PacificNet Inc.
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x QUARTERLY
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF
1934
FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2007
o TRANSITION
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR
THE TRANSITION PERIOD FROM __________ TO ___________
COMMISSION
FILE NUMBER: 000-24985
PACIFICNET
INC.
(Exact
name of registrant in its charter)
Delaware
|
|
91-2118007
|
(State
or other jurisdiction of
incorporation
or organization)
|
|
(I.R.S.
Employer
Identification
Number)
|
23/F,
TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,
|
|
|
CHAOYANG
DISTRICT, BEIJING, CHINA 100028
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|
N/A
|
(Address
of principal executive offices)
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|
(Zip
Code)
|
Registrant’s
telephone number, including area code: 0086-10-59225000
Indicate
by check mark whether the registrant (1) has filed all reports required by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
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 o NO þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
the
Exchange Act).
Large
Accelerated Filer o
Accelerated Filer o
Non-accelerated filer þ
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES o NO þ
As
of May 30, 2007, there were 11,808,993 shares of the issuer’s common stock, par
value $0.0001 per share, outstanding.
PACIFICNET
INC.
Form 10-Q
for the Quarterly Period Ended March 31, 2007
TABLE
OF CONTENTS
PART I.
|
FINANCIAL
INFORMATION
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|
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Report
of Independent Registered Public Accounting Firm
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3
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Item
1.
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Financial
Statements (Unaudited)
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4
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Consolidated
Balance Sheets
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Consolidated
Statements of Operations
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Consolidated
Statements of Cash Flows
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Notes
to Consolidated Financial Statements
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Item
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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Item
3.
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Quantitative
and Qualitative Disclosures about Market Risk
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Item
4.
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Controls
and Procedures
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PART II.
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OTHER
INFORMATION
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Item
1.
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Legal
Proceedings
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Item
1A.
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Risk
Factors
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Item
2.
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Unregistered
Sales of Equity Securities and Use of Proceeds
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Item
3.
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Defaults
upon Senior Securities
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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Item
5.
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Other
Information
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Item
6.
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Exhibits
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Signatures
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PART
I - FINANCIAL INFORMATION
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The
Board
of Directors and Shareholders of Pacific Net Inc.
We
have
reviewed the accompanying consolidated balance sheet of Pacific Net Inc.
(a
Delaware Corporation) and Subsidiaries as of March 31, 2007, and the related
statements of income, and cash flows for the three month period then ended.
These consolidated financial statements are the responsibility of the Company’s
management. The financial statements of Pacific Net Inc. and Subsidiaries
for
the three month period ended March 31, 2006 was reviewed by the Company’s
prior auditor. The prior auditor has withdrawn their audit
opinions.
We
conducted our review in accordance with the standards of the Public Accounting
Oversight Board (United States). A review of interim financial information
consists principally of applying analytical procedures to financial data
and
making inquiries of persons responsible for financial and accounting matters.
It
is substantially less in scope than an audit conducted in accordance with
the
standards of the Public Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based
on
our review, we are not aware of any material modifications that should be
made
to the consolidated condensed financial statements referred to above for
them to
be in conformity with U. S. generally accepted accounting
principles.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As on March 31, 2007, the
company’s accumulated deficit was $47,431,000. 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 16, the financial statements for the two years ended December
31, 2005 and 2004 have been restated.
We
have
previously audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet
of
Pacific Net Inc. and subsidiaries (a Delaware Corporation) as of December
31,
2006 and the related consolidated statements of operations, changes in
stockholders” equity and cash flows for the year then ended (not presented
herein); and in our report dated March 30, 2007 we expressed an unqualified
opinion on these consolidated financial statements.
