes, undermine public
morality or the cultural traditions of the PRC, or compromise State security or
secrets. If an ICP license holder violates these measures, the PRC government
may revoke its ICP license and shut down its websites. DongFang Digital's ICP
license expressly states that it is not allowed to publish news, among other
things, in relation to its Internet content provision. Specifically, Shenzhen,
Beijing and Guangzhou branches of the General Administration of Press and
Publication of the PRC, the government authority regulating news publication,
confirmed with us that so long as we do not provide general news on politics,
society or culture, or establish a "news column," or provide such information
under express heading of "news," we are not required to obtain a license to
publish financial or economic related news content.
REGULATION OF INFORMATION SECURITY
Internet content in China is also regulated and restricted by the PRC government
to protect State security. The National People's Congress, China's national
legislative body, has enacted a law that may subject to criminal punishment in
China any effort to: (1) gain improper entry into a computer or system of
strategic importance; (2) disseminate politically disruptive information; (3)
leak State secrets; (4) spread false commercial information; or (5) infringe
intellectual property rights.
The Ministry of Public Security has promulgated measures that prohibit use of
the Internet in ways which, among other things, result in a leakage of State
secrets or a spread of socially destabilizing content. The Ministry of Public
Security has supervision and inspection rights in this regard and we may be
subject to the jurisdiction of the local security bureaus. If an ICP license
holder violates these measures, the PRC government may revoke its ICP license
and shut down its websites.
INTELLECTUAL PROPERTY RIGHTS
The State Council and the State Copyright Bureau have promulgated various
regulations and rules relating to protection of software in China. Under these
regulations and rules, software owners, licensees and transferees should
register their rights in software with the State Copyright Bureau or its local
offices and obtain software copyright registration certificates. Although such
registration is not mandatory under PRC law, software owners, licensees and
transferees are encouraged to go through the registration process. Therefore
persons with registered software rights may receive better protection. We have
registered all of our self-developed software with the State Copyright Bureau.
PRC law requires owners of Internet domain names to register their domain names
with qualified domain name registration agencies approved by the Ministry of
Information Industry and obtain a registration certificate from such
registration agencies. A registered domain name owner has an exclusive use right
over its domain name. Unregistered domain names may not receive proper legal
protections and may be misappropriated by unauthorized third parties. Our
primary domain names, www.ChinaGoHi.cn and www.GHGC.cn are registered with
CNNIC, a domain name registration agency approved by the Ministry of Information
Industry. In addition, we have registered another domain name, www.FMM88.com,
with the Internet Corporation for Assigned Names and Numbers, or ICANN, an
internationally organized, non-profit corporation that has responsibility for
Internet Protocol (IP) address space allocation.
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PRIVACY PROTECTION
PRC law does not prohibit Internet content providers from collecting and
analyzing personal information from their users. On our website, our users are
required to accept a user agreement whereby they agree to provide certain
personal information to us. PRC law prohibits Internet content providers from
disclosing to any third parties any information transmitted by users through
their networks unless otherwise permitted by law. If an Internet content
provider violates these regulations, the Ministry of Information Industry or its
local offices may impose penalties and the Internet content provider may be
liable for damages caused to its users.
ADVERTISING REGULATION
PRC law requires entities conducting advertising activities to obtain an
advertising permit from the SAIC's local offices. Entities conducting
advertising activities without such permit may be charged a fine or imposed
other penalties by the SAIC's local offices. Currently, foreign investors cannot
own more than 70% equity interest in an advertising agency in China. DongFang
Digital holds an advertising permit.
COMPETITION
We expect competition to persist and intensify in the future. Our competitors
include small firms offering specific applications, divisions of large entities
and large independent firms. A number of competitors have or may develop greater
capabilities and resources than ours. We face the risk that new competitors with
greater resources than ours will enter our market. Our competitors are mainly
leaders in the CRM and VAS markets. Competitive pressures from current or future
competitors could cause our services to lose market acceptance or require a
significant reduction in the price of our services.
1. OUTSOURCING SERVICES (INCLUDING BPO, ITO, CALL CENTER SERVICES) COMPETITORS:
PCCW is one of Asia's leading integrated communications services companies,
providing local telephony and broadband services to businesses.
Chinasoft International Limited, or ICSS, is a leading e-government solution
provider and software developer in the PRC, and has entered the software
outsourcing, interrelated systems integration, consultancy and training services
industry.
2. VALUE-ADDED TELECOM SERVICES (VAS) COMPETITORS:
China Finance Online Co. Ltd., (NASDAQ:JRJC), is one of the leading companies
that specialize in providing online financial and listed company data and
information in China. They offer subscription-based services based on a single
information platform that integrates data and information from multiple sources
with features and functions such as data and information search, retrieval,
delivery, storage and analysis.
TOM Online Inc. (NASDQ:TOMO), is a leading wireless Internet company in China
providing value-added multimedia products and services, targeting the young and
trendy demographics. The company's primary business activities include wireless
value-added services and online advertising. The company offers an array of
services such as SMS, MMS, WAP, wireless IVR (interactive voice response)
services, content channels, search and classified information, and free and
fee-based advanced email.
SINA Corporation (NASDAQ:SINA) is a leading online media company and value-added
information service (VAS) provider for China and for Chinese communities
worldwide offering Internet users and government and business clients an array
of services.
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3. COMMUNICATION PRODUCTS DISTRIBUTION COMPETITORS
There are various smaller regional players in the communications distribution
industry.
EMPLOYEES
As of December 31, 2005, together with our subsidiaries, we had approximately
2,300 employees and contractors. We have not experienced any labor stoppages.
None of our employees are covered by collective bargaining agreements. The
breakdown of number of employees for each of the business units of the Company
is as follows:
COMPANY AND SUBSIDIARIES NUMBER OF EMPLOYEES
--------------------------------------------------------------------------------
PacificNet Inc. 5
PacificNet Limited (Hong Kong) 12
PacificNet Beijing 16
PacificNet Shenzhen 13
PacificNet Guangzhou 1
PacificNet Solutions Ltd. 1
PacificNet Power Ltd. 4
Epro Telecom Holdings Limited 750
Beijing Linkhead Technologies Company Limited 60
Guangzhou Yueshen TaiYang Technology Limited 32
Smartime / Soluteck Technology (Shenzhen) Company Limited 170
Guangzhou 3G 280
Clickcom 10
ChinaGoHi 860
Wanrong 42
iMobile 58
------------------
TOTAL 2314
==================
RESEARCH AND DEVELOPMENT
We place great emphasis on the continued enhancement of our existing products
and solutions, including designing, developing and supporting a portfolio of
converged voice and data enhanced services, products and solutions to help
wireless, fixed-line and Internet service providers offer unprecedented access
to communications, information and commerce. We have ongoing research and
development activities with respect to the following products and solutions:
o multi-media information on demand systems, which integrates
the dynamics of the Internet with voice-based communication
applications, including text-to-speech and voice recognition
capabilities;
o web-based multimedia call center/customer relationship
management for service providers and corporations;
o WISE-xb, which is a call center agent performance management
and reporting software. It provides intelligent routing,
comprehensive ACD/PBX capabilities, Email, IVR, Voice Mail,
Messaging, Conference, Recording, Coaching/Supervising,
Reporting and Interface.;
o voice mail systems;
o color ringback tone systems; and
o value-added services for mobile users.
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EXECUTIVE OFFICES
Our executive offices are located in Hong Kong, Beijing, Shenzhen, Guangzhou,
China, and Minneapolis, USA, at the following addresses:
PacificNet Limited, 601 New Bright Building, 11 Sheung Yuet Road, Kowloon Bay,
Kowloon, Hong Kong. Tel: 011-852-2876-2900, Fax: 011-852-27930689,
[email protected]
PacificNet Shenzhen Office: Room 901, Tower A, Tian An High-Tech Plaza, Tian An
Cyber Park,Fu Tian District, Shenzhen, China Postal Code: 518040
PacificNet Guangzhou Office: 15/F, Building A, Huajian Plaza, No. 233 Tianfu
Road, Tianhe District, Guangzhou, China Postal Code: 510630
PacificNet Beijing Office: 23/F, Building A, TimeCourt, No.6 Shuguang Xili,
Chaoyang District, Beijing, China Postal Code: 100028 Tel:86-010-59225000
PacificNet Inc., 860 Blue Gentian Road, Suite 360, Eagan, MN 55121-1575, USA.
Tel: +1-651-209-3100, Fax: +1-651-209-3103, Email: [email protected]
We maintain a website at www.PacificNet.com.
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RISK FACTORS
Investing in our securities involves a great deal of risk. Careful consideration
should be made of the following factors as well as other information included in
this prospectus before deciding to purchase our common stock. You should pay
particular attention to the fact that we conduct a majority of our operations in
China and are governed by a legal and regulatory environment that in some
respects differs significantly from the environment that may prevail in other
countries. Our business, financial condition or results of operations could be
affected materially and adversely by any or all of these risks.
THE FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,
FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR
OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A
FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT
ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR STATEMENTS.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY AND RECENTLY EXPERIENCED A SIGNIFICANT
INCREASE IN REVENUE THAT MAY NOT BE SUSTAINED.
Our business operations commenced in 1994, and subsequently the business was
incorporated as a Delaware corporate entity in 1999. Our operating history may
be insufficient to evaluate our business and future prospects. Although our
revenue have grown rapidly in the past two years, primarily as a result of our
increased acquisition activity, we cannot assure investors that we will maintain
our profitability or that we will not incur net losses in the future. We expect
that our operating expenses will increase as we expand. Any significant failure
to realize anticipated revenue growth could result in significant operating
losses. We will continue to encounter risks and difficulties in implementing our
business model, including our potential failure to:
o increase awareness of our brands, protect our reputation and
develop customer loyalty;
o manage our expanding operations and service offerings,
including the integration of any future acquisitions;
o maintain adequate control of our expenses; and
o anticipate and adapt to changing conditions in the markets in
which we operate as well as the impact of any changes in
government regulation, mergers and acquisitions involving our
competitors, technological developments and other significant
competitive and market dynamics.
If we are not successful in addressing any or all of these risks, our business
may be materially and adversely affected.
THE ACQUISITION OF NEW BUSINESSES IS COSTLY AND SUCH ACQUISITIONS MAY NOT
ENHANCE OUR FINANCIAL CONDITION.
Our growth strategy is to acquire companies and identify and acquire assets and
technologies from businesses in greater China that have services, products,
technologies, industry specializations or geographic coverage that extend or
complement our existing business. The process to undertake a potential
acquisition is time-consuming and costly. We expend significant resources to
undertake business, financial and legal due diligence on our potential
acquisition target and there is no guarantee that we will acquire the company
after completing due diligence. Any future acquisitions will be subject to a
number of challenges, including:
o the diversion of management time and resources and the
potential disruption of our ongoing business;
o difficulties in maintaining uniform standards, controls,
procedures and policies;
o potential unknown liabilities associated with acquired
businesses;
o the difficulty of retaining key alliances on attractive terms
with partners and suppliers; and
o the difficulty of retaining and recruiting key personnel and
maintaining employee morale.
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Our acquisitions could result in the use of substantial amounts of cash,
potentially dilutive issuances of equity securities, significant amortization
expenses related to goodwill and other intangible assets and exposure to
undisclosed or potential liabilities of acquired companies. During the fiscal
year ended December 31, 2005, we acquired a controlling interest in Guangzhou 3G
Information Technology Co. Ltd. ("Guangzhou3G-WOFE") Click-WOFE and Shenzhen
GuHaiGuanChao Investment Consultant Company Limited ("ChinaGoHi"), a wholly
owned foreign enterprise (WOFE) registered in China. We expect that acquisitions
will strengthen our position as a provider of outsourced call center, VAS and
communication products in Asia. Although our agreements provide that the
consideration is payable upon the acquired company attaining certain income
milestones annually, there is no guarantee that these milestones will be
reached. If they are not reached as anticipated, the time, cost and capital to
acquire the company may outweigh the anticipated benefits from consolidation of
their income. PacificNet recorded approximately $8.88 million of goodwill as a
result of several acquisitions that is not subject to amortization in the
ordinary course of business. To the extent that the businesses acquired in these
transactions do not remain competitive, some or all of the goodwill related to
that acquisition could be charged against future earnings.
A SUBSTANTIAL PORTION OF OUR BUSINESS DEPENDS ON MOBILE TELECOMMUNICATIONS
OPERATORS IN CHINA AND ANY LOSS OR DETERIORATION OF SUCH RELATIONSHIPS MAY
RESULT IN SEVERE DISRUPTIONS TO OUR BUSINESS OPERATIONS.
We rely entirely on the networks and gateways of China Mobile and China Unicom
to provide our wireless value-added services. Thus, we face certain risks in
conducting our wireless value-added services business, such as the following:
Currently, China Mobile and China Unicom are the only mobile telecommunications
operators in China that have platforms for wireless value-added services. Our
agreements with them 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 us, we will not be able to conduct our
existing wireless value-added services business.
Our agreements with China Mobile and China Unicom are subject to negotiation
upon expiration. If any of the mobile telecommunications operators decides to
change its content or transmission fees or its share of revenue, or does not
comply with the terms of the agreement, our revenue and profitability could be
materially adversely affected.
THE MOBILE TELECOMMUNICATIONS OPERATORS MAY LAUNCH AND MAY HAVE ALREADY LAUNCHED
COMPETING SERVICES OR COULD DISCONTINUE THE USE OF EXTERNAL CONTENT AGGREGATORS
SUCH AS OURSELVES ENTIRELY AT ANY TIME.
Due to our reliance on the mobile telecommunications operators for our wireless
value-added services, any loss or deterioration of our relationship with any of
the mobile telecommunications operators may result in severe disruptions to our
VAS business operations and the loss of a significant portion of our revenue.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE MATERIALLY AFFECTED BY
THE CHANGES IN POLICIES OR GUIDELINES OF THE MOBILE TELECOMMUNICATIONS
OPERATORS.
The mobile telecommunications operators in China may, from time to time, issue
certain operating policies or guidelines, requesting or stating its preference
for certain actions to be taken by all wireless value-added service providers
using their platforms. Due to our reliance on the mobile telecommunications
operators, a significant change in their policies or guidelines may have a
material adverse effect on us. For example, some mobile telecommunications
operators recently revised their billing policies to request all wireless
value-added service providers to confirm the subscription status of those users
who have not been active for three months. Such change in policies or guidelines
may result in lower revenue or additional operating costs for us, and we cannot
assure investors that our financial condition and results of operations will not
be materially adversely affected by any policy or guideline change by the mobile
telecommunications operators in the future.
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WE MAY BE SUBJECT TO ADVERSE ACTIONS FOR ANY BREACH OR PERCEIVED BREACH BY US OF
THE POLICIES OR GUIDELINES IMPOSED BY THE MOBILE TELECOMMUNICATIONS OPERATOR
WITH RESPECT TO CONTENT PROVIDED ON OR LINKED THROUGH OUR WEBSITES.
The mobile telecommunications operators in China may impose policies or
guidelines to govern or restrict the content provided by all wireless
value-added service providers, including content developed by us or content
supplied by others to us. The mobile telecommunications operators from time to
time have requested wireless value-added services providers, including us, to
remove objectionable content or links to or from websites with certain
categories of content, including content that they may deem to be sexually
explicit. We aggregate and develop content that we consider attractive to our
targeted user base, and we cannot assure investors that the mobile
telecommunications operators will not from time to time find certain portions of
our content to be objectionable. In the case of a breach or perceived breach of
such policies or guidelines, the mobile telecommunications operators may require
us to reduce or curtail the content on our Internet portal, which may reduce our
portal traffic, and the mobile telecommunications operators may have the right
to impose monetary fines upon us, or terminate our cooperation with them. In
addition, we would be liable to the mobile telecommunications operators for
their economic losses pursuant to our agreements with these operators if we were
found to be in breach of the policies or guidelines promulgated by them. As a
result of the occurrence of any of the above, our financial condition and
results of operations may be materially adversely affected.
OUR DEPENDENCE ON THE SUBSTANCE AND TIMING OF THE BILLING SYSTEMS OF THE MOBILE
TELECOMMUNICATIONS OPERATORS MAY REQUIRE US TO ESTIMATE PORTIONS OF OUR REPORTED
REVENUE FOR WIRELESS VALUE-ADDED SERVICES FROM TIME TO TIME. AS A RESULT,
SUBSEQUENT ADJUSTMENTS MAY HAVE TO BE MADE TO OUR WIRELESS VALUE-ADDED SERVICES
REVENUE IN OUR FINANCIAL STATEMENTS.
As we do not bill our wireless value-added services users directly, we depend on
the billing systems and records of the mobile telecommunications operators to
record the volume of our wireless value-added services provided, charge our
users through mobile telephone bills and collect payments from our users and pay
us. In addition, we do not generally have the ability to independently verify or
challenge the accuracy of the billing systems of the mobile telecommunications
operators. Generally, within 20 to 60 days after the end of each month, a
statement from each of the mobile telecommunications operators confirming the
value of wireless value-added services they bill to users in that month will be
delivered to us, and generally within 60 days after such delivery, we will be
paid by the mobile telecommunications operators for the wireless value-added
services, net of their revenue share, transmission fees and applicable business
taxes, for that month based on such statements.
OUR COMMUNICATION PRODUCTS ARE PROVIDED CASH-ON-DELIVERY, WHICH LEAVES US
VULNERABLE TO THEFT AND EMPLOYEE EMBEZZLEMENT. The purchase of calling cards,
SIM cards and other mobile phone products are made with cash. Although there is
a low risk that clients will not pay for these services when delivered, our
retail stores maintain large sums of money which might make them robbery
targets. We also face the risk that employees who collect the cash and others
who may be aware that cash is available at these sites might embezzle the money.
Theft or embezzlement could have a material adverse effect on the revenue
generated and the financial condition of our business operations.
WE INTEND TO OPERATE EACH OF OUR ACQUIRED BUSINESSES ON A STANDALONE BASIS. We
do not intend to integrate the information or communications systems,
management, or other aspects of the businesses we acquire. If we integrated the
businesses, we might be able to reduce expenses by eliminating duplicative
personnel, facilities, or technology and other costs. In addition, facilities
and technology integration might make inter-company communications and
transactions more efficient. By declining to integrate the acquired businesses,
we might forego opportunities to operate more profitably. Furthermore, our
decision not to integrate these businesses might result in difficulties in
evaluating the effectiveness of our internal control over financial reporting,
which could complicate compliance with Section 404 of the Sarbanes-Oxley Act of
2002.
