Annual Report
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECRITIES EXCHANGE
ACT
OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
ྑ TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
FOR
THE
TRANSITION PERIOD FROM __________ TO __________
COMMISSION
FILE NUMBER: 000-24985
PACIFICNET
INC.
(Exact
name of registrant in its charter)
DELAWARE
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91-2118007
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification Number)
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23/F,
TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,
CHAOYANG
DISTRICT, BEIJING, CHINA 100028
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N/A
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant's
Telephone Number: 0086-10-59225000
(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
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act YES o NOx
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act YES o NOx
Indicate
by check mark whether the registrant (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 o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K contained herein, 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-K or any amendment to
this
Form 10-K. o
Indicate
by check mark if the registrant is a large accelerated filer, an accelerated
filer or a non- accelerated filer.
Large
Accelerated Filero Accelerated
Filero Non-
Accelerated
Filerx
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12(b) of the Exchange Act). Yes o
No x
The
aggregate market value of the common stock held by non-affiliates of the
registrant as of March 31, 2007 was approximately $44,400,866 based upon the
closing sale price of $5.34 per share as reported by The NASDAQ Global Market
on
such date. There were 11,733,929
shares
of the Company's common stock outstanding on March 31, 2007.
DOCUMENTS
INCORPORATED BY REFERENCE - NONE
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PART
I
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3
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ITEM
1. BUSINESS
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3
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ITEM
2. PROPERTIES
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30
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ITEM
3. LEGAL PROCEEDINGS
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31
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ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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32
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PART
II
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32
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ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND
PURCHASES OF EQUITY SECURITIES
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32
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ITEM
6. SELECTED FINANCIAL DATA
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34
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ITEM
7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS
OF OPERATIONS
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37 |
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ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
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47 |
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ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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48
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ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND
FINANCIAL DISCLOSURE
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49
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ITEM
9A. CONTROLS AND PROCEDURES
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49
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ITEM
9B. OTHER INFORMATION
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49
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PART
III
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50
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ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
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50
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ITEM
11. EXECUTIVE COMPENSATION
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53
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ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND
RELATED STOCKHOLDER MATTERS
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62
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ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
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63
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ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
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63
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PART
IV
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64 |
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ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
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64 |
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.
PART
I
ITEM
1. BUSINESS
As
used
in this report, "we", "us," "our," "Company", "PacificNet" or "PACT" refers
to
PacificNet Inc., a Delaware corporation.
OVERVIEW
PacificNet,
Inc. (http://www.PacificNet.com) is a leading provider of Customer Relationship
Management (CRM), mobile internet, e-commerce and gaming technology in China.
PacificNet's clients include leading telecom companies, banks, insurance,
travel, marketing and business services companies and telecom consumers in
Greater China, such as China Telecom, China Mobile, Unicom, PCCW, Hutchison
Telecom, Bell24, Motorola, Nokia, SONY, TCL, Huawei, American Express, Citibank,
HSBC, Bank of China, Bank of East Asia, DBS, TNT, Hong Kong Government, and
leading hotel-casinos in Macau and Asia. PacificNet employs over 1,500 staff
in
its various subsidiaries throughout China with its headquarters in Beijing
and
Hong Kong, offices in Shenzhen, Guangzhou, Macau, and branch offices in 28
provinces in China.
We
were
incorporated in the state of Delaware in 1987. Through our subsidiaries we
invest in and operate companies that provide outsourcing services, telecom
value-added services (VAS) and products (telecom & gaming) services 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. PacificNet's
operations include the following four groups:
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Customer
Relationship Management (CRM) and Outsourcing Services.
We provide (1) Business Process Outsourcing (BPO), such as call centers,
CRM and telemarketing services and (2) IT Outsourcing (ITO), such
as
software programming and development
services.
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·
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Telecom
Value-Added Services (VAS).
We are value-added resellers and providers of Content Providing (CP),
Platform Providing (PP) and Service Providing (SP) telecom VAS, such
as
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).
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·
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Telecom
and Gaming Products and Services.
Our telecom
and gaming products and services
include distribution services, multimedia interactive self-service
kiosk
distribution, online mobile phone distribution, and the design,
manufacture, and marketing of gaming machines (Asian multi-player
electronic gaming machines). In addition to gaming machines, we also
offer
the leading hotel, casino and slot hall operators based in Macau,
China
and other Asian gaming markets a wide range of gaming technology
solutions
including gaming related maintenance.
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Other
Business Services.
We
have a number of subsidiaries that we use primarily for administration,
internal control and acquisition purposes. One of these subsidiaries
is
engaged in the air-conditioning subcontracting business.
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Beginning
in late 2006, we launched our gaming product and technology business in Macau
and Asia. Through our subsidiaries, including PacificNet Games Limited
(“PacGames”) and Take1 Technologies Limited (“Take1”), we design, manufacture,
and market electronic gaming machines (EGM), video lottery terminals (“VLTs”),
Amusement with Prizes (AWP) machines, keno and bingo machines. We are also
involved in gaming operations, in which we place participation games, including
gaming machines linked to wide-area progressive (“WAP”) jackpot systems,
local-area progressive (“LAP”) jackpot systems and non-linked, stand-alone
gaming machines in legal gaming venues. We also license our game themes to
third
parties. We serve the gaming industry in Macau, Asia and Europe. We
manufacture our gaming machines exclusively in Macau and China and we have
development and distribution offices in Macau and Asia. We intend to continue
to
grow our business by acquiring and managing growing technology businesses with
specialized gaming hardware and software products that provide our customers
with state-of-the-art marketing, data management, accounting, security and
gaming software applications and tools to more effectively cope with their
fast
growing Asian gaming operations.
We
seek
to develop games and gaming machines that offer high entertainment value and
generate greater revenues for casinos and other gaming machine operators than
what is currently offered by our competitors. Our gaming machines feature
advanced graphics, digital sound and engaging game themes, and incorporate
secondary bonus rounds and jackpot features. In designing our games and gaming
machines, our designers, engineers, artists and development personnel build
upon
our years of experience in designing and developing entertaining and exciting
games from multi-media entertainment kiosks, photo sticker kiosks, mobile phone
kiosks, coin-op amusement kiosks, jukeboxes, to internet and mobile games and,
now, to gaming machines for the casino industry.
In
addition to our gaming operations, through our subsidiaries we also invest
in
and operate companies that provide outsourcing services, telecom value-added
services (VAS) and telecom products and services. Our business process
outsourcing (BPO) services group includes call centers, providing customer
relationship management (CRM), and telemarketing services. 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 telecom
products and services include IT and distribution services, and online mobile
phone distribution,. We also have a number of subsidiaries that we use primarily
for administration, internal control and acquisition purposes.
Our
business process outsourcing services generate revenues 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 products (telecom &
gaming) service group generates revenue from two main streams. We generate
revenue from the sale of entertainment kiosks and cell phones (which are sold
cash-on-delivery), and we generate revenue from the sale of Asian multi-player
electronic gaming machines and gaming technology solutions. Going forward,
we
intend to earn gaming operations revenue from offering our customers a wide
range of lease and rental options, and earn royalty income from game content
licensing agreement.
CORPORATE
STRUCTURE
We
conduct our business operations through the following business units and
subsidiaries:
(I)
CUSTOMER
RELATIONSHIP MANAGEMENT AND 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, and 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. PacificNet's
software R&D and outsourcing unit, Pacific Solutions Technology, is a CMM
Level 3 certified software development center with over 200 software programmers
located in Shenzhen, China, and specializes in the development of high-end
client-server application software, internet e- commerce software, online and
casino gaming systems and slot machines, banking and telecom applications using
Microsoft Visual C++, Java, and other rapid application development
tools.
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.
(II)
TELECOM VALUE-ADDED SERVICES (VAS) GROUP
SERVICE
PROVIDER COMPANIES
1)
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.
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. In April 2007, we entered into an
agreement to sell our interest in Guangzhou 3G-BVI for
$6,000,000.
(III)
PRODUCTS
(TELECOM & GAMING)
GROUP
1)
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 the sales
and distribution of mobile communication products, accessories, phone cards
and
mobile SIM cards, and telecom related services in Hong Kong and Greater
China.
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. iMobile’s Internet portal has been
one of the top ranked traffic sites and has achieved about 5.4
million registered online users and over 1,200,000 active users, with 10
million
daily page views and 40,000 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)
TAKE1 TECHNOLOGIES GROUP LIMITED ("TAKE1", FORMERLY KNOWN AS: CHEER ERA
LIMITED)
Take1
Technologies (http://www.take1technologies.com), a member of PacificNet group,
is in the business of designing and manufacturing electronic multimedia
entertainment kiosks, coin-op kiosks and machines, electronic gaming machines
(EGM), bingo and slot machines, AWP (Amusements With Prizes) games, server-based
downloadable games systems, and Video Lottery Terminals (VLT) such as Keno
and
Bingo machines, including hardware, software, client- server systems and
cabinets. Take1 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 stations for mobile phones,
and other coin-operated peripherals and consumables. Take1 Technologies is
based
in Hong Kong and markets and distributes its products around the world including
the USA, Canada, Mexico, Europe, China, and Southeast Asia.
4)
PACIFICNET GAMES LIMITED
PacificNet
Games Limited (PacGames), a member of PacificNet group, is a leading provider
of
Asian multi-player electronic gaming machines, gaming technology solutions,
gaming related maintenance, IT and distribution services for the leading hotel,
casino and slot hall operators based in Macau, China and other Asian gaming
markets. PacGames products include multi-player electronic gaming machines
such
as Baccarat, Fish-Prawn-Crab, Sib-Bo Cussec, Roulette, and other multi-player
electronic gaming machines, as well as other legacy slot machines.
PacificNet's
software R&D and outsourcing unit, Pacific Solutions Technology, is a CMM
Level 3 certified software development center with over 200 software programmers
located in Shenzhen, China, and specializes in the development of high-end
client-server application software, internet e- commerce software, online and
casino gaming systems and slot machines, banking and telecom applications using
Microsoft Visual C++, Java, and other rapid application development
tools.
(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. Its subsidiaries also include certain insignificant
business units such as data center and air-conditioning
subcontracting.
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)
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.
4)
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.
5)
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 to provide 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.
GAMING
TECHNOLOGY INDUSTRY OVERVIEW
Gaming
and casino operators constantly seek to increase revenue growth and
profitability at their casinos or slot halls. The importance of gaming machine
revenue to casino operators’ profitability has created demand for gaming
machines that have the ability to generate superior net win. As a result, the
pace of innovation in game design continues to accelerate, and gaming equipment
manufacturers have increasingly focused on enhancing the overall entertainment
value and appeal of games and gaming machines. We believe the development of
electronic gaming machines with localized Chinese and Asian themes and contents
will present the largest opportunity for us as one of the few domestic Chinese
and Asian gaming machine developers. We believe that server-based gaming will
be
the next significant technology development in the gaming machine industry.
Server-based gaming initiatives will require regulatory approval in gaming
jurisdictions prior to any implementation.
VLTs
are
sold, leased to, or operated as participation games by government agencies
that
desire to raise revenue for the jurisdictions in which they operate. Most VLTs
are linked to a central computer for accounting and security purposes and are
monitored by state lotteries or other government authorities. Unlike gaming
machines designed for the casino market, most VLTs are located in places where
casino-type gaming is not the principal attraction, such as racetracks, bars
and
restaurants. In the recent years, many countries in Europe have enacted
legislation permitting VLTs.
GAMING
BUSINESS STRATEGY
Our
business strategy is to increase our market penetration in major regulated
gaming jurisdictions worldwide by developing entertaining products and providing
outstanding service. We plan to do this by leveraging our product development
expertise to introduce innovative new games. We have almost 5 years of
experience developing multi-media entertainment kiosks, fun, humorous and
exciting internet and mobile games in Macau, Hong Kong, China, and other Asian
countries. Over the past few years, we have enhanced our game development
efforts by adding key management, design personnel and software engineers to
our
product development group. We have expanded new gaming software and hardware
R&D facilities in Beijing, Shenzhen, Zhuhai and Macau and organized our game
development teams into workgroup units to help promote innovation while
maintaining a focused development approach in an effort to maximize the
localized Chinese entertainment value of our products. We believe that our
proven game development capabilities, combined with the additional
functionalities and enhanced features of our new gaming platform, will enable
us
to increase our market share in the fast growing gaming markets in Macau, China,
and Asia.
BUSINESS
OPERATION HIGHLIGHTS OF 2006
ENTRY
INTO GAMING TECHNOLOGY BUSINESS
During
the year we took decisive measures to address the negative impact on our overall
profitability as a result of China Mobile’s VAS policy change and the
increasingly competitive telecom products market in China. These measures
included considering strategic alternatives for our low-margin telecom
businesses, such as sales, spin-offs and mergers and turning our focus to the
higher margin and rapidly expanding gaming and entertainment industries. To
do
this, in September 2006, we opened an office in Macau. By leveraging the
entertainment software and hardware development expertise of our CRM and telecom
businesses in combination with the access to market of our newly-acquired
PacificNet Games Limited subsidiary, we seek to brand ourselves as a leading
gaming technology provider in the emerging gaming markets in Macau and Asia.
We
believe that due to the success of our new generation Asian oriented gaming
software, our gaming business has begun to draw the attention of some other
first tier gaming operators in Macau, North Asia, South America and Italy.
Going
forward, while we are focused on increasing market share in the aforementioned
rapidly growing gaming markets, we intend to take full benefit of our
first-mover advantage in the Asian market by entering into long term gaming
software licensing and servicing agreements with both land-based and on-line
gaming operators in those less developed Southern Asian gaming markets, in
particular the Philippines and Cambodia.
ACQUISITION
OF GUANGZHOU WANRONG INFORMATION TECHNOLOGY CO., LIMITED
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.
ACQUISITION
OF PACIFICNET IMOBILE (BEIJING) TECHNOLOGY CO., LIMITED
On
February 06, 2006, we acquired 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.
iMobile’s Internet portal has been one of the top ranked traffic sites and has
achieved about 5.4
million registered online users and over 1,200,000 active users, with 10
million
daily page views and 40,000 blog postings per day, which makes iMobile
the top
ranked site in its category in China.
PRIVATE
PLACEMENT OF CONVERTIBLE DEBENTURES AND WARRANTS
On
March
13, 2006, we completed a private placement in which we sold $8,000,000
in
convertible debentures and issued warrants to purchase up to an aggregate
of
400,000 shares of common stock. 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 dilutive events. The debentures
are
due March 13, 2009. The warrants are exercisable for a period of five years
at
an exercise price of $12.20 per share. We will pay interest in shares,
provided
that certain conditions are met, or in cash at the rate of 6% for the second
year the debentures are outstanding and then 7% for the third year.
Under
the
terms of a registration rights agreement entered into at the time of the
private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by
April 30,
2006, and have the registration statement declared effective by the SEC
no later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration
rights
agreement, the Company was obligated to pay liquidated damages to
the investors at the rate of 2% of the principal amount of the debenture
each month beginning on June 28, 2006 until the effectiveness of the
registration statement, which was equal to $1,120,000, in the aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of
accrued
liquidated damages, the Company signed a Settlement and Release Agreement
with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full
of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding
Fund
Ltd., and Basso Private Opportunities Holding Fund Ltd.. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of
$35,000
in cash, with the remaining liquidated damanges in the amount of $105,000
paid
in the form of a new convertible debenture due February 2009, on substantially
the same terms as the original debentures, except that interest only is
paid on
the new debentures until October 2008 and beginning in November 2008 until
February 2009, when the new debentures are due, the monthly redemption
amount
under the new debentures shall be equal to $315,000.
The
remaining investors also agreed to accept the aggregate $840,000 in liquidated
damages owed to them in the form of the new convertible debentures for
the
amount of their respective portion of the liquidated damages. The Company
also
agreed to amend the original debentures to shorten the term for payment
of the
original principal amount to a 22 month term. As a result the monthly redemption
amount for the original debentures increased from $320,000 to $ 363,638.
All
other terms and conditions of the original debenture remains in full force
and
effect.
ADDITIONAL
ACQUISITION OF PACIFICNET GAMES LIMITED
On
November 9, 2006, we acquired an additional 6% interest in PacificNet Games
Limited (PacGames) for a consideration of $504,000 being 90,000 PACT restricted
shares. Prior to this, in connection with the acquisition of Able Entertainment,
previously announced during the Q3 2006, we owned 45% of PacGames. We now own
51% of PacGames.
EXECUTION
OF TERMINATION AGREEMENT WITH CHINAGOHI
On
November 20, 2006, PacificNet executed an agreement ("Termination Agreement")
to
terminate the Sale and Purchase Agreement with Lion Zone, ChinaGoHi and Mr.
Wang
Wenming (collectively, the "Sellers"). The Termination Agreement was effective
as of November 1, 2006. In the Termination Agreement, the Sellers agreed to
pay
an aggregate of HKD$3,000,000, comprising: USD$100,000 in cash and 275,000
in
restricted shares of PACT, in exchange for 51% interest of Lion Zone, holding
company of ChinaGoHi. Additionally, the Sellers agreed to waive PacificNet's
obligations under the Sale and Purchase Agreement entered into between
PacificNet and the Sellers in December 2005 to issue restricted shares and
to
provide certain loans to the Sellers. PacificNet, however, reserves the rights
to re-purchase the said 51% interest of Lion Zone within 2 years of the date
of
signing the Termination Agreement for a consideration of 5 times audited net
profit under US GAAP for the 12-month period subsequent to the year of signing.
The
decision to terminate the Sale and Purchase Agreement was due to ChinaGoHi’s
inability to obtain the approval of, and get the necessary license to operate
from, the China Securities Regulatory Commission (“CSRC”) and the Chinese
Broadcasting Bureau. We have previously disclosed in our periodic reports
filed with the Securities and Exchange Commission that in the past, the Chinese
government has stopped the distribution of information that it believes violates
PRC law over the Internet or through VAS. We have disclosed the risk that
if the PRC government were to take any action to limit or prohibit the
distribution of information through our networks 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. In July 2006,
the Chinese Broadcasting Bureau along with the CSRC banned the TV membership
sales model, which was the model ChinaGo Hi employed in its business. The Sale
and Purchase Agreement provided that if ChinaGoHi or Lion Zone was banned or
in
any way restricted from conducting business under the existing or new PRC laws
or legislation during the period from signing the Sale and Purchase Agreement
to
July 1, 2006, and ChinaGoHi failed to change its business model in good faith
to
adapt to the new regulations, and such failure resulted in any shortcoming
of
the accumulated net profit, ChinaGoHi and Lion Zone would return to PacInvest
all the cash and shares they obtained under the Agreement.
SUBSEQUENT
EVENTS
ADDDITIONAL
ACQUISITION OF TAKE1 TECHNOLOGIES IN Q1 2007
On
January 5, 2007, we entered into a Securities Subscription Agreement to exercise
an option to acquire an additional 31% interest in Take1 Technologies Limited
(“Take1”). On March 5, 2007, we consummated the purchase for $721,887 (paid
entirely with shares of PacificNet: 149,459 PACT Shares, valued at $483 per
share). As a result, PacificNet has become the majority and controlling
shareholder of Take1 with our ownership percentage increased from 20% to 51%.
FORMING
A CALL CENTER JOINT VENTURE WITH BELLSYSTEM24 IN SHANGHAI, CHINA
On
January 5, 2007, we entered into a joint venture agreement with Bellsystem24,
the largest telemarketing call center in Japan, to form a new joint venture
company called BELL-PACT Consulting Limited. The new joint venture company
is
jointly owned 40% by PacificNet and 60% by Bellsystem24. The joint venture
will
offer CRM call center consulting and training services, technical and business
consulting services, network product sales, software development, system
integration, as well as value-added services and other relevant services out
of
Shanghai catering to the Greater China markets.
COMPLETION
OF $5 MILLION PRIVATE PLACEMENT FINANCING FOR GAMING TECHNOLOGY EXPANSION IN
MACAU AND ASIA
On
February 6, 2007, PacGames entered into a definitive agreement for a $5 million
financing in the form of secured convertible note with Pope Asset Management,
LLC (Pope), an institutional investor. Proceeds from the financing will be
used
to provide PacGames with additional working capital in expanding its gaming
technology operations, funding for strategic acquisitions in China and funding
for general corporate purposes. The $5 million convertible note issued by
PacGames to Pope matures on February 6, 2010, and may be converted into 26%
to
32% ownership interest in PacGames based on reaching certain net income
milestones during fiscal year 2007. The interest rate on the convertible note
will initially be set at 8%, and shall increase to 15% if the note is not
converted prior to maturity.
SALE
OF GUANGZHOU 3G
As
part of our strategy to move away from telecom
VAS, on April 30, our wholly-owned subsidiary, PacificNet Strategic Investment
Holdings Limited, entered into a stock purchase and sale agreement with Heyspace
International Limited to sell its 51% interest in Guangzhou 3G's parent company,
Pacific 3G Information & Technology Co. Limited. The purchase price is
$6,000,000 payable in installments over a six month period or earlier if
Heyspace completes its initial public offering prior to October 31,
2007.
PRODUCTS
AND SERVICES OFFERED
1.
New Business: Gaming Technology Operations
PACIFICNET
GAMES LIMITED
PacificNet
Games Limited (referred to herein as "PacGames"), incorporated in the British
Virgin Islands (BVI), is a 51% owned subsidiary of PacificNet. PacificNet Games
Limited (PacGames), is a leading provider of Asian multi-player electronic
gaming machines, gaming software for online and land based casinos, gaming
technology solutions, gaming related maintenance, IT and distribution services
for the leading hotel, casino and slot hall operators based in Macau, China
and
other Asian gaming markets. PacGames products include multi-player electronic
gaming machines such as Baccarat, Fish-Prawn-Crab, Sib-Bo Cussec, Roulette,
and
other multi-player electronic gaming machines, as well as other legacy slot
machines.
TAKE1
TECHNOLOGIES GROUP LIMITED ("TAKE1", FORMERLY KNOWN AS: CHEER ERA
LIMITED)
Take1
Technologies (http://www.take1technologies.com), a member of PacificNet group,
is in the business of designing and manufacturing electronic multimedia
entertainment kiosks, coin-op kiosks and machines, electronic gaming machines
(EGM), bingo and slot machines, AWP (Amusements With Prizes) games, server-based
downloadable games systems, and Video Lottery Terminals (VLT) such as Keno
and
Bingo machines, including hardware, software, client- server systems and
cabinets. Take1 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 stations for mobile phones,
and other coin-operated peripherals and consumables. Take1 Technologies is
based
in Hong Kong and markets and distributes its products around the world including
the USA, Canada, Mexico, Europe, China, and Southeast Asia.
Through
our gaming technology subsidiaries in Macau, China, we design, manufacture
and
market innovative electronic gaming machines, bingo machines, AWP and VLTs
for
customers in legalized gaming jurisdictions in Macau, Asia, and Europe. Our
video gaming machines include localized Chinese and Asian themes, contents,
advanced graphics and digital sound effects and music. Amusing, entertaining
or
familiar graphics and musical themes with Chinese and Asian contents add to
the
player appeal of our games in Asia.
For
our
gaming technology operations, we generate revenue in two principal ways. First,
we generate product sales revenues from the sale to casinos and other licensed
gaming machine operators of new and used gaming machines and VLTs, conversion
kits (including theme and/or operating system conversions), parts, and original
equipment manufacturing (“OEM”) for third parties. Second, we earn gaming
operations revenues from leasing participation gaming machines and VLTs, and
earn royalties that we receive from third parties under license agreements
to
use our game content.
PRODUCT
SALES
We
offer
the following gaming technology products for sale:
|
·
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Electronic
gaming machines (EGM). Our line of electronic gaming machines combine
localized Chinese and Asian themes and content, advanced graphics,
digital
sound effects and music, and secondary bonus games.
|
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Multi-player
Electronic Table Games
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Multi-player
Electronic Baccarat Machines
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Multi-player
Electronic Sicbo Machines
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Multi-player
Electronic Roulette Machines
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·
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Multi-player
Electronic Fish-Prawn-Crab Machines
|
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·
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Electronic
Bingo Machines
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·
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Video
Lottery Terminals (VLTs)
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·
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Server-Based
Gaming Machines (SBG)
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·
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Amusement
With Prices (AWP) Machines
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Online
Gaming Software Development
|
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Client-Server
Gaming Systems
|
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CMM
Level 3 Certified Gaming Software Development Center in
China
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Cabinet
Design and Sales, Parts Sales, OEM Games. We design and sell gaming
machine cabinets, replacement parts.
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GAMING
TECHNOLOGY OPERATIONS
Our
gaming technology operations business includes the following:
1. Participation
games
Company-owned
gaming machines that we lease based upon any of the following payment methods
are referred to as participation games: (1) a percentage of the net win of
the
gaming machines, (2) fixed daily fees, or (3) in the case of wide-area
progressive gaming machines, a percentage of the amount wagered or a combination
of a fixed daily fee and a percentage of the amount wagered.
2. Wide
Area
Game Network, Community Gaming
Wide
Area Progressive Jackpots (WAP) participation games electronically link gaming
machines that are located across multiple casinos within a gaming jurisdiction.
The linked gaming machines contribute to and compete for large, system-wide
progressive jackpots and are designed to increase gaming machine play for
participating casinos by giving the players the opportunity to win a larger
jackpot than on a stand-alone gaming machine.
3. Local
Area Progressive Jackpots (LAP) participation games
A
LAP system electronically links gaming machines that are located within a
single
casino to a progressive jackpot for that specific casino. Our LAP products
are
designed to give the player the chance to win multiple progressive
jackpots.
4. Video
Lottery Terminals
Our
VLTs
include video gaming machines featured with localized Chinese and Asian themes
and contents, advanced graphics, digital sound effects and music and incorporate
many of the same features from our other gaming machines. We offer a variety
of
multi-game and single-themed VLTs. Our VLTs may be operated as stand-alone
units
or may interface with central monitoring computers operated by government
agencies. Our VLTs typically are located in places where casino-type gaming
is
not the principal attraction, such as racetracks, bars and restaurants. We
began
offering VLTs in 2007. In certain jurisdictions, VLT operators purchase our
VLTs
and we classify the revenue from these purchases as product sales revenues.
In
other jurisdictions, VLT operators lease our VLTs and pay us a lease rate based
on the net earnings of the gaming machine. We classify the lease payments as
gaming operations revenues. We do not include VLTs in our installed base of
participation games.
5. Server-based
Gaming
PacificNet
believes that server-based gaming (“SBG”) will be the next significant
technology development in the gaming machine industry. Server-based gaming
refers to a gaming system in which game content and peripherals are configured,
maintained and refreshed over a network that links groups of gaming machines
to
a remote server that also enables custom configuration by operators and central
determination of game outcomes. Server-based gaming initiatives will require
regulatory approval in gaming jurisdictions prior to any implementation and
represent a significant addition to our existing portfolio of product offerings.
Our implementation for SBG emphasizes localized Chinese and Asian game themes
and excitement for the Asian players. In a networked environment, we believe
game play will no longer be limited to an individual gaming machine; rather,
we
believe SBG will permit game play to be communal among multiple players.
2.
Legacy Business: CRM and Telecom Business
Our
goal
is to take a leading role in providing customer relationship management (CRM)
and gaming technology, 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.
CRM
OUTSOURCING SERVICES
A)
BUSINESS PROCESS OUTSOURCING
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.
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:
(i) 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.
(ii) 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.
(iii)
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.
B)
INFORMATION TECHNOLOGY OUTSOURCING
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 that include 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.
TELECOM VALUE-ADDED SERVICES
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 chat line and
dating services. Mobile and fixed-line phone users can access Guangzhou 3G
IVR
services through one of the four major telecom operators' networks.
3.
TELECOM
PRODUCTS
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 the sales and distribution of mobile
communication products, accessories, phone cards and mobile SIM cards, and
telecom related services in Hong Kong and Greater China.
IMOBILE
-
iMobile's Internet portal has been one of the top ranked traffic sites and
has
achieved about 5.4
million registered online users and over 1,200,000 active users, with 10
million
daily page views and 40,000 blog postings per day, which
makes iMobile the top ranked site in its category in China.
FINANCIAL
INFORMATION ABOUT OUR BUSINESS SEGMENTS
We
identify and classify our 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 include outsourcing services, telecom value-added
services, product (telecom & gaming) services and other business. For
financial information about these operating segments, see Note 15 to our
Consolidated Financial Statements.
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:
PCCW
LIMITED - A leading telecommunications carrier and service provider in Hong
Kong.
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.
SONY
-
Sony Corporation is a leading manufacturer of audio, video, game, communications
and information technology products for the consumer and professional markets.
Sony is one of the leading multi-national corporations in Asia, with 38
companies spanning 15 countries and supported by a family of over 40,000
employees. Sony Corporation of Hong Kong Limited is a wholly owned subsidiary
of
Sony. In 1999, the e-commerce website http://www.SonyStyle.com.hk was launched
to enable convenient on-line shopping in Sony style. For more information,
please see Sony's web sites: http://www.sony.net, Sony Hong Kong
http://www.sony.com.hk and e-commerce website
http://www.SonyStyle.com.hk.
BELLSYSTEM24,
Japan - Established in 1982, Bellsystem24 (http://www.bell24.com) is the largest
telemarketing call center services company in Japan, with over 5,000 clients,
27,348 communication service representatives and 33 offices in Japan.
Bellsystem24 has built a client base of multinational firms and industry leaders
by developing and nurturing long-term relationships. Bellsystem24's commitment
to quality, technological innovation, and value-added services has made it
the
leading provider of outsourced customer care and marketing solutions in Japan.
Bellsystem24 focuses on developing long-term strategic relationships with
clients in customer-intensive industries, including telecommunications, cable,
broadband, satellite broadcasting, Internet services, technology, and financial
services. Through a nationwide network of contact centers utilizing a unique
blend of one-on-one marketing media, knowledge-based tools, advanced technology,
and expert recruiting, staffing, training, and certifications, Bellsystem24
has
fostered a leading position in the customer care industry.
MCDONALD'S
- McDonald's Restaurants (Hong Kong) Limited was established in 1975. The first
McDonald's restaurant, which offered customers the very first American Big
Mac
Meal in Hong Kong, was located at Paterson Street, Causeway Bay. Today there
are
over 200 McDonald's restaurants in Hong Kong, and more than 10,000 McDonald's
staff. In addition to the McDonald's restaurants, McDonald's also opened in
Hong
Kong, in a bid to meet the needs of different customers.
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.
CHINA
GOVERNMENT - State Administration of Taxation - Shenzhen. The Shenzhen Municipal
Office of the State Administration of Taxation (www.szgs.gov.cn) operates 29
units with more than 2000 officers, servicing over 207,759 taxpayers. The
bureau's main responsibilities include the collection and management of various
accessed taxes including tax refunds for exported goods, value-added taxes,
excise duty taxes, business income tax, sales tax, individual income tax, and
the stamp duty on securities
2.
TELECOM VALUE-ADDED SERVICES 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.
NOKIA
-
Nokia is the world leader in mobile communications, driving the growth and
sustainability of the broader mobility industry. Nokia connects people to each
other and the information that matters to them with easy-to-use and innovative
products like mobile phones, devices, and solutions for imaging, games, media
and businesses. Nokia provides equipment, solutions and services for network
operators and corporations.
MOTOROLA
- Motorola is one of the top mobile brands in China in popularity and market
share.
3.
PRODUCTS
(TELECOM & GAMING)
CUSTOMERS
Our
gaming customers include some of the leading casinos, hotels, gaming operators,
bingo, slot and AWP operators in Macau, SE Asia, and Europe. Some of the famous
casinos that are using our gaming products include: Sociedade de Jogos de Macau
(SJM), Sociedade de Turismo e Diversoes de Macau (STDM), Casino Lisboa, Holiday
Inn Macau, Jai Alai Casino Macau, Galaxy Waldo Casino Macau (Galaxy
Entertainment Group), and other land-based gaming operators and bingo operators
in the Philippines, Asia and Europe.
Our
telecom products customers include: China Telecom, China Netcom, China Mobile,
China Unicom, and major mobile phone manufacturers such as Motorola and Nokia.
SALES
AND MARKETING
We
advertise our services by attending various GAMING,
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:
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The
Ministry of Information Industry
(MII)
|
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The
China Securities Regulatory Commission
(CSRC)
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The
Ministry of Culture
|
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The
General Administration of Press and Publication of the P.R.
China
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The
State Copyright Bureau
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The
State Administration of Industry and Commerce
(SAIC)
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The
Ministry of Public Security
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The
Ministry of Commerce
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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
We
cannot
hold the licenses and obtain the approvals necessary to operate the website
because those licenses and approvals cannot be held by foreign entities or
majority foreign-owned entities. PRC regulations currently limit foreign
ownership of companies that provide Internet content services to 50%. This
limitation extends to our IVR, call center e-commence 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 for example through Beijing
Xing Chang Xin Science and Technology Development Co. Limited ("Xinchangxin")
which is 100% owned by Mr. Liu Lei and Gao Chunhui, the Chairman and CEO of
Xinchangxin, who are both PRC citizen. Under PRC law, BEIJING PACIFICNET IMOBILE
TECHNOLOGY CO., LTD.,
PRC
registered wholly owned foreign enterprise (IMOBILE-WOFE), conducts it VAS
and
e-commerce operations with Beijing Xing Chang Xin Science and Technology
Development Co. Limited ("Imobile-DE"), a PRC registered Domestic Enterprise
(DE), through a series of contractual agreements. Under these agreements, the
shareholders of Imobile-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 Imobile-WOFE, we have also entered
into a consulting and services agreements with Imobile-DE, under which
Imobile-WOFE provides technical services and other services to Imobile-DE in
exchange for all of the net income of Imobile-DE. In addition, the shareholders
of Imobile-DE have pledged their shares in Imobile-DE as collateral for
non-payment of fees for the services we provide.
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, Xinchangxin is required to hold an Internet content provider, or ICP,
license issued by the Ministry of Information Industry or its local offices.
Xinchangxin currently holds an ICP license issued by Ministry of Information
Industry Beijing department.
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. Xinchangxin'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 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.
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.
INTERNATIONAL
REGULATION
Many
foreign jurisdictions permit the importation, sale and/or operation of gaming
equipment in casino and non-casino environments. Where importation is permitted,
some countries prohibit or restrict the payout feature of the legacy slot
machine or limit the operation of slot machines to a controlled number of
casinos or casino-like locations. Each gaming machine must comply with the
individual jurisdiction’s regulations. Some jurisdictions require the licensing
of gaming machine operators and manufacturers. We manufacture and supply gaming
equipment to various international markets including Asia, Australia, Canada,
Europe, South America and South Africa. We have the required licenses to
manufacture and distribute our products in the foreign jurisdictions in which
we
do business.