Such
report includes a paragraph that emphasizes facts that raise substantial
doubt
about the Company’s ability to continue as a going concern. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2006, is fairly presented, in all material respects, in relation
to
the consolidated balance sheet from which it has been derived.
/s/
Kabani & Company, Inc.
Los
Angeles, CA
May
30,
2007
ITEM
1. FINANCIAL STATEMENTS
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(In
thousands of United States dollars, except par values and share
numbers)
ASSETS
|
|
March
31,
2007
(Unaudited)
|
|
December
31,
2006
(Audited)
|
|
Current
Assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
4,041
|
|
$
|
1,799
|
|
Restricted
cash - pledged bank deposit
|
|
|
235
|
|
|
234
|
|
Accounts
receivables, net of allowances for doubtful accounts of $1,579
and $2,023
|
|
|
8,411
|
|
|
7,297
|
|
Inventories
|
|
|
428
|
|
|
201
|
|
Loan
receivable from related parties
|
|
|
713
|
|
|
1,706
|
|
Loan
receivable from third parties
|
|
|
178
|
|
|
128
|
|
Marketable
equity securities - available for sale
|
|
|
568
|
|
|
558
|
|
Other
current assets
|
|
|
4,552
|
|
|
4,012
|
|
Total
Current Assets
|
|
|
19,126
|
|
|
15,935
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
6,656
|
|
|
4,711
|
|
Investments
in affiliated companies and subsidiaries
|
|
|
34
|
|
|
115
|
|
Intangible
assets, net
|
|
|
400
|
|
|
323
|
|
Goodwill
|
|
|
7,400
|
|
|
6,552
|
|
Other
assets
|
|
|
-
|
|
|
471
|
|
Net
assets held for disposition
|
|
|
11,795
|
|
|
12,822
|
|
TOTAL
ASSETS
|
|
$
|
45,411
|
|
$
|
40,929
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$
|
404
|
|
$
|
855
|
|
Bank
loans-current portion
|
|
|
933
|
|
|
576
|
|
Capital
lease obligations - current portion
|
|
|
110
|
|
|
120
|
|
Accounts
payable
|
|
|
1,277
|
|
|
417
|
|
Accrued
expenses and other payables
|
|
|
1,964
|
|
|
2,059
|
|
Income
tax payable
|
|
|
88
|
|
|
17
|
|
Loans
payable to related party
|
|
|
577
|
|
|
638
|
|
Convertible
Debenture
|
|
|
6,909
|
|
|
8,000
|
|
Liquidated
damages liability
|
|
|
2,697
|
|
|
2,837
|
|
Total
Current Liabilities
|
|
|
14,959
|
|
|
15,519
|
|
|
|
|
|
|
|
|
|
Bank
loans - non current portion
|
|
|
2,280
|
|
|
1,635
|
|
Capital
lease obligations - non current portion
|
|
|
104
|
|
|
124
|
|
Convertible
debenture- non current portion, net of issuance cost, $193, and
$0
|
|
|
3,252
|
|
|
945
|
|
Warrant
liabilities
|
|
|
844
|
|
|
904
|
|
Total
long-term liabilities
|
|
|
6,480
|
|
|
3,608
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES
|
|
|
21,439
|
|
|
19,127
|
|
Commitments
& contingencies
|
|
|
-
|
|
|
-
|
|
Minority
interest in consolidated subsidiaries
|
|
|
7,126
|
|
|
6,874
|
|
|
|
|
|
|
|
|
|
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:
|
|
|
|
|
|
|
|
March
31, 2007 - 14,355,041shares issued, 11,808,993 Outstanding
|
|
|
|
|
|
|
|
December
31, 2006 - 14,155,597 issued, 11,538,664 outstanding
|
|
|
1
|
|
|
1
|
|
Treasury
stock, at cost (2007 Q1: 2,546,048 shares, 2006: 2,616,933)
|
|
|
(130
|
)
|
|
(257
|
)
|
Additional
paid-in capital
|
|
|
64,560
|
|
|
63,124
|
|
Cumulative
other comprehensive income (loss)
|
|
|
249
|
|
|
220
|
|
Accumulated
deficit
|
|
|
(47,431
|
)
|
|
(47,739
|
)
|
Less
stock subscription receivable
|
|
|
(403
|
)
|
|
(421
|
)
|
TOTAL
STOCKHOLDERS’ EQUITY
|
|
|
16,846
|
|
|
14,928
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
$
|
45,411
|
|
$
|
40,929
|
|
The
accompanying condensed notes are an integral part of these unaudited
consolidated financial statements.
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(Unaudited.
In thousands of United States dollars, except earnings per share and share
amounts)
|
|
FOR
THE THREE MONTH
PERIODS
ENDED
|
|
|
|
March
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(unaudited)
|
|
(unaudited,
restated)
|
|
Net
revenues
|
|
|
|
|
|
|
|
Services
|
|
$
|
4,565
|
|
$
|
3,736
|
|
Product
sales
|
|
|
4,702
|
|
|
2,936
|
|
Total
net revenues
|
|
|
9,267
|
|
|
6,672
|
|
Cost
of revenues
|
|
|
|
|
|
|
|
Services
|
|
|
(3,353
|
)
|
|
(2,577
|
)
|
Product
sales
|
|
|
(3,375
|
)
|
|
(2,743
|
)
|
Total
cost of revenues
|
|
|
(6,728
|
)
|
|
(5,320
|
)
|
Gross
Profit
|
|
|
2,539
|
|
|
1,352
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
(1,567
|
)
|
|
(1,079
|
)
|
Stock-based
compensation expenses
|
|
|
-
|
|
|
(182
|
)
|
Depreciation
and amortization
|
|
|
(172
|
)
|
|
(29
|
)
|
Total
operating expenses
|
|
|
(1,739
|
)
|
|
(1,290
|
)
|
|
|
|
|
|
|
|
|
Income
from continued operations
|
|
|
800
|
|
|
62
|
|
|
|
|
|
|
|
|
|
Other
income (expenses)
|
|
|
|
|
|
|
|
Interest
expenses, net
|
|
|
(200
|
)
|
|
(52
|
)
|
Gain/(loss)
in change in fair value of derivatives
|
|
|
61
|
|
|
-
|
|
Sundry
income, net
|
|
|
19
|
|
|
15
|
|
Total
other expenses
|
|
|
(120
|
)
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
Income
from continued operations before income taxes, minority interests
|
|
|
680
|
|
|
25
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
(68
|
)
|
|
(17
|
)
|
Share
of earnings of associated companies
|
|
|
-
|
|
|
(3
|
)
|
Minority
interests
|
|
|
(534
|
)
|
|
(86
|
)
|
Income/(loss)
from continued operations
|
|
|
78
|
|
|
(81
|
)
|
Income
from discontinued operations
|
|
|
230
|
|
|
882
|
|
Net
income
|
|
|
308
|
|
|
801
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income/(loss):
|
|
|
|
|
|
|
|
Foreign
exchange gain/(loss)
|
|
|
29
|
|
|
(20
|
)
|
Net
comprehensive income
|
|
$
|
337
|
|
$
|
781
|
|
Basic
earnings per share
|
|
$
|
0.03
|
|
$
|
0.07
|
|
Diluted
earnings per share
|
|
$
|
0.03
|
|
$
|
0.07
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares -
Basic |
|
|
11,719,168 |
|
|
10,855,761 |
|
Weighted
average number of shares -
Diluted |
|
|
12,013,109 |
|
|
11,526,945 |
|
The
accompanying condensed notes are an integral part of these unaudited
consolidated financial statements.
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited.