BECAUSE WE DO NOT HAVE EMPLOYMENT AGREEMENTS WITH MANAGEMENT OF THE ACQUIRED
COMPANIES, OUR BUSINESS OPERATIONS MIGHT BE INTERRUPTED IF THEY WERE TO RESIGN
AND SEEK EMPLOYMENT WITH COMPETITORS. As part of our acquisition strategy, we do
not use our own employees or members of our management team to operate the
acquired companies. Key management at these companies has been in place for
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several years and has established solid relationships with their customers.
Competition in our industry for executive-level personnel is strong and we can
make no assurance that we will be able to retain the highly effective executive
employees. Although we provide incentives to management to stay with the
acquired business, we have not entered into employment agreements with them. If
such key persons were to resign we might face impairment of relationships with
remaining employees or customers, which might result in further resignation by
employees, and might cause long-term clients to terminate their relationship
with us. Furthermore, we have not entered into any non-competition and
confidentiality agreements with these employees and management. Due to the
limited enforceability of these types of agreements in China, we face the risk
that employees of the acquired subsidiaries might divulge our software and other
protected intellectual property secrets to competitors.
OUR CUSTOMERS ARE CONCENTRATED IN A LIMITED NUMBER OF INDUSTRIES. Our clients
are concentrated primarily in the telecommunications, telemarketing and
technology industries, and to a lesser extent, the insurance and financial
services industries, where the current trend is to outsource certain CRM and
VAS. Our ability to generate revenue depends on the demand for our services in
these industries. An economic downturn, or a slowdown or reversal of the
tendency in any of these industries to rely on outsourcing could have a material
adverse effect on our business, results of operations or financial condition.
THE MARKET IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND FRAGMENTED AND WE MAY
NOT BE ABLE TO MAINTAIN MARKET SHARE. We expect competition to persist and
intensify in the future. Our competitors are mainly leaders in the CRM services
market, such as PCCW Teleservices (Hong Kong) Limited, China Motion Telecom
International Limited, and Teletech (Hong Kong) Limited. Our competitors also
include small firms offering specific applications, divisions of large entities
and other large independent firms. We face the risk that new competitors with
greater resources than ours will enter our market. Furthermore, increasing
competition among telecom companies in greater China has led to a reduction in
telecommunication services fees that can be charged by such companies. If a
reduction in telecommunication services fees negatively impacts revenue
generated by our clients, they may require us to reduce the price of our
services, or seek competitors of ours that charge less. If we must significantly
reduce the price of our services, the decrease in revenue could adversely affect
our profitability.
KEY EMPLOYEES ARE ESSENTIAL TO GROWING OUR BUSINESS. Tony Tong, our Chairman and
Chief Executive Officer, and Victor Tong, our President, are essential to our
ability to continue to grow through acquisitions. Messrs. Tong and Tong have
established relationships within our industry. Their business contacts have been
critical in identifying, and negotiating with acquisition candidates. If either
of them were to leave our employ, our growth strategy might be hindered, which
could limit our ability to increase revenue.
THE ESTABLISHMENT AND EXPANSION OF INTERNATIONAL OPERATIONS REQUIRES SIGNIFICANT
MANAGEMENT ATTENTION. All of our current, as well as any anticipated future
revenue, are or are expected to be derived from Asia. Our international
operations are subject to risks, including the following, which, if not planned
and managed properly, could materially adversely affect our business, financial
condition and operating results:
o legal uncertainties or unanticipated changes regarding
regulatory requirements, liability, export and import
restrictions, tariffs and other trade barriers;
o longer customer payment cycles and greater difficulties in
collecting accounts receivable;
o uncertainties of laws and enforcement relating to the
protection of intellectual property; and potentially uncertain
or adverse tax consequences.
OUR OPERATIONS COULD BE CURTAILED IF WE ARE UNABLE TO OBTAIN REQUIRED ADDITIONAL
FINANCING. Since inception our investments and operations primarily have been
financed through sales of our common stock. During the fiscal year ended
December 31, 2005, we completed two private placements of our common stock in
which we received approximately $9,300,000 of gross proceeds. In the future we
may need to raise additional funds through public or private financing, which
may include the sale of equity securities, including securities convertible into
our common stock. The issuance of these equity securities could result in
dilution to our stockholders. If we are unable to raise capital when needed, our
business growth strategy may slow, which could severely limit our ability to
increase revenue.
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EFFORTS TO COMPLY WITH RECENTLY ENACTED CHANGES IN SECURITIES LAWS AND
REGULATIONS WILL INCREASE OUR COSTS AND REQUIRE ADDITIONAL MANAGEMENT RESOURCES
AND WE STILL MAY FAIL TO COMPLY. As directed by Section 404 of the
Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to
include a report of management on the company's internal controls over financial
reporting in their annual reports on Form 10-K. In addition, the independent
public accounting firm auditing the company's financial statements must attest
to and report on management's assessment of the effectiveness of the company's
internal controls over financial reporting. This requirement will first apply to
our annual report on Form 10-K for our fiscal year ending December 31, 2007. If
we are unable to conclude that we have effective internal controls over
financial reporting or, if our independent auditors are unable to provide us
with an unqualified report as to the effectiveness of our internal controls over
financial reporting beginning with the fiscal year ended December 31, 2007 as
required by Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose
confidence in the reliability of our financial statements, which could result in
a decrease in the value of our securities.
FLUCTUATIONS IN THE VALUE OF THE HONG KONG DOLLAR OR RMB RELATIVE TO FOREIGN
CURRENCIES COULD AFFECT OUR OPERATING RESULTS. We have historically conducted
transactions with customers outside the United States in United States dollars.
Payroll and other costs of foreign operations are payable in foreign currencies,
primarily Hong Kong dollars and Chinese renminbi. To the extent future revenue
is denominated in foreign currencies, we would be subject to increased risks
relating to foreign currency exchange rate fluctuations that could have a
material adverse affect on our business, financial condition and operating
results. The value of Hong Kong dollars and Chinese renminbi against the U.S.
dollar and other currencies may fluctuate and is affected by, among other
things, changes in the PRC's political and economic conditions. As our
operations are primarily in Asia, any significant revaluation of Hong Kong
dollars or the Chinese renminbi may materially and adversely affect our cash
flows, revenue and financial condition. For example, to the extent that we need
to convert U.S. dollars into Hong Kong dollars or Chinese renminbi for our
operations, appreciation of either currency against the U.S. dollar could have a
material adverse effect on our business, financial condition and results of
operations. Conversely, if we decide to convert our Hong Kong dollars or Chinese
renminbi into U.S. dollars for other business purposes and the U.S. dollar
appreciates against either currency, the U.S. dollar equivalent of the
respective currency we convert would be reduced. To date, we have not engaged in
any hedging transactions in connection with our international operations.
WE HAVE NEVER PAID CASH DIVIDENDS AND ARE NOT LIKELY TO DO SO IN THE FORESEEABLE
FUTURE. We have never declared or paid any cash dividends on our common stock.
We currently intend to retain any future earnings for use in the operation and
expansion of our business. We do not expect to pay any cash dividends in the
foreseeable future but will review this policy as circumstances dictate.
RISKS ASSOCIATED WITH DOING BUSINESS IN GREATER CHINA
There are substantial risks associated with doing business in greater China, as
set forth in the following risk factors.
OUR OPERATIONS AND ASSETS IN GREATER CHINA ARE SUBJECT TO SIGNIFICANT POLITICAL
AND ECONOMIC UNCERTAINTIES.
Changes in laws and regulations, or their interpretation, or the imposition of
confiscatory taxation, restrictions on currency conversion, imports and sources
of supply, 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. Under its current
leadership, the Chinese government has been pursuing economic reform policies
that encourage private economic activity and greater economic decentralization.
There is no assurance, however, that the Chinese government will continue to
pursue these policies, or that it will not significantly alter these policies
from time to time without notice.
CURRENCY FLUCTUATIONS AND RESTRICTIONS ON CURRENCY EXCHANGE MAY ADVERSELY AFFECT
OUR BUSINESS, INCLUDING LIMITING OUR ABILITY TO CONVERT CHINESE RENMINBI INTO
FOREIGN CURRENCIES AND, IF CHINESE RENMINBI WERE TO DECLINE IN VALUE, REDUCING
OUR REVENUE IN U.S. DOLLAR TERMS.
Our reporting currency is the U.S. dollar and our operations in China and Hong
Kong use their respective local currencies as their functional currencies. The
majority of our revenue derived and expenses incurred are in Chinese renminbi
25
with a relatively small amount in Hong Kong dollars and U.S. dollars. We are
subject to the effects of exchange rate fluctuations with respect to any of
these currencies. For example, the value of the renminbi depends to a large
extent on Chinese government policies and China's domestic and international
economic and political developments, as well as supply and demand in the local
market. Since 1994, the official exchange rate for the conversion of renminbi to
U.S. dollars had generally been stable and the renminbi had appreciated slightly
against the U.S. dollar. However, on July 21, 2005, the Chinese government
changed its policy of pegging the value of Chinese renminbi to the U.S. dollar.
Under the new policy, Chinese renminbi may fluctuate within a narrow and managed
band against a basket of certain foreign currencies. As a result of this policy
change, Chinese renminbi appreciated approximately 2.5% against the U.S. dollar
in 2005. It is possible that the Chinese government could adopt a more flexible
currency policy, which could result in more significant fluctuation of Chinese
renminbi against the U.S. dollar. We can offer no assurance that Chinese
renminbi will be stable against the U.S. dollar or any other foreign currency.
The income statements of our international operations are translated into U.S.
dollars at the average exchange rates in each applicable period. To the extent
the U.S. dollar strengthens against foreign currencies, the translation of these
foreign currencies denominated transactions results in reduced revenue,
operating expenses and net income for our international operations. Similarly,
to the extent the U.S. dollar weakens against foreign currencies, the
translation of these foreign currency denominated transactions results in
increased revenue, operating expenses and net income for our international
operations. We are also exposed to foreign exchange rate fluctuations as we
convert the financial statements of our foreign subsidiaries into U.S. dollars
in consolidation. If there is a change in foreign currency exchange rates, the
conversion of the foreign subsidiaries' financial statements into U.S. dollars
will lead to a translation gain or loss which is recorded as a component of
other comprehensive income. In addition, we have certain assets and liabilities
that are denominated in currencies other than the relevant entity's functional
currency. Changes in the functional currency value of these assets and
liabilities create fluctuations that will lead to a transaction gain or loss. We
have not entered into agreements or purchased instruments to hedge our exchange
rate risks, although we may do so in the future. The availability and
effectiveness of any hedging transaction may be limited and we may not be able
to successfully hedge our exchange rate risks.
Although Chinese governmental policies were introduced in 1996 to allow the
convertibility of Chinese renminbi into foreign currency for current account
items, conversion of Chinese renminbi into foreign exchange for capital items,
such as foreign direct investment, loans or securities, requires the approval of
the State Administration of Foreign Exchange, or SAFE, which is under the
authority of the People's Bank of China. These approvals, however, do not
guarantee the availability of foreign currency. We cannot be sure that we will
be able to obtain all required conversion approvals for our operations or that
Chinese regulatory authorities will not impose greater restrictions on the
convertibility of Chinese renminbi in the future. Because a significant amount
of our future revenue may be in the form of Chinese renminbi, our inability to
obtain the requisite approvals or any future restrictions on currency exchanges
could limit our ability to utilize revenue generated in Chinese renminbi to fund
our business activities outside China, or to repay foreign currency obligations,
including our debt obligations, which would have a material adverse effect on
our financial condition and results of operation.
WE ARE REQUIRED TO OBTAIN LICENSES TO EXPAND OUR BUSINESS INTO MAINLAND CHINA.
Our activities must be reviewed and approved by various national and local
agencies of the Chinese government before they will issue business licenses to
us. There can be no assurance that the current Chinese government, or
successors, will continue to approve and renew our licenses. If we are unable to
obtain licenses or renewals we will not be able to continue our business
operations in mainland China, which would have a material adverse effect on our
business, financial condition and results of operations.
WE MAY HAVE LIMITED LEGAL RECOURSE UNDER PRC LAW IF DISPUTES ARISE UNDER OUR
CONTRACTS WITH THIRD PARTIES.
The Chinese government has enacted some laws and regulations dealing with
matters such as corporate organization and governance, foreign investment,
commerce, taxation and trade. However, their experience in implementing,
interpreting and enforcing these laws and regulations is limited, and our
ability to enforce commercial claims or to resolve commercial disputes is
unpredictable. If our new business ventures are unsuccessful, or other adverse
circumstances arise from these transactions, we face the risk that the parties
to these ventures may seek ways to terminate the transactions, or, may hinder or
prevent us from accessing important information regarding the financial and
business operations of these acquired companies. The resolution of these matters
may be subject to the exercise of considerable discretion by agencies of the
26
Chinese government, and forces unrelated to the legal merits of a particular
matter or dispute may influence their determination. Any rights we may have to
specific performance, or to seek an injunction under PRC law, in either of these
cases, are severely limited, and without a means of recourse by virtue of the
Chinese legal system, we may be unable to prevent these situations from
occurring. The occurrence of any such events could have a material adverse
effect on our business, financial condition and results of operations.
WE MUST COMPLY WITH THE FOREIGN CORRUPT PRACTICES ACT.
We are required to comply with the United States Foreign Corrupt Practices Act,
which prohibits United States companies from engaging in bribery or other
prohibited payments to foreign officials for the purpose of obtaining or
retaining business. Foreign companies, including some of our competitors, are
not subject to these prohibitions. Corruption, extortion, bribery, pay-offs,
theft and other fraudulent practices occur from time-to-time in mainland China.
If our competitors engage in these practices they may receive preferential
treatment from personnel of some companies, giving our competitors an advantage
in securing business or from government officials who might give them priority
in obtaining new licenses, which would put us at a disadvantage. Although we
inform our personnel that such practices are illegal, we can not assure that our
employees or other agents will not engage in such conduct for which we might be
held responsible. If our employees or other agents are found to have engaged in
such practices, we could suffer severe penalties.
PRC LAWS AND REGULATIONS RESTRICT FOREIGN INVESTMENT IN CHINA'S
TELECOMMUNICATIONS SERVICES INDUSTRY AND SUBSTANTIAL UNCERTAINTIES EXIST WITH
RESPECT TO OUR CONTRACTUAL AGREEMENTS WITH DIANXUN-DE, SUNROOM-DE, WANRONG-DE
AND IMOBILE-DE TO UNCERTAINTIES REGARDING THE INTERPRETATION AND APPLICATION OF
CURRENT OR FUTURE PRC LAWS AND REGULATIONS.
Since we are deemed to be foreign persons or foreign funded enterprises under
PRC laws and cannot directly invest in telecommunications companies, we operate
our IVR, call center and telecom value-added services business in China through
operating companies or variable interest entities (VIEs) owned by PRC citizens.
We control these companies and operate these businesses through contractual
arrangements with the respective operating companies and their individual
shareholders, but we have no equity control over these companies. Although we
believe we are in compliance with current PRC regulations, we cannot be sure
that the PRC government would view these operating arrangements to be in
compliance with PRC licensing, registration or other regulatory requirements,
with existing policies or with requirements or policies that may be adopted in
the future. In the opinion of our in-house PRC legal counsel, our current
ownership structure, the contractual arrangements among our wholly owned
subsidiaries and the operating company and their shareholders comply with all
existing applicable PRC laws, rules and regulations. Because this structure has
not been challenged or examined by PRC authorities, they have not commented on
it and uncertainties exist as to whether the PRC government may interpret or
apply the laws governing these arrangements in a way that is contrary to the
opinion of our in-house PRC counsel. If we, or the operating companies, were
found to be in violation of any existing PRC laws or regulations, the relevant
regulatory authorities would have broad discretion to deal with such violation,
including, but not limited to the following:
o levying fines;
o confiscating income;
o revoking licenses;
o shutting down servers or blocking websites;
o requiring a restructure of ownership or operations; and/or
o requiring the discontinuance of wireless VAS and online
advertising businesses.
We may also encounter difficulties in obtaining performance under or enforcement
of related contracts. Any of these or similar actions could cause significant
disruption to our business operations or render us unable to conduct a
substantial portion of our business operations and may materially adversely
affect our business, financial condition and results of operations.
OUR CONTRACTUAL AGREEMENTS WITH DIANXUN-DE OR SUNROOM-DE, WANRONG-DE AND
IMOBILE-DE MAY NOT BE AS EFFECTIVE IN PROVIDING OPERATIONAL CONTROL AS DIRECT
OWNERSHIP OF THESE BUSINESSES.
We depend on operating companies in which we have little or no equity ownership
interest and must rely on contractual agreements to control and operate these
businesses. Our contractual agreements with each of the operating companies may
27
not be as effective in providing and maintaining control over the operating
companies and their business operations as direct ownership of these businesses.
For example, we may not be able to take control of the operating company upon
the occurrence of certain events, such as the imposition of statutory liens,
judgments, court orders, death or capacity. Furthermore, if the operating
companies fail to perform as required under those contractual agreements, we
will have to rely on the PRC legal system to enforce those agreements and due to
the uncertainties that exist under PRC Law about the structure of our
acquisition, and there is no guarantee that we will be successful in an
enforcement action. In addition, the PRC government may propose new laws or
amend current laws that may be detrimental to our current contractual agreements
with our operating companies, which may in turn have a material adverse effect
on our business operations.
THE PRC GOVERNMENT MAY PREVENT US FROM ADVERTISING OR DISTRIBUTING CONTENT THAT
IT BELIEVES IS INAPPROPRIATE
China has enacted regulations governing Internet access and the distribution of
news and other information. In the past, the Chinese government has stopped the
distribution of information over the Internet or through VAS that it believes to
violate PRC law, including content that it believes is obscene, incites
violence, endangers national security, is contrary to the national interest or
is defamatory. In addition, we may need the permission of the Chinese government
prior to publishing certain news items, such as news relating to national
security. Furthermore, the Ministry of Public Security has the authority to
cause any local Internet service provider to block any website maintained
outside China at its sole discretion. If the PRC government were to take any
action to limit or prohibit the distribution of information through our network
or via our VAS, or to limit or regulate any current or future content or
services available to users on our network, our business could be significantly
harmed. We are also subject to potential liability for content on our website
that is deemed inappropriate and for any unlawful actions of our subscribers and
other users of our systems. Furthermore, we are required to delete content that
clearly violates the laws of China and report content that we suspect may
violate PRC law. It is difficult to determine the type of content that may
result in liability for us, and if we are wrong, we may be prevented from
operating our website.