COMPETITION
Competition
in the New Gaming Technology Business:
The
electronic gaming machine (EGM) market is intensely competitive and is
characterized by the continuous introduction of new game titles and new
technologies. Our ability to compete successfully in this market is based,
in
large part, upon our ability to:
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Create
an expanding and constantly refreshed portfolio of games with high
earnings performance
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Offer
gaming machines that consistently out-perform gaming machines manufactured
by our competitors
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Identify
and develop or obtain rights to commercially marketable intellectual
properties
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Adapt
our products for use with new technologies
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In
addition, successful competition in this market is based upon:
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Engineering
innovation and reliability
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Mechanical
and electronic reliability
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Marketing
and customer support
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Competitive
prices and lease terms
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We
estimate that about 25 companies in the world manufacture gaming machines and
video lottery terminals (VLTs) for legalized gaming markets. Of these companies,
we believe that International Game Technology (“IGT”), Shuffle Master/
StarGames, WMS Industries, Bally Technologies (formerly Alliance Gaming),
Aristocrat Technologies, Novomatic, Atronic Casino Technology, and Lottomatica’s
recently acquired subsidiary G-Tech Holdings have a majority of this worldwide
market. In the video gaming machine market, we compete with market leader IGT,
as well as Aristocrat Technologies, Bally Technologies, Atronic Casino
Technology, Progressive Gaming, Konami, Franco and Unidesa. In the VLT market,
we compete primarily with IGT, G-Tech Holdings and Scientific Games.
Our
competitors vary in size from small companies with limited resources to a few
large corporations with greater financial, marketing and product development
resources than ours. The larger competitors, particularly IGT, have an advantage
in being able to spend greater amounts than us to develop new technologies,
games and features that are attractive to players and customers. In addition,
some of our competitors have developed, sell or otherwise provide to customers
security, centralized player tracking and accounting systems which allow casino
operators to accumulate accounting and performance data about the operation
of
gaming machines. We do not currently offer these systems. Several of our
competitors pooled their intellectual property patents that provide cashless
gaming alternatives, specifically ticket-in ticket-out technology, so that
when
a casino patron cashes out from a gaming machine they may receive a printed
ticket instead of coins.
Competition
in our Legacy CRM and Telecom Business:
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, AND 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.
TELECOM VALUE-ADDED SERVICES (VAS) COMPETITORS:
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.
3.
PRODUCTS (TELECOM & GAMING) COMPETITORS
International
Game Technology (NYSE:IGT), a global company specializing in the design,
development, manufacturing, distribution and sales of computerized gaming
machines and systems products.
Aruze
Corp. (JASDAQ: 6425), Aruze Corp. is a world leader in the manufacturing of
Pachi-Slot, Pachi-Com, Reel Spinning Slots and Video Gaming Devices. Aruze
Corp.
also develops Arcade Games, Amusement Games and Consumer Game
Software.
GAMING
MACHINE MANUFACTURING
We
manufacture all of our gaming machines at our facilities in Shenzhen and Zhuhai,
China. In 2007, we began reconfiguring our assembly lines in order to lower
our
product lead times and effectively increase our practical capacity with added
production efficiencies.
Manufacturing
commitments are generally based on sales orders from customers. In some cases,
however, component parts are purchased and assembled into finished goods that
are inventoried in order to be able to quickly fill anticipated customer orders.
Our manufacturing process generally consists of assembling component parts
to
complete a gaming machine. We generally warranty our gaming machines sold
internationally for a period of 180 days to one year.
The
raw
materials used in manufacturing our gaming machines include various metals,
plastics, wood, glass and numerous component parts, including electronic
subassemblies, main boards and circuit boards, money acceptors, and LCD screens.
We believe that our sources of supply of component parts and raw materials
are
generally adequate.
In
order
to improve the efficiency of our manufacturing processes and reduce time to
market, we continue to make improvements in sourcing and supply management,
in
inventory and warehouse management, and other manufacturing processes We also
have ongoing manufacturing initiatives, such as enhanced strategic sourcing
and
supplier management, value engineering the product and designing product for
both ease of manufacturability and installation, that we expect will help
improve gross margins in future quarters.
The
European Union (“EU”) has adopted the Restriction on the Use of Certain
Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive
to facilitate the recycling of electrical and electronic equipment sold in
the
EU. The RoHS directive restricts the use of lead, mercury, and certain other
substances in electrical and electronic products placed on the market in the
EU
after July 1, 2006. We have worked with our suppliers to develop RoHS-compliant
products and, as of the effective date of the directive, we were able to provide
RoHS-compliant gaming machines to the EU. We expect that any cost increases
incurred due to the RoHS directive will be offset by savings from design and
other changes we made to our component parts.
EMPLOYEES
As
of
December 31, 2006,
together with our subsidiaries, we had approximately 1,500 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
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PacificNet
Inc.
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5
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PacificNet
Limited (Hong Kong)
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12
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PacificNet
Beijing
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20
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PacificNet
Shenzhen
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20
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PacificNet
Guangzhou
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2
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PacificNet
Epro (Epro Telecom Holdings Limited)
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750
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Beijing
Linkhead Technologies Company Limited (Discontinued)
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60
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Shanghai
Classic Group Limited
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3
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Smartime
/ Soluteck Technology (Shenzhen) Company Limited
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170
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Guangzhou
3G (Sunroom)
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280
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Clickcom
(Dianxun) (Discontinued)
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12
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Wanrong
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42
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iMobile
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75
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PacificNet
Games Limited
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50
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TOTAL
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1,501
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RESEARCH
AND DEVELOPMENT
Our
gaming research and development department is dedicated to developing fun and
exciting electronic table games and slot machines that focus on enhancing Asian
player entertainment value and to introducing leading, innovative systems
products that increase our customers’ revenue stream and facilitates operating
efficiencies. Our dedicated Zhuhai (China) R&D center has approximately 31
employees who possesses significant experience in software development and
content design. Our current emphasis is on developing new technologies to expand
and improve functionalities of Multiplayer Electronic Gaming Machines, Online
Game Software Development, Slot Machines, including software, hardware and
cabinets, and developing new game content through third parties to refresh
and
grow our installed base of gaming devices.
We
conduct extensive testing on the products we offer to ensure they meet the
key
performance and quality standards as required by gaming regulators. In addition,
our R&D personnel constantly work with our customers on responding to their
needs and to also ensure compatibility with other products currently available
in the market. Moreover, we closely monitor the evolving standards in the gaming
industry so that we are able to respond and address new technologies as they
emerge.
INTELLECTUAL
PROPERTY
We
believe our trademarks, intellectual property rights, and propriety Asian gaming
software product development expertise are significant assets. Currently, we
have over five customized Asian gaming products. This portfolio took over three
years to develop and is expected to be a main focus of our R&D resources in
2007 and beyond. Our firm will continue to evolve as we look towards the next
generation of server-based gaming products. In addition to internally developed
and acquired emerging gaming technologies, we will also rely on strategic
partnerships to obtain access to intellectual property.
We
intend
to vigorously protect the investment in our intellectual
property and the unique features of our products and services by actively
applying to intellectual property patent protection. However, we cannot ensure
that intellectual property rights will not be infringed.
EXECUTIVE
OFFICES
Our
executive offices are located in Hong Kong, Macau, Beijing, Shenzhen and
Guangzhou, China and in Aberdeen, South Dakota and Glendale, California at
the
following addresses:
Hong
Kong: Room 2702, Richmond Commercial Building, 107 -111 Argyle Street, MongKok,
Kowloon, Hong Kong
PacificNet
Games Limited. Macau Office:
Av.
Do
Dr. R. Rodrigues No. 600E, Edif, First International Commercial Centre, P906,
Macau SAR, China.
PacificNet
Beijing Office:
23/F,
Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang District, Beijing, China
Postal Code: 100028
Tel:
+86-010-59225000
PacificNet
Shenzhen Office: PacificNet Shenzhen Office: Room 4203, Jinzhonghuan Business
Building, Futian 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
Inc.
416
Production Street North, Aberdeen, SD 57401, USA
655
N.
Central Ave., 17th
Floor,
Glendale, CA 91203, USA
Tel:
+1-
818-649-7500, Fax: +1-646-349-1096
We
maintain a website at http://www.PacificNet.com
ITEM
1A. RISK FACTORS
THE
FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL
CONDITION, AND 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 corporation in 1999. Our operating history may be
insufficient to evaluate our business and future prospects. Although our
revenues have grown rapidly in the past three 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:
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Increase
awareness of our brands, protect our reputation and develop customer
loyalty
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Manage
our expanding operations and service offerings, including the integration
of any future acquisitions
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Maintain
adequate control of our expenses
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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
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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:
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Diversion
of management time and resources and the potential disruption of
our
ongoing business
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Difficulties
in maintaining uniform standards, controls, procedures and
policies
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Potential
unknown liabilities associated with acquired
businesses
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Difficulty
of retaining key alliances on attractive terms with partners and
suppliers
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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, 2006, we acquired controlling interests in Guangzhou Wanrong,
iMobile and PacGames. We expect that these acquisitions will strengthen our
position as a provider of VAS communication products: internet mobile phone
distribution and gaming technology 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. To the extent that the goodwill arise from the acquisitions
carried on the financial statements do not pass the annual goodwill impairment
test, excess goodwill will be charged to future earnings.
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.
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 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.
We
may not be able to attract or retain the management or employees necessary
to
remain competitive in our industries. 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 and in developing and expanding our gaming operations.
Our
future success depends on the retention and continued contributions of our
key
management, finance, marketing, and staff personnel, many of whom would be
difficult or impossible to replace. Our success is also tied to our ability
to
recruit additional key personnel in the future. We may not be able to retain
our
current personnel or recruit any additional key personnel required. The loss
of
services of any of our personnel could have a material adverse effect on our
business, financial condition, results of operations and prospects. 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:
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Legal
uncertainties or unanticipated changes regarding regulatory requirements,
liability, export and import restrictions, tariffs and other trade
barriers
|
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Longer
customer payment cycles and greater difficulties in collecting accounts
receivable
|
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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, 2006,
we
completed a financing in which we placed $8,000,000 in convertible debentures
and issued warrants to purchase up to 400,000 shares of common stock. 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.
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 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, we may need to convert U.S. dollars into Hong Kong
dollars or Chinese renminbi as appreciation of either currency against the
U.S.
dollar could have a material adverse effect on results of our business,
financial condition and 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
RELATED TO OUR GAMING BUSINESS
If
we fail to keep pace with rapid innovations in product design and related
marketing strategies, or if we are unable to quickly adapt our development
and
manufacturing processes to release innovative products or systems, our business
could be negatively impacted.
Our
future success depends to a large extent upon our ability to continue to rapidly
design and market technologically sophisticated and entertaining products that
achieve high levels of player acceptance. Our revenues depend on the earning
power and life span of our games. Newer game themes tend to have a shorter
life
span than more legacy game themes, and as a result, we face pressure to design
and deploy successful game themes to maintain our revenue stream and to remain
competitive. Our ability to develop new and innovative products could be
adversely affected by :an inability to roll out new games, services or systems
on schedule as a result of delays in connection with regulatory product approval
in the applicable jurisdictions, or otherwise.
Our
future success also depends upon our ability to adapt our manufacturing
capabilities and processes to meet the demands of producing new and innovative
products. Because our newer products are generally more technologically
sophisticated than those we have produced in the past, we must continually
refine our production capabilities to meet the needs of continuing product
innovation. In addition, the shorter lifespan of newer products means that
we
must update our production capabilities more frequently and rapidly than in
the
past. If we cannot adapt our manufacturing infrastructure to meet the needs
of
our product innovations, or if we are unable to make upgrades to our production
capacity in a timely manner, our business could be negatively
impacted.
If
the current popularity and acceptance of gaming declines, our business plans
and
operation could be would be negatively impacted.
The
gaming industry can be affected by public opinion of gaming. Our success depends
on continually developing and successfully marketing new games and gaming
machines with strong and sustained player appeal. A new game or gaming machine
will be accepted by casino operators only if we can show that it is likely
to
produce more revenues to the operator than competitors’ products. Gaming
machines can be installed in casinos on a trial basis, and only after a
successful trial period are the machines purchased by the casinos. Participation
gaming machines are replaced by casino operators if the gaming machines do
not
meet and sustain revenue and profitability expectations. Therefore, these gaming
machines are particularly susceptible to pressure from competitors, declining
popularity, changes in economic conditions and increased taxation and are at
risk of replacement by the casinos, which would end our recurring revenues
from
these machines.
We
cannot
assure you that the new products that we introduce will achieve any significant
degree of market acceptance, that the acceptance will be sustained for any
meaningful period. In the event that there is a decline in public acceptance
of
gaming, either through unfavorable legislation affecting the introduction of
gaming into emerging markets, or through legislative and regulatory changes,
including tax increases, in existing gaming markets, our ability to continue
to
sell and lease our gaming machines in those markets and jurisdictions would
be
adversely affected.
The
gaming industry is intensely competitive. We face competition from a number
of
companies, some of which have greater resources, and if we are unable to compete
effectively, our business could be negatively impacted.
Competition
among gaming machine manufacturers is based on, among other things, competitive
pricing and financing terms made available to customers, appeal of game themes
and features to the end player and product quality, features and functionality
of hardware and software. The gaming technology provider market is saturated,
with IGT, Aristocrat, WMS, Bally Gaming and Systems, and, to a lesser extent,
Konami and Progressive Gaming Corporation comprising the primary competition.
The competition is intense due to the number of providers, as well as the
limited number of casino operators and jurisdictions in which they operate.
Pricing, product feature and function, accuracy and reliability are amongst
the
factors in determining a provider’s success in selling its system. While there
are a number of established, well-financed companies producing machines in
the
field, a single competitor, IGT, dominates the PRC domestic market for gaming
machines. Certain of these competitors have access to greater financial,
marketing and product development resources we. do, and as a result, may be
better positioned to compete in the marketplace.
In
addition, new competitors may enter our key markets. Obtaining space and
favorable placement on casino gaming floors is a competitive factor in our
industry. Competitors with a larger installed base of gaming machines than
ours
have an advantage in retaining the most space and best positions in casinos.
These competitors may also have the advantage of being able to convert their
installed machines to newer models in order to maintain their share of casino
floor space. In addition, some of our competitors have developed and sell or
otherwise provide to customers centralized player tracking and accounting
systems which allow operators to accumulate accounting and performance data
about the operation of gaming machines. We do not offer a centralized player
tracking and accounting system and that has put us at a competitive
disadvantage.
The
unpredictable growth of non−legacy gaming markets may affect our business and
prospects.
The
continued growth of non−legacy gaming markets for gaming machines and systems
depends heavily on the public’s acceptance of gaming in these markets, as well
as the ongoing development of the regulatory approval process by national and
local governmental authorities. A portion of our growth is directly tied to
our
ability to access these new markets. We cannot predict which new jurisdictions
or markets, if any, will approve the operation of electronic gaming machines,
the timing of any such approval, the public’s acceptance of our gaming machines
in these markets or our market share or profitability in these markets. Any
decline in the popularity of our gaming products with players, or if we are
unsuccessful in developing new products, services or systems, will have a
negative impact on our revenues.
The
gaming industry is heavily regulated and changes in regulation by gaming
authorities may adversely impact our ability to operate the
business.
The
manufacture and distribution of gaming machines, development of systems and
the
conduct of gaming operations are subject to extensive national, provincial
local
and foreign regulation by various gaming authorities.
Our
ability to continue to operate in certain jurisdictions could be adversely
affected by:
|
·
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Unfavorable
public referendums
|
|
·
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Unfavorable
legislation affecting or directed at manufacturers or gaming operators,
such as Referendums to increase taxes on gaming
revenues
|
|
·
|
Adverse
changes in or finding of non−compliance with applicable governmental
gaming regulations
|
|
·
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Delays
in approvals from regulatory
agencies
|
|
·
|
Limitations,
conditioning, suspension or revocation of any of our gaming
licenses
|
|
·
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Unfavorable
determinations or challenges of suitability by gaming regulatory
authorities with respect to our officers, directors, major stockholders
or
key personnel
|
Although
the laws, rules and regulations of the various jurisdictions in which we operate
vary in their technical requirements, virtually all jurisdictions require
licenses, permits, qualification documentation, including evidence of integrity
and financial stability, and other forms of approval to engage in gaming
operations or the manufacture and distribution of gaming machines. Delays in,
amendments to, or repeals of legislation approving gaming in jurisdictions
in
which we operate or plan to commence operations, or delays in approvals of
our
customers’ operations, may adversely affect our operations
Our
officers, directors, major stockholders and key personnel are also subject
to
significant regulatory scrutiny. In the event that gaming or governmental
authorities determine that any person is unsuitable to act in such capacity
with
respect to the Company, we could be required to terminate our relationship
with
such person. To our knowledge, the Company and our key personnel have obtained,
or applied for, all government licenses, registrations, findings of suitability,
permits and approvals necessary to conduct their respective activities in the
various jurisdictions that we operate. However, there can be no assurance those
licenses, registrations, findings of suitability, permits or approvals will
be
renewed in the future, or that new forms of approval necessary to operate in
emerging or existing markets will be granted.
Furthermore,
some jurisdictions require gaming manufacturers to obtain government approval
before engaging in some transactions, such as business combinations,
reorganizations, borrowings, stock offerings and repurchases. Obtaining licenses
and approvals can be time consuming and costly. We cannot assure you that we
will be able to obtain or maintain all necessary registrations, licenses,
permits, approvals or findings of suitability or that the approval process
will
not result in delays or changes to our business plans.
Our
intellectual property protections may be insufficient to properly safeguard
our
technology.
The
gaming industry is constantly employing new technologies in both new and
existing markets. We rely on a combination of patent and other technical
security measures to protect our products, and we intend to file patents for
protection of such technologies. Our success may depend in part on our ability
to obtain trademark protection for the names or symbols under which we market
our products and to obtain copyright protection and patent protection of our
proprietary software and other game innovations. We also rely on trade secrets
and proprietary know-how. We enter into confidentiality agreements with our
employees regarding our trade secrets and proprietary information. We cannot
assure you that we will be able to build and maintain goodwill in our trademarks
or obtain trademark or patent protection, that any trademark, copyright or
issued patent will provide competitive advantages for us or that our
intellectual properties will not be successfully challenged or circumvented
by
competitors. Furthermore, despite various confidentiality agreements and other
trade secret protections, our trade secrets and proprietary know-how could
become known to, or independently developed by, competitors.
Notwithstanding
these safeguards, our competitors may still be able to obtain our technology
or
to imitate our products. Furthermore, others may independently develop products
similar or superior to ours.
Expenses
incurred with respect to monitoring, protecting and defending our intellectual
property rights could adversely affect our business.
Competitors
and other third parties may infringe on our intellectual property rights, or
may
allege that we have infringed on their intellectual property rights. Monitoring
infringement and/or misappropriation of intellectual property can be difficult
and expensive, and we may not be able to detect any infringement or
misappropriation of our proprietary rights. We may also incur significant
litigation expenses protecting our intellectual property or defending our use
of
intellectual property, reducing our ability to fund product initiatives. These
expenses could have an adverse effect on our future cash flow and results of
operations. Litigation can also divert management focus from running the
day−to−day operations of the business. There can be no assurances that certain
of our products, including those with currently pending patent applications,
will not be determined to have infringed upon an existing third party
patent.
The
intellectual property rights of others may prevent us from developing new
products or entering new markets.
The
gaming industry is characterized by the rapid development of new technologies,
which requires us to continuously introduce new products using these
technologies and innovations, as well as to expand into new markets that may
be
created. Therefore, our success depends in part on our ability to continually
adapt our products and systems to incorporate new technologies and to expand
into new markets that may be created by new technologies. However, to the extent
technologies are protected by the intellectual property rights of others,
including our competitors, we may be prevented from introducing products based
on these technologies or expanding into new markets created by these
technologies. If our products use processes or other subject matter that is
claimed under existing patents, or if other companies obtain patents claiming
subject matter that we use, those companies may bring infringement actions
against us. We might then be forced to discontinue the affected products or
be
required to obtain licenses from the company holding the patent, if it is
willing to give us a license, to develop, manufacture or market our products.
We
also might then be limited in our ability to market new products. We might
also
be found liable for treble damage claims relating to past use of the patented
subject matter if the infringement is found to be willful.
If
the
intellectual property rights of others prevent us from taking advantage of
innovative technologies, our financial condition, operating results or prospects
may be harmed.
The
discontinuation or limitation of any existing licenses from third parties could
adversely affect our business.
Some
of
our most popular games and gaming machine features, including certain branded
games and ticket-in, ticket-out cashless gaming functionality, are based on
trademarks and other intellectual properties licensed from third parties. Our
future success may depend upon our ability to obtain, retain and/or expand
licenses for additional popular intellectual properties in a competitive market.
In the event that we cannot renew and/or expand this or other existing licenses,
we may be required to discontinue the games using the licensed technology or
bearing the licensed marks, or limit our use of such items.
Our
gaming technology, particularly our wide area progressive networks and centrally
determined systems, may experience losses
due to technical difficulties or fraudulent activities.
Our
success depends on our ability to avoid, detect, replicate and correct software
and hardware errors and fraudulent manipulation of our gaming machines and
associated software. To the extent any of our gaming machines or software
experience errors or fraudulent manipulation, our customers may replace our
products and services with those of our competitors. In addition, the occurrence
of errors in, or fraudulent manipulation of, our gaming machines or software
may
give rise to claims for lost revenues and related litigation by our customers
and may subject us to investigation or other action by gaming regulatory
authorities, including suspension or revocation of our gaming licenses or
disciplinary action. Additionally, in the event of such issues with our gaming
machines or software, substantial engineering and marketing resources may be
diverted from other areas to rectify the problem.
Our
business is subject to other economic, market, and regulatory risks:
We
face
risks associated with doing business in international markets related to
political and economic instability and related foreign currency fluctuations.
Unstable governments and changes in current legislation may affect the gaming
market with respect to gaming regulation, taxation, and the legality of gaming
in some markets, as we experienced with the Russian market in fiscal 2006.
Customer
financing is becoming an increasing prevalent component of the sales process
and
therefore increases business risk of non-payment, especially in emerging
markets. In some instances, our gaming machines are installed in casinos on
a
trial basis, and only after a successful trial period are the machines purchased
by the customers. These customer financing arrangements delay our receipt of
cash and can negatively impact our ability to enforce our rights upon default
if
the customer is from a foreign country.
Our
competitors have begun to provide free game theme conversions to customers
in
connection with product sales. While we intend to continue to charge our
customers for game theme conversions including CPU-NXT upgrade kits, we cannot
be sure that competitive pressure will not cause us to increase the number
of
free game theme conversions we offer to our customers, which would decrease
the
revenue we expect to receive for game theme conversions.
RISKS
RELATED TO OUR CRM AND TELECOM VAS PRODUCTS AND SERVICES
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. 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. Furthermore, 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 operations 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.
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.
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.
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
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 US. 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 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 cannot 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 futures
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:
|
·
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Shutting
down servers or blocking websites
|
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·
|
Requiring
a restructure of ownership or
operations
|
|
·
|
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 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
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
gaming, telecom and VAS businesses are 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. 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.
Furthermore, concerns about our stock option granting practices and recording
of
such grants, have led to the withdrawal of the previously issued audit reports
for December 31, 2005 and 2004 by our previous independent auditors, Clancy
and
Co., P.L.L.C. These actions have required us to re-evaluate our disclosure
controls and procedures and conclude that they are ineffective. We have sought
to improve our existing disclosure controls and procedures and to that end,
have
substantially increased our accounting and administrative resources. 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.
If
the audit reports for the fiscal years ended December 31, 2005 and 2004 are
not
reinstated by our previous auditors, or re-issued by our new auditors, in a
timely manner, our common stock may be delisted.
In
March
2007, our prior independent registered accountants, Clancy and Co., PL.L.C.,
withdrew its audit reports for the fiscal years ended December 31, 2005 and
2004. As a result, our Annual Report on Form 10-KSB for the fiscal year ended
December 31, 2005, is deficient for lack of audited reports, and on March 30,
2007, we received a notice of delisting and deficiency from The NASDAQ Stock
Market addressing notifying us of such deficiency. If we are unable to provide
restated financial statements for the relevant periods that are satisfactory
to
enable Clancy to reinstate its audit reports, or we are unable to have the
financial statements for the relevant periods re-audited by our new auditors,
Kabani & Company, Inc., to be included in our Annual Reports for the fiscal
year ended December 31, 2006 and 2005, within the time frame required by NASDAQ,
our common stock could be delisted.
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. In 2007, we began to redeem up to $363,638 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.
We
may have to pay liquidated damages and our debenture may be declared in default
if we are unable to re-instate use of the prospectus contained in our
Registration Statement on Form S-1
On
March
27, 2007, we suspended use of the prospectus contained in our Registration
Statement on Form S-1 (File No. 333-134127) that was declared effective on
December 8, 2006, due to the lack of fiscal year end 2005 and 2004 audited
financial statements. As a result 3,152,228 shares of common stock registered
there under, are not freely tradable upon resale. Under the terms of our
registration rights agreement with the holders of the debentures, we are subject
to paying liquidated damages equal to 2% of the debenture amount on a monthly
basis, up to a maximum of 20% per holder, in the event we suspend use of the
prospectus for longer than 15 consecutive calendar days or more than an
aggregate of 30 calendar days during any 12-month period. Moreover, at the
election of the debenture holder, our debenture could be declared in default,
resulting in acceleration of the amounts due, if such suspension continues
more
than 20 consecutive trading days or 60 non-consecutive trading days during
any
12-month period. We cannot assure you that none of the debenture holders will
declare our debentures in default and demand acceleration of the debenture.
We
may not have cash on hand, or have the ability to access cash to pay the
debenture in full if such a demand is made. If the debenture holders refuse
to
negotiate with us, our failure to pay upon, demand could result in the debenture
holders bringing claims against us for payment, which may include severe penalty
payments.
If they
are successful in such claims, we may suffer significant losses, which may
severely curtail our ability to continue business operations.
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:
|
·
|
Variations
in our quarterly operating results
|
|
·
|
Announcements
that our revenue or income are below analysts'
expectations
|
|
·
|
General
economic slowdowns
|
|
·
|
Changes
in market valuations of similar
companies
|
|
·
|
Sales
of large blocks of our common stock
|
|
·
|
Announcements
by us or our competitors of significant contracts, acquisitions,
strategic
partnerships, joint ventures or capital
commitments
|
|
·
|
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, 2006, we had 11,538,664 shares of common stock outstanding, 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 March 27, 2007,
we
suspended the use of the prospectus contained in our Registration Statement
on
Form S-1 that was declared effective with respect to 3,152,228 shares of our
common stock was suspended. These shares are no longer freely tradable without
restriction or further registration, unless such sales can be made pursuant
to
an available exemption under the Securities Act. 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, 2006, we had stock options outstanding to purchase an aggregate
of
370,500
shares of common stock, those options are exercisable. We also have warrants
outstanding to purchase 1,007,138 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.
NONE
ITEM
2. PROPERTIES
A
description of our property is as follows:
CHINA
-
We maintain our corporate headquarters at 23/F, Building A, TimeCourt, No.6
Shuguang Xili, Chaoyang District, Beijing, China. Postal Code: 100028; and
our
Shenzhen Accounting center located at Room 4203, Jinzhonghuan Business Building,
Futian District, Shenzhen, China; Postal Code: 518040. Both
properties were purchased in 2006.
HONG
KONG
- We maintain our Hong Kong office and development center at Room 2702, Richmond
Commercial Building, 107-111 Argyle Street, Mongkok, Kowloon, HK.
Locations
|
Area
(Square Feet)
|
PacificNet
Beijing Office: 23/F, Building A, TimeCourt, No.6 Shuguang Xili,
Chaoyang
District, Beijing, China, Postal Code:
100028 Tel:86-010-59225000
|
11,324
|
PacificNet
Shenzhen Office: Room 4203, Jinzhonghuan Business Building, Futian
District, Shenzhen, China
Postal
Code: 518040
|
4,950
|
Room
2702, Richmond Commercial Building, 107 -111 Argyle Street, Mong
Kok,
Kowloon, Hong Kong
|
637
|
655
N. Central Ave., 17th Floor, Glendale, CA 91203, USA; and 416 Production
Street North, Aberdeen, SD 57401, USA
|
200
|
We
believe that our offices are adequate for our current operations.
ITEM
3. LEGAL PROCEEDINGS
1.
Legal Proceeding and Judgment Against Guangzhou Yueshen Taiyang Network Science
and Technology Limited, Ms. Li Yan Kuan, and Mr.Wu Yi
Wen
On August
12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
Science and Technology Limited, Ms. Li Yan Kuan, (PRC ID:
440112195706120967, Residential Address: Room G6-305, West Garden,
FuLiHuanShi, HuanShi West Road, LiWan District, Guangzhou, Guangdong,
China) and Mr.Wu Yi Wen, (PRC ID: 440106196412220919, Residential
Address: Room 906, Number 15, SiHeng Road Number 2, TianHe YuanChun, Guangzhou,
Guangdong, China) for failure to pay amounts owed under a promissory note.
On May 15, 2005, we loaned RMB2,000,000 ("Debt Sum") to Yueshen to cover
operating costs, evidenced by a promissory note due on November 15, 2005.
Ms. Kuan and Mr. Wen guaranteed repayment of the note by Yueshen. The Debt
Sum together with the agreed interest rate calculated at 6% per annum was
due on
November 15, 2005.
On
March
28, 2007, the High Court of HKSAR had adjudged that the three defendants
should
pay us the Debt Sum together with interest sum at the rate of 6% per annum
from May 15, 2005 to March 28, 2007, and additional interest charged
at the rate of 5% per annum for the Debt Sum and accrued interest within
90 days
overdue and thereafter at the judgment rate until payment and fixed costs
of
HK$3,405.
2.
Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
(JCHKL), a subsidiary of Johnson Controls Inc. (NYSE:JCI)
(www.jci.com )
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
Court of the Hong Kong Special Administrative
Region seeking HK$4,800,000 as payment for services rendered to
replace 3 sets of trane water-cooled chillers, together with energy saving
performance (the "Chiller System"), at the Fortress Tower in Hong
Kong.
In
connection with the claim, PacificNet Power reviewed a letter
from its client, China Weal Property Management Ltd., dated January
22, 2007 stating that the construction work by JCHKL had not been completed
as
of the date of the letter, and that certain violations itemized in a
letter issued by the Hong Kong Environment Protection Department (EPD)
(Noise Abatement Notice No. N806030) addressed to JCHKL with respect to acoustic
problems with JCHKL’s equipment had not been abated. Further, JCHKL was to
pay penalties between HK$100,000 and HK$200,000 assessed by the
JCHKL for failing to fix the noise problem on the roof of Fortress
Tower.
The
board
of directors of PacificNet Power Limited has reviewed the case
with its client, China Weal Property Management Ltd., and our
Hong Kong legal counsel and it is our belief that the project
work undertaken JCHKL is defective in numerous aspects, as evidenced by the
letter from government letter issued by EPD. As a result, we believe the
construction work was not been completed by JCHKL, and therefore,
JCHKL is not entitled to payment for its services.
On
February 7, 2007, we instructed our Hong Kong legal counsel to issue a
Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
construction work has not complied with the applicable rules and regulations
of
various government authorities in Hong Kong; (ii) the Chiller System provided
by
JCHKL was defective and merchantable unfit and JCHKL has failed
and/or refused to rectify such defective works; and (iii) JCHKL shall return
the work deposit in the amount of HK$1,500,000 to PacificNet Power
Limited and shall compensate and keep PacificNet Power Limited indemnified
against all the loss and damages suffered as a result of any claims from the
China Weal Property Management Ltd, the employer and the potential tenants
of
Fortress Tower.
The
case
is under review by Hong Kong High Court and we have not received any judgment
from the High Court of the Hong Kong Special Administrative Region as of date
of
this report. We are currently proceeding with discovery and counter-claims,
and
we intend to vigorously defend ourselves against the allegations. We are unable
to predict the outcome of these actions, or a reasonable estimate of the range
of possible loss, if any.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The
Company held its annual meeting on December 15, 2006 at the Company's executive
offices located at 23rd Floor, Building A, TimeCourt, No.6 Shuguang Xili,
Chaoyang District, and Beijing, 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
|
3.
|
To
approve the amendments to the Company’s 2005 Stock Option
Plan
|
4.
|
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
(7,009,454 votes or 60.05% voted for), 2. Victor Tong (7,007,814
votes or
60.04% voted for), 3. ShaoJian (Sean) Wang (6,986,279 votes or 59.86%
voted for), 4. Tao Jin (7,007,328 votes or 60.04% voted for), 5.
Peter
Wang (7,006,689 votes or 60.03% voted for), 6. Michael Chun Ha (7,007,178
votes or 60.03% voted for), 7. Jeremy Goodwin (7,007,332 votes or
60.04%
voted for)
|
2.
|
Ratification
and approval of the appointment of Clancy and Co., P.L.L.C. as the
Company's independent auditors: 6,982,952 shares of the Company's
common
stock, constituting a 59.83% majority of the shares of common stock
present in person or by proxy entitled to vote at the meeting voted
in favor of this proposal while 59, 635 voted against and 95, 491
votes
abstain
|
3.
|
Approval
of the amendments to the Company’s 2005 Stock Option Plan: 1,738,412
shares of the Company's common stock, constituting a 14.89% majority
of
the shares of common stock present in person or by proxy entitled
to vote
at the meeting voted in favor of this proposal while 320, 368 voted
against, 108,980 abstained and there were 4,970, 319 broker
non-votes.
|
PART
II
ITEM
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
PURCHASES OF EQUITY SECURITIES
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, 2005 to December 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
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
|
|
|
Quarter
Ended March 31, 2006
|
$8.88
|
$6.57
|
Quarter
Ended June 30, 2006
|
$9.08
|
$7.01
|
Quarter
Ended September 30, 2006
|
$7.65
|
$4.50
|
Quarter
Ended December 31, 2006
|
$6.98
|
$4.20
|
FISCAL
2007
|
|
|
Quarter
Ended March 31, 2007
|
$7.6
|
$4.8
|
HOLDERS
OF RECORD
As
of
March 31, 2007, there were 172 record holders of our common stock. However,
the
total number of beneficial holders is unknown as they hold our common stock
in
street name.
DIVIDENDS
We
have
not paid any cash dividends on our common stock, and we currently intend to
retain any future earnings to fund the development and growth of our
business.
EQUITY
COMPENSATION PLAN INFORMATION
The
following table sets forth aggregate information regarding the Company's equity
compensation plans in effect as of December 31, 2006:
|
Number
of securities to be issued upon
exercise of outstanding options,
warrants and rights
|
Weighted-average
exercise price
of outstanding options,
warrants and rights ($)
|
Remaining
available for
further issuance under
equity compensation
plans
|
Equity
compensation plans approved by security
holders
(under 1998 Stock Option Plan) (1)
|
370,500
|
$2.00
|
0
|
Equity
compensation plans approved by security
holders
(under 2005 Stock Option Plan) (2)
|
-
|
-
|
2,000,000
|
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.
STOCK
PRICE PERFORMANCE PRESENTATION
The
following chart compares the cumulative total stockholder return on the
Company’s shares of Common Stock with the cumulative total stockholder return of
(i) the NASDAQ Stock Market Index and (ii) a peer group index consisting of
companies reporting under the Standard Industrial Classification Code 3669
(Communications Equipment):
The
material in this chart is not soliciting material, is not deemed filed with
the
SEC and is not incorporated by reference in any filing of the Company under
the
Securities Act of 1933, as amended or the Exchange Act, whether made before
or
after the date of this Form 10-K and irrespective of any general incorporation
language in such filing.