In thousands of United States dollars)
|
|
FOR
THE THREE MONTH
PERIODS
ENDED
|
|
|
|
March
31,
|
|
|
|
|
|
2006
|
|
|
|
2007
|
|
(Restated)
|
|
Cash
Flows from operating activities
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
308
|
|
$
|
801
|
|
Adjustments
to reconcile net income to net cash used in operating
activities:
|
|
|
|
|
|
|
|
Equity
loss of associated company
|
|
|
-
|
|
|
3
|
|
Provision
for allowance for doubtful accounts
|
|
|
(378
|
)
|
|
-
|
|
Minority
Interest
|
|
|
534
|
|
|
86
|
|
Depreciation
and amortization
|
|
|
306
|
|
|
196
|
|
(Gain)
loss from discontinued operations
|
|
|
(230
|
)
|
|
(882
|
)
|
Stock-based
compensation
|
|
|
-
|
|
|
182
|
|
Change
in fair value of derivatives
|
|
|
(61
|
)
|
|
-
|
|
Liquidated
damages expense
|
|
|
-
|
|
|
-
|
|
Changes
in current assets and liabilities net of effects from purchase
of
subsidiaries:
|
|
|
|
|
|
|
|
Accounts
receivable and other current assets
|
|
|
307
|
|
|
(1,070
|
)
|
Inventories
|
|
|
(227
|
)
|
|
(83
|
)
|
Accounts
payable and other accrued expenses
|
|
|
(659
|
)
|
|
610
|
|
Net
cash used in operating activities
|
|
|
(100
|
)
|
|
(157
|
)
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
Decrease
in restricted cash
|
|
|
(1
|
)
|
|
(1
|
)
|
Increase
in purchase of marketable securities
|
|
|
(10
|
)
|
|
(24
|
)
|
Acquisition
of property and equipment
|
|
|
(819
|
)
|
|
(1,142
|
)
|
Acquisition
of subsidiaries and affiliated companies
|
|
|
-
|
|
|
(390
|
)
|
Loans
receivable from third parties
|
|
|
(50
|
)
|
|
37
|
|
Loans
receivable from related party
|
|
|
(33
|
)
|
|
(670
|
)
|
Net
cash provided by (used in) investing activities
|
|
|
(913
|
)
|
|
(2,190
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Loan
payable to related party
|
|
|
(61
|
)
|
|
144
|
|
Repayments
under bank line of credit
|
|
|
(451
|
)
|
|
(49
|
)
|
Repayments
of amount borrowed under capital lease obligations
|
|
|
(30
|
)
|
|
(34
|
)
|
(Purchase)
sale of treasury shares
|
|
|
282
|
|
|
(124
|
)
|
Proceeds
from subscription received, exercise of stock options and warrants
|
|
|
18
|
|
|
29
|
|
Net
proceeds from issuance of convertible debenture
|
|
|
2,296
|
|
|
7,500
|
|
Advances
under bank loans
|
|
|
217
|
|
|
153
|
|
Net
cash provided by(used in) financing activities
|
|
|
2,271
|
|
|
7,619
|
|
Effect
of exchange rate change on cash and cash
equivalents
|
|
|
29
|
|
|
18
|
|
Net
increase (decrease) in cash from subsidiaries held for
disposition
|
|
|
955
|
|
|
(1,512
|
)
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
2,242
|
|
|
3,778
|
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
|
|
|
1,799
|
|
|
3,487
|
|
CASH
AND CASH EQUIVALENTS, END OF THE PERIOD
|
|
$
|
4,041
|
|
$
|
7,265
|
|
CASH
PAID FOR:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
221
|
|
$
|
87
|
|
Income
taxes
|
|
$
|
-
|
|
$
|
32
|
|
NON-CASH
INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Property
& equipment acquired under banking loan
|
|
$
|
785
|
|
$$
|
1,082
|
|
Investments
in subsidiaries acquired through the issuance of common stock
|
|
$
|
190
|
|
$
|
397
|
|
The
accompanying condensed notes are an integral part of these unaudited
consolidated financial statements.
PACIFICNET
INC. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
expressed in United States dollars unless otherwise stated)
1.
BASIS OF PRESENTATION
Description
of Operations -
PacificNet Inc. (referred to herein as "PacificNet" or the "Company") is
a
leading provider of gaming technology, e-commerce, and Customer Relationship
Management (CRM) in China. Our gaming products are specially designed for
the
Chinese and Asian gamers, and we focus on integrating localized Chinese and
Asian themes and content, advanced graphics, digital sound effects and popular
domestic music, with secondary bonus games and jackpots. Our gaming products
include: Multi-player Electronic Table Games - Baccarat, Sicbo, Fish-Prawn-Crab,
and Roulette machines, server based games (SBG) with multiple client betting
stations, slot and bingo machines, video lottery terminals (VLTs), amusement
with prices (AWP) machines, gaming cabinet and client/server system designs,
online i-gaming software design, and multimedia entertainment kiosks.
PacificNet's gaming clients include the leading hotels, casinos, and gaming
operators in Macau, Asia, and Europe, and our ecommerce and CRM clients include
the 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, China and Hong Kong government. PacificNet employs about 1,200
staff
in its various subsidiaries throughout China with offices in Hong Kong, Beijing,
Shanghai, Shenzhen, Guangzhou, Macau and Zhuhai China, USA, and the
Philippines.
Consolidated
Interim Financial Statements
- The
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles (“GAAP”) for interim financial
reporting consistent in all material respects with those applied in the
Company’s Annual Report on Form 10-K, as amended, for the year ended
December 31, 2006, but do not include all disclosures required by GAAP. You
should read these interim consolidated financial statements in conjunction
with
the audited financial statements, including the notes thereto, and the other
information set forth in the Company’s Annual Report on Form 10-K, as amended,
for the year ended December 31, 2006. The unaudited consolidated financial
statements include the accounts of PacificNet Inc. and its subsidiaries and
variable interest entities (“VIEs”) for which the Company is the primary
beneficiary. All significant intercompany balances and transactions have
been
eliminated in consolidation. In the opinion of management, all material
adjustments considered necessary for a fair presentation of the Company’s
interim results have been reflected. PacificNet’s 2006 Annual Report on Form
10-K includes certain definitions and a summary of significant accounting
policies and should be read in conjunction with this report. The results
for
interim periods are not necessarily indicative of
annual results.