RISKS RELATED TO OUR TECHNOLOGY AND EQUIPMENT
OUR INSURANCE MAY NOT BE SUFFICIENT TO RESTORE OUR CALL CENTER IF OPERATIONS ARE
INTERRUPTED BY NATURAL DISASTER OR OTHER DESTRUCTION OF OUR FACILITIES OR
EQUIPMENT.
Our operations depend on our ability to protect our call centers, data centers,
CRM information, customer database, data warehouse, computer and
telecommunications equipment and software systems against damage from fire,
power loss, telecommunications interruption or failure, hacker attacks, natural
disaster, epidemic, terrorism, act of war and other similar events. In the event
we experience a temporary or permanent interruption at one or more of our call
centers, through casualty, operating malfunction or otherwise, our business
could be materially adversely affected and we may be required to pay contractual
damages to some clients or allow some clients to terminate or renegotiate their
28
contracts with us. While we maintain certain property and business interruption
insurance, such insurance may not adequately compensate us for all losses that
we may incur and may not be adequate to cover the costs of rebuilding these
centers. If we are unable to restore our operations, our business activities
would cease.
WE MUST RESPOND QUICKLY AND EFFECTIVELY TO NEW TECHNOLOGICAL DEVELOPMENTS.
Our VAS business is highly dependent on our computer and telecommunications
equipment and software systems. Our failure to maintain the superiority of our
technological capabilities or to respond effectively to technological changes
could adversely affect our business, results of operations or financial
condition. Our future success also depends on our ability to enhance existing
software and systems and to respond to changing technological developments. If
we are unable to successfully develop and bring to market new software and
systems in a timely manner, our competitors technologies or services may render
our products or services noncompetitive or obsolete.
RISKS RELATED TO OUR COMMON STOCK
EFFORTS TO COMPLY WITH RECENTLY ENACTED CHANGES IN SECURITIES LAWS AND
REGULATIONS WILL INCREASE OUR COSTS AND REQUIRE ADDITIONAL MANAGEMENT RESOURCES.
OUR FAILURE TO COMPLY COULD ADVERSELY AFFECT OUR STOCK PRICE.
We have rapidly grown by acquisition during 2004 and 2005. We do not integrate
the business operations of our target companies and therefore have separate
administration and accounting personnel at each subsidiary location. We have
sought to improve our existing disclosure controls and procedures and to that
end, have substantially increased our accounting and administrative resources.
While we believe that our disclosure controls are effective, due to the number
of new subsidiaries we have acquired, we have faced significant challenges with
the timely reporting of information necessary to complete the financial
statements to be filed with the Securities and Exchange Commission. Our failure
to timely file our annual and quarterly reports may have an adverse affect on
our stock price and may put our common stock in jeopardy of being delisted.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, public companies
are required to include a report of management on the company's internal
controls over financial reporting in their annual reports on Form 10-K and the
public accounting firm auditing a company's financial statements must attest to
and report on management's assessment of the effectiveness of the company's
internal controls over financial reporting. This requirement will first apply to
our annual report on Form 10-K for our fiscal year ending December 31, 2007. We
have only recently begun to evaluate our internal controls over financial
reporting. Given the status of our efforts, coupled with the fact that guidance
from regulatory authorities in the area of internal controls continues to
evolve, substantial uncertainty exists regarding our ability to comply by
applicable deadlines. If we are unable to conclude that we have effective
internal controls over financial reporting, or if our independent auditors are
unable to provide us with an unqualified report as to the effectiveness of our
internal controls over financial reporting as of December 31, 2007 and future
year ends, as required by Section 404 of the Sarbanes-Oxley Act, we could
experience delays or inaccuracies in our reporting of financial information, or
non-compliance with SEC reporting and other regulatory requirements. This could
subject us to regulatory scrutiny and result in a loss of public confidence in
our management, which could, among other things, adversely affect our stock
price.
WE ISSUED $8,000,000 IN CONVERTIBLE DEBENTURES DUE IN 2009, OR POSSIBLY EARLIER,
WHICH WE MAY NOT BE ABLE TO REPAY IN CASH AND COULD RESULT IN DILUTION OF OUR
BASIC EARNINGS PER SHARE.
In March 2006, we issued $8 million in convertible debentures due March 2009.
The debentures are convertible at any time into shares of our common stock at an
initial fixed conversion price of $10.00 per share, subject to adjustments for
certain events. If any event of default occurs under the debentures or other
related documents, the holders may elect to accelerate the payment of the
outstanding principal amount of the debenture, plus accrued, but unpaid
interest, liquidated damages or other amounts, which shall become immediately
due and payable. Beginning January 1, 2007, we shall redeem up to $320,000 every
month, plus accrued, but unpaid interest, liquidated damages and penalties. We
may choose to pay such redemption amount in cash, or, subject to meeting certain
conditions, we may pay all or a part of the redemption amount in shares of
common stock. We may not have enough cash on hand or have the ability to access
cash to pay the redemption amount, or upon acceleration of the debenture in the
case of an event of default, or at maturity. In addition, the redemption of the
debentures with our shares or the conversion of the debentures into shares of
common stock could result in dilution of our basic earnings per share.
29
THE PRICE OF OUR STOCK HAS FLUCTUATED IN THE PAST AND MAY CONTINUE TO DO SO.
Our stock price has fluctuated dramatically. There is a significant risk that
the market price of our common stock will decrease in the future in response to
any of the following factors, some of which are beyond our control:
o variations in our quarterly operating results;
o announcements that our revenue or income are below analysts'
expectations;
o general economic slowdowns;
o changes in market valuations of similar companies;
o sales of large blocks of our common stock;
o announcements by us or our competitors of significant
contracts, acquisitions, strategic partnerships, joint
ventures or capital commitments; and
o fluctuations in stock market prices and volumes, which are
particularly common among highly volatile securities of
companies with primarily international-based operations.
FUTURE SALES OF SHARES COULD HAVE AN ADVERSE EFFECT ON THE MARKET PRICE OF OUR
COMMON STOCK
As of December 31, 2005, we had 12,000,687 shares of common stock issued, which
shares will be available to be sold in the public market in the near future,
subject to, with respect to shares of common stock held by affiliates and shares
issued between 12 and 24 months ago, the volume restrictions and/or manner of
sale requirements of Rule 144 under the Securities Act. On February 4, 2005, a
registration statement on Form SB-2 was declared effective with respect to
2,702,230 shares of our common stock. These shares are freely tradable without
restriction or further registration, subject to the related prospectus delivery
requirements. Sales by our current shareholders of a substantial number of
shares could significantly reduce the market price of our common stock.
As of December 31, 2005, we had stock options outstanding to purchase an
aggregate of 1,384,100 shares of common stock, of which 529,000 stock options
were exercisable and warrants outstanding to purchase 591,138 shares of our
common stock. To the extent that the options and warrants are exercised, they
may be exercised at prices below the price of our shares of common stock on the
public market, resulting in a significant number of shares entering the public
market and the dilution of our common stock. Further, in March 2006, we
completed a private placement of $8,000,000 in convertible debentures. The
debentures are convertible into shares of common stock at an initial fixed
conversion price of $10.00, subject to adjustments. In the event that any future
financing should also be in the form of securities convertible into, or
exchangeable for, equity securities, investors may experience additional
dilution upon the conversion or exchange of such securities.
ITEM 2. DESCRIPTION OF PROPERTY
A description of our property is as follows:
HONG KONG - We maintain our corporate headquarters, development center and our
Call Center in Hong Kong located at Units 601-603 New Bright Building, 11 Sheung
Yuet Road, Kowloon Bay, Kowloon where we lease approximately 17,739 square feet
for a monthly fee of $16,365 and our branch office is located at Units 2-3, 17th
Floor, Nan Fung Commercial Centre, 19 Lam Lok Street, Kowloon Bay, Hong Kong
where we lease approximately 2,359 square feet for a monthly rental fee of
$1,815.
30
UNITED STATES - Our current U.S. corporate office is located at 860 Blue Gentian
Road, Suite 360, Eagan, Minnesota 55121, where we sublease space for a monthly
rental fee of $1,000.
CHINA - Our current Chinese corporate office is located at PacificNet Shenzhen
Office: Room 901, Tower A, Tian An High-Tech Plaza, Tian An Cyber Park, Fu Tian
District, Shenzhen, China Postal Code:518040, where we lease approximately 1,100
square feet for a monthly fee of $927; and PacificNet Beijing Office: 23/F,
Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang District, Beijing, China.
Postal Code: 100028 (approximately 15,000 square feet). We lease space from a
shareholder. Our offices are located in Beijing, Shanghai, Guangzhou and
Shenzhen. Details are as follows:
LOCATIONS AREA (SQUARE FEET)
-------------------------------------------------------------------------------------------------------------------
PacificNet Limited, 601 New Bright Building, 11 Sheung Yuet Road, Kowloon Bay, 17,739
Kowloon, Hong Kong. Tel: 011-852-2876-2900 , Fax: 011-852-27930689 ,
[email protected]
PacificNet Shenzhen Office: Room 901, Tower A, Tian An High-Tech Plaza, 1,100
Tian An Cyber Park, Fu Tian District, Shenzhen, China Postal Code:518040
No. 30, ShiBaFu North Road, Liwan District, Guangzhou, 510140 2,250
1-2 floor, Yingyuan Bilding, Yingyuan Road, Yuexiu District, Guangzhou, 510410 2,500
PacificNet Beijing Office: 23/F, Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang 14812
District, Beijing, China, Postal Code: 100028 Tel:86-010-59225000
We believe that our offices are adequate for our current operations.
ITEM 3. LEGAL PROCEEDINGS
We are not aware of any material pending or threatened legal proceedings that
involve us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting on December 30, 2005 at the Company's
executive offices located at 901,Tower A, Tian An High-Tech Plaza,Tian An
Cyber Park, Futian District,Shenzhen,China for the following purposes:
1. To elect seven (7) directors to the Board of Directors of the
Company to serve until the next annual meeting of stockholders
and until their successors are duly elected and qualified;
2. To ratify the appointment of Clancy and Co., P.L.L.C. as the
Company's independent auditors; and
3. To transact any other business as may properly be presented at
the Annual Meeting or any adjournment or postponement thereof.
At such meeting the followings proposals were voted and resolved:
1. The following directors were elected to the Board of Directors
of Company, after each receiving a plurality of the votes
cast: 1. Tony Tong (6,079,111 votes or 50.82% voted for), 2.
Victor Tong (6,077,611 votes or 50.81% voted for), 3. Shao
Jian Wang (6,077,581 votes or 50.81% voted for), 4. Tao Jin
(6,079,083 votes or 50.82% voted for), 5. Peter Wang
(6,078,583 votes or 50.82% voted for), 6. Michael Chun Ha
(6,079,683 votes or 50.83% voted for), 7. Jeremy Goodwin
(6,079,083 votes or 50.82% voted for).
2. Ratification and approval of the appointment of Clancy and
Co., P.L.L.C. as the Company's independent auditors
6,071,479 shares of the Company's common stock, constituting a
50.76% majority of the shares of common stock present in
person or by proxy entitled to vote at this meeting have voted
in favor of this proposal.
31
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of October 6, 2005, our common stock was listed on the NASDAQ National Market
under the symbol "PACT". Prior to that time, our common stock was listed on the
NASDAQ Capital Market under the same symbol. The following table sets forth the
range of high and low bid prices of common stock reported by NASDAQ in each
fiscal quarter from January 1, 2004 to December 31, 2005, and for the first
quarter ended March 31, 2006. The quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions.
HIGH LOW
----------------- ----------------
FISCAL 2004
Quarter Ended March 31, 2004 $7.40 $4.81
Quarter Ended June 30, 2004 $5.65 $2.62
Quarter Ended September 30, 2004 $3.85 $1.91
Quarter Ended December 31, 2004 $14.08 $2.43
FISCAL 2005
Quarter Ended March 31, 2005 $11.34 $6.46
Quarter Ended June 30, 2005 $10.23 $6.71
Quarter Ended September 30, 2005 $9.00 $6.85
Quarter Ended December 31, 2005 $8.48 $6.30
FISCAL 2006
January 1, 2006 - March 31, 2006 $8.88 $6.57
HOLDERS OF RECORD
As of March 31, 2006, there were 142 record holders of our common stock.
However, the total number of beneficial holders is unknown as they hold our
common stock in street name.
DIVIDENDS
We have not paid any cash dividends on our common stock, and we currently intend
to retain any future earnings to fund the development and growth of our
business.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth aggregate information regarding the Company's
equity compensation plans in effect as of December 31, 2005:
Number of securities to Weighted-average Remaining available
be issued upon exercise exercise price of for further issuance
of outstanding options, outstanding options, under equity
warrants and rights warrants and rights ($) compensation plans
----------------------- ----------------------- ---------------------
Equity compensation plans approved by
security holders (under 1998 Stock Option
Plan) (1) 1,360,100 3.99 0
Equity compensation plans approved by
security holders (under 2005 Stock Option
Plan) (2) 155,600 6.59 1,844,400
Equity compensation plans not approved by
security holders N/A N/A N/A
--------------
(1) Reflects options granted and available for issuance under the 1998 Stock
Option Plan.
(2) Reflects options granted and available for issuance under the 2005 Stock
Option Plan.
32
RECENT SALES OF UNREGISTERED SECURITIES
There were no sales of unregistered securities during the period covered by the
report that were not previously reported on a Form-8K or Form 10-QSB.
REPURCHASES OF COMPANY COMMON STOCK
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
PERIOD (a) TOTAL NUMBER (b) AVERAGE PRICE (c) TOTAL NUMBER OF (d) MAXIMUM NUMBER (OR
OF SHARES (OR PAID PER SHARE SHARES (OR UNITS) APPROXIMATE DOLLAR
UNITS) PURCHASED (OR) UNIT) PURCHASED AS PART OF VALUE) OF SHARES (OR
PUBLICLY ANNOUNCED UNITS) THAT MAY YET BE
PLANS OR PROGRAMS PURCHASED UNDER THE
PLANS OR PROGRAMS
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
JAN 1 - MAR 31, 2005 NONE -0- NONE $701,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
APR 1 - JUN 30, 2005 NONE -0- NONE $701,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
JUL 1 - JUL 31, 2005 NONE -0- NONE $701,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
AUG 1 - AUG 31, 2005 2,000 (1) $7.5 NONE $686,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
SEP 1 - SEP 30, 2005 NONE -0- NONE $686,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
OCT 1 - OCT 31, 2005 NONE -0- NONE $686,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
NOV 1 - NOV 30, 2005 NONE -0- NONE $686,609
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
DEC 1 - DEC 31, 2005 149,459 (2) $0.00001 NONE $686,608
-------------------------------- -------------------- --------------------- ------------------------ ------------------------
---------------
(1) On August 29, 2005, for USD$ 7.50 per share, we repurchased 2,000 shares,
pursuant to the PacificNet Stock Repurchase Program
(2) On December 30, 2005, for USD$1.00, we repurchased 149,459 restricted shares
of common stock issued to Apex Legend Limited the 80% shareholder of Take 1
Technologies Group Limited. The Company and Take 1 revised the Sale & Purchase
Agreement, dated, October 18, 2005 to convert it into a Convertible Debenture
Agreement. In connection with this, the parties revised the ownership structure
so that PacificNet owns 20% of Take 1. In accordance with this new revised
agreement, PacificNet agreed to purchase the 149,459 restricted shares for
USD$1.00. Referred to the substance of the change of the investment structure as
discussed in the Note 3 to the Consolidated Financial Statements, the original
investment of Take 1 was reduced by US$771,208 for those repurchased shares at
cost to US$385,604 as of December 31, 2005. The management intended to cancel
those repurchased shares subsequent to the year end.
CANCELLATION OF SHARES:
On December 31, 2005, we signed agreements to cancel a total of 45,000
restricted shares of our common stock previously issued to several employees.
33
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
FORWARD-LOOKING STATEMENTS This annual report on Form 10-KSB 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:
o the impact of competitive products;
o changes in laws and regulations;
o adequacy and availability of insurance coverage;
o limitations on future financing;
o increases in the cost of borrowings and unavailability of debt
or equity capital;
o the inability of the Company to gain and/or hold market share;
o exposure to and expense of resolving and defending liability
claims and other litigation;
o consumer acceptance of the Company's products;
o managing and maintaining growth;
o customer demands;
o market and industry conditions,
o the success of product development and new product
introductions into the marketplace;
o the departure of key members of management, and
o 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.
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:
o insufficient sales forces for business development & account
servicing;
o lack of PRC management team in operation;
o less familiarity on partners' product knowledge;
o 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;
o insufficient brand awareness initiatives in the market;
o salary increases due to an active labor market in Hong Kong
and GuangZhou; and
o increasing competition of call center solutions in the Hong
Kong and PRC markets.
34
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.
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. We also record 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, 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.
35
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.
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.
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations data as a
percentage of revenue for the periods indicated.
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2005 (%) 2004 (%)
------------ ------------
Revenue 100 100
Cost of Revenue (75.4) (81.0)
Gross Margin 24.6 19.0
Selling, general and administrative expense (13.2) (12.2)
Depreciation and amortization (0.7) (0.3)
Earnings / (lOSS) from operations 10.7 6.5
Interest (expenses) income, net 0.1 0.3
Sundry income 1.9 1.4
Provision for income taxes (0.5) (0.1)
Share of profit of associated companies (0.00) 0.1
Minority interest (6.6) (5.5)
Discontinued operations - (0.1)
NET PROFIT (LOSS) 5.6 2.6
36
REVENUE. Revenue for the year ended December 31, 2005 was $44,341,000, an
increase of 49% as compared to $29,709,000 for the year ended December 31, 2004.
The increase in revenue was mainly due to revenue derived from the value-added
telecom services rendered by the Company's newly acquired subsidiaries,
Guangzhou3G ($3,143,000), Clickcom ($365,000) and Lion Zone ($1,194,000). In the
aggregate, the three newly acquired subsidiaries contributed to 11% of the total
revenue. Revenue from the VAS and IVR segment can vary from quarter to quarter
due to new product launches and the seasonality of certain product lines. The
"Other Business" column includes the revenue and earnings/(loss) from operations
of our other insignificant subsidiaries. Summarized financial information for
each of our four business operating segments is set forth in the table below.