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-Q.
REPURCHASES
OF COMPANY COMMON STOCK
Period
|
(a)
Total Number of
Shares
(or Units)
Purchased
|
(b)
Average Price
Paid
per Share
(or Unit)
|
(c)
Total Number of
Shares
(or Units)
Purchased
as Part of
Publicly
Announced
Plans
or Programs
|
(d)
Maximum Number
(or
Approximate Dollar Value)
of
Shares (or Units) that May Yet Be
Purchased Under the Plans or
Programs
|
March
13, 2006
|
24,200
|
$5.13
|
NONE
|
$562,385
|
(1)
On
March 13, 2006, we repurchased 24,200 restricted shares of our common stock
from
Yueshen, a subsidiary of Shanghai Classic for a repurchase price of RMB
1,000,000 (approximately USD$124,223 using exchange rate of 1USD= 805 RMB).
The
shares repurchased were proposed by Yueshen and has been unanimously agreed
by
both parties.
The
following selected financial data should be read in conjunction with our
consolidated financial statements and related notes and the following subsection
- Results of Operations as set out in this Annual Report on Form
10-K.
The
table
below sets forth a summary of our selected financial data for each of the years
ended December 31, (amounts in thousands except per share amounts):
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
|
|
(restated)
|
|
|
(restated)
|
|
|
(restated)
|
|
|
|
Statement
of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
$
|
42,738
|
|
$
|
17,186
|
|
$
|
11,071
|
|
$
|
1,178
|
|
$
|
2,319
|
Cost
of revenues
|
|
(36,217)
|
|
|
(12,950)
|
|
|
(7,406)
|
|
|
(672)
|
|
|
(1,787)
|
Operating
expenses
|
|
(20,509)
|
|
|
(3,947)
|
|
|
(4,569)
|
|
|
(1,986)
|
|
|
(3,176)
|
Earning/(loss)
from operations
|
|
(13,988)
|
|
|
289
|
|
|
(904)
|
|
|
(1,475)
|
|
|
(2,644)
|
Earnings/(loss)
available to common stockholders
|
|
(20,093)
|
|
|
2,207
|
|
|
(472)
|
|
|
(1,409)
|
|
|
(2,921)
|
Basic
earnings/(loss) per share
|
|
(1.78)
|
|
|
0.22
|
|
|
(0.06)
|
|
|
(0.27)
|
|
|
(0.70)
|
Diluted
earnings/(loss) per share
|
|
(1.78)
|
|
|
0.21
|
|
|
(0.06)
|
|
|
(0.27)
|
|
|
(0.70)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing earnings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
weighted average shares
|
|
11,258,547
|
|
|
10,154,271
|
|
|
7,268,374
|
|
|
5,234,744
|
|
|
4,191,816
|
Diluted
weighted average shares
|
|
11,258,547
|
|
|
10,701,211
|
|
|
8,241,996
|
|
|
5,234,744
|
|
|
4,191,816
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
$
|
1,900
|
|
$
|
3,487
|
|
$
|
6,353
|
|
$
|
3,781
|
|
$
|
3,694
|
(excludes
restricted cash)
|
Working
capital
|
|
(335
|
) |
|
10,638
|
|
|
12,617
|
|
|
1,187
|
|
|
3,081
|
Total
assets
|
|
41,882
|
|
|
44,598
|
|
|
32,660
|
|
|
7,740
|
|
|
4,314
|
Total
stockholders’ equity
|
|
14,928
|
|
|
31,785
|
|
|
25,310
|
|
|
2,509
|
|
|
3,253
|
FORWARD-LOOKING
STATEMENTS This annual report on Form 10-K, as amended, contains
forward-looking statements within the meaning of the federal securities laws.
These include statements about our expectations, beliefs, intentions or
strategies for the future, which we indicate by words or phrases such as
"anticipate," "expect," "intend," "plan," "will," "we believe," "management
believes" and similar language. The forward-looking statements are based on
our
current expectations and are subject to certain risks, uncertainties and
assumptions, including those set forth in the discussion under "Description
of
Business," including the "Risk Factors" described in that section, and
"Management's Discussion and Analysis or Plan of Operation." Our actual results
may differ materially from results anticipated in these forward-looking
statements.
FACTORS
THAT COULD AFFECT FUTURE RESULTS
Factors
that might cause actual results, performance or achievements to differ
materially from those projected or implied in such forward-looking statements
include, among other things:
|
·
|
The
impact of competitive products
|
|
·
|
Changes
in laws and regulations
|
|
·
|
Adequacy
and availability of insurance coverage
|
|
·
|
Limitations
on future financing
|
|
·
|
Increases
in the cost of borrowings and unavailability of debt or equity capital
|
|
·
|
The
inability of the Company to gain and/or hold market
share
|
|
·
|
Exposure
to and expense of resolving and defending liability claims and other
litigation
|
|
·
|
Consumer
acceptance of the Company's
products
|
|
·
|
Managing
and maintaining growth
|
|
·
|
Market
and industry conditions
|
|
·
|
The
success of product development and new product introductions into
the
marketplace
|
|
·
|
The
departure of key members of
management
|
|
·
|
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 15 years of field experience
in China. The factors that could affect current and future results are as
follows:
|
·
|
Insufficient
sales forces for business development & account
servicing
|
|
·
|
Lack
of PRC management team in operation
|
|
·
|
Less
familiarity on partners' product
knowledge
|
|
·
|
Deployment
costs of a new HR application and the costs to upgrade the call center
computer system
|
|
·
|
Increasing
operations costs (cost of salaries, rent, interest rates & inflation)
under rising economy in Hong Kong
|
|
·
|
Insufficient
brand awareness initiatives in the
market
|
|
·
|
salary
increases due to an active labor market in Hong Kong and
GuangZhou
|
|
·
|
Increasing
competition of call center solutions in the Hong Kong and PRC
markets
|
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 collected
ability of our trade receivables based on a combination of factors. We regularly
analyze our significant customer accounts, and, when we become aware of a
specific customer's inability to meet its financial obligations to us, such
as
in the case of bankruptcy filings or deterioration in the customer's operating
results or financial position, we record a specific reserve for doubtful
accounts to reduce the related receivable to the amount we reasonably believe
is
collectible. We also record reserves for doubtful accounts for all other
customers based on a variety of factors including the length of time the
receivables are past due, the financial health of the customer, macroeconomic
considerations and historical experience. If circumstances related to specific
customers change, our estimates of the recoverability of receivables could
be
further adjusted. In the event that our trade receivables become uncollectible,
we would be forced to record additional adjustments to receivables to reflect
the amounts at net realizable value. The accounting effect of this entry would
be a charge to income, thereby reducing our net profit. Although we consider
the
likelihood of this occurrence to be remote based on past history and the current
status of our accounts, there is a possibility of this occurrence.
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
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) 123-R, Share-Based Payment
(“SFAS 123(R)”). SFAS 123(R) replaces SFAS 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion 25, Accounting for Stock Issued to
Employees. SFAS 123(R) requires, among other things, that all share-based
payments to employees, including grants of stock options, be measured based
on
their grant-date fair value and recognized as expense. Effective January 1,
2006, PacificNet adopted the fair value recognition provisions of SFAS 123(R)
using the modified prospective application method. Under this transition method,
compensation expense recognized for year 2006, includes the applicable amounts
of: (a) compensation expense of all stock-based payments granted prior to,
but
not yet vested as of January 1, 2006 (based on the grant-date fair value
estimated in accordance with the original provisions of SFAS 123 and previously
presented in pro forma footnote disclosures), and (b) compensation expense
for
all stock-based payments granted subsequent to January 1, 2006 (based on the
grant-date fair value estimated in accordance with the new provisions of SFAS
123(R)). Results for periods prior to January 1, 2006, have not been restated.
See Note 1 for further details.
In
February 2006, the FASB issued SFAS No. 155, Accounting
for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133
and 140 (“SFAS
155”). This statement amends SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities
(“SFAS
133”), and SFAS No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities and
resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application
of Statement 133 to Beneficial Interest in Securitized Financial Assets.” This
Statement: (a) permits fair value re-measurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation; (b) clarifies which interest-only strips and principal-only strips
are not subject to the requirements of SFAS 133; (c) establishes a requirement
to evaluate beneficial interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation; (d)
clarifies that concentrations of credit risk in the form of subordination are
not embedded derivatives; and, (e) eliminates restrictions on a qualifying
special-purpose entity’s ability to hold passive derivative financial
instruments that pertain to beneficial interests that are or contain a
derivative financial instrument. The standard also requires presentation within
the financial statements that identifies those hybrid financial instruments
for
which the fair value election has been applied and information on the income
statement impact of the changes in fair value of those instruments. The Company
is required to apply SFAS 155 to all financial instruments acquired, issued
or
subject to a re-measurement event beginning January 1, 2007, although early
adoption is permitted as of the beginning of an entity’s fiscal year.
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an
Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the
accounting for uncertainty in tax positions. This Interpretation requires that
the Company recognize in its financial statements the impact of a tax position
if that position is more likely than not of being sustained on audit, based
on
the technical merits of the position. The provisions of FIN 48 are effective
for
the Company on January 1, 2007, with the cumulative effect of the change in
accounting principle, if any, recorded as an adjustment to opening retained
earnings. The Company is currently evaluating the impact of adopting FIN 48
on
its consolidated financial position, cash flows and results of operations.
Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force (“EITF”), the American Institute of Certified Public
Accountants (“AICPA”), and the SEC did not or are not believed by management to
have a material impact on the Company's present or future financial
statements.
ITEM
7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
RESULTS
OF OPERATIONS
REVENUES
Revenues
for the year ended December 31, 2006 were $42,738,000, which represents a
year-over-year increase of 148.7%. Revenues of $17,186,000 for the year ended
December 31, 2005 have been reclassified from $44,341,000 as reported in
previous year for comparative purposes, as a result of certain discontinued
operations and assets held for disposition identified in Note 16 to consolidated
financial statements under Item 15 below.
The
increase in revenues was mainly due to the growth in Products (Telecom &
Gaming) and Other Business Groups, which posted a year-over-year increase of
712% and 356% respectively. In aggregate, the newly acquired subsidiaries during
2006 contributed to 10% of the total revenues.
Revenues
for the fourth quarter of the year were $9,573,000, an increase of 989% as
compared to $4,812,000 for the fourth quarter of 2005; or a decrease of 11.2%
as
compared to $10,785,000 for the third quarter of the year. Segmented
financial information of the four business operating groups is set out below
followed by a brief discussion of each business group.
For
the year ended December
31, 2006
(in
thousands, except percentages)
|
|
Group
1.
Outsourcing
Services
($)
|
|
Group
2.
Telecom
Value-Added Services
($)
|
|
Group
3.
Products
(Telecom & Gaming)
($)
|
|
Group
4.
Other
Business
($)
|
|
Total
($)
|
|
Revenues
|
|
|
14,146
|
|
|
1,555
|
|
|
23,385
|
|
|
3,652
|
|
|
42,738
|
|
(%
of Total Rev)
|
|
|
(33.1%)
|
|
|
(3.6%)
|
|
|
(54.7%)
|
|
|
(8.5%)
|
|
|
(100%)
|
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
676
|
|
|
(44)
|
|
|
(1,053)
|
|
|
(13,567)
|
|
|
(13,998)
|
|
For
the year ended December
31, 2005
(in
thousands, except percentages)
|
|
Group
1.
Outsourcing
Services
($)
|
|
Group
2.
Telecom
Value-Added Services
($)
|
|
Group
3.
Products
(Telecom & Gaming)
($)
|
|
Group
4.
Other
Business
($)
|
|
Total
($)
|
|
Revenues
|
|
|
13,505
|
|
|
0
|
|
|
2,880
|
|
|
801
|
|
|
17,186
|
|
(%
of Total Rev)
|
|
|
(78.6%)
|
|
|
(0.0%)
|
|
|
(16.8%)
|
|
|
(4.7%)
|
|
|
(100%)
|
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
1,515
|
|
|
0
|
|
|
271
|
|
|
(1,497)
|
|
|
289
|
|
(1)
OUTSOURCING SERVICES
Revenues
for the year ended December 31, 2006 were $14,146,000, a year-over-year increase
of 5% from $13,505,000 for the year ended December 31, 2005. Outsourcing
services revenues made up 36.8% of the Company's total revenues for the fourth
quarter of the year primarily due to
13%
growth in the call center related revenues as compared to the same period in
2005. Revenues from outsourcing services for the fourth quarter of the year
were
$3,833,000, an increase of 5% as compared to $3,645,000 for the fourth quarter
of 2005; or an increase of 3% as compared to $3,733,000 for the third quarter
of
2006.
During
2006, the outsourcing contract center in Hong Kong was close to full
utilization. Pricing was highly competitive but demand for outbound calling
lists, in-sourcing operators and sub-contract call center facilities management,
for American Express and MetLife, remained strong. New contracts won during
the
year included customer service operation management training for NanJing
Airlines, web-based quality management services and supplier quality management
services for McDonalds Corporation, and CRM consulting and call center training
services for China Telecom's Xinjiang Branch and China Unicom's Shanghai Branch.
Under the project service agreement, the Company will enhance the CRM service
level and telemarketing management capability of China Unicom's customer service
center called the "10010 Information Hotline."
(2)
TELECOM VALUE-ADDED SERVICES (VAS)
Revenues
for the year ended December 31, 2006 were $1,555,000 as compared to $0 for
the
year ended December 31, 2005 as a result of reclassifications induced by Note
16. Our acquisitions in 2006 contributed to the increase in revenues and made
the company a major mobile internet contents provider in China. Revenues
from VAS for the fourth quarter of the year were $1,448,000, a sequential
increase of 4,520% from $40,000 for the third quarter of 2006. VAS
revenues made up 13.9% of the Company's total revenues for the fourth quarter
of
the year.
(3)
PRODUCTS (TELECOM & GAMING)
Revenues
for the year ended December 31, 2006 were $25,948,000, a year-over-year increase
of 707% from $3,216,000 for the year ended December 31, 2005.
Revenues
from the products group for the fourth quarter of the year were $5,124,000,
an
increase of 735.9% as compared to $613,000 for the fourth quarter of 2005;
or a
decrease of 20% as compared to $6,411,000 for the third quarter of 2006.
The
revenues made up 49.2% of the Company's total revenues for the fourth quarter
of
2006.
During
the year, substantially all of the products group revenue derived from the
Company’s
mobile
phone distribution business in Greater China. The Company owned one of the
largest on-line mobile phone distribution portal in China and was one of the
top
five largest mobile phone wholesalers in Hong Kong. New agreements had been
entered into with Motorola to become its designated channel partner and
after-sale service provider for Motorola mobile products and accessories in
China. Economies of scale continued to drive year-over-year revenue increase
of
the products group.
Also
included in the products group was the Company’s high potential gaming
technology business. In spite of rather insignificant revenue contribution
in
2006, the acquisition of Able Entertainment in Macau, along with its
exceptionally talented R&D team in Zhuhai, by PacificNet Games Limited
(PacGames) during the year had given the Company major first movers advantage
into the fast growing Asian gaming technology provider market. With PacGames’
world class multi-player electronic table game machines customized to the taste
of Asian gaming customers, the Company has managed to build up excellent
relationships with leading casino operators in Macau and the rest of Asia in
no
time.
(4)
OTHER BUSINESS
Revenues
for other business for the year ended December 31, 2006 was $3,652,000, an
increase of 356% as compared to $801,000 for the year ended December 31, 2005.
Incremental revenues were largely derived from new air conditioning installation
contracts won by the Company’s subcontracting business in Hong Kong.
COST
OF REVENUES AND GROSS MARGIN
Cost
of
revenues for the year ended December 31, 2006
was
$36,217,000, which represents a year-over-year increase of 180%. Cost of
revenues of $12,950,000 for the year ended December 31, 2005 have been
reclassified from $33,440,000 as reported in previous year for comparative
purposes, as a result of certain discontinued operations and assets held for
disposition identified in Note 16 to consolidated financial statements under
Item 15 below.
The
increase in the cost of revenues was directly associated with the corresponding
increase in revenues. Cost of revenues, as a percentage of revenues, was 85%
for
the year ended December 31, 2006 as compared with 75% for the year ended
December 31, 2005. The improvement in cost of revenues was attributable to
the
Company’s constant pursuit of higher margin businesses. The
cost
of revenues in services and product sales for the year ended December 31, 2006
increased year-over-year by 34% and 66% respectively.
Gross
profit for the year ended December 31, 2006 was $6,521,000, which represents
a
year-over-year increase of 54% resulting from our newly acquired subsidiaries
in
2006 and call centre business. Gross profit of $4,236,000 for the year ended
December 31, 2005 have been reclassified from $10,901,000 as reported in
previous year for comparative purposes, as a result of certain discontinued
operations and assets held for disposition identified in Note 16 to consolidated
financial statements under Item 15 below. Gross profit for the fourth quarter
of
the year was $1,899,000, a year-over-year increase of 10% from $1,724,000 for
the same period in 2005; or a sequential increase of 72% for the third quarter
of 2006.
Gross
margin was 15% for the year ended December 31, 2006, compared to 25% for the
year ended December 31, 2005.
Going
forward, improvement of gross margin is expected to continue as a result of
the
new strategic initiative of moving away from the highly competitive legacy
telecom business into the new niche gaming technology business. Assistance
will
be sought from financial advisors and bankers to help dispose of the legacy
businesses units, including but not limited to disposition, spin-offs, mergers
and sale back to founders.
(1)
OUTSOURCING SERVICES
In
2006,
year-over-year cost of revenues for outsourcing services increased by 8% to
$10,908,000 (2005: $10,095,000). Gross profit was 5% lower at $3,238,000 (2005:
$3,409,000). Gross
margin for outsourcing services was 25% for the year ended December 31, 2006,
as
compared to 29% for the year ended December 31, 2005. Gross
profit for outsourcing services accounted for 19% of the total gross profit
for
the year ended December 31, 2006, as compared to 31% for the same period in
2005. Gross profit of $950,000 for the fourth quarter represented a
year-over-year reduction of 11% to the same period in 2005; but a sequential
increase of 30% as compared to $732,000 for the third quarter of 2006
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. Year-over-year gross profit erosion was primarily due
to a
combination of aggressive pricing and higher cost of labor in the highly
competitive Hong Kong market. Extra call center space and depreciation of newly
acquired fixed assets for operations purposes also contributed to a higher
cost
of revenues. Gross
margin for this segment mainly depends on the facilities management services.
(2)
TELECOM VALUE-ADDED SERVICES (VAS)
Cost
of
revenues and gross profit for VAS were $1,138,000 and $416,000 for the year
ended December 31, 2006, respectively, as compared to $0 for the year ended
December 31, 2005 as a result of reclassifications induced by Note 16 Gross
profit for VAS accounted for 6% of the total gross profit for the year ended
December 31, 2006, as compared to 0% for the same period in 2005. For the fourth
quarter of 2006, VAS gross profit was $118,000 as compared to $0 for the same
period in 2005; or a sequential increase of 372% as compared to $87,000 for
the
third quarter of 2006. The inncrease in year-over-year gross profit is due
to a
major VAS acquisition in 2006.
(3)
PRODUCTS (TELECOM & GAMING)
Increase
of 755% in year-over-year cost of revenues for products (telecom & gaming)
to $22,002,000 (2005: $2,572,000) was commensurate with its 61% year-over-year
revenue growth. Gross profit was 349% higher at $1,384,000 (2005: $308,000)
in
absolute terms. Gross margin of mobile phone distribution business in China
and
Hong Kong largely remained steady on a year-over-year basis. Gross profit for
products (telecom & gaming) accounted 21% of the total gross profit both for
the year ended December 31, 2006 and 2005. Gross profit of $583,000 for the
fourth quarter represented a year-over-year increase of 122% as compared to
the
same period in 2005; or a sequential increase of 163% as compared to $222,000
for the third quarter of 2006
Slight
year-over-year gross margin improvement from 7% (2005) to 21% (2006) can be
attributed to the newly acquired gaming technology business. Gross margin
contribution of the gaming technology provider business was not apparent in
2006
due to its startup nature and had relative insignificant revenue throughout
the
year.
(4)
OTHER BUSINESS
Increase
of 666% in year-over-year cost of revenues to $2,169,000 (2005: $283,000) for
Other Business is largely driven by subcontracting revenue growth. 95% of cost
of revenues in 2006 was attributable to the new installation contracts won
by
the Company, gross margins of which remained almost steady at 24% from year
to
year.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
Selling,
General and Administrative expenses (“SG&A”) totaled $5,810,000 for the year
ended December 31, 2006, which represents a year-over-year increase of 70%.
SG&A was $3,411,000 for the year ended December 31, 2005 which have been
reclassified from $5,811,000 as reported in previous year for comparative
purposes, as a result of certain discontinued operations and assets held
for
disposition identified in Note 16 to consolidated financial statements under
Item 15 below. The increase in selling, general and administrative expenses
reflected the expansion of our operations of which expenses were incurred
by our
newly acquired subsidiaries and the expansion of the call centre business.
In
addition to making several key acquisitions in 2006, we laid the foundation
for
a strong future, by hiring additional personnel in key areas to support our
accounting and back-office functions, as well as implemented the systems
to
allow the Company to better measure the performance of each of its units.
SELLING,
GENERAL AND ADMINISTRATIVE
EXPENSES
(in
thousands, except percentages)
|
Total
for the
year
ended
Dec
31, 2006
($)
|
Total
for the
year
ended
Dec
31, 2005
($)
|
|
|
|
|
|
Office
|
1,002
|
904
|
|
Travel
|
|
202
|
|
Entertainment
|
|
78
|
|
Professional
(legal, audit and consultant)
|
587 |
|
|
Audit
|
313
|
110
|
185
|
Selling
|
243
|
88
|
|
Other
|
|
439
|
|
Total
|
|
|
|
(1)
OUTSOURCING SERVICES
Selling,
General and Administrative expenses for outsourcing services were $2,064,000
for
the year ended December 31, 2006, an increase of 22% from $1,694,000 for the
year ended December 31, 2005. Due to the increase in the demand for
telemarketing and call center services, the Company purchased a call center
facility in China, to support the rapidly growing business of the company.
However, in order to meet clients’ diversified needs, a wide array of supporting
services are provided, including professional inbound services, outbound
services, facilities management and insourcing services. The expansion of call
centre services also leaded to the increase number of headcounts.
(in
thousands, except percentages)
|
Group
1.
|
|
Outsourcing
Services
|
|
For
the year ended
December
31, 2006 ($)
|
For
the year ended
December
31, 2005 ($)
|
Percentage
Change
(%)
|
Remuneration
and related expenses
|
1,207
|
776
|
56
|
Office
|
535
|
625
|
-14
|
Travel
|
33
|
46
|
-29
|
Entertainment
|
39
|
38
|
4
|
Professional
(legal, audit and consultant)
|
83
|
63
|
32
|
Selling
|
33
|
4
|
773
|
Other
|
133
|
142
|
-6
|
Total
|
2,064
|
1,694
|
22
|
(2)
TELECOM VALUE-ADDED SERVICES (VAS)
Selling,
General and Administrative expenses for VAS were $324,000 for the year ended
December 31, 2006, an increase of 27% as compared to $256,000 in 2005 The
increase of SG&A expense resulted from acquisitions during the year.
(in
thousands, except percentages)
|
Group
2.
|
|
Telecom
Value-Added Services
|
|
For
the year ended
December
31, 2006 ($)
|
For
the year ended
December
31, 2005 ($)
|
Percentage
Change
(%)
|
Remuneration
and related expenses
|
189
|
76
|
148
|
Office
|
64
|
50
|
29
|
Travel
|
36
|
8
|
363%
|
Entertainment
|
20
|
8
|
162
|
Professional
(legal, audit and consultant)
|
0
|
1
|
-100
|
Selling
|
5
|
-
|
N/A
|
Other
|
10
|
113
|
-91
|
Total
|
324
|
256
|
27
|
(3)
PRODUCTS (TELECOM & GAMING)
Selling,
General and Administrative expenses for products (telecom & gaming) were
$789,000 for the year ended December 31, 2006, a significant increase of 1,783%
as compared to $42,000 for the year ended December 31, 2005. Increase is
primarily due to new acquisitions during the year.
(in
thousands, except percentages)
|
Group
3.
|
|
Products
(Telecom & Gaming)
|
|
For
the year ended
December
31, 2006 ($)
|
For
the year ended
December
31, 2005 ($)
|
Percentage
Change
(%)
|
Remuneration
and related expenses
|
315
|
-
|
N/A
|
Office
|
158
|
-
|
N/A
|
Travel
|
47
|
-
|
N/A
|
Entertainment
|
40
|
-
|
N/A
|
Professional
(legal, audit and consultant)
|
20
|
10
|
101
|
Selling
|
95
|
-
|
N/A
|
Other
|
114
|
32
|
256
|
Total
|
789
|
42
|
1,783
|
(4)
OTHER BUSINESS
Selling,
General and Administrative expenses were $2,634,000
for the year ended December 31, 2006, an increase of 85% as compared to
$1,420,000 in 2005. Year-over-year corporate level remuneration related expenses
increased from approximately $246,000 to $535,000 as a result of strengthening
of internal controls.
|
Group
4.
|
|
Other
Business
|
(in
thousands, except percentages)
|
For
the year ended
Dec
31, 2006 ($)
|
For
the year ended
Dec
31, 2005 ($)
|
Percentage
Change
(%)
|
Remuneration
and related
|
1,168
|
405
|
189
|
Office
|
245
|
229
|
7
|
Travel
|
175
|
148
|
18
|
Entertainment
|
51
|
33
|
56
|
Professional
(legal and consultant)
|
485
|
260
|
86
|
Audit
|
313
|
110
|
185
|
Selling
|
110
|
84
|
32
|
Other
|
86
|
151
|
-43
|
Total
|
2,634
|
1,420
|
85
|
DEPRECIATION
AND AMORTIZATION EXPENSES
Depreciation
and amortization expenses were $1,463,000 for the year ended December 31, 2006,
which represented 476% increase as compared to the year ended December 31,
2005
of which depreciation and amortization expenses was $254,000.
Depreciation
(in thousands, except percentages)
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Group
1. Outsourcing Services
|
67
|
16
|
319
|
Group
2. Telecom Value-Added Services
|
134
|
6
|
2113
|
Group
3. Products (Telecom & Gaming)
|
38
|
-
|
N/A
|
Group
4. Other Business
|
89
|
-
|
N/A
|
Total
|
328
|
22
|
1,391
|
Amortization
(in thousands, except percentages)
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Group
1. Outsourcing Services
|
-
|
210
|
-100
|
Group
2. Telecom Value-Added Services
|
-
|
22
|
-100
|
Group
3. Products (Telecom & Gaming)
|
29
|
-
|
N/A
|
Group
4. Other Business
|
1,106
|
-
|
N/A
|
Total
|
1,135
|
232
|
389
|
EARNINGS
FROM OPERATIONS
Due
to
substantial negative impact from regulatory changes on mobile value-added
service (''MVAS'') in the second half of 2006, the Company had recorded over
$4
million of investment impairment, a non-cash nonrecurring item, against the
Company's investment in various VAS subsidiaries in Q4 2006 alone.
Disposing
or spin-off of the legacy telecom and VAS business units has been an integral
part of the Company’s efforts to become a leading Asian gaming technology
provider. Management, thus, found making conservative provisions for certain
long outstanding receivables with those legacy business units was necessary
under the circumstances. As a result, an aggregate of $8 million of allowance
for doubtful debts was charged at the year end, in which approximately $6
million was related to long outstanding trade receivables, $1 million related
to
mostly long outstanding other receivables extended to set up domestic
enterprises in China, and the rest $1 million related to subsidiary loans for
business development purposes.
Excluding
all non-cash and nonrecurring items as set out below, non-GAAP net loss of
$1,619,000, as compared to net income of $2,489,000 of the same period last
year. Decrease is primarily due to adverse regulatory changes and highly
competitive market environments as previously discussed.
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
for the
year
ended
Dec
31, 2006 ($)
|
Total
for the
year
ended
Dec
31, 2005 ($)
|
(in
thousands)
|
Outsourcing
Services
|
Telecom
Value-
Added
Services
|
Products
(Telecom
&
Gaming)
|
Other
Business
and
Corporate
|
|
($)
|
($)
|
($)
|
($)
|
Operating
profits before non-cash accounting provisions
|
1,470
|
6,385
|
573
|
-9,180
|
-752
|
571
|
Allowance
for doubtful accounts (1)
|
-402
|
-0.2
|
-1,626
|
-4,145
|
-6,173
|
-
|
Goodwill
impairment (2)
|
-392
|
-6,429
|
|
|
-6,821
|
-
|
Restated
Stock-based compensation expenses
|
-
|
-
|
-
|
-
|
-
|
-282
|
Stock-based
compensation expenses (3)
|
-
|
-
|
-
|
-242
|
-242
|
-
|
Operating
profits
|
676
|
-44
|
-1,153
|
-13,567
|
-13,988
|
298
|
1.
|
The
Company’s policy is to provide 50% and 100% provisions for trade and other
receivables over 180 days and 360 days respectively under allowance
for
doubt accounts. As a result, over $1 million in provisions were made
for
the aging trade receivable in each of the Company’s legacy mobile phone
distribution business unit and subcontracting business unit in Hong
Kong,
and $0.5 million for the outstanding trade receivable of the Company’s
data center business unit. The Company also has a policy to review
all
other receivables on an individual basis in addition to the aforementioned
provision by aging policy. As a result, approximately $2.3 million
worth
of provisions were provided for potential loss of long outstanding
accounts arising either as a result of setting up domestic businesses
under private name for operations on behalf of the Company’s subsidiaries
in China or specific accounts that are in dispute. Such accounts
were
considered doubtful should the Company dispose of those legacy business
units in the near future as prescribed by its well-publicized business
transformation strategy.
|
2.
|
Goodwill
impairment is primarily due to impairment of $4,294,967 and $391,299
carried for the goodwill of Linkhead and Clickcom.
Due to poor market prospects, board meeting minutes of Linkhead indicates
that management is instructed to take actions to either liquidate
the
company or seek willing buyers for the company. Goodwill impairment
for
Clickcom, on the other hand, was made as the company was dormant
as of
December 31, 2006
|
3.
|
Stock-based
compensation expenses of $242,473 are due to adoption of SFAS123R
during
the year.
|
INTEREST
INCOME / (EXPENSES), NET
In
thousands, except percentages
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Interest
income
|
162
|
246
|
-34
|
Interest
expense
|
-1,354
|
-197
|
587
|
Interest
income/(expense), net
|
-1,192
|
49
|
-2,533
|
Interest
income was $162,000 for the year ended December 31, 2006, a decrease of 34%
as
compared to $246,000 for the year ended December 31, 2005. The increase is
due
to 86% ($137,000) of interest income generated from lending and fixed-rate
bank
deposits. Interest expenses were $1,354,000 for the year ended December 31,
2006, an increase of 587% as compared to $197,000 for the year ended December
31, 2005. Most of the interest expenses were attributed to bank loans and
bank
overdraft during the year.
Interest
Income (in thousands, except percentages)
|
For
the year ended
December
31, 2006 ($)
|
For
the year ended
December
31, 2005 ($)
|
Percentage
Change
(%)
|
Group
1. Outsourcing Services
|
-
|
5
|
N/A
|
Group
2. Telecom Value-Added Services
|
-
|
-
|
N/A
|
Group
3. Products (Telecom & Gaming)
|
140
|
152
|
-8
|
Group
4. Other Business
|
21
|
89
|
-76
|
Total
|
162
|
246
|
-34
|
Interest
Expense (in thousands, except percentages)
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Group
1. Outsourcing Services
|
309
|
156
|
98
|
Group
2. Telecom Value-Added Services
|
1
|
(0)
|
N/A
|
Group
3. Products (Telecom & Gaming)
|
56
|
6
|
841
|
Group
4. Other Business
|
988
|
35
|
2,723
|
Total
|
1,354
|
197
|
587
|
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, 2005, the non-operating income or sundry income was
$445,000 included in Statement of Operations was mainly derived from the
consulting services income of $62,000, software service income of $201,000,
investment income of $61,000, leasehold income of $40,000 and various others
totaling $81,000.
For
the
year ended December 31, 2006, the non-operating income or sundry income was
$105,000 mainly derived from leasehold income of $76,000 and various others
totaling $29,000.
Sundry
Income (Net) (in
thousands, except percentages)
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Group
1. Outsourcing Services
|
1
|
96
|
-99
|
Group
2. Telecom Value-Added Services
|
0
|
12
|
-100
|
Group
3. Products (Telecom & Gaming)
|
50
|
20
|
150
|
Group
4. Other Business
|
54
|
317
|
-83
|
Total
|
105
|
445
|
-76
|
SHARE
OF PROFIT OF ASSOCIATED COMPANIES
We
recorded the total gain of $17,000
for the year ended 2006 with respect to $(295,000) for 20% ownership interest
in
Take1 Technology (Cheer Era Limited), acquired in April 2004, $(19,000) for
MOABC, the new acquired subsidiary in October 2006, with 20% ownership interest,
and $331,000 for PacGames, acquired 45% ownership interest in September 2006
(we
now owned 51% interest of PacGames).
INCOME
TAXES
The
income taxes expenses for the Company's subsidiaries were $63,000 for the year
ended December 31, 2006. The provision of income taxes depends on the tax rate
and tax exemption. Pursuant to the PRC Income Tax Laws, the Company's
subsidiaries and VIEs are generally subject to Enterprise Income Taxes ("EIT")
at a statutory rate of 33%, which comprises 30% national income tax and 3%
local
income tax. Certain subsidiaries and VIEs are qualified for preferred high
technology or software enterprise tax status, and they are subject to
preferential tax rate of 15% under PRC Income Tax Rules. In addition, Guangzhou
3G-WOFE, as a new High Technology Foreign Investment Enterprises and under
PRC
Income Tax Laws, is entitled to a two-year tax exemption in 2005 and
2006.
Income
Tax (in thousands, except percentages)
|
For
the year ended
December
31,2006 ($)
|
For
the year ended
December
31,2005 ($)
|
Percentage
Change
(%)
|
Group
1.Outsourcing Services
|
-
|
67
|
-100
|
Group
2.Telecom Value-Added Services
|
-
|
-
|
N/A
|
Group
3.Products (Telecom & Gaming)
|
-
|
-
|
N/A
|
Group
4.Other Business
|
63
|
26
|
140
|
Total
|
63
|
93
|
-33
|
MINORITY
INTERESTS
Minority
interests for the year ended December 31, 2006 totaled $153,000. Minority
interests represented the interests of third parties in our subsidiaries'
results.
NET
EARNINGS
Net
loss
for the year ended December 31, 2006 was $20,093,000 as a result of a number
of
nonrecurring items. Segmented details are set out below:
Net
Earnings
(in thousands, except percentages)
|
Group
1.