Use
of Estimates
- The
preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts
of
revenues and expenses during the reporting period. Actual results could differ
from those estimates, and such differences may be material to the financial
statements. Certain prior year amounts have been reclassified to conform
to the
current year presentation.
Reclassification
-
Certain
items in the accompanied consolidated financial statements have been re-classed
for comparative purposes.
Going
Concern
As
shown
in the accompanying consolidated financial statements, the Company incurred
accumulated losses of $47 million and $47.7 million as of March 31, 2007
and
December 31, 2006, respectively. 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; 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. In this regard, 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 entered into a sale and purchase agreement to dispose of the
real
estate in HK for approximately US$1 million and on May 18 & 20, 2007,
the Company entered into various definitive agreements to reduce its equity
interests in certain unprofitable subsidiaries to 15%, namely: Linkhead,
PacTelso, PacSo and PacPower.
2.
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 requirement to measure plan assets and benefit obligations
as
of the date of the employer’s fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. The Company currently
does not have any defined benefit plan and so FAS 158 will not affect the
financial statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures
about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board
having
previously concluded in those accounting pronouncements that fair value is
the
relevant measurement attribute. Accordingly, this Statement does not require
any
new fair value measurements. However, for some entities, the application
of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15,
2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
In
March 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on
issue number 06-10, “Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance
Arrangements,” (“EITF 06-10”). EITF 06-10 provides guidance to help companies
determine whether a liability for the postretirement benefit associated with
a
collateral assignment split-dollar life insurance arrangement should be recorded
in accordance with either SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” (if, in substance, a postretirement
benefit plan exists), or Accounting Principles Board Opinion No. 12 (if the
arrangement is, in substance, an individual deferred compensation contract).
EITF 06-10 also provides guidance on how a company should recognize and measure
the asset in a collateral assignment split-dollar life insurance contract.
EITF
06-10 is effective for fiscal years beginning after December 15, 2007
(Novell’s fiscal 2008), though early adoption is permitted. The management is
currently evaluating the effect of this pronouncement on financial
statements.
3.
EARNINGS PER SHARE
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 the period ended March 31, 2007 exclude the potential
dilutive effect of 889,456 warrants because their impact would be anti-dilutive
based on current market prices. 690,909
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:
|
|
|
Three
Months Ended March 31
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
(IN
THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
PER SHARE
AMOUNTS)
|
|
Numerator:
earnings/(loss)
|
|
$
|
308
|
|
$
|
801
|
|
Denominator:
|
|
|
|
|
|
Weighted-average
shares used to compute basic EPS
|
|
|
11,719,168
|
|
|
10,855,761
|
|
Dilutive
potential from assumed exercise of stock options and
warrants
|
|
|
293,941
|
|
|
671,184
|
|
Weighted-average
shares used to compute diluted EPS
|
|
|
12,013,109
|
|
|
11,526,945
|
|
Basic
earnings per common share:
|
|
$
|
0.03
|
|
$
|
0.07
|
|
Diluted
earnings per common share:
|
|
$
|
0.03
|
|
$
|
0.07
|
|
4.
GOODWILL AND BUSINESS ACQUISITIONS
The
changes in the carrying amount of goodwill for the following reporting periods
are summarized below:
|
|
Group
1.
|
|
Group
2.
|
|
Group
3.
|
|
|
|
Goodwill
|
|
|
|
|
|
Telecom
|
|
|
|
Total
goodwill
|
|
reclassified
to net
|
|
|
|
Outsourcing
|
|
Value-Added
|
|
Products
(Gaming
|
|
on
the restated
|
|
assets
for disposal/
|
|
(US$000s)
|
|
Services
|
|
Services
|
|
and
Technology)
|
|
balance
sheet
|
|
to
be sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of December 31, 2005
|
|
$
|
3,936
|
|
$
|
-
|
|
$
|
979
|
|
$
|
4,915
|
|
$
|
9,909
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
acquired during the year
|
|
|
--
|
|
|
461
|
|
|
1,176
|
|
|
1,637
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of December 31, 2006
|
|
$
|
3,936
|
|
$
|
461
|
|
$
|
2,155
|
|
$
|
6,552
|
|
$
|
3,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
acquired during the first quarter
|
|
|
|
|
|
|
|
|
848
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of March 31, 2007
|
|
$
|
3,936
|
|
$
|
461
|
|
$
|
3,003
|
|
$
|
7,400
|
|
$
|
3,655
|
|
5.
STOCKHOLDERS' EQUITY
a)
COMMON
STOCK
For
the three month period ended March 31, 2007, the Company had the following
equity transactions: (i) 199,444 shares of common stock were issued as the
monthly principal redemption shares for 8 million convertible debentures
from
January to March. Such shares are valued at $ 1,090,914.; (ii) 29,459 shares
of
common stock were released from escrow (PACT treasury shares) for acquiring
additional 31% Ownership in Take 1 Technologies Group Limited valued at
$190,305.(iii) 41,426 treasury shares were sold to the open market with total
consideration $282,845.
b)
STOCK
OPTION PLAN
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. Accordingly, compensation expense was 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
Note 2 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
valuation provisions of SFAS 123(R) apply to new grants and unvested grants
that
were outstanding as of the effective date. For the three months ended March
31,
2007, no new options were granted and no options were vested, thus the
compensation costs is zero. PacificNet elected the modified prospective method
and therefore has not restated results for prior periods due to 123R.