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
----------------------- --------------- ---------------- ------------------- -------------- ---------------
Group 1. Group 2. Group 3. Group 4. Total
For the year ended Outsourcing VAS Business Communications Other ($)
December 31, 2005 Business ($) Distribution Business
($) Business ($)
($)
----------------------- --------------- ---------------- ------------------- -------------- ---------------
Revenue 13,505,000 13,834,000 16,201,000 801,000 44,341,000
(% of Total) (30.5%) (31.2%) (36.5%) (1.8%) (100%)
----------------------- --------------- ---------------- ------------------- -------------- ---------------
Earnings / (Loss) from
Operations 1,360,000 3,899,000 558,000 (1,248,000) 4,569,000
----------------------- --------------- ---------------- ------------------- -------------- ---------------
(1) OUTSOURCING SERVICES
Revenue for the year ended December 31, 2005 was $13,505,000, an increase of 44%
as compared to $9,385,000 for the year ended December 31, 2004. Outsourcing
services revenue made up 26.54% of the Company's total revenue for the fourth
quarter of the year 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 revenue
increased is due to the continuous rapidly growth on computer software product
and the company provides a seamless solution and multi-media channels for
clients to communicate with their customers for building better customer
relationship and generating more sales revenue. The combination of its
innovative infomercials along with our growing call center operations will allow
us to support significant future growth. It is a strong vote of confidence in
our future development in Chinas 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 SERVICES
VAS revenue for the year ended December 31, 2005 was $13,834,000, a significant
increase of 142% as compared to $5,724,000 for the year ended December 31, 2004.
Our acquisition of 3G, Clikcom and Lion Zone in 2005 contributed to the increase
in revenue for this business segment and helped us enter the mobile Internet
market in China. VAS revenue made up 49.1% of the Company's total revenue for
the fourth quarter of the year. Presently, approximately 80% of mobile phone
users use VAS in China. The Company's revenue in the sale of phone cards
continued to grow and we continued to rapidly expand our VAS business, through
strong organic growth as a result of leading companies in China increasingly
selecting us for their important programs. 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.
37
(3) COMMUNICATION PRODUCTS DISTRIBUTION
Revenue for the year ended December 31, 2005 was $16,201,000, an increase of 37%
as compared to $11,790,000 for the year ended December 31, 2004. Its revenue
remained steady growth during the year due to the increasing market growth in
communication products distribution services. Communication products
distribution revenue made up 20.3% of the Company's total revenue for the fourth
quarter of the year. In FY2005, sales mix of high-margin products such as number
cards and IP cards increased whereas substantial portion of FY2004 revenue were
derived from low-margin prepaid stored-value cards. This improved sales mix was
achieved through sales incentive scheme. Furthermore, we believe that our Take1
and My Memory Maker Kiosks are a natural fit in the self-service vending
machine, party, amusement, and casino market, and we also believe there are
strong opportunities for growth in high-traffic tourist and amusement
destinations. Recently, the Company had entered into a definitive agreement to
acquire iMobile in order to enhance our position in this rapidly growing B2C
market in China.
COST OF REVENUE AND GROSS MARGIN Cost of revenue for the year ended December 31,
2005 was $33,439,000 an increase of 38% from $24,074,000 for the year ended
December 31, 2004. The slight increase in the cost of revenue was directly
associated with the increase in revenue. Cost of revenue, as a percentage of
revenue, was 75% for the year ended December 31, 2005 as compared with 81% for
the year ended December 31, 2004. The decrease in percentage cost of revenue 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
$10,902,000 an increase of 93% as compared to $5,635,000 for the year ended
December 31, 2004, resulting from gross margin contributions from our newly
acquired subsidiaries in 2005. Gross profit for the fourth quarter of the year
was $5,047,000, a significant increase of 265% as compared to $1,379,000 for the
same period in 2004; or a significant increase of 153% as compared to the third
quarter of 2005.
We believe that our gross margin overall approximates the industry standards.
The significant increase in gross margin came primarily from, our phone card
business, which has higher gross margins, typical for that industry. We expect
our gross margin percentage to increase gradually as a result of cost reduction
and efficient utilization of assets.
(1) OUTSOURCING SERVICES
As compared to prior year, cost of revenue for outsourcing services increased by
55% to $10,095,000 (2004: $6,491,000). Gross profit was 4% lower at $3,409,000
(2004: $3,543,000). Gross profit of $1,069,000 for the fourth quarter had a
significant increase of 56% as compared to $682,000 for the third quarter of
2005 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. The slightly decline year over year
was primarily due to the enhanced Hong Kong market competition. However, 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 SERVICES
As compared to prior year, cost of revenue for VAS increased by 75% to
$7,715,000 (2004: $4,403,000). Gross profit was 262% much higher at $6,119,000
(2004: $1,688,000). Gross profit of $3,241,000 for the fourth quarter also had a
significant increase of 471% as compared to the same period in 2004; or an
increase of 184% as compared to $1,141,000 for the third quarter of
2005. Throughout the new acquisitions in 2005 such as Lion Zone with higher
gross margin, it moved our strategic consolidation in China's CRM and VAS
market, and increased our customer base and improved our gross margin. The
increasing gross profit is also derived from the continued profitability in the
sale of phone cards. Furthermore, Company increased market share in the
voice/IVR supplier market.
38
(3) COMMUNICATION PRODUCTS DISTRIBUTION
As compared to prior year, cost of revenue for communication products
distribution slightly increased by 17% to $15,347,000 (2004: $13,106,000). Gross
profit was 194% higher at $854,000 (2004: $290,000). The fourth quarter is
normally the strongest due to holiday-related promotions which increase the
spending of our customers with us and therefore higher margin was expected.
Furthermore, since revenue made up the highest rate of 36.5% of the Company's
total revenue and cost of revenue had only slightly increased in 2005, its gross
profit relatively increased more to reach our future expectation. As one of its
subsidiaries, Yueshen, signed an agreement to become a designated integrated
services distributor of China Mobile in 2005, it increased the Company's overall
distribution revenue and profit margin. The improved gross margin was mainly due
to increased sales mix from higher margin products such as number cards with
average gross margin of 8 to 15% and IP calling cards with average gross margin
of 30% instead of low-margin prepaid stored-value cards with just around 2%
gross margin.
(4) OTHER BUSINESS
Cost of revenue and gross profit for PacificNet Power for the year ended
December 31, 2005 was $269,000 and $67,000. PacificNet Power did not exist in
2004, so no comparison is available for 2004
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, General and Administrative
expenses totaled $5,811,000 for the year ended December 31, 2005, an increase of
69% from $3,435,000 for the year ended December 31, 2004. As our fourth quarter
results included several one-time charges or expenses such as the $103,250
NASDAQ National Market Entry Fee, quarterly SG&A had significant increase of
183% as compared to the third quarter of the year. The increase in selling,
general and administrative expenses reflected the expansion of our operations of
which expenses were incurred by our newly acquired subsidiaries 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
$1,628,000 for the year ended December 31, 2005, a reduction of $502,000 from
$2,130,000 for the year ended December 31, 2004. Due to the increase in the
demand for telemarketing and call center services, one of the subsidiaries
purchased a new 250-seat call center facility in China, to support the rapidly
growing business of the company. It caused an increase of 103% to $482,000 for
SG&A for the fourth quarter of the year. 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.
(2) VALUE-ADDED SERVICES
Selling, General and Administrative expenses for VAS were $2,159,000 for the
year ended December 31, 2005, an increase of $2,072,000 as compared to $87,000
in 2004. The increase of SG&A resulted from increasing the size of our
operations which included premises costs and staff costs from the three new
acquisitions.
(3) COMMUNICATION PRODUCTS DISTRIBUTION
Selling, General and Administrative expenses for communication products
distribution were $271,000 for the year ended December 31, 2005, an increase of
188% as compared to $94 for the year ended December 31, 2004. This business is
easily scalable depending on the availability of working capital, since one of
the subsidiaries, YueShen, needs to pay the telephone operators/suppliers cash
upfront.
(4) OTHER BUSINESS
Selling, General and Administrative expenses were $167,000 for the year ended
December 31, 2005.
DEPRECIATION AND AMORTIZATION EXPENSES Depreciation and amortization expenses
were $1,126,000 for the year ended December 31, 2005, which represented 1344%
increase as compared to the year ended December 31, 2004 of which depreciation
and amortization expenses was $78,000.
39
OPERATING PROFIT Operating profit of $4,569,000 for the year ended December 31,
2005, a significant increase of 136% as compared to $1,937,000 from the year
ended December 31, 2004. Operating margins nearly doubled to 10.6% from 6.5% in
the previous year. Quarterly operating profit was $1,702,000, an increase of 66%
as compared to $1,026,000 from Q3 2005. Quarterly operating profit of $380,000,
$1,470,000, and $254,000 generated from the Company's three business units: (1)
CRM Outsourcing Services, (2) Value-Added Services (VAS) and (3) Telecom
Distribution Services, represented an increase of 75%, 50% and 47% respectively.
These are compared to $217,000, $974,000, and $172,000 respectively for Q3 2005.
Operating profit of $1,360,000, $3,899,000 and $558,000 generated from business
units (1), (2) and (3) for the year ended December 31, 2005 represented an
increase of 36%, 110% and 556% respectively, as compared to$1,000,000,
$1,859,000, and $85,000 respectively for the year ended December 31, 2004. The
increase in operating margin reflects Company's continuous shift away from our
traditional lower-margin phone card distribution business (B2B services) to
higher margin value-added telecom services and B2C e-commerce. We believe that
in 2006 this s trategy will result in increased profitability. This strategy is
beginning to work, as our operating margin increased from 6.5% in 2004 to 10.3%
in 2005.
INTEREST EXPENSES / INCOME Interest income was $246,000 for the year ended
December 31, 2005, an increase of 211% as compared to $79,000 for the year ended
December 31, 2004. The increase is due to 62% of interest income generated from
PacificNet Communications. Interest income was mainly generated from $152,000 of
PacificNet Communications from lending and fixed-rate bank deposits (62% of
total interest income) and $45,000 of PacificNet Strategic Investment Holdings
Limited from bank deposits. Interest expenses were $229,000 for the year ended
December 31, 2005, an increase of 24% as compared to $185,000 for the year ended
December 31, 2004. Most of the interest expenses were attributed to bank loans
by PacificNet Strategic Investment Holdings ($34,000) and Linkhead ($26,000),
and bank loans and bank overdraft by Epro ($133,000).
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 mainly derived from Linkhead's consulting services income from system
integration services totalling $380,000.
For the year ended December 31, 2005, the non-operating income or sundry income
was $830,000 included in Statement of Operations was mainly derived from the
consulting services income of $116,000, software service income of $375,000,
investment income of $113,000, leasehold income of $75,000 and various other
totaling $151,000.
SHARE OF PROFIT OF ASSOCIATED COMPANIES We recorded the loss of $8,000 for the
year ended 2005 with respect to our 20% ownership interest in Take1 Technology
(Cheer Era Limited), acquired in April 2004.
INCOME TAXES The income taxes expenses for the Company's subsidiaries were
$222,000 for the year ended December 31, 2005. The provision of income taxes was
the result of the operating profit generated by Guangzhou3G, Clickcom and
ChinaGoHi, the subsidiaries we acquired in 2005. 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 year ended December 31, 2005
totaled $2,926,000. Minority interests represented the interests of third
parties in our subsidiaries' results.
NET PROFIT Net profit for the year ended December 31, 2005 was $2,489,000 as
compared to net profit of $774,000 for the year ended December 31, 2004.
Operating profit of $1,360,000, $3,899,000 and $558,000 generated from the
Company's three business units: (1) CRM Outsourcing Services, (2) Value-Added
Services (VAS) and (3) Telecom Distribution Services, represented an increase of
36%, 110% and 556% respectively as compared to $1,000,000, $1,859,000, and
40
$85,000 respectively for the year ended December 31, 2004. The overall net
profit increased sharply due to (i) the Company acquired direct response
television and infomercial marketing services company in China which received an
award by the Chinese tax bureau as one of the "Top 100 Tax-Paying Enterprises"
in Shenzhen as recognition for profit generation, commercial leadership and
government contribution; (ii) launched a new Mobile Mailbox Service called
"UMAIL" for Unicom's CDMA users on its WAP Portal website; (iii) signed up China
Mobile for New Blog Service and so forth. Furthermore, the new facility in China
should lead to growth in profit margin because the labor cost and office
facility is less than half of the cost in Hong Kong.
CONTRACTUAL OBLIGATIONS
CONTRACTUAL OBLIGATIONS We have significant cash resources to meet our
contractual obligations as of December 31, 2005, as detailed below:
PAYMENTS DUE BY PERIOD
Less than
Contractual Obligations Total 1 year 1-5 years After 5 years
----------------------------------- ------------- ------------- ------------ ---------
Line of credit $ 1,060,000 $ 1,060,000 -- --
Bank Loans $ 194,000 $ 188,000 $ 6,000 --
Operating leases $ 1,676,000 $ 870,000 806,000 --
Capital leases $ 204,000 $ 126,000 $ 78,000 --
------------- ------------- ------------ ---------
Total cash contractual obligations $ 3,134,000 $ 2,244,000 $ 890,000 --
============= ============= ============ =========
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 27% to $20,510,000 at
December 31, 2005, as compared to $16,185,000 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 $2,815,000 increase in 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) 700,000 shares of common stock
were issued as a result of the exercise of stock options and warrants with cash
consideration of $1,014,000 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 $9,579,000
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.
41
CURRENCY EXCHANGE FLUCTUATIONS All of the Company's revenue 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
interbank 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:
o 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.
o 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.
o If the Company is unable to derive any revenue 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
42
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. Revenue and income from operations for the
call center and VAS tend to be higher in the fourth quarter due to special
holiday promotions. Internet/Direct Commerce revenue also tends to be higher in
the fourth quarter due to increased consumer spending during that period.
Revenue from the VAS and IVR segment can vary from quarter to quarter due to new
product launches and the seasonality of certain product lines.
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 - As of December 31, 2005 and 2004 F-2
Consolidated Statements of Operations - For the Years Ended
December 31, 2005 and December 31, 2004 F-3
Consolidated Statements of Changes in Stockholders' Equity
- For the Years Ended December 31, 2005 and December 31, 2004 F-4
Consolidated Statements of Cash Flows
- For the Years Ended December 31, 2005 and December 31, 2004 F-5
Notes to Consolidated Financial Statements F-6
43
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 8A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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. Based upon their evaluation of those controls and procedures
performed as of the period covered by this report, our chief executive officer
and the chief financial officer concluded that our disclosure controls and
procedures were inadequate, need to be strengthened and are not sufficiently
effective to ensure that information required to be disclosed by us in our
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in SEC rules and
forms. The Company has taken various steps to maintain the accuracy of our
financial disclosures, and based on these measures and other significant work,
management believes there are no material inaccuracies or omissions of material
fact in our financial statements and other reports filed with the SEC. However,
material weaknesses in our internal controls over financial reporting could
further adversely impact our current inability to report timely financial
information. Despite the drastic strengthening of our disclosure controls and
procedures over the past 12 months, our efforts have been insufficient and
delayed due to our significant growth and expansion as described in Item 1 and
our recent adoption of FIN46R. We are developing a plan to ensure that all
information will be recorded, processed, summarized and reported on a timely
basis. This plan is dependent, in part, upon reallocation of responsibilities
among various personnel, hiring additional experienced personnel, allocating
additional Information Technology spending, and possible raising additional
funding. It should also be noted that the design of any system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote.
In connection with the audit of our financial statements for the year ended
December 31, 2005, Clancy and Co., P.L.L.C. ("Clancy"), our independent
auditors, informed the Board of Directors on April 27, 2006, of several
"significant deficiencies" that collectively constituted a "material weakness"
in our internal control over financial reporting under standards established by
the Public Company Accounting Oversight Board.
A SIGNIFICANT DEFICIENCY is a control deficiency, or combination of control
deficiencies, that adversely affects the Company's ability to initiate,
authorize, record, process or report external financial data reliably in
accordance with generally accepted accounting principles such that there is more
than a remote likelihood that a misstatement of the Company's annual or interim
financial statements that is more than inconsequential and will not be prevented
or detected.
A MATERIAL WEAKNESS is a significant deficiency, or combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement or the annual or interim financial statements will not be
prevented or detected.
The following conditions were identified:
o The current organization of the accounting department does not provide
PacificNet with the adequate skills to accurately account for and
disclose significant transactions or disclosures.
o Certain key managers in the accounting department do not appear to
have the knowledge and experience required for their responsibilities.
o Substantive matters are not being addressed appropriately by the Board
and Audit Committee resulting in inadequate oversight from the Board
and Audit Committee.
44
o The process that PacificNet is currently using to monitor the ongoing
quality of internal controls performance, identify deficiencies and
trigger timely corrective action is not working effectively.
o There is no adequate means of accurately capturing and recording
certain significant and complex business transactions.
Accordingly, the Company's internal controls over financial reporting are not
effective.
Based upon the Company's evaluation, which considered the above findings of
Clancy, the Company's management, including the Chief Executive Officer, Chief
Financial Officer and President concluded that, as of December 31, 2005, the
Company's internal controls over financial reporting were not effective.
ITEM 8B. OTHER INFORMATION
None
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 April 10, 2006:
Name Age Title
------------------------- -------- -----------------------------------------------------
Tony Tong 37 Chairman and Chief Executive Officer
Victor Tong 35 President, Secretary, and Director
ShaoJian (Sean) Wang 42 Chief Financial Officer, Vice President, and Director
Peter Wang 51 Independent Director (Audit Committee)
Michael Ha 36 Independent Director
Jeremy Goodwin 33 Independent Director (Audit Committee)
Tao Jin 38 Independent Director (Audit Committee)
Mary Ma 35 Vice President of Finance and Chief Financial Officer
for ChinaGoHi Subsidiary
Wenming Wang 44 President of ChinaGoHi Operation
Jingjin Wu 46 Vice President of ChinaGoHi & DRTV Operations
David Lin 39 Vice President of Investment Management
Victor Choy 37 Vice President, Mobile Distribution Services
Brian Lin 41 Vice President, Northern China
Fei Sun 40 Vice President, Southern China
Philip Cheng 42 Vice General Manager
Jack Ou 39 Vice General Manager, Southern China
Mike Fei 38 Chief Legal Counsel, China Operations
Star Mu 37 Regional Manager, Northern China
Shannon Lee 29 Vice President of Investment
Jacob Lakhany 29 Director of Investor Relations and Public Relations
Super Yongchao Wang 32 Vice President of Value Added Services
Telly Wai-Hon Wong 44 Vice President of Call Center Services
Carol Men-Yee Chang 43 Vice President & COO of Call Center Operations
Joyce Mei-Wei Poon 40 Vice President of CRM Services
Fiona Yee-Chong Cheuk 31 Marketing and PR Manager, CRM & Call Center Services
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.