Outsourcing
Services
($)
|
Group
2.
Telecom
Value-
Added
Services ($)
|
Group
3.
Products
(Telecom
&
Gaming) ($)
|
Group
4.
Other
Business
($)
|
Total
for the
year
ended
Dec
31, 2006 ($)
|
Total
for the
year
ended
Dec
31, 2005 ($)
|
Percentage
Change
(%)
|
Operating
profits
|
676
|
-44
|
-1,053
|
-13,567
|
-13,988
|
289
|
-4,940
|
Interest
income/(expenses), net
|
309
|
1
|
85
|
-967
|
1,192
|
49
|
-2,533
|
Loss
in change in fair value of warrants
|
-
|
-
|
-
|
-214
|
-214
|
-
|
N/A
|
Maximum
liquidated damage in connection with convertible debenture covenant
breach
|
-
|
-
|
-
|
-3,817
|
-3,817
|
-
|
N/A
|
Sundry
income
|
1
|
0
|
50
|
53
|
104
|
445
|
-77
|
Earnings
before Income Taxes, Minority Interest and Discontinued Operations
|
368
|
-45
|
-918
|
-18,512
|
-19,106
|
783
|
-2,540
|
CONTRACTUAL
OBLIGATIONS
Cash
resources required to satisfy short and long term contractual obligations as
of
December 31, 2006 are tabulated below:
Payments
Due by Period
Contractual
Obligations (in thousands)
|
Total
|
Less
than 1 year
|
1-5
years
|
After
5 years
|
Line
of credit
|
$855
|
$855
|
--
|
--
|
Bank
Loans
|
$2,211
|
$576
|
$866
|
$769
|
Operating
leases
|
$1,444
|
$680
|
$764
|
--
|
Capital
leases
|
$244
|
$120
|
$124
|
--
|
Total
cash contractual obligations
|
$4,754
|
$2,231
|
$1,754
|
$769
|
OFF-BALANCE
SHEET ARRANGEMENTS
There
were no off-balance sheet guarantees, interest rate swap transactions, foreign
currency forward contracts or long term purchase commitments outstanding as
of
December 31, 2006. Further, the Company had not engaged in any non-exchange
trading activities during 2006.
LIQUIDITY
AND CAPITAL RESOURCES
OVERVIEW
Net
cash
and cash equivalents at December 31, 2006 were approximately $1.9 million,
a decrease of approximately $1.6 million compared to December 31, 2005.
This change resulted from cash used in operations of ($11.9) million, cash
used
in investing activities of $0.3 million and cash provided by financing
activities of $8.4 million.
Significant
components of cash flows from operations are as follows:
|
|
|
|
(Amounts
in millions)
|
|
|
|
Net
loss
|
|
|
$(20.09
|
)
|
Non-cash
and/or nonrecurring items
|
|
|
20.65
|
|
Other
changes in assets and liabilities
|
|
|
(9.45
|
)
|
Net
cash used in operations
|
|
|
$(8.89
|
)
|
Other
significant sources (uses) of cash during 2006 were $7.5 million proceeds from
issuance of convertible debenture, bank loan advances of $0.9 million, $0.2
million proceeds from the issuance of common stock, $2.6 million used in
purchases of office properties in China and equipment, $0.7 million used in
acquisition of and advancing loans to subsidiaries, and $0.3 million used in
corporate development including debt repayments and purchases of treasury
stock.
WORKING
CAPITAL
The
Company's working capital decreased
by 103% to negative $335,000 at December 31, 2006, as compared to $10,638,000
at
December 31, 2005. The decrease in working capital primarily resulted from
$1,587,000 (46%) decrease in cash and cash equivalent, and the increase
of
$8,000,000 in convertible debentures.
ISSUANCE
OF COMMON STOCK
During
the year ended December 31, 2006, the Company had the following equity
transactions (i) 394,000 shares as a result of exercise of stock options with
cash consideration of $237,000; (ii) 618,112 shares for acquisition of
subsidiaries valued at $4,346,000; and (iii) 275,000 shares returned by
ChinaGoHi valued at $1,672,000, due to a termination agreement signed with
ChinaGoHi in November 2006 (as filed in an 8K dated November 28, 2006); (iv)
repurchase of 24,200 shares from Yueshen with a market value of
$124,223.
FUTURE
LIQUIDITY NEEDS
As
of
December 31, 2006, we had approximately $1,900,000 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.
On
February 06, 2007, our subsidiary, PacificNet Games Limited (PacGames) entered
into a definitive agreement for a $5 million financing in the form of secured
convertible debt with Pope Asset Management, LLC (Pope), an institutional
investor. Proceeds from the financing will be used to provide PacGames with
additional working capital in expanding its gaming technology operations,
funding for strategic acquisitions in China and funding for general corporate
purposes.
The
$5
million convertible debt issued by PacGames to Pope, matures on February 6,
2010, and may be converted into 26% to 32% ownership interest in PacGames based
on reaching certain net income milestones during fiscal year 2007 The interest
rate on the convertible debt will initially be set at 8%, and shall increase
to
15% if the note is not converted prior to maturity.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
INFLATION
Inflation
has not had a material impact on the Company's business in recent
years.
All
of
the Company's revenues are denominated either in U.S. dollars or Hong Kong
dollars, while its expenses are denominated primarily in Hong Kong dollars
and
Chinese renminbi ("RMB"). The value of the RMB-to-U.S. dollar or Hong Kong
dollar-to-United States dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Since 1994, the conversion of renminbi into foreign currencies, including U.S.
dollars, has been based on rates set by the People's Bank of China, which are
set daily based on the previous day's inter-bank foreign exchange market rates
and current exchange rates on the world financial markets. Since 1994, the
official exchange rate 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. 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. Since February 2006, the new currency rate
system has been operated; the currency rate of renminbi has become more flexible
while basically maintaining stable and the expectation for a larger appreciation
range is shrinking. Although a devaluation of the Hong Kong dollar or renminbi
relative to the United States dollar would likely reduce the Company's expenses
(as expressed in United States dollars), any material increase in the value
of
the Hong Kong dollar or renminbi relative to the United States dollar would
increase the Company's expenses, and could have a material adverse effect on
the
Company's business, financial condition and results of operations. For
fluctuations in period to period exchange rates, the translation adjustment
is
required to translate from local functional currency to the USD reporting
currency (not RMB to HKD to USD). The Company has never engaged in currency
hedging operations and has no present intention to do so.
CONCENTRATION
OF CREDIT RISK
Credit
risk represents the accounting loss that would be recognized at the reporting
date if counterparties failed completely to perform as contracted.
Concentrations of credit risk (whether on or off balance sheet) that arise
from
financial instruments exist for groups of customers or counterparties when
they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or
other
conditions as described below:
|
·
|
The
Company's business is characterized by rapid technological change,
new
product and service development, and evolving industry standards
and
regulations. Inherent in the Company's business are various risks
and
uncertainties, including the impact from the volatility of the stock
market, limited operating history, uncertain profitability and the
ability
to raise additional capital.
|
|
·
|
All
of the Company's revenue is derived from Asia and Greater China.
Changes
in laws and regulations, or their interpretation, or the imposition
of
confiscatory taxation, restrictions on currency conversion, devaluations
of currency or the nationalization or other expropriation of private
enterprises could have a material adverse effect on our business,
results
of operations and financial
condition.
|
|
·
|
If
the Company is unable to derive any revenues from Greater China,
it would
have a significant, financially disruptive effect on the normal operations
of the Company.
|
*
A
substantial portion of the operations of business operations depend on mobile
telecommunications operators (operators) in China and any loss or deterioration
of such relationship may result in severe disruptions to their business
operations and the loss of a significant portion of the Company's revenue.
The
VIEs rely entirely on the networks and gateways of these operators to provide
its wireless value-added services. Specifically these operators are the only
entities in China that have platforms for wireless value-added services. The
Company's agreements with these operators are generally for a period of less
than one year and generally do not have automatic renewal provisions. If neither
of them is willing to continue to cooperate with the Company, it would severely
affect the Company's ability to conduct its existing wireless value-added
services business.
COMPREHENSIVE
INCOME (LOSS)
Comprehensive
income (loss) consists of net earnings and other gains (losses) affecting
stockholders' equity that, under generally accepted accounting principles are
excluded from net earnings in accordance with Statement of Financial Accounting
Standards ("SFAS") 130, Reporting Comprehensive Income. Additionally, the
translation adjustment is recorded as component of comprehensive income (loss)
in stockholders' equity section of balance sheet
SEASONALITY
AND QUARTERLY FLUCTUATIONS
Several
of our businesses experience fluctuations in quarterly performance.
Traditionally, the first quarter from January to March is a low season for
our
call center business due to the long Lunar New Year holidays in China Revenues
and income from gaming products, call center and telecom value-added services
tend to be higher in the fourth quarter due to special holiday promotions.
Internet/Direct Commerce revenues also tend to be higher in the fourth quarter
due to increased consumer spending during that period. Revenues from the gaming
and VAS can vary from quarter to quarter due to new product launches and the
seasonality of certain product lines.
Sales
of
our gaming machines to Macau and other Asian casinos and gaming operators are
generally strongest in Q3 and Q4 and slowest in the Chinese New Year holiday
season in Q1. In addition, quarterly revenues and net income may increase when
we receive a larger number of approvals for new games from regulators and gaming
operators than in other quarters, when a game or platform that achieves
significant player appeal is introduced or if gaming is permitted in a
significant new jurisdiction. In addition, as further technology advancements
become available for the gaming industry, replacement or conversion of gaming
machines will be impacted once any such advanced technology is approved by
regulators.
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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, 2006 and 2005,
(unaudited/restated)
|
F-2
|
|
Consolidated
Statements of Operations - For the Years Ended
December
31, 2006, December 31, 2005 (unaudited/restated) and December 31,
2004
(unaudited/restated)
|
F-3
|
|
Consolidated
Statements of Changes in Stockholders' Equity
-
For the Years Ended December 31, 2006, December 31, 2005
(unaudited/restated) and December 31, 2004
(unaudited/restated)
|
F-4
|
|
Consolidated
Statements of Cash Flows
-
For the Years Ended December 31, 2006, December 31, 2005
(unaudited/restated) and December 31, 2004
(unaudited/restated)
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
|
|
|
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On
January 25, 2007, we reported on a Current Report on Form 8-K that our
independent public accounting firm, Clancy & Co. P.L.L.C. (“Clancy”),
resigned as of January 19, 2007. We also reported and Clancy confirmed and
agreed in a letter to the SEC that was filed as an exhibit to the Current Report
on Form 8-K/A filed on February 8, 2007 that there were no disagreements
between Clancy and us on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, during the
two
fiscal years of the Company ended December 31, 2004 and 2005 and subsequently
up
to the date of resignation which disagreements, if not resolved to Clancy’s
satisfaction, would have caused Clancy to make reference to the subject matter
of the disagreement in connection with its report issued in connection with
the
audit of the Company’s financial statements. None of the reportable events
described under Item 304(a)(1)(v)(A)-(D) of Regulation S-K occurred within
the
two fiscal years of the Company ended December 31, 2004 and 2005 and
subsequently up to the date of resignation. Clancy's auditors' report on
the financial statements of the Company as of December 31, 2005 did not contain
any adverse opinion or disclaimer of opinion, and such audit report was not
qualified or modified as to uncertainty, audit scope or accounting
principles.
After
Clancy’s
resignation, on March 12, 2007 we received an e-mail communication from Clancy
to which was attached a letter dated February 17, 2007 (“March 12 Letter”).
Clancy has stated that the March 12 Letter was initially sent on February
17,
2007 by regular mail to our Beijing, China headquarters, however, we did
not
receive the letter until it was forwarded in the March 12, 2007 e-mail
communication. The March 12 Letter suggested that certain of the criteria
by
which an option grant date is determined may not have been satisfied in
connection with our fixing of the grant date for options. The communication
did
not include any particular factual information - including which criteria
were
in question or which option grants might be involved - that would assist
the
audit committee of our board of directors in determining whether the financial
statements for any of the preceding three fiscal years should no longer be
relied upon due to an error in our method of accounting for stock option
grants.
After receipt of the communication, the Company’s Audit Committee and
Compensation Committee convened a telephonic meeting on March 17, 2007, at
which
all members of the Board of Directors, the Company’s executive officers and the
Company’s legal counsel attended. As a result of this meeting, the Audit
Committee has commissioned an independent investigation to address all the
issues raised by Clancy. Subsequently, by letter dated March 16, 2007 Clancy
withdrew its audit reports for the fiscal years ended December 31, 2004 and
2005.
ITEM
9A. 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 the evaluation of those controls and procedures performed
as of the period ended December 31, 2006, our chief executive officer and our
chief financial officer concluded that our disclosure controls and procedures
were inadequate, need to be strengthened and were not effective to ensure
that information required to be disclosed by us in our reports that we file
or
submit under the Exchange Act are recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms
During
the year, the Company took various steps to maintain the accuracy of our
financial disclosures, and improve company internal controls over financial
reporting. An internal control team lead by senior managers has been established
to review our entire internal control system, including but not limited to
risk
identification, control procedure setup, staff training, segregation of
incompatible job duties, design of management reporting system, definition
and
delegation of signing authority, establishment of documentation system and
implementation of a company-wide ERP system. It is our expectation that
the implementation of these procedures and systems will assist us in making
our
disclosure controls and procedures and internal controls over financial
reporting effective.
ITEM
9B. OTHER INFORMATION
ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
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 March 31, 2007:
Name
|
Age
|
Title
|
Tony
Tong
|
38
|
Chairman
and Chief Executive Officer
|
Victor
Tong
|
36
|
President,
Secretary, and Director
|
Daniel
Lui
|
43
|
Chief
Financial Officer
|
Shaojian
(Sean) Wang
|
41
|
Director
|
Peter
Wang
|
51
|
Independent
Director (1)(3)
|
Michael
Ha
|
36
|
Independent
Director (2)(3)
|
Jeremy
Goodwin
|
33
|
Independent
Director (1)(3)
|
Tao
Jin
|
38
|
Independent
Director (1)(2)(3)
|
Mike
Fei
|
38
|
Company
Secretary and General Counsel
|
____________
(1)
Member of Audit Committee
(2)
Member of Nominating Committee
(3)
Member of Compensation Committee
Our
executive officers are appointed at the discretion of our board of directors
with no fixed term. There are no family relationships between or among any
of
our executive officers or our directors other than the relationship between
Mr.
Tony Tong and Mr. Victor Tong.
MR.
TONY
TONG, age 38, is the Chairman, CEO, Executive Director, and co-founder of
PacificNet since 1999. From 1995 to 1997, Mr. Tong served as the Chief
Information Officer of DDS Inc., a leading SAP-ERP consulting company in the
USA, which was later acquired by CIBER, Inc. (NYSE: CBR). From 1993 to 1994,
Mr.
Tong worked for Information Advantage, Inc. (NASDAQ:IACO), a leading business
intelligence, Data-Mining and CRM technology provider serving Fortune 500
clients. IACO consummated an IPO on NASDAQ in 1997 and was later acquired by
Sterling Software and Computer Associates (NYSE:CA). From 1992 to 1993, Mr.
Tong
worked as a Business Process Re-engineering Consultant at Andersen Consulting
(now Accenture, NYSE:ACN). From 1990 to 1991, Mr. Tong worked for ADC
Telecommunications (NASDAQ:ADCT), a global supplier of telecom equipment. Mr.
Tong's R&D achievements include being the inventor and patent holder of US
Patent Number 6,012,066 (granted by US Patent and Trademark Office) titled
"Computerized Work Flow System, an Internet-based workflow management system
for
automated web creation and process management." Mr. Tong also serves on the
board of advisors of Fortune Telecom (listed on Hong Kong Stock Exchange:
0110.HK), a leading distributor of mobile phones, PDAs, telecom services, and
accessories in China and Hong Kong. Mr. Tong is a frequent speaker on technology
investment in China, and was invited to present at the Fourth APEC International
Finance & Technology Summit in 2001. Mr. Tong is the Vice Chairman (PRC) of
Hong Kong Call Centre Association, a Fellow of Hong Kong Institute of Directors,
a consultant on privatization and securitization for China's State-owned Assets
Supervision and Administration Commission (SASAC), and a frequent speaker for
LexisNexis, a licensed Continued Professional Development (CPD) trainer, on
China investment. Mr. Tong graduated with Bachelor of Mechanical/Industrial
Engineering Degree from the University of Minnesota and served on the Computer
Engineering Department Advisory Board and was an Adjunct Professor at the
University of Minnesota, USA. Tony Tong is the brother of Victor
Tong.
MR.
VICTOR TONG, age 36, is the President of PacificNet, and has served on our
board
as an Executive Director since 2002. Mr. Victor Tong gained his consulting,
systems integration, and technical expertise through his experience at Andersen
Consulting (now Accenture, NYSE:ACN), American Express Financial Advisors (IDS),
3M, and the Superconductivity Center at the University of Minnesota. In 1994,
Mr. Victor co-founded Talent Information Management ("TIM"), a leading internet
application development and consulting company in Minnesota. PacificNet.com
was
originally founded as an operating division of
TIM.
In 1997, Mr. Tong successfully sold GoWeb, an internet consulting division
of
TIM to Key Investment, a leading technology and media investment company owned
by Vance Opperman, a billionaire in Minnesota who founded West Publishing.
Mr.
Tong became the President of KeyTech, a leading information technology
consulting company based in Minnesota. In 1999, he was recognized in "City
Business 40 Under 40" as one of the future business and community leaders in
Minnesota. Mr. Tong won the Student Commencement Speaker Award and
graduated with honors with a Bachelor of Science in Physics from the University
of Minnesota. Mr. Tong was an adjunct professor at the College of Software
of
Beihang University, one of the top software colleges in China. Victor Tong
is
the brother of Tony Tong.
MR.
DANIEL LUI,
age 43,
has served as Chief Financial Officer since March 1, 2007. Mr. Lui joined
PacificNet with over 17 years of professional and commercial accounting
experience, 7 years of which was in Mainland China. He carries the credentials
of Chartered Accountant (Alberta, Canada) and CPA-inactive (Washington, USA).
Mr. Lui was Vice President of Finance and Company Secretary of Fiberxon Inc.,
a
leading communications subsystem maker, where he was in charge of Fiberxon’s
Finance, Company Secretarial, and Information Technology departments from 2002
to 2007. Prior to joining Fiberxon, Mr. Lui was Chief Financial Officer of
China
Motion NetCom Ltd., a wholly owned subsidiary of China Motion Telecom
International Limited, a Hong Kong Exchange listed company, engaged in long
distance call resale business from 2000 to 2001. Prior to that, Mr. Lui
was Financial Advisory Services Manager of PricewaterhouseCoopers and Auditor
at
KPMG. Mr. Lui received his Bachelors of Business Administration degree from
the
University of Hawaii at Manoa in 1987 and Masters of Business Administration
from University of Alberta in Canada in 1994.
MR.
SHAOJIAN (SEAN) WANG, age 41, has served on our board as a Director since 2002.
From 2002 to May 2006, Mr. Wang also served as Chief Financial Officer of
PacificNet. Mr. Wang is now President and Chief Operating Officer of Hurray!
Holding Co., Ltd. (NASDAQ:HRAY), a NASDAQ-listed Chinese VAS company.
Previously, Mr. Sean Wang was COO and acting Chief Financial Officer (CFO)
at
GoVideo and Opta Corporation, a public listed consumer Electronics Company
in
the US controlled by TCL, a leading consumer electronics maker in China. From
1987 to 2002, he served as a country manager at Ecolab, Inc. and as the managing
director at Thian Bing Investments PTE, Ltd. From 1993 to 2002, Mr. Wang served
as managing director of Thian Bing Investments PTE, Ltd. where he managed the
Singapore-based company's multi-million dollar investment operations and
identified strategic and investment opportunities. Mr. Sean Wang attended Peking
University and received a BS in Economics from Hamline University and an MBA
from Carlson School of Management, University of Minnesota.
MR.
PETER
WANG, age 51, has served on our board as an Independent Director since December
24, 2003. Mr. Wang is currently the Chairman and CEO of China Biopharma, Inc.
(www.chinabiopharma.com.cn, OTCBB:CPBC, formerly Techedge Inc.), a fast growing
developer, producer and distributor of human vaccine products in China,
including human vaccines against influenza, hemorrhagic fever, and Japanese
Encephalitis. Mr. Wang was a co-founder of Unitech Telecom a telecom equipment
manufacturing company (now named UTStarcom, NASDAQ:UTSI). Under his management,
UTStarcom created the first digital loop carrier system and installed the first
PHS system in China. As an entrepreneur, he has successfully co-founded and
built other ventures in the US, including World Communication Group and World
PCS, Inc. Mr. Wang has more than 20 years of experience in communication
products and services. Mr. Wang is Co-Chairman of Business Advisory Council
of
the National Republican Congressional Committee. In 2004, Mr. Wang received
the
Outstanding 50 Asian Americans in Business award for his entrepreneurial
achievement and technology leadership in the telecommunications industry. Mr.
Wang holds a B.S. in Math & Computer Science and a M.S. in Electrical
Engineering from University of Illinois, as well as an MBA in Marketing from
Southeast-Nova University.
MR.
MICHAEL CHUN HA, age 36, has served on our board as an Independent Director
since December 24, 2003. Mr. Ha graduated from the Faculty of Law, University
of
Hong Kong in 1994 with a bachelor degree in law and was admitted as a solicitor
of the High Court of the Hong Kong Special Administrative Region in 1997 and
a
solicitor of the Supreme Court of England and Wales in 1998. From 1995 to 2002,
Mr. Ha worked as lawyer in a number of international and Hong Kong prestigious
law firms, specializing in the areas of corporate finance, securities offerings,
takeovers, cross-border mergers and acquisitions, venture capital, corporate
restructuring, regulatory and compliance issues, project finance, and general
commercial transactions and services in Hong Kong and the People's Republic
of
Hong Kong. In 2002, Mr. Ha commenced his own practice in the trade name of
"Ha
and Ho Solicitors" and the firm specializes in the areas of general commercial
transactions, corporate finance and civil and criminal litigations. Mr. Ha
is
also the company secretary of, Shanxi Central Pharmaceutical International
Company Limited, a Hong Kong main board listed company from year 2000 and a
director of a private investment company, Metro Concord Investment Limited,
from
year 2002.
MR.
JEREMY GOODWIN, age 33, has served on our board as an Independent Director
since
December 24, 2004. Jeremy Goodwin is founder of China Diligizer and Managing
Partner of 3G Capital Partners. He began his career in 1995 at Mees Pierson
Investment Finance S.A. in Geneva, Switzerland where he supported the fund’s
private placement/private equity finance team. Noteworthy transactions executed
by the group included assistance on the placements of the $1.2 Billion Carlyle
Partners II Limited Partnership. In 1997 he went to work for the then parent
institution, ABN Amro, in Beijing, China. In 1999, Mr. Goodwin was employed
with
ING Barings in London as an International Associate. Mr. Goodwin received his
BS
from Cornell University in 1996 in conjunction with the Institute of Higher
International Studies in Geneva, Switzerland. He later pursued his advanced
degree with Princeton University with a concentration in Chinese affairs which
he completed at the prestigious Nanjing Chinese Studies Center of the Johns
Hopkins School of Advanced International Studies. Jeremy is fluent in written
and spoken Mandarin Chinese, French and has working knowledge of
Dutch.
MR.
TAO
JIN, age 38, has served on our board as an Independent Director since January
6,
2005. Mr. Jin is a resident partner at Jun He Law Offices (www.JunHe.com),
a
leading Chinese law firm specializing in commercial legal practice with over
160
lawyers and offices in Beijing, Shanghai, Shenzhen, Dalian, Haikou and New
York.
Founded in April 1989, Jun He was one of the first private law firms formed
in
China, and has been a pioneer in the re-established Chinese legal profession
with a focus in representing foreign clients in business activities throughout
China. Over the past few years, Jun He has been honored a number of times as
one
of the best law firms in China by the Ministry of Justice of China. With a
team
of more than 160 well-trained lawyers, Jun He is one of the largest and most
established law firms in China. Prior to joining Jun He, Mr. Jin served as
Vice
President and Assistant General Counsel of J.P. Morgan Chase Bank, as the head
legal counsel for capital markets transactions in Asia, and for JPMorgan's
M&A transactions in China. Mr. Jin joined Jun He as a partner in 2005. From
1999 to 2002, Mr. Jin served as a Senior New York Qualified Lawyer for Sullivan
& Cromwell, which represented China Unicom, PetroChina and China Telecom in
their IPO's and dual listings in New York and Hong Kong. From 1996 to 1999,
Mr.
Jin served as Associate Lawyer for Cleary, Gottlieb Steen & Hamilton, which
represented various Fortune 500 companies and investment banks in public and
private securities offerings and M&A activities. Mr. Jin received his Juris
Doctor in 1996 with high honors from Columbia University, and received B.S.
in
Psychology in 1990 from Beijing University.
MR.
MIKE
FEI, age 38, is the Company Secretary and General Counsel for PacificNet. Mr.
Fei joined PacificNet in 2004 as in-house PRC Chief Legal Counsel for
PacificNet's China Operations. Mr. Fei is a Member of the All-China Bar
Association and holds a Master of Law degree from the University of New South
Wales of Australia. Mr. Fei has 8 years of experience in the legal profession
and dealt with more than 200 cases of litigation and arbitration which related
to the issues of foreign investment, bankruptcy, merging, commercial contract
and debt disputes.
CORPORATE
GOVERNANCE
BOARD
OF DIRECTORS
We
have
six members serving on our Board of Directors. Each board member is nominated
for election at our annual meeting to serve until the next annual meeting of
stockholders and until their successors are duly elected and
qualified.
BOARD
COMMITTEES
The
Board
of Directors has a Nominating Committee, Compensation Committee and an Audit
Committee.
NOMINATING
COMMITTEE
The
purpose of the Nominating Committee is to assist the Board of Directors in
identifying qualified individuals to become board members, in determining the
composition of the Board of Directors and in monitoring the process to assess
Board effectiveness. Michael Ha and Tao Jin are members of the Nominating
Committee. There have been no changes to the procedures by which the
stockholders of the Company may recommend nominees to the Board of Directors
since the filing of the Company's Definitive Proxy Statement on October 1,
2006,
for its Annual Meeting of Stockholders, which was held on December 15, 2006.
The
Nominating Committee Charter is not available on the Company’s website. A copy
of the Nominating Committee Charter was included in the proxy statement for
the
Annual Meeting held on December 30, 2005.
COMPENSATION
COMMITTEE
Our
Compensation Committee currently consists of Messrs. Jeremy Goodwin, Michael
Chun Ha, Tao Jin, and Peter Wang, who are all independent directors. The
Compensation Committee has a charter which states that it is the responsibility
of the Compensation Committee to make recommendations to the Board of Directors
with respect to all forms of compensation paid to our executive officers and
to
such other officers as directed by the Board and any other compensation matters
as from time to time directed by the Board. The goal of the Compensation
Committee’s policies on executive compensation is to ensure that an appropriate
relationship exists between executive compensation and the creation of
stockholder value, while at the same time attracting, motivating and retaining
executives.
COMPENSATION
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Members
of our Compensation Committee of the Board of Directors were Messrs. Goodwin,
Ha, Tao and Wang. No member of our Compensation Committee was, or has been,
an
officer or employee of the Company or any of our subsidiaries. No member of
the
Compensation Committee has a relationship that would constitute an interlocking
relationship with executive officers or directors of the Company or another
entity.
AUDIT
COMMITTEE OF THE BOARD OF DIRECTORS
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. Tao Jin (Chairman of Audit Committee), Jeremy
Goodwin, and Peter Wang, each of whom are considered "independent" under the
NASDAQ Stock 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.
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.
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 was filed as an exhibit to our Annual
Report on Form 10-KSB filed on April 2, 2004. 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.
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: 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.
Overview
This
compensation discussion describes the material elements of compensation awarded
to, earned by, and paid to each of our executive officers listed in the Summary
Compensation Table below (the "named
executive officers")
during
the last completed fiscal year. This compensation discussion focuses on the
information contained in the following tables and related footnotes and
narrative primarily for the last completed fiscal year, but we have also
described compensation actions taken before or after the last completed fiscal
year to the extent it enhances the understanding of our executive compensation
disclosure.
The
compensation committee currently oversees the design and administration of
our
executive compensation program.
Objectives
and Philosophy
In
General.
The
objectives of our compensation programs are to:
|
·
|
Provide
our executive officers with both cash and equity incentives to motivate
them to further the interests of the company and our
stockholders
|
|
·
|
Provide
employees with long-term incentives to assist in creating a culture
of
corporate ownership, which we believe will assist in retaining these
employees
|
|
·
|
Provide
stability during our growth stage
|
Generally,
the compensation of our executive officers is composed of an annual base salary
annual incentive compensation and equity awards in the form of stock options,
other benefits and perquisites, post-termination severance and acceleration
of
stock option vesting for certain named executive officers upon termination
and/or a change in control. Our other benefits and perquisites consist of life
and health insurance benefits. In setting base salaries, the compensation
committee generally reviews the individual contributions of the particular
executive. In addition, stock options are granted to provide the opportunity
for
long-term compensation based upon the performance of our common stock over
time.
Our philosophy is to aggregate these elements so that they reach at a level
that
is commensurate with our size and sustained performance.
Elements
of Compensation
Compensation
consists of following elements:
Base
Salary.
Base
salaries for our executive officers are established based on the scope of their
responsibilities, taking into account competitive market compensation paid
by
other companies in our industry for similar positions, and the other elements
of
the executive officer’s compensation, including stock-based compensation. Our
intent is to target executive base salaries near the median of the range of
salaries for executives in similar positions with similar responsibilities
at
comparable companies, in line with our compensation philosophy. Base salaries
are reviewed annually, and may be increased annually to realign salaries with
market levels after taking into account individual responsibilities, performance
and experience. Based on publicly available information, we believe that the
base salaries established for our executive officers are comparable to those
paid by similar companies in our industry.
Annual
Bonuses.
Our
executive officers and certain other employees are eligible for annual cash
bonuses, which are paid at the discretion of our compensation committee. The
employment agreement with our executive officers do not provide for minimum
bonuses. The determination of the amount of annual bonuses paid to our executive
officers generally reflects a number of subjective considerations, including
the
performance of
our
company
overall
and the contributions of the executive officer during the relevant
period.
Incentive
Compensation.
We
believe that long-term performance is achieved through an ownership culture
that
encourages long-term performance by our executive officers through the use
of
stock-based awards. Our 2006 Stock Option Plan permits the grant of stock
options, restricted stock, stock appreciation rights, and performance-based
stock awards. Under power delegated by our Board, the Compensation Committee
of
the Board has the authority to award incentive compensation to our executive
officers, employees, consultants and directors in such amounts and on such
terms
as the committee determines in its sole discretion.
Currently,
we do not maintain any incentive compensation plans based on pre-defined
performance criteria. Incentive compensation is intended to compensate executive
officers, employees, consultants and directors for achieving financial and
operational goals and for achieving individual annual performance objectives.
These objectives are expected to vary depending on the individual executive,
but
are expected to relate generally to strategic factors such as expansion of
our
services and to financial factors such as improving our results of operations.
The actual amount of incentive compensation for the prior year will be
determined following a review of each executive’s individual performance and
contribution to our strategic goals conducted during the first quarter of each
year. Specific performance targets used to determine incentive compensation
for
each of our executive officers in 2007 have not yet been
determined.
Other
Compensation.
Each
employment agreement provides the executive with certain other benefits,
including reimbursement of business and entertainment expenses and housing
allowance. Each executive is eligible to participate in all benefit plans and
programs that are or in the future may be available to other executive employees
of our
company,
including any profit-sharing plan, thrift plan, health insurance or health
care
plan, disability insurance, pension plan, supplemental retirement plan, vacation
and sick leave plan, and other similar plans. The compensation committee in
its
discretion may revise, amend or add to the officer’s executive benefits and
perquisites as it deems advisable. We believe that these benefits and
perquisites are typically provided to senior executives of similar
companies.
Compensation
Committee Report on Executive Compensation
Our
compensation committee has certain duties and powers as described in its
charter. The compensation committee is currently composed of the four
independent directors named at the end of this report, each of whom is
independent as defined by the NASDAQ Global Market listing
standards.
The
compensation committee has reviewed and discussed with management the
disclosures contained in the Compensation Discussion and Analysis section of
this Annual Report on Form 10-K. Based upon this review and discussion, the
compensation committee recommended to our Board of Directors that the
Compensation Discussion and Analysis section be included in our Annual Report
on
Form 10-K to be filed with the SEC.
|
|
Compensation
Committee of the Board of Directors
|
|
|
Michael
Ha, Chairman
|
|
|
Jeremy
Goodwin |
|
|
Jin
Tao
|
|
|
Peter
Wang
|
This
report shall not constitute
soliciting material or otherwise be considered filed
under
the Securities Act or the Securities Exchange Act.
Summary
Compensation Table
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
and Principal Position
|
|
Year
|
|
Salary
($)
|
|
Housing
Allowance
|
|
Option
Awards
($)
(1)
|
|
All
Other
Compensation
|
|
Total
($)
|
|
Tony
Tong, Chairman, Chief Executive Officer and Director
|
|
|
2006
|
|
|
$100,000
|
|
|
|
|
|
$21,552
|
|
|
|
|
|
$121,552
|
|
Joe
Levinson,
Chief Financial Officer
|
|
|
2006
|
|
|
$40,000
|
(2) |
|
|
|
|
|
|
|
|
|
|
$40,000
|
|
Victor
Tong,
President and Director
|
|
|
2006
|
|
|
$48,000
|
|
|
$24,000
|
|
|
$21,552
|
|
|
|
|
|
$93,552
|
|
|
1)
|
Valuation
based on the dollar amount of option grants recognized for financial
statement reporting purposes pursuant to FAS 123R with respect to
2006. On
December 15, 2006, the board of directors cancelled all options granted
in
2005 and 2006.
|
|
2)
|
Mr.
Levinson resigned as our Chief Financial Officer on February 9,
2007.
|
Employment
Agreements
On
March
25, 2003, we entered into an Executive Employment Contract with Victor Tong.
Mr.
Tong currently serves as our President. The employment agreement provides
for
Mr. Tong to earn an annual base salary of $48,000 in cash, plus $10,000 in
stock
compensation annually
until
January 1, 2006. 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 compensation committee may
deem
appropriate. Mr. Tong is entitled to receive a monthly housing allowance
of
$2,000 and a monthly automobile allowance of $500. Mr. Tong’s employment
contract was renewed for a period of three years through December 30, 2008,
starting from the expiration of the previous employment contract which ended
on
December 30, 2005. Mr. Tong’s annual base salary was also increased to $100,000
on October 29, 2006.
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. Mr.
Tong’s employment contract was renewed for a period of three years through
December 30, 2008, starting from the expiration of the previous employment
contract which ended on December 30, 2005.