The
status of the Stock Option Plan as of March 31, 2007, is as
follows:
|
|
OPTIONS
OUTSTANDING
|
|
WEIGHTED
AVERAGE EXERCISE PRICE
|
|
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
|
|
Granted
|
|
|
-
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
OUTSTANDING
MARCH 31, 2007
|
|
|
370,500
|
|
|
$2.00
|
|
Following
is a summary of the status of options outstanding at March 31, 2007:
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
|
$1,237,470
|
0.32
|
$2.00
|
370,500
|
$2.00
|
The
370,500 outstanding options, which granted during year 2004, will be expired
at
July 26 of 2007. Those options were vested from July 1st
of 2005
with 10 months vesting period, and the corresponding compensation cost have
been
recorded within the vesting period. The weighted-average fair value of such
options was $1.41.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%
|
|
No
options were granted, cancelled and exercised during the three month period
ended March 31, 2007.
c)
WARRANTS
At
March
31, 2007, 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 3.09 years and the weighted average exercise price per share is $10.61
per share.
Following
is a summary of the warrant activity:
|
|
Warrants
outstanding
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
Aggregate
Intrinsic
Value
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
591,138
|
|
$
|
9.50
|
|
$
|
-
|
|
Granted
|
|
|
416,000
|
|
|
-
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
1,007,138
|
|
$
|
10.61
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
OUTSTANDING,
MARCH 31, 2007
|
|
|
1,007,138
|
|
$
|
10.61
|
|
$
|
-
|
|
Following
is a summary of the status of warrants outstanding at March 31, 2007:
|
Total
warrants
Outstanding
|
Weighted
Average
Remaining
Life (Years)
|
Total
Weighted
Average
Exercise
Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-1-15
|
123,456
|
1.79
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
2.63
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
2.69
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
3.95
|
$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. 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%
|
|
No
warrants were granted, cancelled and exercised during quarterly ended March
31
of 2007.
d)
TREASURY STOCK
The
following is a summary of the movement of the Company's shares held as treasury
stock as at March 31 of 2007:
|
|
Number
of
shares
|
|
Escrowed
shares returned to treasury in 2003
|
|
|
800,000
|
|
Shares
purchased in the open market
|
|
|
2,000
|
|
Repurchase
of shares from Yueshen
|
|
|
24,200
|
|
Cancellation
of former employee shares
|
|
|
45,000
|
|
Termination
with ChinaGoHi - Returned shares plus Escrow shares
|
|
|
825,000
|
|
Incomplete
acquisition of Allink
|
|
|
200,000
|
|
Holdback
shares as contingent consideration due to performance targets not
yet met
- Includes shares related to Clickcom (78,000); Guangzhou Wanrong
(138,348); iMobile (153,500); Games (160,000); and Take 1
(120,000)
|
|
|
649,848
|
|
Balance,
March 31, 2007
|
|
|
2,546,048
|
|
Shares
outstanding at March 31, 2007
|
|
|
11,808,993
|
|
Shares
issued at March 31, 2007
|
|
|
14,355,041
|
|
From
January 24th,
2007 to
Jan 30th,
2007,
we sold 41,426 treasury shares to the open market with total consideration
$282,845.
On
February 4th
of 2007
(30 days after deal closing), we released 29,459 shares of common stock from
escrow (PACT treasury shares) for acquiring additional 31% Ownership in Take
1
Technologies Group Limited. The remaining 120,000 shares are treated as holdback
shares and will be released to Take 1 once they met their future performance
targets.
6.
CONVERTIBLE DEBENTURES
6.1
Eight
Million 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 remain in full force and effect. The outstanding original
principal amount as at March 31, 2007 is $6,909,086.
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
gain of $60,694 representing the change in fair value of warrants was recognized
during the three months ended March 31, 2007.
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."
|
Due
to
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 $945,000 and the interest accrued
thereon to current liabilities.
The
Company accrued 2% as liquidated damages and 30% as mandatory default amount
from the date of ineffectiveness of registration statement as
follows:
($,000)
|
|
2006
|
|
Liquidated
damages
|
|
|
2%
|
|
$
|
450
|
|
Mandatory
default
|
|
|
30%
|
|
|
2,247
|
|
Total
|
|
|
|
|
$
|
2,697
|
|
Such
amounts have been recorded as liquidated damages liability as of March 31,
2007.
6.2
Five
Million Convertible Note
On
February 7, 2007, PacificNet Games Limited (PacGames), a 51% owned subsidiary
of
the Company, entered into a definitive $5 million convertible secured note
financing agreement with Pope Asset Management, LLC (Pope), an institutional
investor. Proceeds of the financing are 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 convertible secured note issued to Pope matures on February 6, 2010.
Subject to reaching certain net income milestones during fiscal year 2007,
the note is convertible into an equity interest of PacGames ranging between
26%
to 32% . The interest rate of the convertible note has initially been set
at 8%,
and shall increase to 15% if the note is not converted prior to maturity.
PacGames received the first payment of $2.5 million during the first quarter
of
2007.
In
connection with the issuance of the note, PacGames incurred issuance costs
of
$204,121, which primarily consisted of investment banker fees, legal and
other
professional fees. These costs have been capitalized and will be amortized
over
three years, the life of the note.
7.
SEGMENT INFORMATION
The
Company has classified its operating segments in accordance with SFAS No.
131
“DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.”
Operating segments comprise 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 four operating segments are 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.
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 earnings/(loss), income and expense not allocated to reportable
segments.