45
The following is a brief description of each board of director, key positions
and brief biography:
MR. TONY TONG, age 37, is the Chairman, CEO, Executive Director, and founder of
PacificNet. 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 the 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.
MR. VICTOR TONG, age 35, currently is the President, Secretary and an Executive
Director of the Company. Previously, Mr. Victor Tong worked for Andersen
Consulting (now Accenture), American Express Financial Advisors (IDS), and 3M.
In 1999, he was recognized in "CityBusiness 40 Under 40" as one of the future
business and community leaders in Minnesota. Mr. Tong won the Student
Commencement Speaker Award while 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.
MR. SHAOJIAN (SEAN) WANG, age 42, is the Chief Financial Officer and has served
on our board of directors since 2002. Sean Wang served as the chairman of
GoVideo, a subsidiary of Opta which is a majority owned subsidiary of TCL, a
leading consumer electronics company in China. From 1987 to 1993, Mr. Wang held
a number of increasingly important positions with St. Paul, Minnesota-based
Ecolab Inc., culminating in his serving as General Manager for the company's
Indonesia operations. Mr. Wang received a Bachelor of Science Degree in
Economics from Hamline University in St. Paul, Minnesota, and a Masters of
Business Administration from The Carlson School of Management at the University
of Minnesota. Mr. Wang also attended Peking University in Beijing, China.
MR. PETER WANG, age 51, is a Director. Mr. Wang has served on our board of
directors since 2003. Since December 2000, Mr. Wang has served as President and
Chief Executive Officer of Techedge, Inc. Mr. Wang was a founder of Unitech
Telecom (now named UTStarcom, NASDAQ: UTSI) and from June 1990 through August
1995 was President of Unitech Telecom. Under his management, UTStarcom created
the first digital loop carrier system and installed the first PHS (Personal
Handyphone System) system in China. From September 1995 through November 2000,
he co-founded and served as President and Chief Executive Officer of
World Communication Group. As an entrepreneur, he has successfully co-founded
and built other ventures in the US, including World PCS, Inc. Before forming his
own companies, he worked at AT&T Bell Labs and Racal-Milgo Information System.
With AT&T Bell Labs, he worked on Network Evolution Planning and representing
AT&T Network System Division served on Network Management Protocol Forum. He
also serves on the board of directors of two publicly traded companies in the
United States, Techedge, Inc. and General Components, Inc. Mr. Wang has a BS in
Computer Science and a MS in Electrical Engineering from University of Illinois,
as well as an MBA in Marketing from Southeast-Nova University.
MR. MICHAEL CHUN HA, age 36, is a Director. Mr. Ha has served on our board of
directors since 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 a lawyer in a number of prestigious international and Hong Kong
law firms, specializing in the areas of corporate finance, securities offerings,
takeovers, cross-border mergers and acquisitions, venture capital, corporate
46
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". Mr. Ha specializes in the areas of general commercial
transactions, corporate finance and civil and criminal litigation. Mr. Ha has
been the company secretary of Shanxi Central Pharmaceutical International
Company Limited, a Hong Kong main board listed company. Since 200,3 Mr. Ha
has been a director of a private investment company, Metro Concord Investment
Limited.
MR. JEREMY GOODWIN, age 33, is a Director with the company. Mr. Goodwin is also
President of China Diligizer International (CDI) and a Managing Director with
Etech Securities. He began his career in 1995 as an intern at Mees Pierson
Investment Finance S.A. in Geneva, Switzerland where he provided administrative
support to the fund raising/private placement 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 where he established the Global
Clients desk representing the bank's multinational clients to sovereign
regulatory agencies and local financial institutions while monitoring their
working capital needs. During his time there, the office was approved by the
Central Bank of China to operate as a fully licensed branch. Noteworthy
transactions executed by the group included assistance in the business
development and project management for the Royal Dutch Shell Oil project and the
Beijing Capital International Airport listing on the Hong Kong Stock Exchange
arranged by the Hong Kong office of ABN Amro Rothschild. 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, is a Director. Mr. Jin is a partner at JunHe, one of the
top five law firms in China. Prior to JunHe, from April 2002 to May 2005, he was
a Vice President and Assistant General Counsel of J.P. Morgan Chase Bank. From
August 1999 to March 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.
The following is the list of PacificNet's management team, key positions and
brief biography:
MS. MARY MA, age 35, has been with PacificNet since Feb 2004. Previously, Ms. Ma
worked as Manager of Corporate Finance and Audit Division for China Motion, a
telecom company listed on the Hong Kong Stock Exchange. Ms. Ma also worked as
Finance Manager for Shenzhen Lufthansa Technik Ltd., a subsidiary of Germany
Lufthansa Group. Ms. Ma also worked as Vice President for a public company
listed on NASDAQ where she gained working experience in the US. Ms. Ma is
experienced accountant with working knowledge of Chinese Accounting Standard,
IAS and USGAAP, corporate finance, finance analysis and operation. Ms. Ma
received MBA degree from American Kennedy Western University, and bachelor
degree in Accounting.
MR. WENMING WANG, age 44, has been the President of PacificNet's ChinaGoHi
Operation since December 2005. In addition to being a successful self-made
private entrepreneur in China, Mr. Wang has been elected a congressman of
People's Congress for Shenzhen Municipality, China, since 2005. Mr. Wang is the
Founder, Chairman and Chief Executive Officer of Shenzhen Guhaiguanchao
Investment Advisory Co., Ltd. (ChinaGoHi), a leading investment advisory
services company in China. Mr. Wang is also the chief publisher of Sino-Business
Weekly (ISSN 1671-6728, www.fmm88.com , www.lcgj.cn), a leading financial
investment management magazine covering China's stock market and securities
investment. Mr. Wang has extensive experience in China's stock market and
investment consulting industry for more than 10 years since the launch of
China's stock markets. Under his leadership, Shenzhen Guhaiguanchao has achieved
growing revenue, profits, and industry recognition since its establishment in
2002, and was by Shenzhen government as "Shenzhen's Top 100 Tax-paying
Enterprises" in 2003 and 2004.
47
MR. WU JINGJIN, age 46, ,is one of the co-founders and executive director of
Shenzhen Guhaiguancao Investment Advisory Co., Ltd. (ChinaGoHi) a leading
investment advisory company in mainland China. Mr. Wu was one of the pioneer
analysts in mainland China and has extensive working experience in China's
investment banking and investment consulting industry since the launch of
China's stock market. From1994-1999, Mr. Wu worked as Senior Manager at J&A
Securities, one of the leading investment banks in mainland China at that time.
Mr. Wu holds an MBA degree from the State University of New York at Buffalo.
MR. DAVID LIN, age 39, has been with PacificNet since 2004. Previously, Mr. Lin
worked as Assistant President of ABB Meishi Power Investment Co., Ltd. Mr. Lin
also worked as Corporate Secretary and Assistant General Manager for a public
company listed on NASDAQ where he gained working experience in the US. Mr. Lin
received Master degree of finance from Fudan University, and Bachelor degree of
English from Tianjin University.
MR. VICTOR CHOY, age 37, joined PacificNet in 2005 as Vice President of Mobile
Distribution Services. From 2003 to present, Mr. Choy is a partner and director
of Ora Telecom China, a subsidiary of the Singapore based manufacturer and
distributor of original accessories for major brands including Nokia and
Motorola, as well as OEM branded Bluetooth products, with sales offices in 12
countries in Asia and Europe. Mr. Choy has over 13 years of telecom experience
in HK, China and SE Asia. From 1998 to 2002, Mr. Choy worked as the General
Manager of Asia Pacific (APAC) for Avenir Telecom, a listed company from France
and a leading mobile distributor, telecom retailer, Internet service provider,
and mobile accessory manufacturer in Europe. Mr. Choy helped Avenir Telecom
build its APAC business from $0 to annual revenue of US$100 million within 2
years of operation in mobile phone and accessories distribution. In 2000, Mr.
Choy expanded the company into China and found Avenir Telecom China Limited in
Shenzhen. In one year, the Avenir China opened 7 retail outlets in the city of
Shenzhen and Guangzhou and also started the distribution of products for China
Mobile and China Unicom by signing first level distributorship agreements. At
Avenir, Mr. Choy initiated a JV between Cetelec and China Motion, a Hong Kong
listed telecom company, to run an aftersales service center for mobile phones
and pagers in Shenzhen. Mr. Choy formed a cooperation with France Telecom's
Rapidlink subsidiary, to provide retail and distribution services to China
Unicom Guangdong. Mr.Choy received the Bachelor of Science degree in Actuarial
Science and Computer Science from University of Toronto in 1992.
MR. BIN "BRIAN" LIN, age 41, was promoted to the Vice President for PacificNet
China Operations in 2005. Mr. Lin is currently the President of Linkhead, a
leading IVR and CTI technology provider 51% owned by PacificNet. Previously, Mr.
Lin worked for Nortel in Canada, Tandem Computer, Motorola, and UTStarcom. Mr.
Lin received the Master of Applied Science degree in Electrical Engineering from
the University of Toronto in 1989.
MR. FEI SUN, age 40, has been with PacificNet since 2003 and has served several
positions including Manager of Shenzhen office, Director of Investment, etc. Mr.
Sun has been a director of Linkhead for 10 years and serves as the General
Manager of Linkhead Shenzhen Office. From 1991, Mr. Sunfei worked in Japan as
the Chief Representative of China in a software company co-organized by CATIC
and Japanese Central Electronic Power Research Institution, focused on software
development and organized the Japanese company software development outsourced
to the Chinese company. Mr. Sun graduated with Master Degree of Electronic
Engineering from China NorthEast Industrial University.
MR. PHILIP CHENG, age 42, has been with PacificNet since 2005. As the Vice
General Manager of PacificNet, Philip is responsible for the company's synergy
development, corporate strategy coordinating and execution for all PacificNet's
subsidiaries so as to enhance the internal control and resource sharing among
the group. Prior to joining PacificNet, Mr. Cheng worked for CSL, the largest
mobile operator in Hong Kong, and was in charge of CSL's Value-Added Services
development in China. Previously, Mr. Cheng worked as deputy general manager in
the VAS department for Guangzhou Suntek Technology, a leading telecom equipment
and VAS provider listed on China's stock exchange. Mr. Cheng received his Master
and Bachelor degree of Science respectively in 1988 and 1985 from Southern China
University of Technology, Department of Radio Engineering, Major of
Communications, and performed his master research in Digital Signal Processing.
MR. JACK OU, age 39, joined PacificNet in 2005 as Manager and Financial
Controller of PacificNet Guangzhou Operations. From 1986 to 1998, Mr. Jack Ou
worked as the Vice Director at the Guangzhou Justice Bureau and as PRC attorney
at Guangdong Overseas Chinese Law Firm. Subsequently, Mr. Jack Ou worked as the
Manager of Research Department and Assistant General Manager in Guangdong Huafu
Investment Inc. From 2003 to 2005, Mr. Ou served as a Manager and Research
Analyst at Everbright Securities, a leading securities brokerage firm in China.
48
Mr. Ou published many research reports covering China stock market and listed
companies, with a focus on analyzing the financial accounting reports of China's
listed companies. Mr. Ou is an accredited PRC lawyer and received his Law Degree
from the Sun Yat-Sen University, Guangzhou, China. Mr. Ou also graduated from
Guangdong Communist Party Executive College and received a Master of Economics
Degree.
MR. MIKE FEI, 38, joined PacificNet in 2004 as in-house 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. STAR MU, age 37, joined PacificNet in 2003 as Regional Manager, North China.
Mr. Mu received his bachelor degree in Computer Science from the Northwestern
Polytechnical University of China in 1992.
MISS. SHANNON LEE, age 29, joined PacificNet in 2005 as Vice President of China
Investment of PacificNet. From 2003 to 2004, Miss Li served as a Project Manager
(Investment) of Sun & Sun Capital Holdings Pte. Ltd., a leading Singapore-based
investment bank focusing on IPO and investment banking services. Previously,
Miss Li worked as the Executive Assistant to President at Linkhead (now 51%
owned by PacificNet). Miss Li graduated with honors with a Bachelor of Science
in Automobile Design and Manufacturing from Harbin Institute of Technology,
China in 1998 and received the Master of Business Administration degree from the
University of Nottingham, UK in 2003.
MR. JACOB LAKHANY, age 29, is the Director of Investor Relations and has been
with PacificNet since 2003. Previously Mr. Lakhany was a Quality Assurance
Supervisor for APAC Customer Service, a leading CRM call center services company
listed on NASDAQ, where he gained experience in the outsourced telemarketing
industry overseeing service quality and relationships with companies such as
Citibank, Sears, Shell, Chase Manhattan, and Bank One. Mr. Lakhany attended
Northern State University in Aberdeen, SD.
MR. SUPER YONGCHAO WANG, age 32, joined PacificNet as VP of VAS in 2005. Mr.
Wang is also the President of Guangzhou 3G Information Technology Co., Ltd.
(GZ3G), a 51% owned subsidiary of PacificNet. Previously, Mr. Wang was the
Deputy General Manager of Suntek Information (Listed on China's Shanghai stock
exchange), the first private voice information IVR service provider in China.
>From 1996 to 1999, Mr. Wang served as the Deputy General Manager of GD Suntek,
managing 18 branches' operation nationwide. In 2000 Mr. Wang founded Guangzhou
Sunroom Information Ltd. (GZ-Sunroom, subsidiary of GZ3G) focusing on wireless
value-added services provision and was appointed CEO of the company. In the
following two years, GZ-Sunroom worked with 27 branches of China Mobile
successfully to launch its VAS and IVR business. GZ-Sunroom had become one of
the largest mobile and telephone information service providers (SP) serving 26
provinces in China. Mr. Wang received the B.A in Business Administration from
Jinan University in Guangzhou in 1994 and studied master course of Economics at
Guangdong Academy of Sciences in 2002.
MR. TELLY WONG, age 44, joined PacificNet in 2003 as part of the Epro
acquisition. Mr. Wong is the Managing Director and a co-founder of PacificNet
Epro for the last 10 years, and is responsible for directing the overall
business policies and strategies and overseeing the business development of
Epro's overall call center and CRM services. Prior to Epro, Mr. Wong was the MIS
Manager of Star Paging, one of the largest paging operation in Hong Kong. During
his services with Star Paging, Mr. Wong was responsible for managing the entire
management information system of the paging group. He was also a founder of
Brightfair Technology Ltd which was incorporated in 1989 and mainly involved in
paging system software design for carriers in the countries of South East Asia.
Mr. Wong, holds a Master Degree in Business Administration,
MS. CAROL CHANG, age 43, joined PacificNet in 2003 as part of the Epro
acquisition. Ms. Chang joined Epro in 1988 as Marketing Executive and was late
promoted to Epro Telecom's General manager in 1994 and then to Chief Operating
Officer for PacificNet Epro's call center operations. Ms. Chang is now mainly
responsible for Hong Kong call center business operations. Ms. Chang holds a BSc
Degree in Computer Science from the University of Texas at Austin, USA.
MS. JOYCE POON, age 40, joined PacificNet in 2003 as part of the Epro
acquisition. Ms. Poon is the General Manager of PacificNet Epro responsible for
the development and management of CRM consulting and training services in China.
Mr. Poon has been with Epro since its founding in 1994, serving many key roles
in customer service operations and business development. Her most recent role
was, and continues to be, in charge of the Company's Training and Consulting
Division she formed two years ago. The Division has enjoyed steady growth and
has received high praises from some of the largest enterprise clients in China.
Ms. Poon, General Manager, of PRC Business, holds a MBA Degree in Marketing.
49
MS. FIONA CHEUK, age 31, joined PacificNet Epro in 2004 as Marketing Manager.
The major duty of Ms. Cheuk is to drive innovative and effective marketing
strategy of exploring more business opportunities for the company. She also
takes responsibility for delivering efficient marketing communications of
raising brand awareness and revealing value differentiation of our products and
services in the competitive market. Prior to joining Epro, Ms. Cheuk gained
customer relationship management and marketing experiences while working at
SmarTone Telecom (HKSE:0315.HK) and Cisco Systems. Ms. Cheuk holds a MBA Degree
in Marketing from Western Sydney University.
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.
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. Peter Wang, 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.
50
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all cash compensation paid or to be paid by the
Company, as well as certain other compensation paid or accrued, during each of
the Company's last three fiscal years to each named executive officer.
------------------------- ------------- ------------------------------------ -------------------------------------------
Annual Compensation Long Term Compensation Awards
------------------------- ------------- ------------------------------------ -------------------------------------------
Name / Fiscal Year Salary ($) Bonus ($) Other ($) Restricted Stock All Other
Principal Position Stock Award ($) Options Comp. ($)
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ ------------
Tony Tong, CEO 2005 $70,000 - - - 66,000 $8,000
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ ------------
2004 $70,000 - $24,000 (1) - 65,000 $4,000
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ ------------
2003 $100,000 - - 120,000 $3,000
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ ------------
------------------
(1) This amount represents a housing allowance.
(2) Represents medical and life insurance premiums paid by the Company. Mr. Tong
has no arrangement to receive any cash surrender amount under the life insurance
policy.
OPTION GRANTS DURING FISCAL YEAR 2005 (INDIVIDUAL GRANTS)
The following table sets forth certain information with respect to stock option
grants to our named executive officers during the fiscal year ended December 31,
2005.
------------------------------------------------------------------------------------------- -------------------------------
Potential Realizable Value at
Assumed Rates of Stock Price
Appreciation for Option Term(3)
------------------------------------------------------------------------------------------- -------------------------------
Options % of Total Options Exercise
Granted to Employees or Expiration
Name Granted (1) in 2005 (2) Base Price Date 5% 10%
---------------------- ------------- ----------------------- ----------- ------------------ -------------- ----------------
Tony Tong, CEO 66,000 9.7% $6.50 July 26, 2009 $ 521,452 $ 628,099
---------------------- ------------- ----------------------- ----------- ------------------ -------------- ----------------
(1) All options were granted pursuant to our 1999 Stock Plan and as amended in
2002 and 2003. The options have a ten-year term and vest and become exercisable
over four years. In the event of a change in control of the Company, the options
will be substituted by the successor corporation or will fully vest and become
exercisable for a period of fifteen days.
(2) Based on an aggregate of 2,000,000 shares subject to options granted to our
employees in 2005.
(3) Potential realizable values are computed by (a) multiplying the number of
shares of Common Stock subject to a given option by the exercise price, (b)
assuming that the aggregate stock value from that calculation compounds at the
annual 5% or 10% rate shown in the table for the entire four-year term of the
option and (c) subtracting from that result the aggregate option exercise price.