On
August
3, 2006, the Company entered into a consulting services agreement with Levinson
Services Partners, of which Joe Levinson, the Company’s former Chief Financial
Officer is manager, which set forth Mr. Levinson’s duties as the Chief Financial
Officer of the Company and the terms of his compensation. The agreement was
for
a term of three (3) years commencing on September 5, 2006. The consulting
agreement provided that Mr. Levinson was to receive an annual base salary of
$120,000, plus stock options to purchase up to 12,000 shares of Company common
stock per year, vesting in equal installments over a 10 month period,
and
stock
options granted on an annual basis which vest only if the stock price of
PacificNet common stock reaches certain thresholds. Mr. Levinson was also to
be
reimbursed for expenses. The consulting agreement was terminated as a result
of
Mr. Levinson’s resignation as Chief Financial Officer on February 9,
2007.
Grants
of Plan-Based Awards
During
the fiscal year ended December 31, 2006,
options were issued to the named executive officers to purchase 70,000 shares
of
common stock in the aggregate. On December 15, 2006, our board of directors
decided to cancel all options previously granted in 2005 and 2006, due to the
increasing cost to administer stock options.
Outstanding
Equity Awards at Fiscal Year-End
The
following table summarizes the number of securities underlying outstanding
plan
awards for each named executive officer as of December 31,
2006.
Name
|
|
Number
of
Securities
Underlying
Unexercised
Options (#) Exercisable
|
|
Number
of
Securities
Underlying
Unexercised
Options (#) Unexercisable
|
|
Equity
Incentive Plan Awards; Number of Securities Underlying Unexercised
Unearned Options (#)
|
|
Option
Exercise
Price
($)
|
|
Option
Expiration
Date
|
|
Tony
Tong, CEO
|
|
|
75,000
|
|
|
-
|
|
|
-
|
|
|
|
|
|
7-26-2007
|
|
Victor
Tong, President
|
|
|
75,000
|
|
|
-
|
|
|
-
|
|
|
|
|
|
7-26-2007
|
|
Joseph
Levinson, CFO
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
-
|
|
Option
Exercises and Stock Vested
The
following table summarizes stock option exercises by our named executive
officers in 2006.
|
Option
Awards
|
Name/
Principal
Position
|
Number
of Shares
Acquired
on Exercise (#)
|
Value
Realized
on
Exercise ($)
|
Tony
Tong, CEO
|
90,000
|
$193,500
|
Victor
Tong, President
|
90,000
|
$198,000
|
Joseph
Levinson, CFO
|
-
|
-
|
1998
Incentive Stock Option Plan
Administration
of the 1998 Plan
2,000,000
shares of common stock are reserved under the PacificNet, Inc. 1998 Stock
Option
Plan (the "1998 Incentive Plan”)
for
issuance upon exercise of stock options. . The 1998 Incentive Plan provides
for
a term of ten years from the date of its adoption by the board of directors
(unless the Incentive Plan is earlier terminated), after which no awards
may be
made.
The 1998
Plan may be 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 1998 Plan. Options granted under the 1998
Plan
may be "incentive stock options" as defined in Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), or nonqualified options.
Options
Options
granted under the 1998 Plan may be either “incentive
stock options”
(“ISOs”),
which
are intended to meet the requirements for special federal income tax treatment
under the Code, or “nonqualified
stock options”
(“NQSOs”).
Options may be granted on such terms and conditions as the Committee may
determine; provided, however, that the exercise price of an option may not
be
less than the fair market value of the underlying stock on the date of grant
and
the term of the option my not exceed 10 years (110% of such value and 5 years
in
the case of an ISO granted to an employee who owns (or is deemed to own)
more
than 10% of the total combined voting power of all classes of capital stock
of
the Company or a parent or subsidiary of the Company). ISOs may only be granted
to employees. In addition, the aggregate fair market value of Common Stock
covered by ISOs (determined at the time of grant) which are exercisable for
the
first time by an employee during any calendar year may not exceed $100,000.
Any
excess is treated as a NQSO.
Transferability
of Options.
The
Options may not be sold, pledged, assigned, hypothecated, transferred, or
disposed of in any manner other than by will or by the laws of descent or
distribution and may be exercised, during the lifetime of the Optionee, only
by
the Optionee.
Term;
Amendments
The
1998
Plan is effective for 10 years, unless it is sooner terminated or suspended.
The
Committee may at any time amend, alter, suspend or terminate the 1998 Plan;
provided that no amendment requiring stockholder approval will be effective
unless such approval has been obtained. No termination or suspension of the
2005
Plan will affect an award which is outstanding at the time of the termination
or
suspension.
Certain
Federal Income Tax Consequences
Incentive
stock options granted under the 1998 Plan will be afforded favorable federal
income tax treatment under the Code. If an option is treated as an incentive
stock option, the optionee will recognize no income upon grant or exercise
of
the option unless the alternative minimum tax rules apply. Upon an optionee's
sale of the shares (assuming that the sale occurs at least two years after
grant
of the option and at least one year after exercise of the option), any gain
will
be taxed to the optionee as long-term capital gain. If the optionee disposes
of
the shares prior to the expiration of the above holding periods, then the
optionee will recognize ordinary income in an amount generally measured as
the
difference between the exercise price and the lower of the fair market value
of
the shares at the exercise date or the sale price of the shares. Any gain
or
loss recognized on such a premature sale of the shares in excess of the amount
treated as ordinary income will be characterized as capital gain or
loss.
All
other
options granted under the 1998 Plan will be nonstatutory stock options and
will
not qualify for any special tax benefits to the optionee. An optionee will
not
recognize any taxable income at the time he or she is granted a nonstatutory
stock option. However, upon exercise of the nonstatutory stock option, the
optionee will recognize ordinary income for federal income tax purposes in
an
amount generally measured as the excess of the then fair market value of
each
share over its exercise price. Upon an optionee's resale of such shares,
any
difference between the sale price and the fair market value of such shares
on
the date of exercise will be treated as capital gain or loss and
will
generally
qualify for long-term capital gain or loss treatment if the shares have been
held for more than one year. Recently enacted legislation provides for reduced
tax rates for long-term capital gains based on the taxpayer's income and
the
length of the taxpayer's holding period.
The
foregoing does not purport to be a complete summary of the federal income
tax
considerations that may be relevant to holders of options or to the Company.
It
also does not reflect provisions of the income tax laws of any municipality,
state or foreign country in which an optionee may reside, nor does it reflect
the tax consequences of an optionee's death.
2005
Equity Incentive Plan
Awards
The
2005
Equity Incentive Plan (the "2005 Plan") provides for the grant of options
and
stock appreciation rights (“SARs”) of up to an aggregate of 2,000,000 shares of
Common Stock to directors, officers, employees and independent contractors
of
the Company or its affiliates. If any award expires, is cancelled, or terminates
unexercised or is forfeited, the number of shares subject thereto is again
available for grant under the 2005 Plan.
Administration
of the 2005 Plan
The
2005
Plan is administered by the Board of Directors or a committee of the Board
of
Directors consisting of not less than two members of the Board, each of whom
is
a “non-employee
director”
within
the meaning of Rule 16b-3 promulgated under the Exchange Act and an “outside
director” within
the meaning of Code Section 162(m) (in either case, the “Committee”).
Among
other things, the Committee has complete discretion, subject to the express
limits of the 2005 Plan, to determine the persons to be granted an award,
the
type of award to be granted, the number of shares of Common Stock subject
to
each award, the exercise price of each option, the term of each award, the
vesting schedule for an award, whether to accelerate vesting, the value of
the
stock, and the required withholding. The Committee may amend, modify or
terminate any outstanding award, provided that the participant’s consent to such
action is required if the action would materially and adversely affect the
participant. The Committee is also authorized to construe the award agreements,
and may prescribe rules relating to the 2005 Plan. Notwithstanding the
foregoing, the Committee does not have any authority to grant or modify an
award
under the 2005 Plan with terms or conditions that would cause the grant,
vesting
or exercise to be considered nonqualified “deferred
compensation”
subject
to Code Section 409A.
Limitation
on number of Awards.
Among
other things, in order for the grant of stock options and SARs to qualify
as
performance-based compensation and be excluded from the Company’s corporate
income tax deduction cap of $1,000,000 per year for its Named Executive
Officers, as set forth in Section 162(m) of the Code, the stockholders must
approve the maximum number of shares of common stock that can be issued to
any
one person under the Plan in any calendar year. The number of shares of Common
Stock for which stock options or SARs may be granted to a participant under
the
2005 Plan in any calendar year cannot exceed 500,000.
Options
Options
granted under the 2005 Plan may be either “incentive
stock options”
(“ISOs”),
which
are intended to meet the requirements for special federal income tax treatment
under the Code, or “nonqualified
stock options”
(“NQSOs”).
Options may be granted on such terms and conditions as the Committee may
determine; provided, however, that the exercise price of an option may not
be
less than the fair market value of the underlying stock on the date of grant
and
the term of the option my not exceed 10 years (110% of such value and 5 years
in
the case of an ISO granted to an employee who owns (or is deemed to own)
more
than 10% of the total combined voting power of all classes of capital stock
of
the Company or a parent or subsidiary of the Company). ISOs may only be granted
to employees. In addition, the aggregate fair market value of Common Stock
covered by ISOs (determined at the time of grant) which are exercisable for
the
first time by an employee during any calendar year may not exceed $100,000.
Any
excess is treated as a NQSO.
Stock
Appreciation Rights.
Stock
appreciation rights may be granted under our 2005 Plan. Stock appreciation
rights allow the recipient to receive the appreciation in the fair market
value
of our common stock between the exercise date and the date of grant. The
Committee determines the terms of stock appreciation rights, including when
such
rights become exercisable and whether to pay the increased appreciation in
cash
or with shares of our common stock, or a combination thereof. Stock appreciation
rights expire under the same terms that apply to stock options.
Additional
Terms
Except
as
provided in the 2005 Plan, awards granted under the 2005 Plan are not
transferable and may be exercised only by the respective grantees during
their
lifetime or by their guardian or legal representative. Each award agreement
will specify, among other things, the effect on an award of the disability,
death, retirement, authorized leave of absence or other termination of
employment. The Company may require a participant to pay the Company the
amount
of any required withholding in connection with the grant, vesting, exercise
or
disposition of an award. A participant is not considered a stockholder with
respect to the shares underlying an award until the shares are issued to
the
participant.
Term;
Amendments
The
2005
Plan is effective for 10 years, unless it is sooner terminated or suspended.
The
Committee may at any time amend, alter, suspend or terminate the 2005 Plan;
provided that no amendment requiring stockholder approval will be effective
unless such approval has been obtained. No termination or suspension of the
2005
Plan will affect an award which is outstanding at the time of the termination
or
suspension.
Certain
Federal Income Tax Consequences
The
following is a general summary of the federal income tax consequences under
current tax law of options and stock appreciation rights. It does not purport
to
cover all of the special rules, including special rules relating to participants
subject to Section 16(b) of the Exchange Act and the exercise of an option
with previously-acquired shares, or the state or local income or other tax
consequences inherent in the ownership and exercise of stock options and
the
ownership and disposition of the underlying shares or the ownership and
disposition of restricted stock.
Options.
A
participant does not recognize taxable income upon the grant of NQSO or an
ISO.
Upon the exercise of a NQSO, the participant recognizes ordinary income in
an
amount equal to the excess, if any, of the fair market value of the shares
acquired on the date of exercise over the exercise price thereof, and the
Company will generally be entitled to a deduction for such amount at that
time.
If the participant later sells shares acquired pursuant to the exercise of
a
NQSO, the participant recognizes long-term or short-term capital gain or
loss,
depending on the period for which the shares were held. Long-term capital
gain
is generally subject to more favorable tax treatment than ordinary income
or
short-term capital gain.
Upon
the
exercise of an ISO, the participant does not recognize taxable income If
the
participant disposes of the shares acquired pursuant to the exercise of an
ISO
more than two years after the date of grant and more than one year after
the
transfer of the shares to the participant, the participant recognizes long-term
capital gain or loss and the Company is not be entitled to a deduction. However,
if the participant disposes of such shares within the required holding period,
all or a portion of the gain is treated as ordinary income and the Company
is
generally entitled to deduct such amount.
Stock
Appreciation Rights.
Generally, no taxable income is realized upon the grant of an SAR. Upon
exercise, the holder of the SAR is taxed at ordinary income tax rates on
the
amount of any cash and the fair market value of any stock received.
In
addition to the tax consequences described above, a participant may be subject
to the alternative minimum tax, which is payable to the extent it exceeds
the
participant’s regular tax. For this purpose, upon the exercise of an ISO, the
excess of the fair market value of the shares over the exercise price therefore
is an adjustment which increases alternative minimum taxable income. In
addition, the participant’s basis in such shares is increased by such excess for
purposes of computing the gain or loss on the disposition of the shares for
alternative minimum tax purposes. If a participant is required to pay an
alternative minimum tax, the amount of such tax which is attributable to
deferral preferences (including the incentive option adjustment) is allowed
as a
credit against the participant’s regular tax liability in subsequent years. To
the extent the credit is not used, it is carried forward.
Option
Exercises and Stock Vested
The
following table summarizes stock option exercises by our named executive
officers in 2006.
|
Option
Awards
|
Stock
Awards
|
Name/
Principal
Position
|
Number
of Shares Acquired on Exercise (#)
|
Value
Realized
on
Exercise ($)
|
Number
of Shares Acquired on Vesting (#)
|
Value
Realized
on
Vesting ($)
|
Tony
Tong, CEO
|
90,000
|
$193,500
|
-
|
-
|
Victor
Tong, President
|
90,000
|
$198,000
|
-
|
-
|
Joseph
Levinson, CFO
|
-
|
-
|
-
|
-
|
Pension
Benefits
We
do not
sponsor any qualified or non-qualified defined benefit plans.
Nonqualified
Deferred Compensation
We
do not
maintain any non-qualified defined contribution or deferred compensation plans.
The compensation committee may elect to provide our officers and other employees
with non-qualified defined contribution or deferred compensation benefits if
the
compensation committee determines that doing so is in our best
interests.
Name
of Director
|
Year
|
Fees
Owed or
Paid
in Cash
|
Option
Awards
($)
(1)
|
All
other
compensation
($)
|
Total($)
|
ShaoJian
(Sean) Wang
|
2006
|
-
|
$12,316
|
-
|
$12,316
|
Peter
Wang
|
2006
|
-
|
$9,237
|
-
|
$9,237
|
Michael
Ha
|
2006
|
-
|
$9,237
|
-
|
$9,237
|
Tao
Jin
|
2006
|
-
|
$9,237
|
-
|
$9,237
|
Jeremy
Goodwin (2)
|
2006
|
$10,000
|
-
|
-
|
$10,000
|
(1)
|
Valuation
based on the dollar amount of option grants recognized for financial
statement reporting purposes pursuant to FAS 123(R). On December
15, 2006,
the board of directors cancelled all options granted in 2005 and
2006.
|
(2)
|
As
per Mr. Goodwin’s request the director fees for 2006 were paid in
cash.
|
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 options 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.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
The
following table sets forth as of December 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.
NAME
AND ADDRESS OF BENEFICIAL OWNER
|
NUMBER
OF SHARES STOCK
BENEFICIALLY OWNED(1)
|
%
OF COMMON STOCK
BENEFICIALLY OWNED
|
Sino
Mart Management Ltd. (2)
c/o
ChoSam Tong
16E,
Mei On Industrial Bldg.17 Kung Yip Street, Kwai Chung, NT, Hong
Kong
|
1,851,160
|
16.04%
|
ChoSam
Tong (3)
16E,
Mei On Industrial Bldg. 17 Kung Yip Street, Kwai Chung, NT, Hong
Kong
|
1,861,160
|
16.13%
|
Kin
Shing Li (4)
Rm.
3813, Hong Kong Plaza 188 Connaught Road West, Hong Kong
|
1,150,000
|
9.97%
|
Tony
Tong (5)
|
371,000
|
3.22%
|
Victor
Tong (6)
|
171,000
|
1.48%
|
ShaoJian
(Sean) Wang (7)
|
56,000
|
*
|
Peter
Wang (8)
|
25,000
|
*
|
Michael
Chun Ha
|
0
|
*
|
Tao
Jin (9)
|
12,000
|
*
|
Jeremy
Goodwin
|
0
|
*
|
All
directors and officers as a group (7 persons)
|
635,000
|
5.5%
|
*
Less
than one percent.
**
The
address for each beneficial owner not otherwise specified is: c/o PacificNet
Inc., 23/F,
Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang District, Beijing,
China,100028
(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.
ChoSam Tong. Also includes 10,000 shares issuable upon exercise of
Currently Exercisable Options owned by Mr. ChoSam Tong.
|
(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 75,000 shares of common
stock.
|
(6)
|
Includes
Currently Exercisable Options to acquire 75,000 shares of common
stock.
|
(7)
|
Includes
Currently Exercisable Options to acquire 40,000 shares of common
stock.
|
(8)
|
Represents
shares issuable upon exercise of Currently Exercisable
Options.
|
(9)
|
Includes
2,000 shares issuable upon exercise of Currently Exercisable
Options.
|
There
were no transactions, or currently proposed transactions in an amount exceeding
$120,000, since the beginning of the Company’s last fiscal year in which the
Company was or is to be a participant and in which any related person had or
will have a direct or indirect material interest.
We
will
reimburse our officers and directors for any reasonable out-of-pocket business
expenses incurred by them in connection with certain activities on our behalf
such as identifying and investigating possible target businesses and business
combinations. There is no limit on the amount of accountable out-of-pocket
expenses reimbursable by us, which will be reviewed only by our board or a
court
of competent jurisdiction if such reimbursement is challenged.
All
ongoing and future transactions between us and any of our officers and directors
or their respective affiliates, including loans by our officers and directors,
will be on terms believed by us to be no less favorable than are available
from
unaffiliated third parties and such transactions or loans, including any
forgiveness of loans, will require prior approval in each instance by a majority
of our uninterested “independent” directors (to the extent we have any) or the
members of our board who do not have an interest in the transaction, in either
case, who had access, at our expense, to our attorneys or independent legal
counsel.
Our
board
of directors has determined that Peter Wang, Michael Ha, Jeremy Goodwin and
Tao
Jin are considered “independent”
under
Section 121(B) (as currently applicable to the Company) of the listing standards
of The NASDAQ Stock Market.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During
fiscal years ended December 31, 2006 and 2005, our principal independent
auditors were Kabani & Company, Inc. (“Kabani”), Clancy and Co., P.L.L.C.
and its Hong Kong affiliate HLB Hodgson Impey Cheng (collectively, "Clancy").
Clancy resigned as our independent auditor on January 19, 2007. The following
is
a summary of the services provided and fees billed to us by Clancy during 2006
and 2005.
AUDIT
FEES
An
aggregate of $160,000 has been accrued for professional services rendered
by
Kabani for the Audit of the Financial Statements for the year ended December
31,
2006.
During
2006, the aggregate fees billed by Clancy for professional services rendered
for
the review of the financial statements included in the Company’s Registration
Statement on Form S-1, including amendments thereto, the Company's Quarterly
Reports on Form 10-Q during the fiscal year ended December 31, 2006, and the
Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31,
2005, and amendments thereto, was $150,000.
During
2005, the aggregate fees billed by Clancy for professional services rendered
for
the audit of the Company's annual financial statements for the fiscal year
ended
December 31, 2004 included in the Company’s Annual Report on Form 10-KSB, and
for the review of the financial statements included in the Company's Quarterly
Reports on Form 10-QSB during the fiscal year ended December 31, 2005 was
$182,400.
AUDIT
RELATED FEES
NONE.
TAX
FEES
NONE.
ALL
OTHER FEES
NONE.
PRE-APPROVAL
OF SERVICES
The
Audit
Committee pre-approves all services, including both audit and non-audit
services, provided by our independent accountants. For audit services, each
year
the independent auditor provides the Audit Committee with an engagement letter
outlining the scope of the audit services proposed to be performed during the
year, which must be formally accepted by the audit commences. The independent
auditor also submits an audit services fee proposal, which also must be approved
by the audit commences.
PART
IV
ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBITS
The
following exhibits are filed as part of this report:
EXHIBIT
NUMBER
|
DESCRIPTION
|
3.1
|
Certificate
of Incorporation, as amended. (1)
|
3.2
|
Form
of Amended By Laws of the Company.(1)
|
4.0
|
Specimen
Stock Certificate of the Company (3)
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet
Inc.
and the purchasers identified therein (2)
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(2)
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated December
9, 2004 (3)
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated November
17, 2004 (3)
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc.
and the
Holders identified therein (4)
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to each
of
the Holders (4)
|
4.6(a)+
|
Form
of Amended and Restated Variable Rate Convertible Debenture due March
2009
issued to each of the Holders
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(4)
|
4.8
|
Form
of Registration Rights Agreement, dated February 28,
2006(5)
|
4.9+
|
Form
of Variable Rate Convertible Debenture due February
2009
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(6)
|
10.2
|
Amendment
to 1998 Stock Option Plan. (7)
|
10.3
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription
of
Shares in Epro Telecom Holdings Limited (8)
|
10.4
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares in
Beijing
Linkhead Technologies Co., Ltd. (8)
|
10.5
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet
Inc.
and the purchasers identified therein (3)
|
10.6
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet
Inc.
and the purchasers identified therein (3)
|
10.7
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
10.8
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(9)
|
10.9
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
10.10
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science and Technology Ltd. (11)
|
10.11
|
PacificNet
Inc. Amended
and Restated 2005 Stock Option Plan (10)
|
10.12
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information Technology
Co., Ltd. (11)
|
10.13
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(11
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(12)
|
10.15
|
Form
of Lock-Up Agreement, dated March 13, 2006(5)
|
10.16
|
Form
of Voting Agreement, dated March 13, 2006(5)
|
10.17
|
Agreement
among PacificNet Strategic Investment Holdings Limite, Shenzhen
GuHaiGuanChao Investment Consultant Co., Ltd., Lion Zone Holdings
Limited
and Mr. Wang Wenming for the termination of “the Agreement for the Sale
and Purchase 51% Shares of Lion Zone Holdings Limited”
(13)
|
10.18+
|
Tony
Tong Employment Agreement
|
10.19+
|
Victor
Tong Employment Agreement
|
10.20
|
Consulting
Service Agreement with Daniel Howing Lui (14)
|
14
|
Code
of Ethics (8)
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
|
Corporate
structure chart of our corporate and share ownership structure
|
+
Filed
herewith.
(1) |
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.
|
(2) |
Incorporated
by reference to the Registration Statement on Form S-3 filed on March
2,
2004
|
(3) |
Incorporated
by reference to the Form SB-2 Registration Statement filed on December
30,
2004.
|
(4) |
Incorporated
by reference to the Company's Form 8-K filed on March 6,
2006
|
(5) |
Incorporated
by reference to the Company’s Form 10-KSB/A filed on November 3,
2006.
|
(6) |
Incorporated
by reference to the Company's Form SB-2 filed on October 21,
1998.
|
(7) |
Incorporated
by reference to the Company's 10-KSB filed on March 31,
2003.
|
(8) |
Incorporated
by referenced to the Company's Form 10-KSB filed on April 2,
2004.
|
(9) |
Incorporated
by reference to the Company's Form 8-K filed on April 19,
2004.
|
(10) |
Incorporated
by reference to the Company’s Definitive Proxy Statement filed on October
26, 2006.
|
(11) |
Incorporated
by reference to the Company’s Form 10-KSB filed on April 19,
2005.
|
(12) |
Incorporated
by reference to the Company's Form 8-K filed on December 20,
2005.
|
(13) |
Incorporated
by reference to the Company’s Form 8-K filed on November 27,
2006.
|
(14) |
Incorporated
by reference to the Company’s Form 8-K filed on February 23,
2007.
|
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:
May 10, 2007
|
BY:
/S/ TONY TONG
|
|
|
|
Tony
Tong
Chief
Executive Officer (Principal Executive Officer)
|
|
|
|
|
|
|
Date:
May 10, 2007
|
BY:
/S/ DANIEL LUI
|
|
|
|
Daniel
Lui
Chief
Financial Officer (Principal Financial Officer)
|
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
NAME
|
|
TITLE
|
DATE
|
|
|
|
|
/s/
TONY TONG
|
|
Director,
Chairman and CEO
|
May
10, 2007
|
Tony
Tong
|
|
|
|
|
|
|
|
/s/
VICTOR TONG
|
|
Director,
President
|
May
10, 2007
|
Victor
Tong
|
|
|
|
|
|
|
|
/s/
DANIEL LUI
|
|
Chief
Financial Officer
|
May
10, 2007
|
|
|
|
|
|
|
|
|
/s/
PETER WANG
|
|
Director
|
May
10, 2007
|
Peter
Wang
|
|
|
|
|
|
|
|
/s/
MICHAEL CHUN HA
|
|
Director
|
May
10, 2007
|
Michael
Chun Ha
|
|
|
|
|
|
|
|
/s/
TAO JIN
|
|
Director
|
May
10, 2007
|
Tao
Jin
|
|
|
|
|
|
|
|
/s/
JEREMY GOODWIN
|
|
Director
|
May
10, 2007
|
Jeremy
Goodwin
|
|
|
|
|
|
|
|
/s/
ShaoJian (Sean) Wang
|
|
Director
|
May
10, 2007
|
ShaoJian
(Sean) Wang
|
|
|
|
EXHIBITS
EXHIBIT
NUMBER
|
DESCRIPTION
|
3.1
|
Certificate
of Incorporation, as amended. (1)
|
3.2
|
Form
of Amended By Laws of the Company.(1)
|
4.0
|
Specimen
Stock Certificate of the Company (3)
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet
Inc.
and the purchasers identified therein (2)
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(2)
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated December
9, 2004 (3)
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated November
17, 2004 (3)
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc.
and the
Holders identified therein (4)
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to each
of
the Holders (4)
|
4.6(a)+
|
Form
of Amended and Restated Variable Rate Convertible Debenture due March
2009
issued to each of the Holders
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(4)
|
4.8
|
Form
of Registration Rights Agreement, dated February 28,
2006(5)
|
4.9+
|
Form
of Variable Rate Convertible Debenture due February
2009
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(6)
|
10.2
|
Amendment
to 1998 Stock Option Plan. (7)
|
10.3
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription
of
Shares in Epro Telecom Holdings Limited (8)
|
10.4
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares in
Beijing
Linkhead Technologies Co., Ltd. (8)
|
10.5
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet
Inc.
and the purchasers identified therein (3)
|
10.6
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet
Inc.
and the purchasers identified therein (3)
|
10.7
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
10.8
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(9)
|
10.9
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
10.10
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science and Technology Ltd. (11)
|
10.11
|
PacificNet
Inc. Amended
and Restated 2005 Stock Option Plan (10)
|
10.12
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information Technology
Co., Ltd. (11)
|
10.13
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(11
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(12)
|
10.15
|
Form
of Lock-Up Agreement, dated March 13, 2006(5)
|
10.16
|
Form
of Voting Agreement, dated March 13, 2006(5)
|
10.17
|
Agreement
among PacificNet Strategic Investment Holdings Limite, Shenzhen
GuHaiGuanChao Investment Consultant Co., Ltd., Lion Zone Holdings
Limited
and Mr. Wang Wenming for the termination of “the Agreement for the Sale
and Purchase 51% Shares of Lion Zone Holdings Limited”
(13)
|
10.18+
|
Tony
Tong Employment Agreement
|
10.19+
|
Victor
Tong Employment Agreement
|
10.20
|
Consulting
Service Agreement with Daniel Howing Lui (14)
|
14
|
Code
of Ethics (8)
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
99.1+
|
Corporate
structure chart of our corporate and share ownership structure
|
(1) |
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.
|
(2) |
Incorporated
by reference to the Registration Statement on Form S-3 filed on March
2,
2004
|
(3) |
Incorporated
by reference to the Form SB-2 Registration Statement filed on December
30,
2004.
|
(4) |
Incorporated
by reference to the Company's Form 8-K filed on March 6,
2006
|
(5) |
Incorporated
by reference to the Company’s Form 10-KSB/A filed on November 3,
2006.
|
(6) |
Incorporated
by reference to the Company's Form SB-2 filed on October 21,
1998.
|
(7) |
Incorporated
by reference to the Company's 10-KSB filed on March 31,
2003.
|
(8) |
Incorporated
by referenced to the Company's Form 10-KSB filed on April 2,
2004.
|
(9) |
Incorporated
by reference to the Company's Form 8-K filed on April 19,
2004.
|
(10) |
Incorporated
by reference to the Company’s Definitive Proxy Statement filed on October
26, 2006.
|
(11) |
Incorporated
by reference to the Company’s Form 10-KSB filed on April 19,
2005.
|
(12) |
Incorporated
by reference to the Company's Form 8-K filed on December 20,
2005.
|
(13) |
Incorporated
by reference to the Company’s Form 8-K filed on November 27,
2006.
|
(14) |
Incorporated
by reference to the Company’s Form 8-K filed on February 23,
2007.
|
|
Report
of Independent Registered Public Accounting
Firm
|
F-1
|
|
Consolidated
Balance Sheets - As of December 31, 2006 and
2005
|
F-2
|
|
Consolidated
Statements of Operations - For the Years Ended
December
31, 2006, December 31, 2005 (unaudited/restated) and December 31,
2004 (unaudited/restated)
|
F-3
|
|
Consolidated
Statements of Changes in Stockholders' Equity
-
For the Years Ended December 31, 2006, December 31, 2005
(unaudited/restated) and December 31, 2004
(unaudited/restated)
|
F-4
|
|
Consolidated
Statements of Cash Flows
-
For the Years Ended December 31, 2006, December 31, 2005
(unaudited/restated) and December 31, 2004
(unaudited/restated)
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of Pacific Net Inc.
We
have
audited the accompanying consolidated balance sheet of PacificNet Inc (a
Delaware Corporation) and Subsidiaries as of December 31, 2006 and the related
consolidated income statements, changes in stockholders’ equity and cash flows
for the year 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 audit. The
financial statements of PacificNet Inc. and Subsidiaries as of December 31,
2005
and 2004 were audited by other auditor whose report dated April 25, 2006,
expressed an unqualified opinion on those financial statements. As discussed
in
Note 18 to the financial statements, the Company has adjusted its 2005 and
2004
financial statements to retrospectively apply the stock option pricing. The
other auditor reported on the financial statements before the retrospective
adjustment. The other auditor has withdrawn their opinion.
We
conducted our audit in accordance with the standard established by the Public
Company Accounting Oversight Board (United States). Those standards require
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 audit 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, 2006 and the results of their consolidated
operations and cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. During the year ended
December 31, 2006, the Company incurred net losses of $20,093,000. In
addition, the Company had a negative cash flow in operating activities amounting
to $8,885,000 in the year ended December 31, 2006, and the Company’s accumulated
deficit was $47,739,000 as of December 31, 2006. In addition, the Company is
in
default on its convertible debenture obligation. These factors, among others,
as
discussed in Note 1 to the consolidated financial statements, raise substantial
doubt about the Company’s ability to continue as a going concern. Management’s
plans in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from
the
outcome of this uncertainty. As discussed in Note 18, the financial statements
for the two years ended December 31, 2005 and 2004 have been restated.
/s/
KABANI & COMPANY, INC.