For
the three months ended
March
31, 2007 (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
|
|
|
3,963
|
|
|
527
|
|
|
4,773
|
|
|
4
|
|
|
9,267
|
|
(%
of Total Rev)
|
|
|
(42.8
|
%)
|
|
(5.7
|
%)
|
|
(51.5
|
%)
|
|
(0
|
%)
|
|
(100
|
%)
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
400
|
|
|
-3
|
|
|
1,196
|
|
|
-793
|
|
|
800
|
|
(%
of Total Profit)
|
|
|
(50.0
|
%)
|
|
(-0.4
|
%)
|
|
(149.5
|
%)
|
|
(-99.1
|
%)
|
|
(100
|
%)
|
Total
Assets
|
|
|
8,270
|
|
|
1,510
|
|
|
17,045
|
|
|
18,586
|
|
|
45,411
|
|
(%
of Total Assets)
|
|
|
(18.2
|
%)
|
|
(3.3
|
%)
|
|
(37.5
|
%)
|
|
(40.9
|
%)
|
|
(100
|
%)
|
Goodwill
|
|
|
3,936
|
|
|
461
|
|
|
3,003
|
|
|
-
|
|
|
7,400
|
|
Geographic
Area
|
|
|
HK,
PRC
|
|
|
HK,
PRC
|
|
|
HK,
PRC, Macau
|
|
|
HK,PRC
|
|
|
|
|
For
the three months ended
March
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
(Restated)
($)
|
|
Revenues
|
|
|
3,022
|
|
|
295
|
|
|
3,355
|
|
|
0
|
|
|
6,672
|
|
(%
of Total Rev)
|
|
|
(45.3
|
%)
|
|
(4.4
|
%)
|
|
(50.3
|
%)
|
|
(0
|
%)
|
|
(100
|
%)
|
Earnings
/ (Loss) from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
|
|
|
206
|
|
|
15
|
|
|
359
|
|
|
-518
|
|
|
62
|
|
%
of Total Profit)
|
|
|
(332.3
|
%)
|
|
(0.0
|
%)
|
|
(579.0
|
%)
|
|
(-835.5
|
%)
|
|
(100
|
%)
|
Total
Assets
|
|
|
7,347
|
|
|
1,010
|
|
|
14,566
|
|
|
35,807
|
|
|
58,730
|
|
(%
of Total Assets)
|
|
|
(12.5
|
%)
|
|
(1.7
|
%)
|
|
(24.8
|
%)
|
|
(61.0
|
%)
|
|
(100
|
%)
|
Goodwill
|
|
|
3,936
|
|
|
461
|
|
|
979
|
|
|
-
|
|
|
5,376
|
|
Geographic
Area
|
|
|
HK,PRC
|
|
|
HK,PRC
|
|
|
HK,PRC,
Macau
|
|
|
HK,PRC
|
|
|
|
|
Product
and service revenues classified by major geographic areas are as follows
(in
thousands):
For
the three months ended
March
31, 2007
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
|
Product
revenues
|
$2,137
|
$1,550
|
$1,015
|
$
4,702
|
Service
revenues
|
$3,492
|
$1,073
|
-
|
$
4,565
|
For
the three months ended
March
31, 2006
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(Restated)
|
Product
revenues
|
$2,936
|
-
|
-
|
$2,936
|
Service
revenues
|
$3,027
|
$709
|
$
|
$3,736
|
8.
RELATED PARTY TRANSACTIONS
LEASE
AGREEMENT
In
November 2004, the Company entered into 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 FROM RELATED PARTIES
At
March
31, 2007, there was a total loan receivable of approximately $713,000 due
from
related parties. Included in which were
$279,000
from MOABC, an affiliated company that is 15% owned by PacificNet, and $434,000
from shareholders and directors of certain of the Company’s subsidiaries in
connection with the acquisition of those subsidiaries. The amounts due from
shareholders and directors of subsidiaries are comprised of $254,000 due
from a
shareholder of Yueshen, $64,000 due from a director of Soluteck and $115,000
due
from a director of PACT Communications. Terms of these related parties loan
receivables and payables are summarized below:
LOAN
TO
MOABC
MOABC
is
an affiliated company, 15% owned by PacificNet, as of March
31,
2007. A
convertible loan of $279,000 is outstanding from MOABC as of March
31,
2007.
Terms of the convertible loan provide PacificNet an option at any time during
the term of the loan to convert in part or in whole of the then outstanding
loan
principle into equity interest of MOABC, at $23,160 for each 1% of MOABC
shares.
LOAN
TO
YUESHEN’S SHAREHOLDER
As
of
March 31, 2007, there was a loan outstanding of $254,000 receivable from
the
shareholder of Yueshen. This loan is secured by 106,240 PacificNet shares.
Further discussion of the Company’s legal dispute with Yueshen can be found
under Part II of this 10Q document - Item1: Legal Proceedings.
LOAN
TO
SOLUTECK’S DIRECTOR
As
of
March 31, 2007, there was a loan outstanding of $64,000 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
TO
COMMUNICATIONS' DIRECTOR
As
of
March 31, 2007, there was a loan outstanding of $115,000 receivable from
a
director of Communications, due on August 31, 2007. The interest rate for
the
loan is 10% per annum plus 1% penalty interest per month in case of delinquency.
The loan is secured by 30,000 PacificNet shares.
LOAN
DUE TO RELATED PARTIES
As
of
March
31,
2007,
there
was
an outstanding loan payable of $577,000 due
to
related parties. Included in which was a
loan
payable of $292,000 to a shareholder of EPRO. The loan was advanced to Epro
by a
shareholder of EPRO on behalf of the Company for working capital purposes.
The
loan is due on August 4, 2010. Interest is charged at Hong Kong prime lending
rate.
As
of
March
31,
2007, a
loan of $285,000 was payable to a shareholder of Smartime. The loan was advanced
to Smartime by a shareholder of Smartime on behalf of the Company for working
capital purposes.
9.
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 2007 Q1 amounted to $152,000 (2006
Q1:
$128,000). Future minimum lease payments under non-cancelable operating leases
are $655,000 for the period from January 2007 to December 2008 and $684,000
for
the period from January 2008 to December 2011, respectively.
RESTRICTED
CASH - Term deposit of $235,000 has been pledged to certain financial
institutions for bank line overdraft protection of Epro.