The 5% and 10% assumed annual rates of stock price appreciation are mandated by
the rules of the SEC and do not represent our estimate or projection of future
Common Stock prices.
OPTION EXERCISE AND VALUES
Aggregated Option Exercises During Fiscal Year 2005 and Fiscal Year-End Option
Values.
The following table sets forth information for our executive officers relating
to the number and value of securities underlying exercisable and unexercisable
options they held at December 31, 2005 and sets forth the number of shares of
Common Stock acquired and the value realized upon exercise of stock options held
as of December 31, 2005 by our named executive officers.
-------------------------- --------------- ------------- ------------------------------------- ----------------------------------
Shares
Acquired On Value No. of Securities Underlying Value ($) of Unexercised In-the-
Name Exercise Realized (1) Unexercised Options At 12/31/05 Money Options At 12/31/05 (2)
-------------------------- --------------- ------------- ----------------- ------------------- ----------------- ----------------
Exercisable Unexercisable Exercisable Unexercisable
-------------------------- --------------- ------------- ----------------- ------------------- ----------------- ----------------
Tony Tong, CEO 6,000 $29,700 145,000 66,000 $677,650 $12,120
-------------------------- --------------- ------------- ----------------- ------------------- ----------------- ----------------
51
(1) The "Value Realized" is based on the closing price of our Common Stock as
quoted on NASDAQ on the date of exercise, minus the per share exercise price,
multiplied by the number of shares issued upon exercise of the option.
(2) The value of unexercised in-the-money options is calculated based on the
difference between the closing price of $6.77 per share as quoted on NASDAQ on
December 31, 2005, and the exercise price for the shares, multiplied by the
number of shares underlying the option. The actual value of unexercised options
fluctuate depending on the price of our Common Stock.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL
On December 30, 2002, we entered into an Executive Employment Contract with Tony
Tong. Mr. Tong currently serves as our Chief Executive Officer. The employment
agreement provides for Mr. Tong to earn an annual base salary of $100,000 in
cash, plus $60,000 in stock compensation annually until April 1, 2005. Mr. Tong
is also eligible for an annual bonus for each fiscal year during the term of his
contract based on performance standards as the Board or compensation committee
designates. Mr. Tong 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 our net profit.
COMPENSATION OF DIRECTORS
DIRECTORS' FEES. All of the Company's directors are reimbursed for out-of-pocket
expenses relating to attendance at meetings. Each director is paid a sign-on
bonus of 10,000 stock options of common stock of the Company. Each director is
also entitled to US$500 for each board meeting that such director attends in
person, by conference call, or by committee action and US$200 for each committee
meeting, payable by cash, common stock or stock options of the Company, at the
option of the Company.
ANNUAL RETAINER FEE. Each director is paid an annual retainer fee of US$10,000
in the form of common stock or stock option of the Company. Such retainer fee is
paid semi-annually in arrears. The number of shares of common stock issued is
based on the average closing market price over the ten trading days prior to the
end of the six month period that the retainer fee is due.
CODE OF ETHICS
On May 14, 2003, we adopted a code of ethics that applies to our Chief Executive
Officer and Chief Financial Officer, and other persons who perform similar
functions. A copy of our Code of Ethics is filed as an exhibit to this Annual
Report on Form 10-K. Our Code of Ethics is intended to be a codification of the
business and ethical principles which guide us, and to deter wrongdoing, to
promote honest and ethical conduct, to avoid conflicts of interest, and to
foster full, fair, accurate, timely and understandable disclosures, compliance
with applicable governmental laws, rules and regulations, the prompt internal
reporting of violations and accountability for adherence to this Code.
52
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth as of March 31, 2006 the number of shares of our
Common Stock beneficially owned by (i) each person who is known by us to be the
beneficial owner of more than five percent of the Company's Common Stock; (ii)
each director; (iii) each of the named executive officers in the Summary
Compensation Table; and (iv) all directors and executive officers as a group.
Unless otherwise indicated, the stockholders listed in the table have sole
voting and investment power with respect to the shares indicated.
----------------------------------------------------------------- -------------------------- -----------------------
NUMBER OF SHARES STOCK % OF COMMON STOCK
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) BENEFICIALLY OWNED
----------------------------------------------------------------- -------------------------- -----------------------
Sino Mart Management Ltd. (2) 1,835,160 13.86%
c/o ChoSam Tong
16E, Mei On Industrial Bldg.
17 Kung Yip Street, Kwai Chung, NT, Hong Kong
----------------------------------------------------------------- -------------------------- -----------------------
ChoSam Tong (3)
16E, Mei On Industrial Bldg.
17 Kung Yip Street, Kwai Chung, NT, Hong Kong 1,839,160 13.89%
----------------------------------------------------------------- -------------------------- -----------------------
Kin Shing Li (4)
Rm. 3813, Hong Kong Plaza
188 Connaught Road West, Hong Kong 1,150,000 8.69%
----------------------------------------------------------------- -------------------------- -----------------------
Tony Tong (5) 347,391 2.62%
----------------------------------------------------------------- -------------------------- -----------------------
Victor Tong (6) 175,400 1.32%
----------------------------------------------------------------- -------------------------- -----------------------
ShaoJian (Sean) Wang (7) 88,000 *
----------------------------------------------------------------- -------------------------- -----------------------
Peter Wang (8) 11,000 *
----------------------------------------------------------------- -------------------------- -----------------------
Michael Chun Ha (9) 31,000 *
----------------------------------------------------------------- -------------------------- -----------------------
Tao Jin (10) 6,000 *
----------------------------------------------------------------- -------------------------- -----------------------
Jeremy Goodwin (11) 6,000 *
----------------------------------------------------------------- -------------------------- -----------------------
All directors and officers as a group (7 persons) 664,791 5.02%
----------------------------------------------------------------- -------------------------- -----------------------
* Less than one percent.
** The address for each beneficial owner not otherwise specified is: c/o
PacificNet Inc., 860 Blue Gentian Rd., Suite 360, Eagan, MN 55121.
USA.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to the shares shown. Except as indicated
by footnote and subject to community property laws where applicable,
to our knowledge, the stockholders named in the table have sole voting
and investment power with respect to all common stock shares shown as
beneficially owned by them. A person is deemed to be the beneficial
owner of securities that can be acquired by such person within 60 days
upon the exercise of options, warrants or convertible securities (in
any case, the "Currently Exercisable Options"). Each beneficial
owner's percentage ownership is determined by assuming that the
Currently Exercisable Options that are held by such person (but not
those held by any other person) have been exercised and converted.
(2) Sino Mart Management Ltd. is owned by Mr. ChoSam Tong, the father of
Messrs. Tony Tong and Victor Tong.
(3) Includes shares of common stock of Sino Mart Management Ltd., which is
owned by Mr. ChoSamTong.
(4) Information obtained from the Schedule 13D/A filed by Mr. Kin Shing Li
on October 14, 2003.
(5) Includes Currently Exercisable Options to acquire 163,000 shares of
common stock.
(6) Includes Currently Exercisable Options to acquire 153,000 shares of
common stock.
(7) Includes 69,000 shares issuable upon exercise of Currently Exercisable
Options.
(8) Represents shares issuable upon exercise of Currently Exercisable
Options.
(9) Includes 6,000 shares issuable upon exercise of Currently Exercisable
Options.
(10) Represents shares issuable upon exercise of Currently Exercisable
Options.
(11) Represents shares issuable upon exercise of Currently Exercisable
Options.
53
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None
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 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)
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 PacificNetInc. 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
10.15+ PacificNet Inc. 2005 Stock Option Plan
10.16+ Agreement for the Sale and Purchase of Shares in GuangZhou 3G
Information Technology Co., Ltd.
10.17 Agreements of Consulting, Pledge, and Power of Attorney of
Clickcom and Sunroom
10.18 Agreement for the Sale and Purchase of Shares in Lion Zone
Holdings (13)
14 Code of Ethics (9)
21 List of Subsidiaries (Included in Exhibit 99.1)
23.1+ Consent of Clancy & Co. P.L.L.C
54
EXHIBIT
NUMBER DESCRIPTION
------ -----------
99.1+ Corporate structure chart of our corporate and share ownership
structure
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
55
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During fiscal years ended December 31, 2005 and 2004 and 2003,, our principal
independent auditor was Clancy and Co., P.L.L.C. and its Hong Kong affiliate HLB
Hodgson Impey Cheng (collectively, "Clancy".) The following is a summary of the
services provided and fees billed to us by Clancy
AUDIT FEES
The aggregate fees billed by Clancy for professional services rendered for the
audit of the Company's annual financial statements for the 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 were $182,400 and $82,060, respectively.
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 Committee
before the audit commences. The independent auditor also submits an audit
services fee proposal, which also must be approved by the Committee before the
audit commences.
56
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: April 28, 2006 BY: /S/ TONY TONG
-----------------------------
Tony Tong
Chief Executive Officer
Principal Executive Officer)
Date: April 28, 2006 BY: /S/ SHAO JIAN WANG
-----------------------------
Shao Jian Wang
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 April 28, 2006
-----------------------
Tony Tong
/s/ VICTOR TONG Director, President and Secretary April 28, 2006
-----------------------
Victor Tong
/s/ SHAO JIAN WANG Director and CFO April 28, 2006
-----------------------
Shao Jian Wang
/s/ PETER WANG Director April 28, 2006
-----------------------
Peter Wang
/s/ MICHAEL CHUN HA Director April 28, 2006
-----------------------
Michael Chun Ha
/s/ TAO JIN Director April 28, 2006
-----------------------
Tao Jin
/s/ JEREMY GOODWIN Director April 28, 2006
-----------------------
Jeremy Goodwin
57
INDEX TO EXHIBITS
EXHIBITS
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)
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 PacificNetInc. 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
10.15+ PacificNet Inc. 2005 Stock Option Plan
10.16+ Agreement for the Sale and Purchase of Shares in GuangZhou 3G
Information Technology Co., Ltd.
10.17 Agreements of Consulting, Pledge, and Power of Attorney of
Clickcom and Sunroom
10.18 Agreement for the Sale and Purchase of Shares in Lion Zone
Holdings (13)
14 Code of Ethics (9)
21 List of Subsidiaries (Included in Exhibit 99.1)
23.1+ Consent of Clancy & Co. P.L.L.C
58
EXHIBIT
NUMBER DESCRIPTION
------ -----------
99.1+ Corporate structure chart of our corporate and share ownership
structure
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
59
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets - As of December 31, 2005 and 2004 F-2
Consolidated Income Statements - For the Years Ended
December 31, 2005 and December 31, 2004 F-3
Consolidated Statements of Changes in Stockholders' Equity
- For the Years Ended December 31, 2005 and December 31, 2004 F-4
Consolidated Statements of Cash Flows
- For the Years Ended December 31, 2005 and December 31, 2004 F-5
Notes to Consolidated Financial Statements F-6
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of PacificNet 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 income statements, 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 more fully described in Note 17 to the consolidated financial statements, the
2004 income statement and statement of cash flows have been restated.
/s/ CLANCY AND CO, P.L.L.C.
CLANCY AND CO, P.L.L.C.
Scottsdale, Arizona
April 25, 2006
F-1
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except par values and share numbers)
DECEMBER 31, DECEMBER 31,
2005 2004
---------------- ----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 9,579 $ 6,764
Restricted cash - pledged bank deposit 1,652 3,501
Accounts receivables 5,998 5,644
Inventories 1,836 1,297
Loan receivable from related parties 2,520 --
Loan receivable from third parties 1,572 --
Other current assets 7,973 4,325
---------------- ----------------
Total Current Assets 31,130 21,531
Property and equipment, net 4,300 1,118
Investments in affiliated companies and subsidiaries 410 1,063
Marketable equity securities - available for sale 539 29
Goodwill 14,227 8,912
---------------- ----------------
TOTAL ASSETS $ 50,606 $ 32,653
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank line of Credit 1,060 651
Bank loans-current portion 188 1,327
Capital lease obligations - current portion 126 80
Accounts payable 3,186 3,150
Accrued expenses 4,620 128
Income tax payable 296 10
Subscription payable 775 --
Loan payable to related party 369 --
---------------- ----------------
Total Current Liabilities 10,620 5,346
---------------- ----------------
Long-term liabilities:
Bank loans - non current portion 6 69
Capital lease obligations - non curent portion 78 129
---------------- ----------------
Total long-term liabilities 84 198
---------------- ----------------
Total liabilities 10,704 5,544
Minority interest in consolidated subsidiaries 8,714 2,396
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, 10,831,024 outstanding
December 31, 2004 - 10,627,737 shares issued, 9,791,583 outstanding 1 1
Treasury stock, at cost (2005: 1,169,663 shares; 2004: 836,154 shares) (119) (104)
Additional paid-in capital 57,690 53,916
Cumulative other comprehensive income (loss) 247 (24)
Accumulated deficit (26,587) (29,076)
Less stock subscription receivable (44) --
---------------- ----------------
Total Stockholders' Equity 31,188 24,713
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 50,606 $ 32,653
================ ================
F-2
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(In thousands of United States dollars, except loss per share and share amounts)
(RESTATED)
2005 2004
YEAR ENDED DECEMBER 31: ---------------- ----------------
Revenues $ 44,341 $ 29,709
Services 20,994 10,222
Product sales 23,347 19,487
---------------- ----------------
Cost of revenues (33,439) (24,074)
Services (12,540) (6,507)
Product sales (20,899) (17,567)
---------------- ----------------
Gross margin 10,902 5,635
Selling, general and administrative expenses (5,811) (3,435)
Depreciation and amortization (293) (78)
Interest expense (229) (185)
---------------- ----------------
EARNINGS / (LOSS) FROM OPERATIONS 4,569 1,937
Interest income 246 79
Sundry income 830 422
---------------- ----------------
Earnings before Income Taxes, Minority Interest and Discontinued Operations 5,645 2,438
Provision for income taxes(1) (222) (30)
Share of profit of associated companies (8) 32
Minority interests (2,926) (1,623)
---------------- ----------------
Earnings before Discontinued Operations 2,489 817
---------------- ----------------
LOSS FROM DISCONTINUED OPERATIONS -- (43)
Net Earnings Available to Common Stockholders $ 2,489 $ 774
================ ================
BASIC EARNINGS / (LOSS) PER COMMON SHARE:
Earnings from continuing operations $ 0.25 $ 0.11
Earnings from discontinued operations -- --
---------------- ----------------
Net earnings $ 0.25 $ 0.11
================ ================
DILUTED EARNINGS PER COMMON SHARE:
Earnings from continuing operations $ 0.23 $ 0.09
Earnings from discontinued operations -- --
---------------- ----------------
Net earnings $ 0.23 $ 0.09
================ ================
The accompanying notes are an integral part of these consolidated financial statements.
___________________
(1) Income taxes of $66,000, $110,000, $20,000 and $26,000 generated from the
Company's four business units: (1) CRM Outsourcing Services, (2) Value Added
Services (VAS), (3) Telecom Distribution Services and (4) Other Business.
F-3
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
CUMULATIVE
OTHER
ADDITIONAL STOCK COMPREHENSIVE TOTAL
PREFERRED COMMON PAID-IN SUBSCRIPTION INCOME ACCUMULATED TREASURY STOCKHOLDERS'
STOCK STOCK CAPITAL RECEIVABLE /(LOSS) DEFICIT STOCK EQUITY
-------- -------- -------- ------------ -------- -------- -------- --------
BALANCE AT DECEMBER 31, 2003
(5,363,977 SHARES) -- $ 1 $ 31,790 ($ 24) ($29,850) ($ 5) $ 1,912
COMPREHENSIVE EARNINGS:
Net earnings -- -- -- -- 774 774
--------
TOTAL COMPREHENSIVE EARNINGS: 774
Issuance of common stock for
acquisition of subsidiaries
(1,756,240 shares) -- -- 8,866 -- -- 8,866
Proceeds from the sale of common
stock, net of related costs
(2,205,697, shares) -- -- 11,773 -- -- 11,773
Issuance of common stock for
acquisition of Cheer Era
(149,459 shares) -- -- 771 -- -- 771
Repurchase of common shares
(less 36,154 shares) ( 99) ( 99)
Exercise of stock options and
warrants for cash (352,364 shares) 716 716
-------- -------- -------- ------------ ---------- --------- --------- ----------
BALANCE AT DECEMBER 31, 2004
(9,791,583 SHARES) -- $ 1 $ 53,916 ($ 24) ($29,076) ($ 104) $ 24,713
COMPREHENSIVE EARNINGS:
Net earnings -- -- -- -- 2,489 2,489
Cumulative Other Comprehensive gain 271 271
--------
Total comprehensive earnings 2,760
=========
Issuance of common stock for
acquisition of subsidiaries
(515,900 shares) -- -- 3,971 -- -- 3,971
Issuance of common stock (20,000 shares)
for services 63 63
PIPE related
Expenses -- -- (547) (547)
Repurchase of common shares for
acquisition of Cheer Era
(less 149,459 shares) -- -- (771) (771)
Cancellation of common shares
(less 45,000 shares) -- -- -- -- -- -- --
Repurchase of common shares
(less 2,000 shares) -- (15) (15)
Exercise of stock options and
warrants for cash
(700,000 shares) -- 1,058 1,058
Less stock subscription receivable (44) (44)
-------- -------- -------- ------------ ---------- --------- --------- ----------
BALANCE AT DECEMBER 31, 2005
(10,831,024 SHARES) -- $ 1 $ 57,690 $ (44) $ 247 ($26,587) ($ 119) $ 31,188
======== ======== ======== ============ ========== ========= ========= =========
F-4
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars, except loss per share and share amounts)
(RESTATED)
2005 2004
--------------- ---------------
Cash Flows from operating activities
Net earnings $ 2,489 $ 774
Adjustment to reconcile net earnings to net cash provided by (used in)
operating activities:
Equity loss (earnings) of associated company 8 (32)
Common stock issued for services rendered 63 --
Unrealized exchange gain due to foreign currency translation (271) --
Minority Interest 2,926 1,623
Unrealized losses on marketable equity securities 11 17
Depreciation and amortization 1,126 78
Changes in current assets and liabilities net of effects from
purchase of subsidiaries:
Accounts receivable and other current assets 2,732 (3,584)
Inventories (539) (1,221)
Accounts payable and other accrued expenses (3,880) (2,069)
--------------- ---------------
Net cash provided by (used in) operating activities 4,665 (4,414)
--------------- ---------------
Cash flows from investing activities
DECREASE IN RESTRICTED CASH 1,849 (3,289)
Increase in purchase of marketable securities (521) (46)
Acquisition of property and equipment (2,252) (206)
Acquisition of subsidiaries and affiliated companies (1,183) (724)
--------------- ---------------
Net cash used in investing activities (2,107) (4,265)
--------------- ---------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Decrease in loan receivables 2,753 --
Increase in loans receivable from related party (2,520) --
Increase in loan payable to related party 369
Advances (repayments) under bank line of credit 409 (548)
Advances under bank loan (1,201) (130)
Advances (repayments) of amount borrowed under capital lease obligations (5) (92)
Proceeds from sale of common stock -- 11,773
Repurchase of treasury shares (15) (99)
Proceeds from exercise of stock options and warrants 1,014 716
Payment of certain PIPE related expenses (547) --
--------------- ---------------
Net cash provided by financing activities 257 11,620
--------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENT 2,815 2,941
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 6,764 3,823
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 9,579 $ 6,764
=============== ===============
CASH PAID (RECEIVED) FOR:
Interest $ 229 $ 20
Income taxes $ (53) $ 20-
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued for services rendered
Issuance of option shares through increase in subscription receivable $ 44 --
Investment in subsidiary acquired through issuance of subscriptions payable $ 775 --
Repurchase of shares issued to Cheer Era $ 771 --
Investments in subsidiaries acquired through the issuance of common stock $ 3,971 $ 9,637
F-5
PACIFICNET INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 intercompany 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.