LOS
ANGELES, CA
March
30,
2007
CONSOLIDATED
BALANCE SHEETS
(In
thousands of United States dollars, except par values and share
numbers)
|
|
As
at December 31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
(Restated)
(Unaudited)
|
|
ASSETS
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,900
|
|
$
|
3,487
|
|
Restricted
cash - pledged bank deposit
|
|
|
234
|
|
|
163
|
|
Accounts
receivables, net of allowance for doubtful accounts of $3,400
and $5
|
|
|
8,141
|
|
|
4,327
|
|
Inventories
|
|
|
201
|
|
|
27
|
|
Loan
receivable from related parties
|
|
|
1,706
|
|
|
2,257
|
|
Loan
receivable from third parties
|
|
|
128
|
|
|
1,572
|
|
Marketable
equity securities - available for sale
|
|
|
558
|
|
|
539
|
|
Other
current assets
|
|
|
4,173
|
|
|
2,281
|
|
Total
Current Assets
|
|
|
17,041
|
|
|
14,653
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
4,711
|
|
|
1,320
|
|
Investments
in affiliated companies and subsidiaries
|
|
|
115
|
|
|
410
|
|
Intangible
assets, net
|
|
|
323
|
|
|
|
|
Goodwill
|
|
|
6,552
|
|
|
4,915
|
|
Other
assets
|
|
|
471
|
|
|
-
|
|
Net
assets held for disposition
|
|
|
12,669
|
|
|
23,300
|
|
TOTAL
ASSETS
|
|
$
|
41,882
|
|
$
|
44,598
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$
|
855
|
|
$
|
1,060
|
|
Bank
loans-current portion
|
|
|
576
|
|
|
188
|
|
Capital
lease obligations - current portion
|
|
|
120
|
|
|
126
|
|
Accounts
payable
|
|
|
1,266
|
|
|
605
|
|
Accrued
expenses and other payables
|
|
|
2,110
|
|
|
880
|
|
Income
tax payable
|
|
|
70
|
|
|
12
|
|
Subscription
payable
|
|
|
-
|
|
|
775
|
|
Loan
payable to related party
|
|
|
638
|
|
|
369
|
|
Convertible
debenture
|
|
|
8,000
|
|
|
-
|
|
Warrant
Liability |
|
|
904 |
|
|
- |
|
Liquidated
damages liability
|
|
|
2,837
|
|
|
-
|
|
Total
Current Liabilities
|
|
|
17,376
|
|
|
4,015
|
|
Long-term
liabilities:
|
|
|
|
|
|
|
|
Bank
loans - noncurrent portion
|
|
|
1,635
|
|
|
6
|
|
Capital
lease obligations - noncurrent portion
|
|
|
124
|
|
|
78
|
|
Convertible
debenture - noncurrent portion
|
|
|
945
|
|
|
-
|
|
Total
long-term liabilities
|
|
|
2,704
|
|
|
84
|
|
Total
liabilities
|
|
|
20,080
|
|
|
4,099
|
|
Minority
interest in consolidated subsidiaries
|
|
|
6,874
|
|
|
8,714
|
|
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, 2006 - 14,155,597 issued, 11,538,664 outstanding
|
|
|
- |
|
|
- |
|
December
31, 2005 - 12,000,687 shares issued, 10,831,024 outstanding
|
|
|
1
|
|
|
1
|
|
Treasury
stock, at cost (2006: 2,616,933 shares ;2005: 1,169,663 shares)
|
|
|
(257
|
)
|
|
(119
|
)
|
Additional
paid-in capital
|
|
|
63,124
|
|
|
59,346
|
|
Cumulative
other comprehensive income
|
|
|
220
|
|
|
247
|
|
Accumulated
deficit
|
|
|
(47,739
|
)
|
|
(27,646
|
)
|
Stock
subscription receivable
|
|
|
(421
|
)
|
|
(44
|
)
|
Total
Stockholders' Equity
|
|
|
14,928
|
|
|
31,785
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
41,882
|
|
$
|
44,598
|
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(In
thousands of United States dollars, except loss per share and share
amounts)
|
|
For
the Years Ended December 31,
|
|
|
|
|
|
(Restated)
(Unaudited)
|
|
(Restated)
(Unaudited)
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
YEAR
ENDED DECEMBER 31:
|
|
|
|
|
|
|
|
Net
Revenues
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
$
|
16,790
|
|
$
|
13,970
|
|
$
|
10,222
|
|
Product
sales
|
|
|
25,948
|
|
|
3,216
|
|
|
849
|
|
Total
net revenue
|
|
|
42,738 |
|
|
17,186 |
|
|
11,071 |
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Revenues
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Services
|
|
|
(12,155
|
)
|
|
(10,108
|
)
|
|
(6,507
|
)
|
Product
sales
|
|
|
(24,062
|
)
|
|
(2,842
|
)
|
|
(899
|
)
|
Total
cost of revenue
|
|
|
(36,217 |
) |
|
(12,950 |
) |
|
(7,406 |
) |
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
6,521
|
|
|
4,236
|
|
|
3,665
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
Selling,
General and Administrative expenses
|
|
|
(5,810
|
)
|
|
(3,411
|
)
|
|
(3,245
|
)
|
Stock-based
compensation expenses
|
|
|
(242
|
)
|
|
-
|
|
|
-
|
|
Restated
stock-based compensation expenses
|
|
|
-
|
|
|
(282
|
)
|
|
(1,246
|
)
|
Provision
for doubtful accounts
|
|
|
(6,173
|
)
|
|
-
|
|
|
-
|
|
Depreciation
and amortization
|
|
|
(1,463
|
)
|
|
(254
|
)
|
|
(78
|
)
|
Goodwill
impairment
|
|
|
(6,821
|
)
|
|
-
|
|
|
-
|
|
Total
Operating expenses
|
|
|
(20,509
|
)
|
|
(3,947
|
)
|
|
(4,569
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Income/(loss)
from continued operations
|
|
|
(13,988
|
)
|
|
289
|
|
|
(904
|
)
|
Other
income (expenses):
|
|
|
|
|
|
|
|
|
|
|
Interest
income/(expense), net
|
|
|
1,192
|
|
|
49
|
|
|
(106
|
)
|
Gain
(loss) in change in fair value of derivatives
|
|
|
(214
|
)
|
|
-
|
|
|
-
|
|
Liquidated
damages expense
|
|
|
(3,817
|
)
|
|
-
|
|
|
-
|
|
Sundry
income, net
|
|
|
105
|
|
|
445
|
|
|
21
|
|
Total
other income (expense)
|
|
|
(5,118
|
)
|
|
494
|
|
|
(85
|
)
|
Income
from continued operations before Income Taxes, Minority Interests
and
Discontinued Operations
|
|
|
(19,106
|
)
|
|
783
|
|
|
(989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
(63
|
)
|
|
(93
|
)
|
|
(22
|
)
|
Share
of earnings from investment on equity method
|
|
|
17
|
|
|
(8
|
)
|
|
32
|
|
Minority
Interests
|
|
|
153
|
|
|
(763
|
)
|
|
(558
|
)
|
Income
from continued operations
|
|
|
(18,999
|
)
|
|
(81
|
)
|
|
(1,537
|
)
|
Income
(loss) from discontinued operations:
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Loss
on disposal
|
|
|
(1,207
|
)
|
|
-
|
|
|
-
|
|
Loss
from discontinued operations
|
|
|
113
|
|
|
2,288
|
|
|
1,065
|
|
Total
income (loss) from discontinued operations
|
|
|
(1,096
|
) |
|
2,288
|
|
|
1,065
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME (LOSS)
|
|
|
(20,093
|
)
|
|
2,207
|
|
|
(472
|
)
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
Foreign
exchange gain (loss)
|
|
|
(27
|
)
|
|
247
|
|
|
-
|
|
Net
comprehensive income (loss)
|
|
$
|
(20,120
|
)
|
$
|
2,454
|
|
$
|
(472
|
)
|
|
|
|
|
|
|
|
|
|
|
|
BASIC
EARNINGS PER COMMON SHARE:
|
|
|
|
|
|
|
|
|
|
|
Earnings
from continuing operations
|
|
$
|
(1.69
|
)
|
$
|
(0.01
|
)
|
$
|
(0.21
|
)
|
Earnings
from discontinued operations
|
|
$
|
(0.10
|
)
|
$
|
0.23
|
|
$
|
0.15
|
|
Net
earnings per common share
|
|
$
|
(1.78
|
)
|
$
|
0.22
|
|
$
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED
EARNINGS PER COMMON SHARE:
|
|
|
|
|
|
|
|
|
|
|
Earnings
from continuing operations
|
|
$
|
(1.69
|
)
|
$
|
(0.01
|
)
|
$
|
(0.19
|
)
|
Earnings
from discontinued operations
|
|
$
|
(0.10
|
)
|
$
|
0.21
|
|
$
|
0.13
|
|
Net
earnings per diluted share
|
|
$
|
(1.78
|
)
|
$
|
0.21
|
|
$
|
(0.06
|
)
|
Weighted
average number of shares (Basic):
|
|
|
11,258,547 |
|
|
10,154,271
|
|
|
5,234,744
|
|
Weighted
average number of shares (Diluted):
|
|
|
11,964,587 |
|
|
10,701,211
|
|
|
5,234,744
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For
the
Years Ended December 31, 2004 (Restated, Unaudited), 2005 (Restated, Unaudited)
and 2006.
(In
thousands of United States dollars)
|
|
Common
Stock
(Outstanding)
|
|
|
|
|
|
|
|
|
|
Treasury
Stock
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Additional
Paid-in
Capital
|
|
Stock
Subscription
Receivable
|
|
Cumulative
Other
Comprehensive
Income/(loss)
|
|
Accumulated
Deficit
(Restated)
|
|
Shares
|
|
Amount
|
|
Total
Stockholder's
Equity
(Restated)
|
|
Balance
at December 31, 2003, as restated
|
|
|
5,363,977
|
|
$
|
1
|
|
$
|
31,918
|
|
$
|
--
|
|
$
|
(24
|
)
|
$
|
(29,381
|
)
|
|
800,000
|
|
$
|
(5
|
)
|
$
|
2,509
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
1,756,240
|
|
|
--
|
|
|
8,866
|
|
|
|
|
|
--
|
|
|
--
|
|
|
|
|
|
|
|
|
8,866
|
|
Proceeds
from the sale of common stock, net of related costs
|
|
|
2,205,697
|
|
|
--
|
|
|
11,773
|
|
|
|
|
|
--
|
|
|
--
|
|
|
|
|
|
|
|
|
11,773
|
|
Issuance
of common stock for acquisition of Cheer Era
|
|
|
149,459
|
|
|
--
|
|
|
771
|
|
|
|
|
|
--
|
|
|
--
|
|
|
|
|
|
|
|
|
771
|
|
Repurchase
of common shares
|
|
|
-36154
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
36,154
|
|
|
(99
|
)
|
|
(99
|
)
|
Exercise
of stock options and warrants for cash
|
|
|
352,364
|
|
|
|
|
|
716
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
716
|
|
Issuance
of stock options
|
|
|
|
|
|
|
|
|
1,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,246
|
|
Net
loss
|
|
|
|
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
(472
|
)
|
|
|
|
|
|
|
|
(472
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
AT DECEMBER 31, 2004
|
|
|
9,791,583
|
|
|
1
|
|
|
55,290
|
|
|
|
|
|
(24
|
)
|
|
(29,853
|
)
|
|
836,154
|
|
|
(104
|
)
|
|
25,310
|
|
Foreign
currency translation gain
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
271
|
|
|
|
|
|
|
|
|
|
|
|
271
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
515,900
|
|
|
--
|
|
|
3,971
|
|
|
|
|
|
--
|
|
|
--
|
|
|
161,050
|
|
|
--
|
|
|
3,971
|
|
Issuance
of common stock for services
|
|
|
20,000
|
|
|
|
|
|
63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
63
|
|
PIPE
related Expenses
|
|
|
|
|
|
--
|
|
|
(547
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(547
|
)
|
Repurchase
of common shares for acquisition of Cheer Era
|
|
|
-149,459
|
|
|
--
|
|
|
(771
|
)
|
|
|
|
|
|
|
|
|
|
|
149,459
|
|
|
--
|
|
|
(771
|
)
|
Cancellation
of common shares
|
|
|
-45,000
|
|
|
--
|
|
|
--
|
|
|
|
|
|
--
|
|
|
--
|
|
|
45,000
|
|
|
--
|
|
|
--
|
|
Repurchase
of common shares
|
|
|
-2,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000
|
|
|
(15
|
)
|
|
(15
|
)
|
Exercise
of stock options and warrants for cash
|
|
|
700,000
|
|
|
|
|
|
1,058
|
|
|
|
|
|
|
|
|
|
|
|
-24,000
|
|
|
|
|
|
1,058
|
|
Stock
subscription receivable
|
|
|
|
|
|
|
|
|
|
|
|
(44
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(44
|
)
|
Issuance
of stock options
|
|
|
|
|
|
--
|
|
|
282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
282
|
|
Net
income
|
|
|
|
|
|
--
|
|
|
--
|
|
|
|
|
|
--
|
|
|
2,207
|
|
|
|
|
|
|
|
|
2,207
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
AT DECEMBER 31, 2005
|
|
|
10,831,024
|
|
|
1
|
|
|
59,346
|
|
|
(44
|
)
|
|
247
|
|
|
(27,646
|
)
|
|
1,169,663
|
|
|
(119
|
)
|
|
31,785
|
|
Exercise
of stock options for cash and receivable
|
|
|
394,000
|
|
|
|
|
|
834
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
834
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
618,112
|
|
|
|
|
|
4,346
|
|
|
|
|
|
|
|
|
|
|
|
1,142,798
|
|
|
|
|
|
4,346
|
|
Cancellation
of common stock for acquisition of subsidiaries
|
|
|
-275,000
|
|
|
|
|
|
(1,672
|
)
|
|
|
|
|
|
|
|
|
|
|
275,000
|
|
|
|
|
|
(1,672
|
)
|
Repurchase
of common shares - Treasury shares
|
|
|
-29,472
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29,472
|
|
|
(138
|
)
|
|
(138
|
)
|
Foreign
currency translation loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(27
|
|
|
|
|
|
|
|
|
|
|
|
(27
|
)
|
Issuance
of stock options
|
|
|
|
|
|
|
|
|
242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
242
|
|
Issuance
of warrants for issuing fee of convertible debts (16,000
warrants)
|
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
Stock
subscription receivable
|
|
|
|
|
|
|
|
|
|
|
|
(377
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(377
|
)
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(20,093
|
)
|
|
|
|
|
|
|
|
(20,093
|
)
|
BALANCE
AT DECEMBER 31, 2006
|
|
|
11,538,664
|
|
$
|
1
|
|
$
|
63,124
|
|
$
|
(421
|
)
|
$
|
220
|
|
$
|
(47,739
|
)
|
|
2,616,933
|
|
$
|
(257
|
)
|
$
|
14,928
|
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands of United States dollars, except profit per share and share
amounts)
|
|
For
the Years Ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
Cash
Flows from operating activities
|
|
|
|
(Restated)
(Unaudited)
|
|
(Restated)
(Unaudited)
|
|
Net
income (loss)
|
|
|
(20,093
|
)
|
|
2,207
|
|
|
(472
|
)
|
Adjustment
to reconcile net income (loss) to net cash provided by (used in)
operating
activities:
|
|
|
|
|
|
|
|
|
|
|
Share
of earnings from investment on equity method
|
|
|
(17
|
)
|
|
8
|
|
|
(32
|
)
|
Common
stock issued for services rendered
|
|
|
-
|
|
|
63
|
|
|
-
|
|
Provision
for allowance for doubtful accounts
|
|
|
6,173
|
|
|
-
|
|
|
-
|
|
Minority
Interest
|
|
|
(153
|
)
|
|
763
|
|
|
558
|
|
Depreciation
and amortization
|
|
|
1,661
|
|
|
254
|
|
|
78
|
|
Inventory
write down charge
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Loss
from discontinued operation
|
|
|
1,094
|
|
|
(2,288
|
) |
|
(1,065
|
) |
Goodwill
impairment
|
|
|
6,821
|
|
|
-
|
|
|
-
|
|
Stock-based
compensation
|
|
|
242
|
|
|
282
|
|
|
1,246
|
|
Change
in fair value of derivatives
|
|
|
214
|
|
|
-
|
|
|
-
|
|
Amortization
of interest discount
|
|
|
690
|
|
|
-
|
|
|
-
|
|
Liquidated
damages expense
|
|
|
3,817
|
|
|
-
|
|
|
-
|
|
Changes
in current assets & liabilities net of effects from purchase of
subsidiaries:
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Accounts
receivable and other current assets
|
|
|
(10,689
|
)
|
|
776
|
|
|
(5,451
|
)
|
Inventories
|
|
|
(38
|
)
|
|
79
|
|
|
(30
|
)
|
Accounts
payable and accrued expenses
|
|
|
391
|
|
|
(1,452
|
)
|
|
1,612
|
|
Net
cash provided by (used in) operating activities
|
|
|
(8,885
|
)
|
|
692
|
|
|
(3,556
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
Decrease
in restricted cash
|
|
|
(70
|
)
|
|
3,338
|
|
|
(3,289
|
)
|
Increase
in purchase of marketable securities
|
|
|
(19
|
)
|
|
(521
|
)
|
|
(29
|
)
|
Acquisition
of property and equipment
|
|
|
(2,608
|
)
|
|
(570
|
)
|
|
(696
|
)
|
Acquisition
of subsidiaries and affiliated companies
|
|
|
(667
|
)
|
|
(1,183
|
)
|
|
(724
|
)
|
Loans
receivable from third parties
|
|
|
1,281
|
|
|
(2,257
|
)
|
|
-
|
|
Loans
receivable from related parties
|
|
|
(342
|
)
|
|
(1,572
|
)
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(2,425
|
)
|
|
(2,765
|
)
|
|
(4,738
|
)
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS PROVIDED BY FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
Loans
payable to related party
|
|
|
269
|
|
|
369
|
|
|
|
|
Advances
(repayments) under bank line of credit
|
|
|
(205
|
)
|
|
409
|
|
|
(548
|
)
|
Increase
(repayment) of amount borrowed under capital lease obligations
|
|
|
40
|
|
|
(5
|
)
|
|
(92
|
)
|
Repurchase
of treasury shares
|
|
|
(138
|
)
|
|
(15
|
)
|
|
(99
|
)
|
Proceeds
from sale of common stock
|
|
|
|
|
|
|
|
|
11,773
|
|
Proceeds
from exercise of stock options and warrants
|
|
|
237
|
|
|
1,014
|
|
|
716
|
|
Net
proceeds from issuance of convertible debenture
|
|
|
7,500
|
|
|
|
|
|
|
|
Advances
under bank loans
|
|
|
935
|
|
|
(951
|
)
|
|
(637
|
)
|
Payment
of certain PIPE related expenses
|
|
|
-
|
|
|
(547
|
)
|
|
- |
|
Net
cash provided by financing activities
|
|
|
8,638
|
|
|
274
|
|
|
11,113
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate change on cash and cash equivalents
|
|
|
(43
|
)
|
|
31
|
|
|
17
|
|
Net
increase (decrease) in cash from subsidiaries held for
disposition
|
|
|
1,129
|
|
|
(1,098
|
)
|
|
(264
|
)
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
(1,587
|
)
|
|
(2,866
|
)
|
|
2,572
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
3,487
|
|
|
6,353
|
|
|
3,781
|
|
CASH
AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
1,900
|
|
$
|
3,487
|
|
$
|
6,353
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
PAID (RECEIVED) FOR:
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
664
|
|
$
|
229
|
|
$
|
20
|
|
Income
taxes
|
|
$
|
5
|
|
$
|
(53
|
)
|
$
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
NONCASH
INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
Fixed
assets acquired under banking loan
|
|
|
1,082
|
|
$
|
-
|
|
$
|
-
|
|
Options
exercised for share receivable
|
|
$
|
421
|
|
$
|
44
|
|
$
|
-
|
|
Investment
in subsidiaries acquired through issuance of subscriptions
payable
|
|
$
|
-
|
|
$
|
775
|
|
$
|
-
|
|
Investment
in subsidiaries acquired through issuance of common stock
|
|
$
|
4,346
|
|
$
|
3,971
|
|
$
|
9,637
|
|
The
accompanying notes form an integral part of these consolidated financial
statements
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 products
(telecom and gaming) 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). Our products (telecom and gaming) include
gaming technology and communication products distribution. The Company's
operations are primarily targeted in Greater China and certain Asian country
markets.
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES
OF CONSOLIDATION AND BASIS OF PRESENTATION
The
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America and present
the
financial statements of the Company and its wholly owned and majority-owned
subsidiaries including variable interest entities ("VIEs") for which the Company
is the primary beneficiary. All significant inter-company accounts and
transactions have been eliminated. Investments in entities in which the Company
can exercise significant influence, but which are less than majority owned
and
not otherwise controlled by the Company, are accounted for under the equity
method.
The
Company has adopted FASB Interpretation No. 46R "Consolidation of Variable
Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research
Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
consolidated by a company if that company is subject to a majority of the risk
of loss for the VIE or is entitled to receive a majority of the VIE's residual
returns. VIEs are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the company is the primary
beneficiary of these entities. Acquisitions of subsidiaries or variable interest
entities are accounted for using the purchase method of accounting. The results
of subsidiaries or variable interest entities acquired during the year are
included in the consolidated income statements from the effective date of
acquisition.
INITIAL
MEASUREMENT OF VIE- The Company initially measures the assets, liabilities,
and
non-controlling interests of the VIEs at their fair values at the date of the
acquisitions. Goodwill is recorded for the excess of the fair value of the
newly
consolidated assets and the reported amount of assets transferred by the primary
beneficiary to the VIE over the sum of the fair value of the consideration
paid,
the reported amount of any previously held interests, and the fair value of
the
newly consolidated liabilities and non-controlling interests are allocated
and
reported as a pro rata adjustment of the amounts that would have been assigned
to all of the newly consolidated assets as if the initial consolidation had
resulted from a business combination.
ACCOUNTING
AFTER INITIAL MEASUREMENT OF VIE - Subsequent accounting for the assets,
liabilities, and non-controlling interest of a consolidated variable interest
entity are accounted for as if the entity were consolidated based on voting
interests and the usual accounting rules for which the VIE operates are applied
as they would to a consolidated subsidiary as follows:
|
·
|
Carrying
amounts of the VIE are consolidated into the financial statements
of
PacificNet as the primary beneficiary (referred as "Primary Beneficiary"
or "PB")
|
|
·
|
Inter-company
transactions and balances, such as revenues and costs, receivables
and
payables between or among the Primary Beneficiary and the VIE(s)
are
eliminated in their entirety
|
|
·
|
There
is no direct ownership interest by the Primary Beneficiary in the
VIE,
equity of the VIE is eliminated with an offsetting credit to minority
interest
|
PRC
laws
and regulations restrict us, as a foreign entity, from having a direct
controlling interest in entities such as Beijing Xing
Chang Xin Sci -tech Development Co. Ltd (IMOBILE-DE) and Guangzhou Sunroom
Information Industry Co., Ltd. (Sunroom-DE) that hold operating licenses to
engage in domestic online ecommerce and telecom value-added services in China.
As a result, we conduct substantially all of our operations through Beijing
PacificNet IMOBILE Technology Co., Ltd (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
IMOBILE-DE and Sunroom-DE (the entities that actually carry out the operating
activities). These agreements provide that all of the DE profits will flow
through to the respective WOFEs. Pursuant to these agreements, the Company
guarantees any obligations undertaken by these companies under their contractual
agreements with third parties, and the Company is entitled to receive service
fees in an amount equal to 51% of the net income of these companies.
Accordingly, we bear the risks of and enjoy the rewards associated with the
investments in the WOFEs.
The
operations of DEs are managed by their original management teams, however,
the
Company has the power to appoint or change directors and senior management
because it indirectly ultimately controls the voting power of the shareholders
of each DE through the Power of Attorney given to PacificNet's President
according to the operating agreements between the DEs and WOFEs. Pursuant to
the
Consulting and Service Agreements signed between each WOFE and their respective
DE, the WOFE ("Party A") agrees to be the exclusive provider of telecom
consulting services to the DE ("Party B"). During the term of the agreement,
Party B shall not accept technical and consulting services provided by any
third
party. Party B agrees to pay a fee to Party A equal to 100% of its monthly
net
income for the services provided. Payment of the service fees has been secured
through a share pledge agreement with the shareholders of each of the DEs,
whereby they pledged all of their shares to the respective WOFE.
(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 Imobile-DE for entering into the acquisition
transactions while none of the investment consideration was injected into the
DEs. Therefore, additional funding from PacificNet is needed to support the
DEs'
business development and working capital.
(2)
Fees
from Service Contracts are substantial, but are not commensurate with the level
of service provided by the WOFEs to the DEs. The contractual and funding
arrangements with the DEs evidence that PacificNet has closely participated
in
the majority of the DEs' economics. PacificNet is the primary beneficiary
through its WOFE subsidiaries since PacificNet is the only enterprise with
a
sufficiently large interest in the VIEs. In compliance with PRC's foreign
investment restrictions on Internet Content Provider and Value Added Telecom
Services Provider's laws and regulations, the Company conducts all of its
value-added services for telecom in China via the following significant domestic
VIEs below. The respective management agreements between the VIE's and WOFE's
create a variable interest and accordingly, these two Vies are consolidated
as
VIE through their respective WOFEs from the date of acquisition.
The
following is a summary of all the VIEs of the Company:
Beijing Xing
Chang Xin Sci -tech Development Co. Ltd (the "Imobile-VIE"), a China company
controlled through business agreement. Through Imobile-VIE, a variable interest
entity, PacificNet is able to engage in the business of ICP, and operates mobile
distribution and value-added service in the PRC. The business of the VIE is
managed by their original management teams. Imobile-VIE is owned by Gao Chunhui,
CEO 51% and Liu Lei, COO 49%, of the Company. The registered capital of the
VIE
is RMB 2,000,000. 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.
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 revenues and net loss accounted for
approximately 11% and -1.2% of our consolidated revenues and net earnings before
minority interests, respectively.
The
initial capital investments in these VIEs were not funded by us but we have
provided loans to these VIEs to fund their R&D and expansion plans. As of
December 31, 2005, the amount of loans to Clickcom VIE and Sunroom VIE were
approximately US $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.
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. Fair market value of
the
identifiable assets and liabilities, including tangible and intangible, is
primarily ascertained with replacement cost method. At time of acquisition,
based on market research and discussion with management, a benchmark is
established with reference to comparable replacement cost in open market.
Occasionally, net book value is used as a fair market value equivalent if the
assets and liabilities of the newly acquired subsidiaries and/or VIEs were
either current in nature or newly established.
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 annually in accordance
with SFAS 142. The assessment includes first comparing implied P/E valuation
of
the goodwill carrying subsidiaries (adjusted by R&D expenses written off) to
benchmarks as found in comparable publicly traded companies. If a comfortable
buffer over the public benchmark does not exist, more sophisticated DCF
analysis, based on 5 year cash flows forecasts, will follow to ascertain if
goodwill impairment is warranted.
The
Company applies the criteria specified in SFAS No. 141, "Business Combinations"
to determine whether an intangible asset should be recognized separately from
goodwill. Intangible assets acquired through business acquisitions are
recognized as assets separate from goodwill if they satisfy either the
"contractual-legal" or "separability" criterion. Per SFAS 142, intangible assets
with definite lives are amortized over their estimated useful life and reviewed
for impairment in accordance with SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-lived Assets." Intangible assets, such as purchased
technology, trademark, customer list, user base and non-compete agreements,
arising from the acquisitions of subsidiaries and variable interest entities
are
recognized and measured at fair value upon acquisition. Intangible assets are
amortized over their estimated useful lives from one to ten years. The Company
reviews the amortization methods and estimated useful lives of intangible assets
at least annually or when events or changes in circumstances indicate that
it
might be impaired. The recoverability of an intangible asset to be held and
used
is evaluated by comparing the carrying amount of the intangible asset to its
future net undiscounted cash flows. If the intangible asset is considered to
be
impaired, the impairment loss is measured as the amount by which the carrying
amount of the intangible asset exceeds the fair value of the intangible asset,
calculated using a discounted future cash flow analysis. The Company uses
estimates and judgments in its impairment tests, and if different estimates
or
judgments had been utilized, the timing or the amount of the impairment charges
could be different.
We
currently have nine reporting units: EPRO, Smartime/Soluteck, Guangzhou 3G-WOFE
(assets held for disposition), iMobile-WOFE, Shanghai Classic (including
discontinued subsidiary - Yueshen), Wangrong, Clickcom (discontinued operation),
PacificNet Games, Linkhead (discontinued operation), but those that are marked
either assets held for disposition or discontinued are excluded for the purposes
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, to reflect the fair value of the assets and liabilities acquired
in the
transaction. The Company has one class of goodwill arising from business
combination resulting from the acquisitions of our subsidiaries. Goodwill
has been revised to reflect certain expenses that should have been written
off
prior to certain acquisitions, not subsequent to the acquisitions, to better
reflect the assets acquired and liabilities assumed in certain business
combinations during 2003 in accordance with SFAS No. 141, "Business
Combinations”. Originally, the Company had acquired certain intangible assets
such as research and development costs and related party receivables that
were
considered as part of the purchase price allocation, then subsequently expensed
them at year end.
The
total
carrying amount of goodwill recorded on the balance sheets at December 31,
2006
is $6,552,000 and the changes in the carrying amount of goodwill for the
following reporting periods are summarized below:
(US$000s)
|
|
Group
1.
Outsourcing
Services
|
|
Group
2.
Telecom
Value-Added
Services
|
|
Group
3.
Products
(Telecom
& Gaming
|
|
Total
|
|
Balance
as of December 31, 2003, as originally reported
|
|
$
|
567
|
|
$
|
-
|
|
$
|
-
|
|
$
|
567
|
|
Effect
of correction of an error
|
|
|
393
|
|
|
-
|
|
|
-
|
|
|
393
|
|
Balance
as of December 31,2003, as restated
|
|
|
960
|
|
|
-
|
|
|
-
|
|
|
960
|
|
Goodwill
acquired during the year
|
|
|
2,976
|
|
|
-
|
|
|
979
|
|
|
3,955
|
|
Balance
as of December 31, 2004
|
|
$
|
3,936
|
|
|
-
|
|
$
|
979
|
|
$
|
4,915
|
|
Goodwill
acquired during the year
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5,315
|
|
Balance
as of December 31, 2005
|
|
|
3,936
|
|
|
-
|
|
|
979
|
|
|
4,915
|
|
Goodwill
acquired during the year
|
|
|
-
|
|
|
461
|
|
|
1,176
|
|
|
1,637
|
|
Balance
as of December 31, 2006
|
|
$
|
3,936
|
|
$
|
461
|
|
$
|
2,155
|
|
$
|
6,552
|
|
The
Company assesses the need to record impairment losses on our goodwill assets
at
least annually or when an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount. The assessment includes using a combination of qualitative and
quantitative analyses such as DCF/PE multiples based on 5 year profit forecasts,
and published comparables, where applicable. The Company concluded that there
have been no material adverse changes on the operating environments during
the
reporting periods that would have otherwise affected the carrying value of
the
goodwill. In addition, there has been no disposal of any reporting subsidiaries
and, as a result, no gain or loss is recognized during those reporting
periods.
The
following table summarizes goodwill from the Company's acquisitions during
2006
and 2005:
(USD000s)
|
|
December
31, 2006
|
|
December
31, 2005
|
|
Epro
|
|
$
|
3,703
|
|
$
|
3,703
|
|
Shanghai
Classic (discontinue Yueshen)
|
|
|
979
|
|
|
979
|
|
Smartime
(Soluteck)
|
|
|
233
|
|
|
233
|
|
Billionaire
(Wangrong)
|
|
|
461
|
|
|
-
|
|
iMobile
|
|
|
430
|
|
|
-
|
|
PacificNet
Games
|
|
|
746
|
|
|
-
|
|
Total
|
|
$
|
6,552
|
|
$
|
4,915
|
|
The
following table summarizes the intangible assets acquired from PacificNet
Games:
(USD000s)
|
|
December
31, 2006
|
|
December
31, 2005
|
|
Technology
|
|
$
|
353
|
|
$
|
-
|
|
Less:
Accumulated amortization
|
|
|
(30
|
)
|
|
-
|
|
Net
|
|
$
|
323
|
|
$
|
-
|
|
Amortization
expense related to intangible assets was $30,000 in the year ended December
31,
2006.
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.
During
the year ended December 31, 2006 and 2005 the Company impaired goodwill as
follows:
(USD000s)
|
|
2006
|
|
2005
|
|
Linkhead
(discontinued)
|
|
$
|
4,295
|
|
$
|
-
|
|
Clickcom
(discontinue)
|
|
|
391
|
|
|
-
|
|
G3G
(assets held for disposal)
|
|
|
2,135
|
|
|
-
|
|
Total
|
|
$
|
6,821
|
|
$
|
-
|
|
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) Telecom Value-Added Telecom Services (VAS) including Content
Providing (CP), Interactive Voice Response (IVR), Platform Providing (PP) and
Service Providing (SP); and (3) Products (telecom & gaming) Services,
including calling cards, GSM/ CDMA/ XiaoLingTong products, and multimedia
self-service kiosks.
Revenues
from outsourcing services are recognized when the services are rendered.
Revenues from license agreements are recognized when a signed non-cancelable
software license exists, delivery has occurred, the Company's fee is fixed
or
determinable, and collectability is probable at the date of sale. Revenues
from
software development services are recognized when the customer accepts the
installation and no significant modification or customization work is involved,
in accordance with SOP 97-2 "Software Revenue Recognition." Revenues from
support services such as consulting, implementation and training services are
recognized when the services are performed, collectability is probable and
such
revenues are contractually nonrefundable.
Revenues
from value-added telecom services are derived principally from providing mobile
phone users with short messaging service ("SMS"), multimedia messaging service
("MMS"), color ring back tone ("CRBT"), wireless application protocol ("WAP")
and interactive voice response system ("IVR"). These services include news
and
other content subscriptions, mobile dating service, picture and logo download,
ring tones, ring back tones, mobile games, chat rooms and access to music files.
These revenues from are charged on a monthly or per-usage basis and are
recognized in the period in which the service is performed, provided that no
significant Company obligations remain, collection of the receivables is
reasonably assured and the amounts can be accurately estimated. In accordance
with EITF No. 99-19, "Reporting Revenues Gross as a Principal Versus Net as
an
Agent," revenues are recorded on a gross basis when the Company is considered
the primary obligor to the VAS users. Under the gross method, the amounts billed
to VAS users are recognized as revenues and the fees charged or retained by
the
third-party operators are recognized as cost of revenues.
Revenues
from the sale of products and systems are recognized when the product and system
is completed, shipped, and the risks and rewards of ownership have
transferred.
Revenues
from the distribution of all types of calling cards and product sales is
recognized in accordance with EITF No. 99-19, "Reporting Revenues Gross as
a
Principal Versus Net as an Agent," where revenues are recorded on a gross basis
when the Company is considered the primary obligor to the users, maintains
an
inventory of products before the products are ordered by customers, has latitude
in establishing the pricing power of products, is subject to physical inventory
loss risk, and has credit risk as it is responsible for collecting the sales
price from the customer and is responsible for paying the supplier regardless
of
whether or not the sales price is fully collectible.
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 doubtful accounts for all other customers based on a variety
of
factors including the length of time the receivables are past due, the financial
health of the customer, macroeconomic considerations and historical experience.
If circumstances related to specific customers change, the Company's estimates
of the recoverability of receivables could be further adjusted. Allowance
for doubtful accounts at December 31, 2006 was approximately $3,400 (2005:
$5).
PROPERTY
AND EQUIPMENT
Property
and equipment is stated at cost and depreciated using the straight-line method
over the shorter of the estimated useful life of the asset or the lease term,
ranging from three to five years. Significant improvements and betterments
are
capitalized. Routine repairs and maintenance are expensed when incurred. When
property and equipment is sold or otherwise disposed of, the asset account
and
related accumulated depreciation account are relieved, and any gain or loss
is
included in operations.
INVENTORIES
Inventories
consist of finished goods and are stated at the lower of cost or market value.
Cost is computed using the first-in, first-out method and includes all costs
of
purchase and other costs incurred in bringing the inventories to their present
location and condition. Market value is determined by reference to the sales
proceeds of items sold in the ordinary course of business after the balance
sheet date or management estimates based on prevailing market conditions. The
inventories consist of finished goods and represent telecommunication products
such as mobile phone, rechargeable phone cards, smart chip, and interactive
voice response cards.
Income
taxes 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, 2006 and 2005, the Company did
not capitalize any costs related to the purchase of software and related
technologies and content.
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 plus
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.
Diluted
EPS is calculated by dividing net earnings by the weighted average number of
common shares outstanding and other dilutive securities. Dilutive
earnings per share for 2006 exclude the potential dilutive effect of 889,456
warrants because their impact would be anti-dilutive based on current market
prices. 800,000
convertible debentures are tested by using if-converted method. The result
shows
when convertible debentures are included in the computation, diluted EPS
increases. According to SFAS No.128, those convertible debentures are ignored
in
the computation of diluted EPS. 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, 2006. As we have
a
net loss for reporting period, the effect of common stocks equivalent (options
+
warrants) is anti-dilutive, therefore, the “dilutive potential from assumed
exercised of stock options and warrants” is zero for year 2006:
|
|
FY
2006
|
|
FY2005
|
|
Numerator:
earnings (USD000s)
|
|
$
|
(20,093
|
)
|
$
|
2,207
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted-average
shares used to compute basic EPS
|
|
|
11,258,547
|
|
|
10,154,271
|
|
Dilutive
potential from assumed exercise of stock options
|
|
|
-
|
|
|
489,552
|
|
Dilutive
potential from assumed exercise of stock warrants
|
|
|
-
|
|
|
57,388
|
|
Weighted-average
shares used to compute diluted EPS
|
|
|
11,258,547
|
|
|
10,701,211
|
|
Basic
earnings per common share:
|
|
$
|
(1.78
|
)
|
$
|
0.22
|
|
Diluted
earnings per common share:
|
|
$
|
(1.78
|
)
|
$
|
0.21
|
|
Prior
to
January 1, 2006, PacificNet accounted for awards granted under stock-based
compensation plans following the recognition and measurement principles of
APB
25, Accounting
for Stock Issued to Employees,
and
related interpretations. Compensation expense, if any, is recognized for awards
granted at an exercise price less than fair market value of the underlying
common stock on the date of grant.