BANK
LINE
OF CREDIT - As of March 31, 2007, the Company’s outstanding bank line of credit
were as follows:
|
(i)
|
Epro
has an overdraft banking facility of up to $294,000 with certain
banking
institutions, which is secured by a pledge of its fixed deposits
of
$235,000. Interest is charged at Hong Kong Prime Rate and payable
at the
end of each calendar month or the date of settlement, whichever
is
earlier.
|
|
(ii)
|
Smartime
has an overdraft banking facility of up to $110,000 with a Hong
Kong
banking institution. This overdraft facility is secured by a personal
deposit account of a director of
Smartime.
|
BANK
LOANS - Tabulated below are bank loans outstanding (in
thousands):
|
|
March
31, 2007
(Unaudited)
|
|
December
31, 2006
|
|
Secured
[1]
|
|
$
|
2,476
|
|
$
|
1,668
|
|
Unsecured
|
|
$
|
737
|
|
$
|
543
|
|
Less:
Current portion
|
|
$
|
(933
|
)
|
$
|
(576
|
)
|
Noncurrent
portion
|
|
$
|
2,280
|
|
$
|
1,635
|
|
[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
$235,000 (2006: $234,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as follows:
US$
|
April
2007 to March 2008
|
April
2008 to March 2009
|
April
2009 to March 2010
|
April
2010 to March 2011
|
April
2011 to March 2012
|
Thereafter
|
TOTAL
|
Beijing
PACT office mortgage (1)
|
50,954
|
53,806
|
56,845
|
42,871
|
80,635
|
761,625
|
1,046,736
|
Shenzhen
PACT office mortgage (2)
|
21,673
|
23,045
|
24,505
|
26,056
|
27,706
|
648,420
|
771,405
|
Sub-total
|
72,627
|
76,851
|
81,350
|
68,927
|
108,342
|
1,410,044
|
1,818,141
|
|
|
|
|
|
|
|
|
Bank
line of credit (3)
|
436,841
|
403,754
|
130,996
|
-
|
-
|
-
|
971,590
|
AR
factoring loans (3)
|
423,802
|
-
|
-
|
-
|
-
|
-
|
423,802
|
Sub-total
|
860,642
|
403,754
|
130,996
|
-
|
-
|
-
|
1,395,392
|
|
|
|
|
|
|
|
|
TOTAL
|
933,270
|
480,604
|
212,346
|
68,927
|
108,342
|
1,410,044
|
3,213,533
|
|
(1)
|
Fixed
mortgages expiring in 2012 at interest rate of 5.5% per
annum.
|
|
(2)
|
Fixed
mortgage expiring in 2012 at interest rate of 6.2% per
annum.
|
|
(3)
|
Interest
rates charged range from Hong Kong Prime Lending Rate to Prime
+
2%.
|
CAPITAL
LEASE OBLIGATIONS - The Company leases various equipments under capital leases
expiring in 2008. Aggregate minimum future lease payments under capital leases
for each of the next two years are as follows: 2007: $80,000; 2008: $24,000,
and
thereafter: none.
Liquidated
damages: Refer to Note 6 for details
10.
OTHER CURRENT ASSETS
Other
current assets comprises of the following (in thousands):
|
|
March
31, 2007
(Unaudited)
|
|
December
31, 2006
|
|
Loans
to employees
|
|
$
|
367
|
|
$
|
411
|
|
Advances
to sales
representatives
|
|
|
1,127
|
|
|
358
|
|
Receivable
from Lion Zone Holdings
|
|
|
385
|
|
|
485
|
|
Prepayment
|
|
|
725
|
|
|
887
|
|
Deposit-utilities
|
|
|
1,327
|
|
|
1,292
|
|
Prepaid
expense
|
|
|
360
|
|
|
408
|
|
Others
|
|
|
261
|
|
|
171
|
|
Total
|
|
$
|
4,552
|
|
$
|
4,012
|
|
11.
INCOME TAXES
The
Company is registered in the state of Delaware and has operations in primarily
three tax jurisdictions - the PRC, Hong Kong and the United States.
The
income taxes expenses for the Company's subsidiaries were $68,000 for the
3-month period ended March 31, 2007. 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.
For
operations in the United States of America and Hong Kong the Company has
incurred net accumulated operating loss for income tax purposes. The Company
believes that it is more likely than not that these net accumulated operating
loss will not be utilized in the future. Therefore, the Company has provided
full valuation allowance for the deferred tax assets arising from the losses
at
these locations as of March 31, 2007. Accordingly, the Company has no net
deferred tax assets as of March 31, 2007.
12.
SUBSEQUENT
EVENTS
Sale
of Interest in Linkhead Technology
Bejing Limited. ("Linkhead")
On
May
20, 2007, the Company entered into a definitive agreement to sell its 36%
equity
interest in Linkhead, a PRC limited liability corporation engaged in the
business of resaling of NMS hardware and software platforms in China, to
Mr. Mu
Yingliang, a resident of People’s Republic of China. Consideration for the 36%
interest of Linkhead was RMB10,000 (or US$1,295), to be paid within 90 days
after signing of the agreement. The Company’s interest in Linkhead decreased
from 51% to 15% after the transaction.
Sale
of Interest in PacificNet Telecom Solution Inc.
("PacTelso")
On
May
20, 2007, the Company entered into a definitive agreement to sell its 36%
equity
interest in PacTelso, an intermediate holding company registered under the
laws
of British Virgin Islands, to Mr. Mu Yingliang, a resident of People’s Republic
of China. Consideration for the 36% interest of PacTelso was RMB10,000 (or
US$1,295), to be paid within 90 days after signing of the agreement The
Company’s interest in PacTelso decreased from 51% to 15% after the
transaction.
Sale
of Interest in PacificNet Solutions Limited. ("PacSo")
On
May
18, 2007, the Company entered into a definitive agreement to sell its 45%
equity
interest in PacSo, a company registered under the laws of Hong Kong SAR,
China
and engaged in systems integration, software application, and e-business
solutions services, to Mr. Alex Au, a resident of Hong Kong SAR, China.