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:
o carrying amounts of the VIE are consolidated into the financial
statements of PacificNet as the primary beneficiary (referred as
"Primary Beneficiary" or "PB");
o intercompany transactions and balances, such as revenue and costs,
receivables and payables between or among the Primary Beneficiary and
the VIE(s) are eliminated in their entirety; and
o because 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.
F-6
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 willflow
through to the respective WOFEs. Pursuant to these agreements, the Company
guarantee 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 twoVIEs are
consolidated as VIE through their respective WOFEs from the date of acquisition.
The following is a summary of all the VIEs of the Company:
o 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,
please see risk factor section in relation to insufficient registered
capital). 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 revenue and net earnings accounted for approximately 1.5%
and 5.6% of our consolidated revenue and net earnings before minority
interests respectively.
o 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 of December 31, 2005, Sunroom-VIE's revenue and net
loss accounted for approximately 11% and -1.2% of our consolidated
revenue and net earnings before minority interests, respectively.
F-7
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 and therefore
no goodwill was generated from the consolidation of the VIEs. As of December 31,
2005, the amount of loans to Clickcom VIE and Sunroom VIE were approximately
US$256,000 (low interest at 2%) and US$250,000 (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.
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.
F-8
We currently have seven reporting units: Lion Zone, Linkhead, EPRO, YueShen,
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 50% 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.
The Company has one class of goodwill arising from business combination
resulting from the acquisitions of our subsidiaries. The total carrying amount
of goodwill recorded on the balance sheets at December 31, 2005 is $14,227,000
and the changes in the carrying amount of goodwill for the following reporting
periods are summarized below:
Group 1. Group 2. Group 3. Total
Outsourcing Value-Added Distribution of
(US$000s) Services Services Communications
Products
---------- ---------- ---------- ----------
Balance as of December 31, 2003 $ 567 $ (147) $ -- $ 420
Goodwill acquired during the year 2,976 4,416 1,100 8,492
Impairment losses -- -- -- --
Goodwill written off related to sale of business unit -- -- -- --
---------- ---------- ---------- ----------
Balance as of December 31, 2004 3,543 4,269 1,100 8,912
========== ========== ========== ==========
Goodwill acquired during the year -- 5,315 -- 5,315
Impairment losses -- -- -- --
Goodwill written off related to sale of business unit -- -- -- --
---------- ---------- ---------- ----------
Balance as of December 31, 2005 3,543 $ 9,584 $ 1,100 $ 14,227
========== ========== ========== ==========
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,
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:
(USD000s) December 31, 2005 December 31, 2004
--------- ----------------- -----------------
Epro $3,310 $3,310
---- ------ ------
Linkhead 4,269 4,269
-------- ----- -----
Yueshen 1,100 1,100
------- ----- -----
Smartime (Soluteck) 233 233
------------------- --- ---
Clickcom 391 -
-------- --- -
GZ3G (Sunroom) 4,042 -
-------------- ----- -
Lion Zone (ChinaGoHi) 882 -
-------- --------
Total $ 14,227 $ 8,912
----- ======== ========
F-9
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. Revenue from license agreements is 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.
Revenue 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." Revenue
from support services such as consulting, implementation and training services
is recognized when the services are performed, collectibility is probable and
such revenue is 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.
Revenue from the sale of products and systems is 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.
F-10
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 UAT, (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.
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. There is no
allowance for doubtful accounts recorded at December 31, 2005 or 2004.
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.
F-11
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.
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. Research and development costs
charged to operations for 2005 were approximately 182,400 (2004: $161,000).
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. Dilutive
earnings per share for 2005 exclude the potential dilutive effect of 473,456
warrants because their impact would be anti-dilutive based on current market
prices. All per share and per share information are adjusted retroactively to
reflect stock splits and changes in par value.
The reconciliation of the numerators and denominators of the basic and diluted
EPS calculations was as follows for the years ended December 31:
2005 2004
---------- ----------
Numerator: earnings $ 2,489 $ 774
Denominator:
Weighted-average shares used to compute basic EPS 10,154,271 7,268,374
Dilutive potential from assumed exercise of stock options 489,552 157,585
Dilutive potential from assumed exercise of stock warrants 57,388 816,037
---------- ---------
Weighted-average shares used to compute diluted EPS 10,701,211 8,241,996
========== ==========
Basic earnings per common share: $ 0.25 $ 0.11
========== ==========
Diluted earnings per common share: $ 0.23 $ 0.09
========== ==========
F-12
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 10.
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):
2005 2004
----------- ----------
Net earnings/ (loss):
As reported $ 2,489 $ 774
Stock-based compensation cost, net of tax (3,300) (1,188)
-------- ----------
Pro forma (811) (414)
Basic earnings/ (loss) per share:
As reported $ 0.25 $ 0.11
Pro forma (0.08) (0.06)
Diluted profit/ (loss) per share:
As reported $ 0.23 $ (0.09)
Pro forma $ (0.08) $ (0.05)
The fair value of options granted during 2005 and 2004, respectively was
approximately $4.85 and $1.88 per option respectively based on the Black-Scholes
option pricing model using valuation assumptions of: a) average remaining
contractual life of four and two years; b) expected volatility of 43.18% and
153.68%, c) dividend yield of 0% for both years; and d) a risk free interest
rate of 5% and 3%.
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 $150,047 in 2005 (2004: $9,908).
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)
F-13
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 $100,000.
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 $567,000, gross unrealized losses of $28,000 and
estimated fair value of $539,000. The acquisition of marketable securities and
unrealized losses on marketable equity securities are recorded on consolidated
statements of cash flows.
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
and losses resulting from foreign exchange transactions are included in
General and Administrative Expenses an amount of US$76,000. During the year
ended December 31, 2005, the foreign currency translation adjustments to the
Company's comprehensive income was $271,000 and the currency translation gain
was approximately $29,000, primarily as a result of the Chinese Renminbi
appreciating against the U.S. dollar.
F-14
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 revenue 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.
RECENT ACCOUNTING PRONOUNCEMENTS
---------------------------------
The Financial Accounting Standards Board issued the following recent 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 impact 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.
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:
GUANGZHOU YUESHEN TAI YANG TECHNOLOGY LTD. ("YUESHEN")
------------------------------------------------------
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 telecommunication company located and incorporated in the People's
Republic of China ("Yueshen"). 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
F-15
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.
(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.
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 211,886
Property Plant and equipment 38,917
Goodwill 1,100,585
-----------
Total Assets Acquired 1,351,388
Current Liabilities assumed (155,245)
-----------
Net assets acquired $ 1,196,143
===========
As of December 31, 2004 and 2005, Goodwill of $1,100,585 represents the excess
of the purchase price over the fair value of the net tangible and identifiable
intangible assets acquired and is not deductible for tax purposes. The total
amount of goodwill by reportable segment Communications Distribution Business
was $1,100,585 (see Note 15).
In accordance with SFAS 142, goodwill is not amortized but is tested for
impairment at least annually. The purchase price allocation for the Yueshen
acquisition was based on management's estimates and its overall industry
experience. Immediately after the signing of the definitive agreement, the
Company obtained effective control over Yueshen. Accordingly, the operating
results of Yueshen have been consolidated with those of the Company starting
April 12, 2004. Pursuant to SFAS 141 "Business Combinations", the earn-out
consideration was considered contingent consideration for the purpose of 2004
Form 10KSB, which did not become certain until the audited combined after-tax
profit of US$224,000 for 15 months ended March 31, 2005 became available.
UNAUDITED PROFORMA CONSOLIDATED FINANCIAL INFORMATION
DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2005 AND 2004
The following un-audited 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.
Year ended December 31
2005 2004
(UN-AUDITED AND IN THOUSANDS
OF U.S. DOLLARS)
----------------------------
Revenue Fully $ 12,547
Net earnings attributable to shareholders consolidated 182
Earnings per share - basic (cents) 0.02
Earnings per share - diluted (cents) In 2005 0.02
PacificNet included the financial results of the subsidiary in its consolidated
2005 financial results and from the date of the acquisition, April 12, 2004
through December 31, 2004.
F-16
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") 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) USD$500,000, payable in shares of common stock of the Company (the
"Common Stock"), equivalent to 100,000 restricted shares (the "Shares") of
Common Stock, based on a fair market value of $5.00, 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.
The Shares are restricted shares issued under an exemption from registration of
the Securities Act of 1933, as amended. If at the time the Shareholders are
eligible to sell the Shares under Rule 144, the fair market value of the Common
Stock is less than USD$3.50, the Company shall issue additional shares of Common
Stock for an aggregate amount of USD$100,000, up to a maximum of 60,000 shares
of Common Stock. If at such time the fair market value of the Common Stock is
more than USD$8.00 per share, the Shareholders and the Company will share on an
equal basis any excess over USD$8.00 per share.
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:
Estimated fair values:
Current Assets $ 460,957
Property Plant and equipment 60,505
Intangible Assets 562
Goodwill 233,000
------------
Total Assets Acquired 755,024
Current Liabilities assumed (255,024)
------------
Net assets acquired $ 500,000
============
As of December 31, 2004 and 2005, goodwill of $233,000 represents the excess of
the purchase price over the fair value of the net tangible and identifiable
intangible assets acquired and is not deductible for tax purposes and the total
amount of goodwill by reportable segment for Business Process Outsourcing was
$3,543,000 in both years (see Note 15).
In accordance with SFAS 142, goodwill is not amortized but is tested for
impairment at least annually. 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. Pursuant to SFAS 141 "Business Combinations", the earn-out
consideration was considered contingent consideration and after the audited
combined after-tax profit of US$250,000 for the 12 months ended September 30,
2005 was available. All the contingent consideration has been reflected in the
consolidated financial statements of the Company as of December 31, 2005.
F-17
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2005 AND 2004
The following un-audited 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.
Year ended December 31
2005 2004
(UN-AUDITED AND IN THOUSANDS
OF U.S. DOLLARS)
----------------------------
Revenue Fully $ 1,830
Operating income --
Net earnings attributable to shareholders Consolidated $ 269
Earnings per share - basic (cents) $ 0.037
Earnings per share - diluted (cents) In 2005 $ 0.037
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 purchase consideration for 51% of Clickcom is approximately one million,
which 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. 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)
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 in the acquisition
follows:
Estimated fair values: In US$
-----------
Current Assets $ 136,474
Goodwill 391,352
-----------
Total Assets Acquired 527,826
Liabilities assumed -
-----------
Net assets acquired $ 527,826
===========
At December 31, 2005, goodwill of $391,352 represents the excess of the purchase
price over the fair value of the net tangible and identifiable intangible assets
acquired and is not deductible for tax purposes and the total amount of goodwill
by reportable segment for VAS Business was $9,584,000 in the same year (see Note
15)
In accordance with SFAS 142, goodwill is not amortized but is tested for
impairment at least annually. 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
December 16, 2004. 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 US$390,000 being 78,000 restricted shares at US$5.00 per share 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.
F-18
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2005 AND 2004
The following un-audited 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.
Year ended December 31
2005 2004
(UN-AUDITED AND IN THOUSANDS
OF U.S. DOLLARS)
Revenue $44,481 $29,878
Operating income $4,737 $1,958
Net profit $2,620 $784
Earnings per share - basic (cents) $0.26 $0.11
Earnings per share - diluted (cents) $0.24 $0.10
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.
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 is approximately $5.9 million
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 522,750
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. 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.
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.
F-19
A summary of the assets acquired and liabilities for Guangzhou 3G WOFE assumed
in the acquisition follows:
Estimated fair values:
Current Assets $ 253,000
Goodwill $ 4,041,800
-----------
Total Assets Acquired $ 4,294,200
Liabilities assumed --
-----------
Net assets acquired $ 4,294,200
===========
At December 31, 2005, goodwill of $4,041,800 represents the excess of the
purchase price over the fair value of the net tangible and identifiable
intangible assets acquired and is not deductible for tax purposes and the total
amount of goodwill by reportable segment for VAS Business was $9,584,000. (See
Note 15).
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 US$2,356,200 being 294,525 shares at US$8.0 per share has not
been reflected in the consolidated financial statements of the Company as of
December 31, 2005.
F-20
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2005 AND 2004
The following un-audited 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.
3G Year ended December 31
2005 2004
(UN-AUDITED AND IN THOUSANDS
OF U.S. DOLLARS)
Revenue $45,312 $32,690
Operating income $4,910 $1,374
Net profit $2,734 $458
Earnings per share - basic (cents) $0.27 $0.06
Earnings per share - diluted (cents) $0.26 $0.06
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 is an aggregate of US$10.2 million: US$2.1 million payable
in cash to the Seller and US$6.6 million in shares (approximately 825,000
shares) of our common stock valued at $8 per share. 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. In addition, we has agreed
to issue our restricted shares, a number to be based on 51% of the net cash
divided by the 60-day volume weighted average price of PacificNet, upon
auditor's certification of ChinaGoHi's US$7 million accumulated net cash profit
for the fiscal years ended 2003, 2004 and 2005 (subject to completion of 2005
annual USGAAP audit).
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.
F-21
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 9,384,165
Property Plant and equipment 308,580
Goodwill 881,681
-----------
Total Assets Acquired $ 9,692,745
Current Liabilities assumed (4,803,884)
Long Term Liabilities assumed --
-----------
Net assets acquired $ 4,888,861
===========
At December 31, 2005, goodwill of $881,681 represents the excess of the purchase
price over the fair value of the net tangible and identifiable intangible assets
acquired and is not deductible for tax purposes and the total amount of goodwill
by reportable segment for VAS Business was $9,584,000 (see Note 15).
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 US$6,825,000
being 687,000 restricted shares at US$8 per share and cash of US$1,325,000 have
not been reflected in the consolidated financial statements of the Company as of
December 31, 2005.
F-22
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2005 AND 2004
The following un-audited 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.
Year ended December 31
2005 2004
(UN-AUDITED AND IN THOUSANDS
OF U.S. DOLLARS)
Revenue $55,209 $39,164
Operating income $7,332 $4,267
Net profit $3,354 $1,688
Earnings per share - basic (cents) $0.33 $0.23
Earnings per share - basic (cents) $0.31 $0.20
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 in affiliated companies and goodwill consist of the following as of
December 31, 2005 (in thousands):
COLLATERAL/OWNERSHIP % AND BUSINESS DESCRIPTION
AMOUNT DESCRIPTION
INVESTMENTS IN AFFILIATED COMPANIES:
Take1 (Cheer Era Limited) [1] $ 386 20% ownership interest; trader of
vending machine located in Hong
Kong.
Xmedia Holdings Inc 95 25% ownership; provides new media
business development and
marketing to advertisers.
Less: Provision for Impairment (95)
------
Total $ 386
=====
TAKE 1 TECHNOLOGIES GROUP LIMITED (FORMERLY KNOWN AS: CHEER ERA LIMITED "CHEER
------------------------------------------------------------------------------
ERA")
-----
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 $1,156,812, of which $385,604 was paid in cash and
$771,208 was paid in 149,459 PacificNet shares at $5.16, and warrants within a
duration of three years to purchase up to 80,000 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)
F-23
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. The conversion rate
will be based on a valuation of SIX (6) times the average annual net
profits of 3 years ending December 31, 2007 audited by PacificNet 's
auditors.
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. The management intends to cancel these repurchased shares subsequent to
the year end. 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):
2005 2004
-------- --------
Office furniture, fixtures and leasehold improvements $ 1,505 $ 989
Computers and office equipment 2,939 2,394
Motor Vehicles 270 69
Software 947 614
Electronic Equipment 4,932 1,169
Other 77 468
Less: Accumulated depreciation (6,370) (4,585)
--------------------
Net Property and Equipment $ 4,300 $ 1,118
====================
For the years ended December 31, 2005 and 2004, the total depreciation and
amortization expenses were $1,126,000, of which $833,000 was included in the
cost of revenue, and $78,000, respectively.
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 $653,000 (2004: $397,854). Future minimum lease payments
under non-cancelable operating leases are 2006: $870,000 and 2007: $806,000.
RESTRICTED CASH - The Company has a $163,000 pledged bank deposit for Epro which
represents overdraft protections with certain financial institutions and a fixed
deposit of $1,489,000 for Lion Zone utilized to provide guarantee for related
party.
F-24
BANK LINE OF CREDIT (2005): As of December 31, 2005, the Company utilized
$1,060,000 of the banking facility including $945,000 from Epro and $112,000
from Smartime, and the differences of the exchange rate of $3,000. 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.
BANK LINE OF CREDIT (2004): The Company has an overdraft banking facility with
certain major bankers in the aggregate amount of $1,309,000, which is secured by
a pledge of the Company's fixed deposits in the amount 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,
which ever is earlier. As of December 31, 2004, the Company utilized $651,000 of
the above-mentioned banking facility.
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 1.5% and 5.6%, 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.