Effective
January 1, 2006, PacificNet adopted the fair value recognition provisions
of
SFAS 123(R). See Item 6 for a description of the Company’s adoption of SFAS
123R.The fair value of stock options is determined using the Black-Scholes
option pricing model, which is consistent with the valuation techniques
previously utilized for options in footnote disclosures required under SFAS
123,as amended by FASB Statement No. 148, “Accounting for Stock-Based
Compensation - Transition and Disclosure.” The determination of the fair value
of stock-based compensation awards on the date of grant using an option-pricing
model is affected by the Company’s stock price as well as assumptions regarding
a number of complex and subjective variables, including the expected volatility
of the Company’s stock price over the term of the awards, actual and projected
employee stock option exercise behaviors, risk-free interest rate and expected
dividends. The compensation costs, which approximated $242,473 for year 2006,
are recognized on a straight-line base over the option vesting term and the
amortized cost is included in selling, general and administrative expenses.
The
valuation provisions of SFAS 123(R) apply to new grants and unvested grants
that
were outstanding as of the effective date.
During
year 2006, we had 370,500 stock options exercisable, 394,000 options were
exercised, and 680,000 options granted in year 2005 were cancelled. The board
also authorized to issue 500,000 options on September 21, 2006. However due
to
the increasing cost of option administration, the board of directors decided
to
cancel all options authorized during year 2005 and 2006, and plan to issue
restricted stock or stock appreciation right (SAR) for future executive and
employee incentive compensation. See note 12 b) for the status of the Company’s
stock option plan.
Additional
information on options outstanding as of December 31, 2006 is as
follows:
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
OPTIONS
|
WEIGHTED
AVERAGE
REMAINING
CONTRACTUAL
LIFE
|
Options
outstanding
|
$2.00
|
370,500
|
0.57 years
|
Options
exercisable
|
$2.00
|
370,500
|
0.57
year
|
CONVERTIBLE
DEBENTURES
On
March
13, 2006, we completed a private placement in which we sold $8,000,000 in
convertible debentures and issued warrants to purchase up to an aggregate of
400,000 shares of common stock. 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 dilutive events. The debentures are
due March 13, 2009. The warrants are exercisable for a period of five years
at
an exercise price of $12.20 per share. At the closing of the private placement,
we prepaid the first year's interest on debentures equal to 5% of the aggregate
principal amount of debentures. We will pay interest in cash or shares, provided
that certain conditions are met, at the rate of 6% for the second year the
debentures are outstanding and then 7% for the third. Beginning January 1,
2007,
we are obligated to redeem up to $320,000 every month, plus accrued, but unpaid
interest, liquidated damages and penalties. We also have the option to prepay
the debentures at any time, provided that certain conditions have been met,
after the 12 month anniversary of the effective date of the registration
statement that has been filed with the Securities and Exchange Commission with
respect to the common stock issuable upon conversion of the debentures, some
or
all of the outstanding debentures for cash in an amount equal to 120% of the
principal amount outstanding, plus accrued, but unpaid interest, liquidated
damages and penalties outstanding. At any time after the six month anniversary
of the effective date of the registration statement, we may force the holders
to
convert up to 50% of the then outstanding principal amount of the debentures,
subject to certain trading conditions being met. 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 and penalties, which
shall
become immediately due and payable.
Under
the
terms of a registration rights agreement entered into at the time of the private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April
30,
2006, and have the registration statement declared effective by the SEC no
later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to
the investors at the rate of 2% of the principal amount of the debenture
each month beginning on June 28, 2006 until the effectiveness of the
registration statement, which was equal to $1,120,000, in the aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of accrued
liquidated damages, the Company signed a Settlement and Release Agreement
with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding
Fund
Ltd. and Basso Private Opportunities Holding Fund Ltd.. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
in cash, with the remaining liquidated damages in the amount of $105,000
paid in
the form of a new convertible debenture due February 2009, on substantially
the
same terms as the original debentures, except that interest only is paid
on the
new debentures until October 2008 and beginning in November 2008 until February
2009, when the new debentures are due, the monthly redemption amount under
the
new debentures shall be equal to $315,000.
The
remaining investors also agreed to accept the aggregate $840,000 in liquidated
damages owed to them in the form of the new convertible debentures for the
amount of their respective portion of the liquidated damages. The Company
also
agreed to amend the original debentures to shorten the term for payment of
the
original principal amount to a 22 month term. As a result the monthly redemption
amount for the original debenture increased from $320,000 to $ 363,638. All
other terms and conditions of the original debenture remains in full force
and
effect.
C.E.
Unterberg, Towbin L.L.C. acted as placement agent and received a negotiated
cash
fee in the amount of $449,500 and a warrant to purchase up to 16,000 shares
at
an exercise price of $12.20 per share, which expire five years from the date
of
issuance. The fair value of these warrants totaled $28,141. Such amount was
charged to other assets, net, and credited to additional paid-in capital and
will be amortized over the life of the debentures. Maxim Group also acted as
Placement Agent and received a cash fee in the amount of $50,000.
In
connection with the issuance of the debentures, the Company incurred $1,106,135
of issuance costs, which primarily consisted of investment banker fees, legal
and other professional fees. These costs have been recorded as additional
expense during year 2006.
The
gross
proceeds of $8,000,000 are recorded as a current debenture liability. In
addition, fair values attributed to the Investors’ warrants in accordance with
EITF issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to
and Potentially Settled in a Company’s Own Stock” are recorded as liabilities.
The initial value related to the Investors’ warrants is $690,642. An aggregate
loss of $213,692 representing the change in fair value of warrants was
recognized during the twelve months ended December 31, 2006.
In
accordance with recent FASB guidance, due to certain factors, including a
liquidated damages provision in the registration rights agreement, the Company
values and accounts for the embedded conversion feature and the warrants related
to the debentures as derivatives. Accordingly, these derivative liabilities
are
measured at fair value with changes in fair value reported in earnings as long
as they remain classified as liabilities. The Company reassesses the
classification at each balance sheet date. If the classification required under
EITF No. 00-19 changes as a result of events during the period, the contract
should be reclassified as of the date of the event that caused the
reclassification.
PROBABLE
EVENT OF DEFAULT
On
March
16, 2007 our predecessor auditor withdrew their opinion on our previously filed
financial statements for the years ended December 31, 2005, December 31, 2004
and December 31, 2003. As a result, on March 27, 2007, we notified the holders
of the outstanding convertible debenture that we suspended use of the prospectus
contained in our Registration Statement on Form S-1 (File No. 333-134127) that
was declared effective on December 8, 2006, due to the lack of fiscal year
end
2005 and 2004 audited financial statements and that they must cease selling
under the prospectus. The suspension of the use of the prospectus after April
17, 2007, could trigger an event of default under the registration rights
agreement and the convertible debentures, and if any of the holders so elect,
they could accelerate and demand payment under the debentures, in accordance
with the registration rights agreement based on the following
provisions.
|
a)
|
If,
during the Effectiveness Period, either the effectiveness of the
Registration Statement lapses for any reason or the Holder shall
not be
permitted to resell Registrable Securities under the Registration
Statement for a period of more than 20 consecutive Trading Days or
60
non-consecutive Trading Days during any 12 month period, the Company
has
to pay ‘Mandatory Default Amount’ as
|
the
sum
of (i) the greater of (A) 130% of the outstanding principal amount of this
Debenture, plus all accrued and unpaid interest hereon, or (B) the outstanding
principal amount of this Debenture, plus all accrued and unpaid interest hereon,
divided by the Conversion Price on the date the Mandatory Default Amount is
either (a) demanded (if demand or notice is required to create an Event of
Default) or otherwise due or (b) paid in full, whichever has a lower Conversion
Price, multiplied by the VWAP on the date the Mandatory Default Amount is either
(x) demanded or otherwise due or (y) paid in full, whichever has a higher VWAP,
and (ii) all other amounts, costs, expenses and liquidated damages due in
respect of this Debenture."
|
b)
|
If
any Event of Default occurs, the outstanding principal amount of
this
Debenture plus accrued but unpaid interest, liquidated damages and
other
amounts owing in respect thereof through the date of acceleration,
shall
become, at the Holder’s selection, immediately due and payable in cash at
the Mandatory Default Amount. Commencing 5 days after the occurrence
of
any Event of Default that results in the eventual acceleration of
this
Debenture, the interest rate on this Debenture shall accrue at an
interest
rate equal to the lesser of 18% per annum or the maximum rate permitted
under applicable law.
|
The
provisions mentioned above and as per the terms of the Debenture, the Company
has reclassified the principal amount of the Debenture of $8,000,000 and the
principal amount of the new Debenture of $945,000 and the interest accrued
thereon to the current liability.
The
Company accrued 2% as liquidated damages and 30% as mandatory default amount
from the date of ineffectiveness of registration statement as
follows:
($,000)
|
|
|
|
2006
|
|
Liquidated
damages
|
|
|
2%
|
|
$
|
450
|
|
Mandatory
default
|
|
|
30%
|
|
|
2,247
|
|
Total
|
|
|
|
|
$
|
2,697
|
|
The
Company also expensed the unamortized discount of $691,000 to expense for the
year ended December 31, 2006.
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 $31,052 in 2006 (2005:
$87,511).
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 14)
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, 2006. The component costs of these securities are summarized as follows:
cost of $559,000, gross unrealized losses of $1,000 and estimated fair value
of
$558,000. 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 $16,000. During the year ended December 31, 2006,
the
foreign currency translation adjustments to the Company's comprehensive income
was $27,000 and the currency translation gain was approximately $72,000,
primarily as a result of the Hong Kong dollars appreciating against the U.S.
dollar.
The
Company determines and classified its operating segments in accordance with
SFAS
No. 131 "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION"
based on the following considerations: (a) each of the Company's operating
segments is a discrete business unit that earns revenues and incurs expenses;
(b) the operating results are regularly reviewed by PacificNet's chief operating
decision makers for the purposes of fine-tuning its strategies going forward,
making resource allocation decisions such as whether further working capital
advances are required and assessing individual performance; and (c) discrete
financial information for each subsidiary within each operating segment is
available. The chief operating decision makers are the Company's President
and
CEO and its Chairman, and their decisions are based on discussions with each
segment's senior management and financial controllers regarding non-financial
indicators such as customer satisfaction, loyalty and new marketplace
competition as well as financial indicators such as internally generated
financial statements, to assess overall financial performance.
GOING
CONCERN
As
shown
in the accompanying consolidated financial statements, the Company incurred
accumulated losses of $47.7 million and $27.6 million as of December 31, 2006
and December 31, 2005, respectively. Negative cash flows from the operations
of
$8.9 million were noted for the year ended December 31, 2006. These matters
raise substantial doubt about the Company’s ability to continue as a going
concern.
In
view
of the matters described in the preceding paragraph, recoverability of a major
portion of the recorded asset amounts shown in the accompanying balance sheet
is
dependent upon continued operations of the Company, which in turn is dependent
upon the Company’s ability to raise additional capital, obtain financing and to
succeed in its future operations. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The
Company has taken certain restructuring steps to provide the necessary capital
to continue its operations. These steps included, but not limited to: 1)
accelerate disposal and spin-off of unprofitable or unfavorable
return-on-investment non-gaming operations. On April 30, 2007, the Company
entered into a sale and purchase agreement to dispose of its interest in
Guangzhou3G for a consideration of US$6 million. On May 5, 2007, the Company
also entered into a sale and purchase agreement to dispose of the real estate
in
HK for approximately US$1 million; 2) focus on execution of the new high
potential gaming business initiatives; 3) acquisition of profitable and/or
strategic operations through issuance of equity instruments; 4) formation
of
strategic relationship with key gaming operators in Asia; 5) issuance and/or
restructure of new long-term convertible debentures.
Recent
Pronouncements
In
February 2007, FASB issued FASB Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal
years beginning after November 15, 2007. Early adoption is permitted subject
to
specific requirements outlined in the new Statement. Therefore, calendar-year
companies may be able to adopt FAS 159 for their first quarter 2007 financial
statements.
The
new
Statement allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item's fair value in subsequent reporting
periods must be recognized in current earnings. FAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. The management is currently evaluating the effect of this
pronouncement on financial statements.
In
September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
employer to recognize the over funded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income
of a
business entity or changes in unrestricted net assets of a not-for-profit
organization. The Company currently does not have any defined benefit plan
and
so FAS 158 will not affect the financial statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is
the
relevant measurement attribute. Accordingly, this Statement does not require
any
new fair value measurements. However, for some entities, the application of
this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
In
March
2006 FASB issued SFAS 156 “Accounting for Servicing of Financial Assets.” This
Statement amends FASB Statement No. 140, “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,” with
respect
to the accounting for separately recognized servicing assets and servicing
liabilities. The Company does not have any servicing assets and therefore the
statement will not have any impact on the financial statements.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments.” SFAS No. 155 amends SFAS No 133, “Accounting for
Derivative Instruments and Hedging Activities,” and SFAF No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.” SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise
would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. The management is currently evaluating the effect of this
pronouncement on financial statements.
2.
BUSINESS ACQUISITIONS
During
2006 and 2005, 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:
On
January 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. 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.
The
consideration was paid as follows:
(i)
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.
(ii)
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.
(iii)
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.
The
cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities for Guangzhou Wangrong assumed in the
acquisition follows:
Estimated
fair values:
|
|
Current
Assets
|
|
|
$185,050
|
|
Liabilities
assumed
|
|
|
--
|
|
Net
assets acquired
|
|
|
185,050
|
|
Consideration
paid
|
|
|
646,158
|
|
Goodwill
|
|
|
$461,108
|
|
As
of
December 31, 2006, goodwill of $461,108 represents the excess of the purchase
price over the fair value of the assets acquired and is not deductible for
tax
purposes. The total amount of goodwill by reportable segment for Telecom
Value-added Services was $461,000 (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 Guangzhou Wanrong
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 Guangzhou Wanrong. Accordingly, the
operating results of Guangzhou Wanrong have been consolidated with those of
the
Company starting January 31, 2006. Pursuant to SFAS 141 "Business Combinations",
the earn-out consideration was considered contingent consideration and after
the
audited combined after-tax profit of US $500,000 for the 12 months ended
December 31, 2006 is available. Accordingly, the contingent consideration of
138,348 shares has not been reflected in the consolidated financial statements
of the Company as of December 31, 2006.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2006 AND 2005
The
following un-audited pro forma consolidated financial information for the three
months ended March 31, 2006 and 2005, as presented below, reflects the results
of operations of the Company assuming the acquisition occurred on January 1,
2005 and 2006 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, 2005 and 2006
respectively, and may not be indicative of future operating
results.
Guangzhou
Wanrong |
|
Years
ended December 31
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
(UN-AUDITED
AND IN
THOUSANDS
OF U.S. DOLLARS)
|
|
Revenues
|
|
$
|
43,692
|
|
$
|
18,150
|
|
$
|
11,812
|
|
Operating
income
|
|
$
|
(14,032
|
)
|
$
|
287
|
|
$
|
(1,209
|
)
|
Net
profit
|
|
$
|
(20,115
|
)
|
$
|
2,207
|
|
$
|
(629
|
)
|
Earnings
per share - basic
|
|
$
|
(1.79
|
)
|
$
|
0.22
|
|
$
|
(0.09
|
)
|
Earnings
per share - diluted
|
|
$
|
(1.79
|
)
|
$
|
0.21
|
|
$
|
(0.08
|
)
|
PacificNet
included the financial results of Guangzhou Wanrong in its consolidated 2006
financial results from the date of the purchase, January 31, 2006 through
December 31, 2006.
PACIFICNET
IMOBILE (BEIJING) TECHNOLOGY CO., LIMITED (INCORPORATED IN THE
PRC)
On
February 26, 2006, PacificNet acquired 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. iMobile's
Internet portal has been one of the top ranked traffic sites and has achieved
about 5.4
million registered online users and over 1,200,000 active users, with 10
million
daily page views and 40,000 blog postings per day, which makes iMobile the
top
ranked site in its category in China. This acquisition was structured in
the
same manner as our other acquisitions, that are classified and accounted
for as
variable interest entities in accordance with FASB Interpretation No. 46R
"Consolidation of Variable Interest Entities" ("FIN 46R"), an Interpretation
of
Accounting Research Bulletin No. 51.), 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.
The
results of variable interest entities acquired during the period are included
in
the consolidated income statements from the effective date of the
acquisition.
The
consideration was paid as follows:
(i)
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.
(ii)
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.
(iii)
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.
(iv)
PacificNet will also invest approximately RMB 2 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.
The
cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities for iMobile assumed in the acquisition
follows:
Estimated
fair values:
|
|
Current
Assets
|
|
|
$127,500
|
|
Liabilities
assumed
|
|
|
--
|
|
Net
assets acquired
|
|
|
127,500
|
|
Consideration
paid
|
|
|
557,000
|
|
Goodwill
|
|
|
$429,500
|
|
At
December 31, 2006, goodwill of $429,500 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 Products (Telecom & Gaming) was $2,155,000. (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 iMobile 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 iMobile. Accordingly, the operating results of iMobile have been
consolidated with those of the Company starting February 26, 2006. 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 $500,000 for the 12 months ended December 31,
2006 is available. Accordingly, the contingent consideration of 153,500 shares
has not been reflected in the consolidated financial statements of the Company
as of December 31, 2006.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2006 AND 2005
The
following un-audited pro forma consolidated financial information for the years
ended December 31, 2005 and 2006, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1, 2005
and 2006 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, 2005 and 2006
respectively, and may not be indicative of future operating
results.
iMobile
|
|
Years
ended December 31
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
(UN-AUDITED
AND IN
THOUSANDS
OF U.S. DOLLARS)
|
|
Revenues
|
|
$
|
43,285
|
|
$
|
24,080
|
|
$
|
16,517
|
|
Operating
income
|
|
$
|
(13,899
|
)
|
$
|
202
|
|
$
|
(883
|
)
|
Net
profit
|
|
$
|
(20,085
|
)
|
$
|
2,171
|
|
$
|
(461
|
)
|
Earnings
per share - basic
|
|
$
|
(1.78
|
)
|
$
|
0.21
|
|
$
|
(0.06
|
)
|
Earnings
per share - diluted
|
|
$
|
(1.78
|
)
|
$
|
0.20
|
|
$
|
(0.06
|
)
|
PacificNet
included the financial results of iMobile in its consolidated 2006 financial
results from the date of the purchase, February 26, 2006 through December 31,
2006.
PACIFICNET
GAMES LIMITED
On
August
3, 2006, PacificNet’s wholly owned subsidiary PacificNet Games Limited
(“PacGames”, [太平洋网络游戏有榰公司])
completed the acquisition of 100% of Able Entertainment Technology Ltd., a
leading gaming technology provider based in the Macau Special Administrative
Region of China. Upon completion of this transaction, the Company owned 35%
of
PacificNet Games Limited. Under the purchase agreement, Able Entertainment
Technology Ltd represented that is expects to generate an annual profit of
USD
$1,600,000 and will provide for an adjustment to the purchase price if PacGames
does not achieve an annual net profit of USD $1,600,000 during the first
12-month period ended June 30, 2007, and USD $3,000,000 during the second
12-month period ended June 30, 2008.
The
purchase price consideration is 200,000 restricted PACT shares in exchange
for
100% of the issued and outstanding shares of Able Entertainment Technology
Ltd.
or a 35% ownership interest in PacGames. As of December 31, 2006, 40,000 total
restricted shares of PacificNet had been issued for the acquisition and 160,000
shares were held back as contingent consideration payable upon completion of
certain earnings criteria pursuant to the purchase agreement.
On
September 22, 2006, PACT acquired another 10% of PacGames in exchange for 57,100
restricted shares of the Company’s common stock. Those shares have been issued
out according to sale and purchase agreement.
On
November 9, 2006, we acquired an additional 6% interest in PacificNet Games
Limited (PacGames) for a consideration of $504,000 (paid entirely with shares
of
PacificNet: 90,000 PACT Shares, valued at $5.60 per share, price on the day
of
transaction). Those
shares have been issued out according to sale and purchase
agreement.
The
company currently owns 51% of PacGames.
The
cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A
summary
of the assets acquired and liabilities for PacGames assumed in the acquisition
follows:
Estimated
fair values:
|
Current
Assets
|
|
|
$642,111
|
|
Property,
plant and equipment
|
|
|
$25,051
|
|
Intangible
asset
|
|
|
179,858
|
|
Total
Assets Acquired
|
|
|
847,020
|
|
Liabilities
assumed
|
|
|
(291,598
|
)
|
Net
assets acquired
|
|
|
555,422
|
|
Consideration
paid
|
|
|
1,301,811
|
|
Goodwill
|
|
|
$746,389
|
|
At
December 31, 2006, goodwill of $746,389 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 Products (Telecom & Gaming) was
$2,155,000.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for PacGames 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 PacGames. Accordingly, the operating results of PacGames have
been
consolidated with those of the Company starting March 30, 2006. 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 $700,000 for the year ended December 31, 2006 is
available. Accordingly, the contingent consideration of 160,000 shares has
not
been reflected in the consolidated financial statements of the Company as of
December 31, 2006.
The
following table summarizes the intangible assets acquired from PacificNet
Games:
(USD000s)
|
|
December
31, 2006
|
|
December
31, 2005
|
|
Technology
|
|
|
$353
|
|
|
-
|
|
Less:
Accumulated amortization
|
|
|
(30
|
)
|
|
-
|
|
Net
|
|
|
$323
|
|
|
-
|
|
Amortization
expense related to intangible assets was $30,000 in the year ended December
31,
2006.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
DECEMBER 31, 2006 AND 2005
The
following un-audited pro forma consolidated financial information for the years
ended December 31, 2005 and 2006, as presented below, reflects the results
of
operations of the Company assuming the acquisition occurred on January 1, 2005
and 2006 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, 2005 and 2006
respectively, and may not be indicative of future operating
results.
PacGames
|
|
Years
ended December 31
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
(UN-AUDITED
AND IN
THOUSANDS
OF U.S. DOLLARS)
|
|
Revenues
|
|
$
|
44,176
|
|
$
|
17,186
|
|
$
|
11,071
|
|
Operating
income
|
|
$
|
(13,263
|
)
|
$
|
289
|
|
$
|
(904
|
)
|
Net
profit
|
|
$
|
(20,059
|
)
|
$
|
2,207
|
|
$
|
(472
|
)
|
Earnings
per share - basic
|
|
$
|
(1.78
|
)
|
$
|
0.22
|
|
$
|
(0.06
|
)
|
Earnings
per share - diluted
|
|
$
|
(1.778
|
)
|
$
|
0.21
|
|
$
|
(0.06
|
)
|
Accordingly,
PacificNet included the financial results of PacGames in its consolidated 2006
financial results from August 3, 2006 through December 31, 2006.
3.
INVESTMENT IN AFFILIATED COMPANIES
Investments
Investments
in affiliated companies consist of the following as of December 31, 2006
(in thousands):
(USD000s)
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
|
AMOUNT
|
DESCRIPTION
|
INVESTMENTS
IN AFFILIATED COMPANIES:
|
|
|
Take1
(Cheer Era Limited) [1]
|
$
100
|
20%
ownership interest; trader of vending machine located in Hong
Kong
|
MOABC
|
(19)
|
20%
ownership interest
|
Glad
Smart
|
30
|
15%
ownership interest
|
Community
media co.
|
4
|
5%
ownership interest
|
Total
|
$
115
|
|
TAKE
1 TECHNOLOGIES GROUP LIMITED (FORMERLY KNOWN AS: CHEER ERA LIMITED
"CHEERERA")
On
January 05, 2007, we entered into an agreement for PacificNet to exercise the
option to acquire an additional 31% interest in Take 1. The completion date
for
the new Securities Subscription Agreement was March 5, 2007, with a
consideration of $721,887 (paid entirely with shares of PacificNet: 149,459
PACT
Shares, valued at $4.83 per share). As a result, PacificNet has become the
majority and controlling shareholder of Take1 with our ownership percentage
increased from 20% to 51%.
Initial
equity investment of 30% in Take 1 was made in April 2004 by the Company,
through its subsidiary PacificNet Strategic Investment Holdings Limited for
a
consideration of $1,156,812, comprising $385,604 in cash and $771,208 in 149,459
PacificNet shares at $5.16 per share. PacificNet’s
interest in Take 1 was reduced to 20% in the year 2005 from 30% as a result
of
PacificNet repurchasing an aggregate of 149,459 at nominal value.
As
of
December 31, 2006, there was an outstanding inter-company convertible loan
of
$1,026,000 due from Take 1. The Convertible Loan, expiring on October 17, 2008,
is guaranteed personally and jointly by the two minority shareholders of Take
1,
and bears an interest rate of 8% per annum or 6-month Prime Rate of Hong
Kong.
4.
PROPERTY AND EQUIPMENT, NET
Property
and equipment consists of the following as of December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Office
furniture, fixtures and leasehold improvements
|
|
$
|
908
|
|
$
|
383
|
|
Computers
and office equipment
|
|
|
1,720
|
|
|
986
|
|
Motor
Vehicles
|
|
|
130
|
|
|
83
|
|
Software
|
|
|
395
|
|
|
375
|
|
Electronic
Equipment
|
|
|
68
|
|
|
18
|
|
Land
and buildings
|
|
|
2,805
|
|
|
77
|
|
Less:
Accumulated depreciation
|
|
|
(1,315
|
)
|
|
(602
|
)
|
Net
Property and Equipment
|
|
$
|
4,711
|
|
$
|
1,320
|
|
For
the
years ended December 31, 2006 and 2005, the total depreciation and amortization
expenses were $2,521,000 and $1,126,000, of which $1,058,000 and $872,000 was
included in the cost of revenues, respectively.
The
significant increase of the office furniture, fixtures and leasehold
improvements was mainly due to most of the computers and office equipment in
2006 are derived from the expansion of our business including Epro ($200,000).
Additionally, Beijing office purchased through Inc ($1,617,000) during 2006
and
the real estate in Hong Kong recorded in PacCom ($1,053,000) are accounted
under
Land and Buildings.
5.
COMMITMENTS AND CONTINGENCIES
OPERATING
LEASES -
The
Company leases warehouse and office space under operating leases with fixed
monthly rentals. None of the leases included contingent rentals. Lease expense
charged to operations for 2006 amounted to $571,000 (2005: $494,000). Future
minimum lease payments under non-cancelable operating leases are $680,000 for
2007, $764,000 for 2008 through 2011
RESTRICTED
CASH - The Company has a $234,000 pledged bank deposit for Epro which represents
overdraft protections with certain financial institutions.
BANK
LINE
OF CREDIT (2006): As
of
December 31, 2006, the Company’s outstanding bank lines of credit were as
follows:
|
(i)
|
Epro
has an overdraft banking facility with certain major financial
institutions in the aggregate amount of $744,000, which is secured
by a
pledge of its fixed deposits of $234,000, 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.
|
|
(ii)
|
Smartime
has an overdraft banking facility with a large Hong Kong bank in
the
aggregate amount of $111,000. This overdraft facility is personally
pledged by the deposit account of a director of
Smartime.
|
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.
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.
6.
OTHER CURRENT ASSETS
Other
current assets comprises of the following as at December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Prepayment
|
|
$
|
1,048
|
|
$
|
711
|
|
Utilities
deposit
|
|
|
1,292
|
|
|
707
|
|
Receivable
from Lion Zone Holdings Ltd (See note 14)
|
|
|
485
|
|
|
|
|
Loans
to employees
|
|
|
411
|
|
|
519
|
|
Prepaid
expenses
|
|
|
408
|
|
|
-
|
|
Advances
to sales reps
|
|
|
358
|
|
|
92
|
|
Others
|
|
|
170
|
|
|
252
|
|
Total
|
|
$
|
4,173
|
|
$
|
2,281
|
|
Bank
loans represent the following at December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Secured
[1]
|
|
$
|
1,668
|
|
$
|
108
|
|
Unsecured
|
|
|
543
|
|
|
86
|
|
Less:
current portion
|
|
|
(576
|
)
|
|
(188
|
)
|
Noncurrent
portion
|
|
$
|
1,635
|
|
$
|
6
|
|
Bank
Loans are generated by two of the Company's subsidiaries. One
of
the subsidiaries is 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
$234,000 (2005: $163,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as follows:
2007:
$526,000, 2008: $424,000 and 2009: $213,000, thereafter: none.)
The
remaining bank loans of $1,048,000 are generated by PacificNet Inc. relating
to
a fixed asset bought during the first quarter with total cost of $1,648,000.
The
repayment of the bank loan was $69,000. (Aggregate future maturities of
borrowing for the following period are as follows: Less than 1 year: $50,000,
1-5 year: $229,000 and after 5 years: $769,000)
8.
CAPITAL LEASE OBLIGATIONS
The
Company leases various equipments under capital leases expiring in various
years
through 2008. The assets and liabilities under capital leases are recorded
at
the lower of the present value of the minimum lease payments or the fair value
of the asset. The assets are depreciated over the lesser of their related lease
terms or their estimated productive lives and are secured by the assets
themselves. Depreciation of assets under capital leases is included in
depreciation expense for 2006 and 2005
Aggregate
minimum future lease payments under capital leases as of December 31, 2006
for
each of the next five years are as follows: (2007: $132,000; 2008: $89,000;
and
2009: $42,000,
and
thereafter: none.)
Capital
lease obligations represent the following at December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Total
minimum lease payments
|
|
$
|
263
|
|
$
|
216
|
|
Interest
expense relating to future periods
|
|
|
(19
|
)
|
|
(12
|
)
|
Present
value of the minimum lease payments
|
|
|
244
|
|
|
204
|
|
Less:
current portion
|
|
|
(120
|
)
|
|
(126
|
)
|
Noncurrent
portion
|
|
$
|
124
|
|
$
|
78
|
|
Following
is a summary of fixed assets held under capital leases at December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Computers
and office equipment
|
|
$
|
630
|
|
$
|
441
|
|
Less:
accumulated depreciation
|
|
|
(391
|
)
|
|
(286
|
)
|
Net
|
|
$
|
239
|
|
$
|
155
|
|
Accrued
expenses consist of the following at December 31 (in
thousands):
|
|
2006
|
|
2005
|
|
Deposits
and advance payments
|
|
$
|
352
|
|
$
|
277
|
|
Professional
fee
|
|
|
321
|
|
|
|
|
Director
fee
|
|
|
100
|
|
|
|
|
Salaries
and benefit payable
|
|
|
792
|
|
|
591
|
|
Marketing
expense
|
|
|
389
|
|
|
|
|
Others
|
|
|
156
|
|
|
12
|
|
Total
|
|
$
|
2,110
|
|
$
|
880
|
|
10.
STOCKHOLDERS' EQUITY
a)
COMMON
STOCK
During
the year ended December 31, 2006, the Company had the following equity
transactions (i) 394,000 shares as a result of exercise of stock options with
cash consideration of $237,000; (ii) 618,112 shares for acquisition of
subsidiaries valued at $4,346,000; and (iii) 275,000 shares returned by
ChinaGoHi valued at $1,672,000, due to a termination agreement signed with
ChinaGoHi in November 2006 (as filed in an 8K dated Nov 28, 2006); (iv)
repurchase of 24,200 shares from Yueshen with a market value of
$124,223.
During
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) repurchase of 149,459 shares
with a market value of $771,000 related to affiliated company (see Note 3 for
details).
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.
The
status of the Stock Option Plan as of December 31, 2006, is as
follows:
|
|
Options
outstanding
|
|
WEIGHTED
AVERAGE EXERCISE PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2003
|
|
|
986,000
|
|
|
$2.97
|
|
Granted
|
|
|
553,000
|
|
|
$2.00
|
|
Cancelled
|
|
|
(400,000
|
)
|
|
$4.25
|
|
Exercised
|
|
|
(271,500
|
)
|
|
$1.42
|
|
OUTSTANDING,
DECEMBER 31, 2004
|
|
|
867,500
|
|
|
$2.24
|
|
Granted
|
|
|
680,000
|
|
|
$6.57
|
|
Cancelled
|
|
|
--
|
|
|
--
|
|
Exercised
|
|
|
(100,000
|
)
|
|
$2.00
|
|
Forfeited
|
|
|
(3,000
|
)
|
|
$1.75
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
1,444,500
|
|
|
$4.29
|
|
Granted
|
|
|
500,000
|
|
|
$4.75
|
|
Cancelled
|
|
|
(1,180,000
|
)
|
|
$5.80
|
|
Exercised
|
|
|
(394,000
|
)
|
|
$2.12
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
370,500
|
|
|
$2.00
|
|
Following
is a summary of the status of options outstanding at December 31, 2006:
Grant
Date
|
Total
Options
Outstanding
|
Aggregate
Intrinsic
Value
|
Weighted
Average Remaining
Life
(Years)
|
Total
Weighted
Average
Exercise
Price
|
Option
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-7-26
|
370,500
|
$1,548,690
|
0.57
|
$2.00
|
370,500
|
$2.00
|
On
May
28, 2006, the board of directors and management approved and authorized the
cancellation of 680,000 stock options that were previously authorized but not
granted during fiscal year 2005. Those options were authorized but not granted
and unvested and unexercised.
There
are
370,500 options, which granted during year 2004, were outstanding and vested
in
year 2006. Those options have a term of three years and 0.83 year vesting
period. The weighted-average fair value of such options was $1.42.The
assumptions used in calculating the fair value of options granted using the
Black-Scholes option- pricing model are as follows:
Risk-free
interest rate
|
2.75%
|
|
Expected
life of the options
|
1.65
years
|
|
Expected
volatility
|
61.33%
|
|
Expected
dividend yield
|
0%
|
|
There
were
500,000 options authorized on September 21 of 2006 with a $4.75 exercise
price.
Such options have a term of 5 years and will be vested 5% per quarter commencing
from January 1st
2007. On
December 15, 2006, the board of directors decided to cancel all options
previously granted in 2005 and 2006 due to the increasing cost of option
administration. The board of directors plan to issue restricted stock or
stock
appreciation right (SAR) for future executive and employee incentive
compensation.
c)
WARRANTS
At
December 31, 2006, the Company had outstanding and exercisable warrants to
purchase an aggregate of 1,007,138 shares of common stock. The weighted average
remaining life is 3.34 years and the weighted average price per share is
$10.61.
Following
is a summary of the warrant activity:
|
Warrants
outstanding
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
Aggregate
Intrinsic
Value
|
OUTSTANDING,
DECEMBER 31, 2003
|
0
|
$
-
|
$
-
|
Granted
|
622,002
|
-
|
-
|
Forfeited
|
-
|
-
|
-
|
Exercised
|
(30,864)
|
-
|
-
|
OUTSTANDING,
DECEMBER 31, 2004
|
591,138
|
$
9.50
|
$
-
|
Granted
|
-
|
-
|
-
|
Forfeited
|
-
|
-
|
-
|
Exercised
|
-
|
-
|
-
|
OUTSTANDING,
DECEMBER 31, 2005
|
591,138
|
$
9.50
|
$
-
|
Granted
|
416,000
|
-
|
-
|
Forfeited
|
-
|
-
|
-
|
Exercised
|
-
|
-
|
-
|
OUTSTANDING,
DECEMBER 31, 2006
|
1,007,138
|
$
10.61
|
$
-
|
Following
is a summary of the status of warrants outstanding at December 31, 2006:
|
Total
warrants
Outstanding
|
Weighted
Average
Remaining
Life (Years)
|
Total
Weighted
Average
Exercise
Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-1-15
|
123,456
|
2.04
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
2.88
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
2.94
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
4.20
|
$12.20
|
416,000
|
$12.20
|
On
March
13, 2006, we issued 400,000 warrants to several institutional investors in
connection with a private placement of $8 million in convertible debentures.
On
the same day we issued another 16,000 warrants to our placement agent for the
transaction. See Note 1 for further details. Those warrants have a term of
5
years and immediately vesting. The assumptions used in calculating the fair
value of such warrants granted using the Black-Scholes option- pricing model
are
as follows:
Risk-free
interest rate
|
4.78%
|
|
Expected
life of the options
|
5.00
years
|
|
Expected
volatility
|
37.08%
|
|
Expected
dividend yield
|
0%
|
|
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, 2006:
|
|
|
Number
of
shares
|
|
|
Remarks
|
|
Escrowed
shares returned to treasury in 2003
|
|
|
800,000
|
|
|
|
|
Shares
purchased in the open market
|
|
|
43,426
|
|
|
|
|
Repurchase
of shares from Take 1
|
|
|
149,459
|
|
|
|
|
Repurchase
of shares from Yueshen
|
|
|
24,200
|
|
|
|
|
Cancellation
of former employee shares
|
|
|
45,000
|
|
|
|
|
Termination
with ChinaGoHi
|
|
|
825,000
|
|
|
Returned
shares plus Escrow shares
|
|
Incomplete
acquisition of Allink
|
|
|
200,000
|
|
|
|
|
Holdback
shares as contingent consideration due to performance targets not
yet
met
|
|
|
529,848
|
|
|
Includes
shares related to Clickcom (78,000); Guangzhou(Wanrong (138,348);
iMobile
(153,500); Games (160,000);
|
|
Balance,
December 31, 2006
|
|
|
2,616,933
|
|
|
|
|
Shares
outstanding at December 31, 2006
|
|
|
11,538,664
|
|
|
|
|
Shares
issued at December 31, 2006
|
|
|
14,155,597
|
|
|
|
|
We
included 5,272 common shares purchased in the open market, which are failed
to
report in previous annual report in above treasury stock movement table. We
total paid $14,847 for those shares with average share price
$2.82.
11.
INCOME TAXES
The
components of income before income taxes are as follows:
(USD000s)
|
|
2006
|
|
2005
|
|
2004
|
|
Income
(loss) subject to PRC
|
|
$
|
82
|
|
$
|
2,262
|
|
$
|
1,366
|
|
Income
(loss) subject to Hong Kong
|
|
|
(3,090
|
)
|
|
1,125
|
|
|
345
|
|
Loss
subject to United States
|
|
|
(17,022
|
)
|
|
(1,087
|
)
|
|
(2,161
|
)
|
Income
(loss) before taxes
|
|
|
(20,030
|
)
|
|
2,300
|
|
|
(450
|
)
|
Less:
income taxes
|
|
|
(63
|
)
|
|
(93
|
)
|
|
(22
|
)
|
Net
income available to common stockholders
|
|
$
|
(20,093
|
)
|
$
|
2,207
|
|
$
|
(472
|
)
|
United
States of America
As
of
December 31, 2006, the Company’s subsidiary in the United States of America had
approximately $4,555,000 in net operating loss carry forwards available to
offset future taxable income. Federal net operating losses can generally
be
carried forward 20 years. The Tax Reform Act of 1986 limits the use of net
operating loss and tax credit carry forwards in certain situations when changes
occur in the stock ownership of a company. In the event the Company has a
change
in ownership, utilization of carry forwards could be restricted. The deferred
tax assets for the United States entity at December 31, 2006 consists mainly
of
net operating loss carry forwards and were fully reserved as the management
believes it is more likely than not that these assets will not be realized
in
the future.
The
following table sets forth the significant components of the net deferred tax
assets for operation in the United States of America as of December 31,
2006 and 2005.
(USD000s)
|
|
2006
|
|
2005
|
|
Net
Operating Loss Carry forwards
|
|
$
|
1,822
|
|
$
|
1,732
|
|
Total
Deferred Tax Assets
|
|
|
1,822
|
|
|
1,732
|
|
Less:
Valuation Allowance
|
|
|
(1,822
|
)
|
|
(1,732
|
)
|
Net
Deferred Tax Assets
|
|
$
|
-
|
|
$
|
-
|
|
The
following is a reconciliation of the provision for income taxes at the U.S.
federal income tax rate to the income taxes reflected in the Statement of
Operations:
|
|
December
31, 2006
|
|
December
31, 2005
|
|
December
31, 2004
|
|
Tax
expense (credit) at statutory rate-federal
|
|
|
(34
|
)%
|
|
(34
|
)%
|
|
(34
|
)%
|
State
tax expense net of federal tax
|
|
|
(6
|
)
|
|
(6
|
)
|
|
(6
|
)
|
Changes
in valuation allowance
|
|
|
40
|
|
|
40
|
|
|
40
|
|
Foreign
income tax:
|
|
|
|
|
|
|
|
|
|
|
PRC
|
|
|
33 |
|
|
33 |
|
|
33 |
|
HK
|
|
|
17.5 |
|
|
17.5 |
|
|
17.5 |
|
Changes
in valuation allowance |
|
|
26.6 |
|
|
(47.5 |
) |
|
(48.5 |
) |
Tax
expense at actual rate
|
|
|
77
|
%
|
|
3
|
%
|
|
2
|
%
|
Hong
Kong
As
of
December 31, 2006, the Company’s Hong Kong subsidiary had net operating loss
carry forwards which can be carried forward indefinitely to offset future
taxable income. The deferred tax assets for the Hong Kong subsidiary at December
31, 2006 consists mainly of net operating loss carry forwards and were fully
reserved as the management believes it is more likely than not that these
assets
will not be realized in the future. .
The
following table sets forth the significant components of the net deferred
tax
assets for operation in the Hong Kong region as of December 31, 2006 and
2005.
(USD000s)
|
|
2006
|
|
2005
|
|
Net
Operating Loss Carry forwards
|
|
$
|
540
|
|
$
|
-
|
|
Total
Deferred Tax Assets
|
|
|
540
|
|
|
-
|
|
Less:
Valuation Allowance
|
|
|
(540
|
)
|
|
-
|
|
Net
Deferred Tax Assets
|
|
$
|
-
|
|
$
|
-
|
|
China
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 preferential tax rates. Additionally,
as of
December 31, 2006 and 2005, the Company had accumulated net operating loss
carry
forwards for Chinese tax purposes of approximately $0 and $447,000,
respectively. Realization of the Chinese tax net operating loss carry forwards
is dependent on future profitable operations, as well as a maximum five-year
carry forward period. Accordingly, management has recorded a valuation allowance
to reduce the deferred tax associated with the net operating loss carry forwards
to zero.
The
following table sets forth the significant components of the net deferred
tax
assets for operation in the PRC as of December 31, 2006 and
2005.
(USD000s)
|
|
2006
|
|
2005
|
|
Net
Operating Loss Carry forwards
|
|
$
|
-
|
|
$
|
86
|
|
Total
Deferred Tax Assets
|
|
|
-
|
|
|
86
|
|
Less:
Valuation Allowance
|
|
|
-
|
|
|
(86
|
)
|
Net
Deferred Tax Assets
|
|
$
|
-
|
|
$
|
-
|
|
Aggregate
net deferred tax assets
The
following table sets forth the significant components of the aggregate net
deferred tax assets of the Company as of December 31, 2006 and
2005:
(USD000s)
|
|
2006
|
|
2005
|
|
Total
Deferred Tax Assets
|
|
$
|
2,362
|
|
$
|
1,818
|
|
Less:
Valuation Allowance
|
|
|
(2,362
|
)
|
|
(1,818
|
)
|
Net
Deferred Tax Assets
|
|
$
|
-
|
|
$
|
-
|
|
Income
tax payable was approximately $70,000 at December 31, 2006 (2005:
$12,000).
12.
RELATED PARTY TRANSACTIONS
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, 2006, there was a total loan receivable of approximately $1,706,000
due from related parties while the loan due to related party was
$638,000.
As
at the
year end, the
related party loan receivables included $1,026,000 due from Take 1, an
affiliated company that is 20% owned by PacificNet, $196,000 due from MOABC,
an
affiliated company that is 20% owned by PacificNet, and $384,000 due from
shareholders and directors of certain of the Company’s subsidiaries in
connection with the acquisition of these subsidiaries. The loans receivable
from
shareholders and directors of these subsidiaries is comprised of $256,000 due
from a shareholder of Yueshen and $128,000 due from a director of Soluteck.
The
terms of these related parties loan receivables and payables are summarized
below:
LOAN
TO TAKE 1
Take
1 is
an affiliated company and is 20% owned by PacificNet as of December 31, 2006.
A
convertible loan of $1,026,000 is outstanding from Take 1 as of December 31,
2006. 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 principle up to $1,026,000 (or HKD $8,000,000) into shares of Take 1 to
reach 51% ownership of Take 1. The loan was extended as a working capital loan
to finance the expansion of Take 1's business in Europe and North America.
LOAN
TO MOABC
MOABC
is
an affiliated company and is 20% owned by PacificNet as of December 31, 2006.
A
convertible loan of $196,000 is outstanding from MOABC as of December 31, 2006.
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
principle by using the price of $23,160 (1% of shares). The provision for
doubtful debts of $293,000 for the loan to MOABC was recorded in
2006.
LOAN
TO GLAD SMART
Glad
Smart is an affiliated company and is 15% owned by PacificNet as of December
31,
2006. A loan of $100,000 is outstanding from Glad Smart as of December 31,
2006.
The loan was extended as a working capital loan to finance the expansion of
Glad
Smart’s voice card business operation.
LOAN
TO YUESHEN’S SHAREHOLDER
As
of
December 31, 2006, there was a loan outstanding of $256,000 receivable from
the
shareholder of Yueshen given that the provision was $993,000, a subsidiary
of
the Shanghai Classic. 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. Further
discussion of the outcome of our legal dispute with Yueshen is found under
Part
II of this 10Q document - Item1: Legal Proceedings.
LOAN
TO SOLUTECK’S DIRECTOR
As
of
December 31, 2006, there was a loan outstanding of $128,000 receivable from
a
director of Soluteck, 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
PAYABLE TO RELATED PARTY
As
of
December 31, 2006, a loan of $356,000 was payable to a shareholder of EPRO.
The
loan was advanced to Epro for working capital purposes. The loan is due on
August 4, 2010. Interest being charged per annum is at Hong Kong Prime lending
rate, which was approximately 6.5% per annum in 2005 and 8% in
2006.
As
of
December 31, 2006, a loan of $282,000 was payable to a shareholder of Smartime.
The loan was advanced to Smartime for working capital purposes.
13.
SEGMENT INFORMATION
SFAS
No.
131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
("SFAS
131"),
establishes standards for reporting information about operating segments and
for
related disclosures about products, services and geographic areas. Operating
segments are identified as components of an enterprise about which separate
discrete financial information is available for evaluation by the chief
operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance.
PacificNet’s
chief
decision-makers, as defined under SFAS 131, are the Chief Executive Officer
and
Chairman. During 2006 and 2005, PacificNet had four operating
segments.
The
Company’s reportable segments are operating units, which represent the
operations of the Company’s significant business operations. Summarized
financial information concerning the Company’s reportable segments is shown in
the following table. The “Other” column includes the Company’s other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable
segments.
For
the year ended December
31, 2006
(in
thousands, except percentages)
|
|
Group
1.
Outsourcing
Services
($)
|
|
Group
2.
Telecom
Value-Added Services
($)
|
|
Group
3.
Products
(Telecom & Gaming)
($)
|
|
Group
4.
Other
Business
($)
|
|
Total
($)
|
|
Revenues
|
|
|
14,146
|
|
|
1,555
|
|
|
23,385
|
|
|
3,652
|
|
|
42,738
|
|
(%
of Total Rev)
|
|
|
(33.1%)
|
|
|
(3.6%)
|
|
|
(54.7%)
|
|
|
(8.5%)
|
|
|
(100%)
|
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
676
|
|
|
(44)
|
|
|
(1,053)
|
|
|
(13,567)
|
|
|
(13,988)
|
|
(%
of Total Profit)
|
|
|
(4.8%)
|
|
|
(-0.3%)
|
|
|
(-7.5%)
|
|
|
(-97.0%)
|
|
|
(-100%)
|
|
Total
Assets
|
|
|
8,367
|
|
|
1,258
|
|
|
12,673
|
|
|
19,584
|
|
|
41,882
|
|
(%
of Total Assets)
|
|
|
(20.0%)
|
|
|
(3.0%)
|
|
|
(30.3%)
|
|
|
(46.8%)
|
|
|
(100%)
|
|
Goodwill
|
|
|
3,936
|
|
|
461
|
|
|
2,155
|
|
|
-
|
|
|
6,552
|
|
Geographic
Area
|
|
|
HK,
PRC
|
|
|
HK,
PRC
|
|
|
HK,
PRC, Macau
|
|
|
HK,PRC
|
|
|
|
|
For
the year ended
December
31, 2005 (in thousands, except percentages)
|
|
Group
1.
Outsourcing
Services
($)
|
|
Group
2.
Telecom
Value-Added Services
($)
|
|
Group
3.
Products
(Telecom & Gaming)
($)
|
|
Group
4.
Other
Business
($)
|
|
Total
($)
|
|
Revenues
|
|
|
13,505
|
|
|
0
|
|
|
2,880
|
|
|
801
|
|
|
17,186
|
|
(%
of Total Rev)
|
|
|
(78.6%)
|
|
|
(0.0%)
|
|
|
(16.8%)
|
|
|
(4.7%)
|
|
|
(100%)
|
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
1,515
|
|
|
0
|
|
|
271
|
|
|
(1,497)
|
|
|
289
|
|
%
of Total Profit)
|
|
|
(1,524.2%)
|
|
|
(0.0%)
|
|
|
(93.8%)
|
|
|
(518.0%)
|
|
|
(100%)
|
|
Total
Assets
|
|
|
6,994
|
|
|
0
|
|
|
9,333
|
|
|
28,271
|
|
|
44,598
|
|
(%
of Total Assets)
|
|
|
(15.7%)
|
|
|
(0.0%)
|
|
|
(20.9%)
|
|
|
(63.4%)
|
|
|
(100%)
|
|
Goodwill
|
|
|
3,936
|
|
|
-
|
|
|
979
|
|
|
-
|
|
|
4,915
|
|
Geographic
Area
|
|
|
HK,PRC
|
|
|
HK,PRC
|
|
|
HK,PRC,
Macau
|
|
|
HK,PRC
|
|
|
|
|
For
the
year ended December 31, 2004
For
the year ended
December
31, 2004 (in thousands, except percentages)
|
|
Group
1.
Outsourcing
Services
($)
|
|
Group
2.
Telecom
Value-Added Services
($)
|
|
Group
3.
Products
(Telecom & Gaming)
($)
|
|
Group
4.
Other
Business
($)
|
|
Total
($)
|
|
Revenues
|
|
|
10,034
|
|
|
0
|
|
|
849
|
|
|
188
|
|
|
11,071
|
|
(%
of Total Rev)
|
|
|
(90.6%)
|
|
|
(0.0%)
|
|
|
(7.7%)
|
|
|
(1.7%)
|
|
|
(100%)
|
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
1,594
|
|
|
0
|
|
|
6
|
|
|
(2,504)
|
|
|
(904)
|
|
%
of Total Profit)
|
|
|
(-176.3%)
|
|
|
(0.0%)
|
|
|
(-0.7%)
|
|
|
(277%)
|
|
|
(100%)
|
|
Total
Assets
|
|
|
6,017
|
|
|
0
|
|
|
5,018
|
|
|
21,625
|
|
|
32,660
|
|
(%
of Total Assets)
|
|
|
(18.4%)
|
|
|
(0.0%)
|
|
|
(15.4%)
|
|
|
(66.2%)
|
|
|
(100%)
|
|
Goodwill
|
|
|
3,936
|
|
|
-
|
|
|
979
|
|
|
-
|
|
|
4,915
|
|
Geographic
Area
|
|
|
HK,PRC
|
|
|
HK,PRC
|
|
|
HK,PRC,
Macau
|
|
|
HK,PRC
|
|
|
|
|
The
Company identifies and classifies its operating segments based on reporting
entities that exhibit similar long-term financial performance based on the
nature of the products and services with similar economic characteristics such
as margins, business practices and target market. The operating segments are
classified into four major segments which are summarized as
follows:
(1)
Outsourcing
Services - involves human voice services such as Business Process Outsourcing,
CRM, call center, IT Outsourcing and software development services. These types
of services are conducted through our subsidiaries EPRO, Smartime/Soluteck
and
PacificNet Solution Ltd.
(2)
Telecom Value-Added 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 (discontinued), Linkhead
(discontinued), Clickcom (discontinued) and Guangzhou 3G/Sunroom. For example,
Linkhead is a master reseller of NMS hardware and software platforms in China,
and its voice cards are used as an integral part of voice hardware using CPCI
industry control machines, and also by Media Servers to support access from
PSTN
and VoIP, Softswitch and 3G networks.
(3)
Product (Telecom & Gaming) Services Group - involves
communication and gaming products, GSM/CDMA/3G Products, Multimedia
Communication Kiosks. This Group includes the following subsidiaries: PacificNet
Communications Limited, iMobile, Allink, Take1 and PacificNet Games. PacificNet
Games Limited (PacGames) is a leading developer of Asian electronic gaming
machines, multi-player electronic gaming technology solutions and gaming related
maintenance, IT, and distribution services for the leading hotel and casino
operators based in the Macau and other Asian gaming markets.
(4)
Other
Business -other administrative, financial and investment services and non-core
businesses such as PacificNet Power Limited (PacPower), Pacific Financial
Services Limited, etc.
Product
and service revenues classified by major geographic areas are as follows (in
thousands):
For
the year ended December 31, 2006
|
|
Hong
Kong
|
|
PRC
|
|
Macau
|
|
United
States
|
|
Total
|
|
Product
revenues
|
|
|
$19,829
|
|
|
$5,755
|
|
|
$364
|
|
|
$
-
|
|
|
$25,948
|
|
Service
revenues
|
|
|
$13,527
|
|
|
$3,263
|
|
|
$-
|
|
|
$
-
|
|
|
$16,790
|
|
For
the year ended December 31, 2005
|
|
Hong
Kong
|
|
PRC
|
|
Macau
|
|
United
States
|
|
Total
|
|
Product
revenues
|
|
|
$3,216
|
|
|
$-
|
|
|
$-
|
|
|
$
-
|
|
|
$3,216
|
|
Service
revenues
|
|
|
$10,355
|
|
|
$3,615
|
|
|
$-
|
|
|
$
-
|
|
|
$13,970
|
|
For
the
year ended December 31, 2004
For
the year ended December 31, 2004
|
|
Hong
Kong
|
|
PRC
|
|
Macau
|
|
United
States
|
|
Total
|
|
Product
revenues
|
|
|
$849
|
|
|
$-
|
|
|
$-
|
|
|
$
-
|
|
|
$849
|
|
Service
revenues
|
|
|
$9,240
|
|
|
$982
|
|
|
$-
|
|
|
$
-
|
|
|
$10,222
|
|
14.
DISCONTINUED OPERATIONS/ASSETS HELD FOR
DISPOSITION
Financial
Statements for the year ended December 31, 2003, 2004 & 2005 have been
reclassified to account for the following discontinued operations and/or assets
held for disposition.
1.
Guangzhou Yueshen Taiyang Network Science and Technology Limited
(“Yueshen”)
Operations
of Yuenshen were discontinued during the year. Accordingly, the Company had
recorded a charge to loss on disposal of $0.5 million at December 31,
2006.
On
12
August, 2006, to recover the loan advanced to Yueshen, we commenced a law suit
in the High Court of the Hong Kong Special Administrative Region ("HKSAR")
against i) Guangzhou Yueshen Taiyang Network Science and Technology Limited
as
borrower and both ii) Ms. Li Yan Kuan and iii) Mr. Yi Wen as guarantors for
the
loan sum of RMB 2,000,000 ("Debt Sum") together with the agreed interest rate
calculated at 6% per annum all due on 15 November, 2005 according to the
promissory note and guarantee entered into by the three defendants on 15 May,
2005.
2.
Guangzhou Clickcom Digit-net Science and Technology Ltd.
(“Clickcom”)
Operations
of Clickcom were discontinued and became dormant during the year as a result
of
poor business and market prospects. Former staffs of Clickcom have been
reassigned to MOABC. Nominal amount of fixed assets are subject to disposition.
Accordingly, Clickcom has been classified as Asset Held for Disposition in
2006.
Approximately $400,000 of goodwill carried for Clickcom has been charged to
impairment by the Company at the year end of 2006.
3.
Beijing Linkhead Technologies Company Limited (“Linkhead”)
Due
to
bleak industry prospects, board of directors of Linkhead had resolved a special
board resolution in January 2007 to direct management to engage in active search
for willing buyers to acquire or prepare to enter into liquidation process.
Accordingly, Linkhead has been classified as Asset Held for Disposition in
2006.
Approximately $4 million of goodwill carried for Linkhead has been charged
to
impairment by the Company at the year end of 2006.
4.
Guangzhou 3G Information Technology Co. Ltd. (“GZ3G”)
On
April
30, 2007, the Company entered into a definitive agreement
with HeySpace International Limited to sell PacificNet’s 51% equity
ownership of GZ3G group of companies for a consideration of $6 million.
Accordingly, GZ3G has been classified as Asset Held for Disposition in 2006.
Approximately $2.1 million in goodwill being carried on the Company’s books had
been written down to level the Company’s total carrying cost of GZ3G to the
intended disposition value.
5.
Lion
Zone Holdings Ltd. (“Lion Zone”)
On
November 20, 2006, PacificNet executed an agreement ("Termination Agreement")
to
terminate the Sale and Purchase Agreement with Lion Zone, ChinaGoHi and Mr.
Wang
Wenming (collectively, the "Sellers"). The Termination Agreement was effective
as of November 1, 2006. In the Termination Agreement, the Sellers agreed
to pay
an aggregate of HKD$3,000,000, comprising: USD$100,000 in cash and 275,000
in
restricted shares of PACT, in exchange for 51% interest of Lion Zone, holding
company of ChinaGoHi. Additionally, the Sellers agreed to waive PacificNet's
obligations under the Sale and Purchase Agreement entered into between
PacificNet and the Sellers in December 2005 to issue restricted shares and
to
provide certain loans to the Sellers. PacificNet, however, reserves the rights
to re-purchase the said 51% interest of Lion Zone within 2 years of the date
of
signing the Termination Agreement for a consideration of 5 times audited
net
profit under US GAAP for the 12-month period subsequent to the year of signing.
The
following is a summary of discontinued
operations.
(In
thousands)
|
|
ChinaGoHi
|
|
Yueshen
|
|
Linkhead
|
|
G3G
|
|
Clickcom
|
|
Total
|
|
Investment
|
|
|
4,475
|
|
|
275
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
4,750
|
|
Net
earnings consolidated into PACT
|
|
|
175
|
|
|
229
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
404
|
|
Consideration
received/receivable
|
|
|
3,947
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
3,947
|
|
Loss
on disposal
|
|
|
(703
|
)
|
|
(504
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(1,207
|
)
|
Income/(loss)
from discontinued operations
|
|
|
|
|
|
-
|
|
|
(1,089
|
)
|
|
1,206
|
|
|
(4
|
)
|
|
113
|
|
Net
assets for disposal /to be sold
|
|
|
|
|
|
-
|
|
|
1,579
|
|
|
10,945
|
|
|
145
|
|
|
12,669
|
|
15.
CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by
the
political, economic and legal environments in the PRC, by the general state
of
the PRC's economy. The Company's business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods
of
taxation, among other things.
16.
EVENTS SUBSEQUENT TO DECEMBER 31, 2006 (UNAUDITED)
ADDDITIONAL
ACQUISITION OF TAKE1 TECHNOLOGIES IN Q1 2007
On
January 05, 2007, we entered into an agreement for PacificNet to exercise the
option to acquire an additional 31% interest in Take1 Technologies Limited
(“Take1”) (formerly known as “CHEER ERA LIMITED”). The completion date for the
new Securities Subscription Agreement was March 5, 2007, with a consideration
of
$721,887 (paid entirely with shares of PacificNet: 149,459 PACT Shares, valued
at $4.83 per share). As a result, PacificNet has become the majority and
controlling shareholder of Take1 with our ownership percentage increased from
20% to 51%. Take1 is a leading designer, developer and manufacturer of gaming,
multimedia entertainment and communication kiosk products including casino-use
electronic gaming tables, photo and video entertainment kiosks, digital camera
photo development stations, multimedia messaging services (MMS) and mobile
content download stations for mobile phones, and other coin-operated peripherals
and consumables. Take1 Technologies is based in Hong Kong and markets and
distributes its products around the world including the USA, Canada, Mexico,
Europe, China, and Southeast Asia.
SALE
OF
CONVERTIBLE DEBENTURES BY OUR SUBSIDIARY PACIFICNET GAMES LIMITED
On
February 9, 2007, the Company through its subsidiary, PacificNet Games Limited
(PacGames) entered into a definitive agreement for a $5 million financing in
the
form of a convertible secured note from Pope Asset Management, LLC (Pope),
an
institutional investor. Proceeds from the financing will be used to provide
PacGames with additional working capital to expand its gaming technology
operations, to make further synergistic acquisitions in China and for general
corporate purposes.
The
$5
million financing, evidenced by a convertible secured note issued by PacGames
to
Pope, matures on February 6, 2010, and may be converted into 26% to 32%
ownership interest in PacGames based on reaching certain net income milestones
during fiscal year 2007. The interest rate on the convertible debenture will
initially be set at 8%, and shall increase to 15% if the note is not converted
prior to maturity.
17.
Legal Proceedings
1.
Legal Proceeding and Judgment Against Guangzhou Yueshen Taiyang Network Science
and Technology Limited, Ms. Li Yan Kuan, and Mr.Wu Yi
Wen
On August
12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
Science and Technology Limited, Ms. Li Yan Kuan, (PRC ID:
440112195706120967, address: (Chinese G6--305) and Mr.Wu Yi Wen, (PRC
ID: 440106196412220919, Guangzhou address: (Chinese) for failure to pay amounts
owed under a promissory note. On May 15, 2005, we loaned RMB2,000,000
("Debt Sum") to Yueshen to cover operating costs, evidenced by a promissory
note
due on November 15, 2005. Ms. Kuan and Mr. Wen guaranteed repayment of the
note by Yueshen. The Debt Sum together with the agreed interest rate
calculated at 6% per annum was due on November 15, 2005.
On
March
28, 2007, the High Court of HKSAR had adjudged that the three defendants
should
pay us the Debt Sum together with interest sum at the rate of 6% per annum
from May 15, 2005 to March 28, 2007, and additional interest charged
at the rate of 5% per annum for the Debt Sum and accrued interest within
90 days
overdue and thereafter at the judgment rate until payment and fixed costs
of
HK$3,405.
2.
Lawsuit between PacificNet Power Limited and Johnson Controls Hong Kong Limited
(JCHKL), a subsidiary of Johnson Controls Inc. (NYSE:JCI)
(www.jci.com )
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
Court of the Hong Kong Special Administrative Region seeking HK$4,800,000
as payment for services rendered to replace 3 sets of trane water-cooled
chillers, together with energy saving performance (the "Chiller System"),
at the Fortress Tower in Hong Kong.
In
connection with the claim, PacificNet Power reviewed a letter
from its client, China Weal Property Management Ltd., dated January 22,
2007 stating that the construction work by JCHKL had not been completed as
of
the date of the letter, and that certain violations itemized in a letter
issued by the Hong Kong Environment Protection Department (EPD) (Noise
Abatement Notice No. N806030) addressed to JCHKL with respect to acoustic
problems with JCHKL’s equipment had not been abated. Further, JCHKL was to
pay penalties between HK$100,000 and HK$200,000 assessed by the JCHKL
for failing to fix the noise problem on the roof of Fortress
Tower.
The
board
of directors of PacificNet Power Limited has reviewed the case
with its client, China Weal Property Management Ltd., and our
Hong Kong legal counsel and it is our belief that the project
work undertaken JCHKL is defective in numerous aspects, as evidenced by the
letter from government letter issued by EPD. As a result, we believe the
construction work was not been completed by JCHKL, and therefore,
JCHKL is not entitled to payment for its services.
On
February 7, 2007, we instructed our Hong Kong legal counsel to issue a
Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
construction work has not complied with the applicable rules and regulations
of
various government authorities in Hong Kong; (ii) the Chiller System provided
by
JCHKL was defective and merchantable unfit and JCHKL has failed
and/or refused to rectify such defective works; and (iii) JCHKL shall return
the work deposit in the amount of HK$1,500,000 to PacificNet Power
Limited and shall compensate and keep PacificNet Power Limited indemnified
against all the loss and damages suffered as a result of any claims from
the
China Weal Property Management Ltd, the employer and the potential tenants
of
Fortress Tower.
The
case
is under review by Hong Kong High Court and we have not received any judgment
from the High Court of the Hong Kong Special Administrative Region as of
date of
this report. We are currently proceeding with discovery and counter-claims,
and
we intend to vigorously defend ourselves against the allegations. We are
unable
to predict the outcome of these actions, or a reasonable estimate of the
range
of possible loss, if any.
18.
Restatement
On
March
19, 2007 our predecessor auditor withdrew their opinion on our previously
filed
financial statements for the years ended December 31, 2005 and 2004 due to
uncertainties around certain option grants during the said period. An
independent investigation in this connection has been commissioned by our
Audit
Committee to address this matter.
In
its
May 3, 2007 Report, the Audit Committee concluded that, “…the Audit Committee
did indeed find that, although the number and terms of option grants were
being
fixed by the Compensation Committee who deferred to the Board merely for
a
secondary review approval; whereby the Board of Directors still maintained
the
authority to cancel a prerequisite grant consummated by the Compensation
Committee, therefore that Grant could likely be interpreted only as final
at the
date of approval of the company’s Board of Directors. Hence, with this approach
which seems to be more aligned with the SEC interpretation, financial
restatement would be required to account for the granting of options that
were
“in the money” due to procedural administrative delay and the difference in the
Compensation Committee grant date and the Board of Directors approval date.
Accordingly, the Audit Committee recommended to the Board of Directors of
Pacificnet, Inc. to charge additional stock based compensation expense to
the
company’s financial statements for the fiscal years ended December 31, 2003,
2004 and 2005 respectively...”
Based
on
the Audit Committee Recommendations, extra stock-based compensation charges
of
approximately $0.3 million, $1.2 million and $0.1 million are charged to
each of
the years ended December 31, 2005, 2004 and 2003, respectively, Also, for
the
years ended December 31, 2005 and 2004, approximately $2.4 million and $0.2
million have been reclassified from Selling, General & Administrative
expenses to Discontinued Operations for financial statement presentation
purposes. Following are the effects of the restatement:
Fiscal
years ended December 31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In
thousands, except share and share amounts)
|
|
2005
|
|
2005
|
|
2004
|
|
2004
|
|
2003
|
|
2003
|
|
|
|
As
reported
|
|
As
restated
|
|
As
reported
|
|
As
restated
|
|
As
reported
|
|
As
restated
|
|
Consolidated
balance sheets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
paid-in capital
|
|
$ |
57,690
|
|
$ |
59,346
|
|
$ |
53,916
|
|
$ |
55,290
|
|
$ |
31,790
|
|
$ |
31,918
|
|
Accumulated
deficit
|
|
|
(25,990
|
)
|
|
(27,646
|
)
|
|
(28,479
|
)
|
|
(29,853
|
)
|
|
(29,253
|
)
|
|
(29,381
|
)
|
TOTAL
STOCKHOLDERS' EQUITY
|
|
|
31,785
|
|
|
31,785
|
|
|
25,310
|
|
|
25,310
|
|
|
2,509
|
|
|
2,509
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
51,203
|
|
$ |
44,598
|
|
$ |
33,250
|
|
$ |
32,660
|
|
$ |
7,770
|
|
$ |
7,740
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
income statements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
General and Administrative expenses
|
|
$ |
(5,811
|
)
|
$ |
(3,411
|
)
|
$ |
(3,435
|
)
|
$ |
3,245
|
|
$ |
(1,572
|
)
|
$ |
(1,569
|
)
|
Stock-based
compensation expenses |
|
|
|
|
|
(282 |
) |
|
|
|
|
(1,246 |
) |
|
|
|
|
(128 |
) |
Income/(loss)
from operations
|
|
|
4,569
|
|
|
289
|
|
|
1,937
|
|
|
(904
|
)
|
|
(1,337
|
)
|
|
(1,475
|
)
|
Income/(loss)
before income taxes, minority interest and discontinued
operations
|
|
|
5,645
|
|
|
783
|
|
|
2,438
|
|
|
(989
|
)
|
|
(1,256
|
)
|
|
(1,394
|
)
|
Income/(loss)
before discontinued operations
|
|
|
0
|
|
|
(81
|
)
|
|
817
|
|
|
(1,537
|
)
|
|
(1,281
|
)
|
|
(1,414
|
)
|
Net
income available to common stockholders
|
|
$ |
2,489
|
|
$ |
2,207
|
|
$ |
774
|
|
$ |
(472
|
)
|
$ |
(1,281
|
)
|
$ |
(1,409
|
)
|
Earnings/(loss)
per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.25
|
|
$ |
0.22
|
|
$ |
0.11
|
|
$ |
(0.06
|
)
|
$ |
(0.24
|
)
|
$ |
(0.27
|
)
|
Diluted
|
|
$ |
0.23
|
|
$ |
0.21
|
|
$ |
0.09
|
|
$ |
(0.06
|
)
|
$ |
(0.24
|
)
|
$ |
(0.27
|
)
|
Shares
used in computing earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
10,154,271
|
|
|
10,154,271
|
|
|
7,268,374
|
|
|
7,268,374
|
|
|
5,234,744
|
|
|
5,234,744
|
|
Diluted
|
|
|
10,701,211
|
|
|
10,701,211
|
|
|
8,241,996
|
|
|
8,241,996
|
|
|
5,234,744
|
|
|
5,234,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
statements of cash flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings (loss)
|
|
$ |
2,489
|
|
$ |
2,207
|
|
$ |
774
|
|
$ |
(472
|
)
|
$ |
(1,281
|
)
|
$ |
(1,409
|
)
|
Stock-based
compensation
|
|
|
0
|
|
|
282
|
|
|
0
|
|
|
1,246
|
|
|
0
|
|
|
128
|
|
Net
cash provided by (used in) operating activities
|
|
$ |
9,250
|
|
$ |
2,980
|
|
|
(4,431
|
)
|
|
(2,491
|
)
|
|
(905
|
)
|
|
(905
|
)
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
$ |
2,815
|
|
$ |
(2,866
|
)
|
$ |
2,941
|
|
$ |
2,572
|
|
$ |
129
|
|
$ |
87
|
|
F-39