6. OTHER CURRENT ASSETS
Other current assets is represented in Consolidated Balance Sheets which include
the following at December 31 (in thousands):
2005 2004
------------------------------ ---------------------- --------------
Deposit $ 707 $ 870
Prepayment 1,294 354
Other receivables 5,972 3,101
---------------------- --------------
Total $ 7,973 $ 4,325
====================== ==============
F-25
7. BANK LOANS
Bank loans represent the following at December 31 (in thousands):
2005 2004
----------------------------------------------- -------- --------
Secured [1] $ 108 $ 860
Unsecured 86 $ 536
Less: current portion (188) (1,327)
------- -------
Non current portion $ 6 $ 69
======= =======
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 and 2007: $6,000).
8. CAPITAL LEASE OBLIGATIONS
The Company leases various equipments under capital leases expiring in various
years through 2005. 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)
Capital lease obligations represent the following at December 31, 2005 (in
thousands):
2005 2004
------- -------
Total minimum lease payments $ 216 $ 225
Interest expense relating to future periods (12) (16)
------- -------
Present value of the minimum lease payments 204 209
Less: curent portion (126) (80)
------- -------
Non curent portion $ 78 $ 129
======= =======
Following is a summary of fixed assets held under capital leases at December 31
(in thousands):
2005 2004
------- -------
Computers and office equipment $ 441 $ 268
Less: accumulated depreciation (286) (246)
------- -------
$ 155 $ 22
======= =======
9. ACCRUED EXPENSES
Accrued expenses consist of the following at December 31 (in thousands):
2005 2004
------- -------
Deposits and advance payments received $ 3,312 $ 31
Payroll payable 713 21
Other 595 76
------- -------
Total $ 4,620 $ 128
======= =======
F-26
10. SUBSCRIPTION PAYABLE
In December 2005, the Company executed agreements and acquired controlling
interests 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.
The following subscription payable represents the partial payment in cash
payable to seller and the shares consideration of 137,500 PacificNet shares
payable under the terms and conditions of the Sale and Purchase Agreement are
deemed issued as of December 31, 2005 totaling $775,000.
See note 2 for details regarding the acquisitions.
11. SUNDRY INCOME
Sundry income for the years ended December 31, 2005 and 2004, consists of the
following on the consolidated income statements (in thousands):
2005 2004
------- -------
Consulting service income $ 116 $ 380
Investment income 113 --
Leasehold income 75 --
Software service income 375 --
Others 151 42
------- -------
TOTAL $ 830 $ 422
======= =======
12. 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 $1,014,000; (ii) 515,900 shares for
acquisition of subsidiaries valued at $3,971,000;(iii) 20,000 shares at $3.10
per share, or $63,000 for investor relations services rendered based on the fair
market value of the services rendered; and (iv) cancellation of 149,459 shares
with a market value of $771,000 related to affiliated company (see Note 3 for
details).
For the year ended December 31, 2004, the Company had the following equity
transactions (i) 352,364 shares as a result of exercise of stock options and
warrants with cash consideration of $716,000; (ii) 1,756,240 shares for
acquisition of subsidiaries valued at $8,866,000; and (iii) 2,205,697 shares for
cash proceeds of $11,773,000 (net of offering costs); and (iv) 149,459 shares
with a market value of $771,000 for acquisition of affiliated company (see Note
3 for details).
F-27
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 2005.
The status of the Stock Option Plan as of December 31, 2005, is as follows:
OPTIONS WEIGHTED
AVERAGE
EXERCISE PRICE
---------------- --------------
OUTSTANDING, DECEMBER 31, 2002 312,600 $1.13
Granted 963,000 $2.97
Exercised (350,000) $1.13
---------------
OUTSTANDING, DECEMBER 31, 2003 925,600 $2.87
Granted 600,000 $ 2.00
Cancelled (400,000) $4.25
Exercised (321,500) $ 2.11
---------------
OUTSTANDING, DECEMBER 31, 2004 804,100 $ 1.90
Granted 680,000 $ 6.57
Cancelled - --
Exercised (100,000) $ 1.99
---------------
OUTSTANDING, DECEMBER 31, 2005 1,384,100 $3.99
===============
Additional information on options outstanding as of December 31, 2005 is as
follows:
WEIGHTED AVERAGE
AVERAGE REMAINING
EXERCISE CONTRACTUAL
PRICE OPTIONS LIFE
--------------------------------------
Options outstanding $ 3.99 1,384,100 3.50 years
Options exercisable $ 2.06 529,000 1.50 years
F-28
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:
EXERCISE PRICE EXPIRATION DATE
Shares of common stock PER SHARE OF WARRANTS
---------------------- --------------- -----------------------
123,456 $7.15 January 15, 2009
117,682 $3.89 November 15, 2009
350,000 $12.21 December 9, 2009
--------
591,138
========
The Company believes 330,000 warrants issued in connection with certain
acquisition agreements (Note 2) with the following subsidiaries, Yueshen:
50,000, CheerEra: 80,000, Smartime: 50,000, Clickcom: 50,000, and Guangzhou3G:
100,000 are 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.
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 Remarks
shares
------------------------------------------------------------------------------------------------
Balance, December 31, 2003 800,000
------------------------------------------------------------------------------------------------
Repurchase in the open market 36,154
---------
------------------------------------------------------------------------------------------------
Balance, December 31, 2004 836,154
------------------------------------------------------------------------------------------------
Repurchase in the open market 2,000
------------------------------------------------------------------------------------------------
Repurchase of shares from Take 1 149,459 See note 3 to the F/S
------------------------------------------------------------------------------------------------
Cancellation of former employee shares 45,000
------------------------------------------------------------------------------------------------
Holdback shares as contingent 298,550 Including 24,200 shares
consideration due to performance relating to Yueshen, 196,350
targets not yet met shares to 3G and 78,000
shares to Clickcom
------------------------------------------------------------------------------------------------
Share consideration for (137,500) Due to share issuance in
acquisition of Chinagohi deemed progress; actual share
issued under Sale and Purchase certificate delivered after
Agreement the year end
------------------------------------------------------------------------------------------------
Options exercised but shares (24,000) Share issuance in progress
deemed issued ---------- prior to year end
------------------------------------------------------------------------------------------------
Balance, December 31, 2005: 1,169,663
------------------------------------------------------------------------------------------------
Shares outstanding at December 31, 2005 10,831,024
----------
------------------------------------------------------------------------------------------------
Shares issued at December 31, 2005 12,000,687
==========
------------------------------------------------------------------------------------------------
13. INCOME TAXES
The Company and its subsidiaries are subject to income taxes on an equity basis
on income arising in or derived from the tax jurisdictions in which they
operate, which can be summarized as follows:
UNITED STATES OF AMERICA (USA)
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 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
$54,000 (2004 $10,000).
F-29
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 $168,000
(2004: $20,000).
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.
14. 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 of December 31, 2005, there was a total loan receivable of approximately.
$2,520,000 due from related parties while the loan due to related party was
$369,000.
As at the year end, the related party loan receivables included $769,000 due
from Take 1, an affiliated company that is 20% owned by PacificNet, $1,751,000
due from shareholder and directors of PacificNet's subsidiaries. The loans
receivable from shareholders and directors of PacificNet's subsidiaries
comprised of $1,215,000 due from a shareholder of Yueshen, $80,000 due from a
shareholder of EPRO, $199,000 due from a director of Soluteck, and $257,000 due
from a director of Clickcom. The terms of these three related parties loan
receivables and payables 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% oned by PacificNet. As of December 31, 2005, there was a
Convertible Loan of $769,000 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 YUESHEN'S SHAREHOLDER
As of December 31, 2005, there was $1,215,000 loan receivable due from the
shareholder of Yueshen, a subsiiary of the Company. The purpose of the loan was
to repay the working capital loan owed by the predecessor of Yueshen prior to
PacificNet's acquisition and to finance Yueshen shareholder's other projects.
This loan is collateralized with 106,240 PacificNet shares owned by the
shareholder of Yueshen.
F-30
LOAN TO SOLUTEK'S DIRECTOR
As of December 31, 2005, there was a loan outstanding of $199,000 receivable
from a director of Solutek, payable in three equal installments of $72,314
each, being principal plus interest, due on December 14 for three consecutive
years ending 2007. The interest rate for the loan is 8% per annum plus 5%
penalty interest in case it has not been timely paid. The loan is collateralized
with 100,000 PacificNet's shares owned by the borrowing director and Ms Iris Lo,
and the remaining assets of Smartime Holding Ltd.
LOAN TO DIRECTOR OF CLICKCOM
As of December 31, 2005, there was a loan of $257,000 receivable from the
shareholders of Clickcom VIE. The loan was advanced by the Company to Clickcom
VIE which in turn loaned to the shareholders of Clickcom VIE to finance the
development of new projects. Pursuant to the loan agreement signed between the
Company and Clickcom VIE, this loan has a two year term due on August 30, 2007
and bears a 2% interest rate and is personally and jointly guaranteed by all the
three shareholders of Clickcom VIE on top of the pledged shares up to 130,000
PacificNet's shares and all remaining assets and equity ownership of Clickcom
BVI.
LOAN TO SHAREHOLDER OF EPRO
As of December 31, 2005, a net loan receivable of $80,000 was due from a
shareholder of Epro. The loan is unsecured, interest-free and repayable on
demand.
LOAN PAYABLE TO RELATED PARTY
As of December 31, 2005, a loan of $513,000 was payable to a shareholder of
EPRO. The loan was advanced to Epro for working capital purpose expiring by
August 4, 2010 at Hong Kong Prime lending rate approximately 6.5% interest per
annum prevailing in the year 2005.
F-31
15. SEGMENT INFORMATION
SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
("SFAS 131"), establishes standards for reporting information about operating
segments and for related disclosures about products, services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance. PacificNet's chief
decision-makers, as defined under SFAS 131, is the Chief Executive Officer and
Chairman. During 2005 and 2004, PacificNet had four operating segments.
The Company's reportable segments are operating units, which represent the
operations of the Company's significant business operations. Summarized
financial information concerning the Company's reportable segments is shown in
the following table. The "Other" column includes the Company's other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable segments.
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
FOR THE YEAR ENDED Group 1. Group 2. Group 3.
DECEMBER 31, 2005 Outsourcing VAS Business Communications Group 4. Total
Business Distribution Business Other Business ($)
($) ($) ($) ($)
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
Revenue 13,505,000 13,834,000 16,201,000 801,000 44,341,000
(% of Total Rev) (30.5%) (31.2%) (36.5%) (1.8%) (100%)
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
Earnings / (Loss) from
Operations (100% of 1,360,000 3,899,000 558,000 (1,248,000) 4,569,000
Total Profit) (29.8%) (85.3%) (12.2%) (-27.3%) (100%)
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
Total assets 7,335,000 19,363,000 9,493,000 14,415,000 50,606,000
(% of Total Asset) (14.5%) (38.3%) (18.8%) (28.5%) (100%)
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
Goodwill 3,543,000 9,584,000 1,100,000 - 14,227
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
Geographic Area HK, PRC HK, PRC HK, PRC HK,PRC
-------------------------- -------------------- ------------------- ----------------------- ------------------ ---------------
For the year ended 1. 2. 3. Communications 4.
December 31, 2004 Outsourcing Business VAS Business Distribution Business Other Business Total
($) ($) ($) ($) ($)
Revenues 9,385,000 5,724,000 11,790,000 2,810,000 29,709,000
(% of Total Rev) (31.5%) (19.27%) (39.68%) (9.55%) (100%)
Earnings / (Loss) from
Operations 1,000,000 1,859,000 85,000 (1,007,000) 1,937,000
(51.6%) (96%) (4.4%) (-52%) (100%)
Total assets 6,017,000 2,600,000 5,018,000 19,018,000 32,653,000
(% of total assets) (18.4%) (8.0%) (15.4%) (58.2%) (100%)
Goodwill 3,543,000 4,269,000 1,100,000 - 8.912,000
------------------------------------------------------------------------------------------------------------------------------
Geographic Area HK, PRC HK, PRC HK, PRC 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 Services (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.
(3) Communication Products Distribution Services Group - primarily
involves voice products distribution such as distribution of calling
cards and other products, which are conducted through our subsidiary
Yueshen and PacificNet Communication.
(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 revenue classified by major geographic areas are as follows
(in thousands):
Hong Kong PRC United States Total
---------------------------------------------------
Product revenue $20,131 $ 3,216 $- $ 23,347
Service revenue $10,640 $10,354 $- $ 20,994
F-32
16. RESTATEMENT AND CORRECTION OF ERROR
2004 Consolidated Income Statement and Consolidated Statement of Cash Flows
The consolidated income statement has been restated to present separately
revenues and costs of revenues from product sales and services in accordance
with Rule 5-03 of Regulation S-X. There was no effect on previously reported
total revenues, total costs of revenues, net earnings or earnings per share
amounts.
The consolidated statement of cash flows has been restated to properly reflect
the changes in the balance sheet accounts resulting from minority interests
accounting. The restatement had no effect on previously reported net increase in
cash and cash equivalents or cash balances.
The restatement for the year ended December 31, 2004 can be summarized as
follows:
As As
Previously Reported Restated
Cash Flows from operating activities
Net earnings $ 774 $ 774
Adjustment to reconcile net earnings to net cash provided by (used in)
operating activities:
Equity loss (earnings) of associated company - (32)
Minority Interest 2,506 1,623
Unrealized losses on marketable equity securities 17 17
Depreciation and amortization 78 78
Changes in current assets and liabilities net of effects from
purchase of subsidiaries:
Accounts receivable and other current assets (7,793) (3,584)
Inventories (1,221) (1,221)
Accounts payable and other accrued expenses 1,921 (2,069)
--------------- ---------------
Net cash provided by (used in) operating activities (3,718) (4,414)
--------------- ---------------
Cash flows from investing activities
DECREASE IN RESTRICTED CASH (3,289) (3,289)
Increase in purchase of marketable securities (46) (46)
Acquisition of property and equipment (730) (206)
Acquisition of subsidiaries and affiliated companies (640) (724)
--------------- ---------------
Net cash used in investing activities (4,705) (4,265)
--------------- ---------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Repayments on under bank line of credit (548) (548)
Advances (repayments) of amount borrowed under capital lease obligations (92) (92)
Repayments on bank loans (386) (130)
Proceeds from sale of common stock 11,773 11,773
Repurchase of treasury shares (99) (99)
Proceeds from exercise of stock options and warrants 716 716
--------------- ---------------
Net cash provided by (used in) financing activities 11,364 11,620
--------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,941 2,941
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,823 3,823
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,764 $ 6,764
=============== ===============
F-33
2005 Quarterly Reviews (unaudited)
As discussed in Note 1, the Company accounts for its VIEs in accordance with
U.S. generally accepted accounting principles which requires the consolidation
of VIEs from the date of acquisition. During 2005, the Company's quarterly
consolidated financial condition, results of operations, and reported cash flow
did not properly reflect VIE accounting. As a result, the quarterly financial
statements have been restated.
The restatements for the interim periods ended March 31, 2005, June 30, 2005 and
September 30, 2005 are summarized as follows:
March 31, 2005 June 30, 2005 September 30, 2005
----------------------- ----------------------- -----------------------
Previously As Previously As Previously As
reported restated reported restated reported restated
---------- ---------- ---------- ---------- ---------- ----------
BALANCE SHEET-
Total assets 31,012 31,330 38,986 42,420 40,232 42,768
Minority interest 2,198 2,319 3,207 4,957 3,718 5,316
Total liabilities 3,682 3,879 7,109 8,793 6,423 7,361
Additional paid-in 53,919 53,919 56,865 56,865 57,653 57,653
capital
Retained earnings (28,660) (28,660) (28,068) (28,068) (27,457) (27,457)
Total stockholders' 25,132 25,132 28,670 28,670 30,091 30,091
equity
Total liabilities and 31,012 31,330 38,986 42,420 40,232 42,768
stockholders equity
INCOME STATEMENT:
Revenue 9,133 9,212 19,885 21,492 30,607 32,593
Minority Interest (443) (417) (1,185) (1,304) (1,949) (1,916)
Net income 415 415 1,008 1,008 1,619 1,619
Earnings per share
Basic 0.04 0.04 0.10 0.10 0.16 0.16
Diluted 0.04 0.04 0.10 0.10 0.15 0.15
F-34
17. STATEMENTS OF CASH FLOWS SUPPLEMENTARY INFORMATION
IN YEAR 2005:
During 2005, PACT made investments for approximately $8,196,000 in subsidiary
companies in form of cash, subscription payable and equity consideration of
$1,950,000, $2,275,000 and $3,971,000 respectively. This amount represents
equity interests in Chinagohi (51%), Clickcom (51%) and Sunroom 3G (51%). The
details of these acquisitions are separately disclosed in the notes of the
consolidated financial statement under Note 2 "BUSINESS ACQUISITIONS". As the
consideration for these acquisition transactions are part cash and part
non-cash, the breakdown below is the cash portion paid or payable for the
subsidiaries acquired:
2005
In US$000s Remark
---------------------------------------- -------------- --------------
Chinagohi - subsidiary $ 2,275
Clickcom - subsidiary 268 --
Sunroom 3G - subsidiary 1,683 --
--------------
Subtotal: 4,226
Cash still contained within the group on
consolidation Less cash acquired in
subsidiaries (768)
--------------
Less: subscription payable (2,275) Note (a)
--------------
Net cash paid for the acquisition: $ 1,183
==============
Note (a) of which $1,500 was eliminated due to intercompany payable
IN YEAR 2004:
During 2004, PACT made investments for approximately US$11,325,000 in subsidiary
and affiliated companies in form of cash and equity consideration of
US$1,688,000 and US$9,637,000 respectively. This amount represents equity
interests in EPRO (50%), LINKHEAD (51%), YUESHEN (51%), SMARTIME (51%) and CHEER
ERA (30%). The details of these acquisitions are separately disclosed in the
notes of the consolidated financial statement under Note 2 "BUSINESS
ACQUISITIONS". As the consideration for these acquisition transactions are part
cash and part non-cash, the breakdown below is the cash portion paid for the
subsidiaries and affiliated company acquired:
2004
In US$000s Reference
-------------------------------------------------------------------------
EPRO - subsidiary $500.0 (a) below
LINKHEAD - subsidiary 222.5 (b) below
YUESHEN - subsidiary 579.9 (c) below
SMARTIME - subsidiary --
CHEER ERA - affiliated 385.6
---------
Subtotal: 1,688
Less cash acquired in subsidiaries (964) Cash still contained
(a+b+c) less US$338.3 paid to --------- within the group on
selling shareholder of YUESHEN consolidation
NET CASH PAID FOR THE ACQUISITION: $724
========
F-35
18. EVENTS SUBSEQUENT TO DECEMBER 31, 2005 (UNAUDITED)
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 thereunder.
BUSINESS ACQUISITIONS
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
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 nd 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.
F-36