Consideration for the 45% interest of PacSo was HK$4,500 (or US$583), to
be paid
within 90 days after signing of the agreement. The Company’s interest in PacSo
decreased from 60% to 15% after the transaction.
Sale
of Interest in PacificNet Power Limited ("PacPower")
On
May
18, 2007, the Company entered into a definitive agreement to sell its 36%
equity
interest in PacPower, a company registered under the laws of Hong Kong SAR,
China and engaged in air-conditioning contracting and consulting businesses,
to
Mr. Alex Au, a resident of Hong Kong SAR, China. Consideration for the 36%
interest of PacPower was HK$3,600 (or US$466), to be paid within 90 days
after
signing of the agreement. The Company’s interest in PacPower decreased from 51%
to 15% after the transaction.
Sale
of Interest in MOABC.com
("MOABC")
On
May
20, 2007, the Company entered into a definitive agreement to sell its 5%
equity
interest in MOABC, a PRC limited liability corporation engaged in the business
of value-added services platform providing, to Mr. Jack Ou, a resident of
People’s Republic of China. Consideration for the 5% interest of MOABC was
RMB5,000 (or US$647), to be paid within 90 days after signing of the agreement.
The Company’s interest in MOABC decreased from 20% to 15% after the
transaction.
Sale
of Interest in Guangzhou 3G Information Technology Co., Ltd. ("Guangzhou
3G")
On
April
30, 2007, the Company entered into a definitive agreement to sell its 51%
interest in Guangzhou 3G to HeySpace International Limited, a BVI company
owned
by founders of Guangzhou 3G, for consideration of US$6 million, to be paid
in cash in 5 installments over 7 months. The Company acquired a controlling
interest in Guangzhou 3G, a PRC registered wholly owned foreign enterprise,
through the purchase of a 51% interest in Guangzhou 3G's parent company,
Pacific
3G Information & Technology Co. Limited, a British Virgin Islands Company,
in March 2005 for a consideration of US$5.5 million, which was paid partly
in
cash and partly in PACT stock.
Guangzhou
3G was one of the largest value-added telecom and information services providers
in China. It conducts its VAS operations with Guangzhou Sunroom Information
Industrial Co., Ltd., a PRC registered Domestic Enterprise (DE), through
a
series of contractual agreements. Its business and profitability were severely
impacted by certain adverse billing policies implemented by China Mobile
during
2006.
Information
relating to the operations of the subsidiaries up to the periods of disposal
during the three month period ended March 31, 2007 is as follows:
(In
US$ thousands)
|
Linkhead
|
G3G
|
Clickcom
|
Power
|
Solutions
|
MOABC
|
Total
|
Income/(loss)
from discontinued operations
|
($8)
|
$261
|
($1)
|
-
|
$1
|
($23)
|
$230
|
Net
assets held for disposition
|
$1,387
|
$10,230
|
$138
|
$106
|
($23)
|
($43)
|
$11,795
|
13.
ACQUISITION
TAKE
1
TECHNOLOGIES GROUP LIMITED
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 January 05, 2007, with a
consideration of $965,505 (paid entirely with shares of PacificNet: 149,459
PACT
Shares, valued at $6.46 per share). As a result, PacificNet has become the
majority and controlling shareholder of Take1 with our ownership percentage
increasing from 20% to 51%.
An
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.
Summarized
below is the assets acquired and liabilities assumed for Take 1 in the
acquisition:
Estimated
fair values:
|
|
|
|
|
Current
Assets
|
|
|
$106,422
|
|
Intangible
asset
|
|
|
$64,665
|
|
Total
Assets Acquired
|
|
|
$171,087
|
|
Liabilities
assumed
|
|
|
($728,156
|
)
|
Net
assets acquired
|
|
|
($557,069
|
)
|
Investment
on equity method (20%)
|
|
|
$385,604
|
|
Loss
from Investment
|
|
|
$(285,260
|
)
|
Additional
Consideration (31%)-partially paid
|
|
|
$190,305
|
|
Goodwill
|
|
|
$847,718
|
|
At
March
31, 2007, goodwill of $847,718 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 is
reported under reportable segment for Products (Telecom &
Gaming)..
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for Take 1 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 Take 1. Accordingly, the operating results of Take 1 have been consolidated
with those of the Company starting January 05, 2007. 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$128,205 for the quarter ended March 31, 2007 is
available. Accordingly, the contingent consideration of 120,000 shares has
not
been reflected in the consolidated financial statements of the Company as
of
March 31, 2007.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE QUARTER ENDED
MARCH 31, 2007 AND 2006
The
following is an un-audited pro forma consolidated financial information for
the
quarter ended March 31, 2006 and 2007, as presented below, reflects the
results of operations of the Company assuming the acquisition occurred on
January 1, 2006 and 2007, 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, 2006 and 2007, respectively, and may not be indicative of future
operating results.
|
|
Quarter
ended March 31
|
|
|
|
2007
|
|
2006
|
|
|
|
(un-audited
and in thousands of U.S. dollars except
for earnings per share)
|
|
Revenue
|
|
|
$9,267
|
|
|
$6,916
|
|
Operating
income
|
|
|
$800
|
|
|
$47
|
|
Net
profit
|
|
|
$308
|
|
|
$796
|
|
Earnings
per share - basic
|
|
|
$0.03
|
|
|
$0.07
|
|
Earnings
per share - diluted
|
|
|
$0.03
|
|
|
$0.07
|
|
Accordingly,
PacificNet included the financial results of Take 1 in its consolidated 2007
financial results from January 5, 2007 through March 31, 2007.
14
INVESTMENTS IN AFFILIATED COMPANIES
Investments
in affiliated companies consists of the following as of March 31,
2007:
(US$
thousands)
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
|
AMOUNT
|
DESCRIPTION
|
INVESTMENTS
IN AFFILIATED COMPANIES:
|
|
|
Glad
Smart
|
$30
|
15%
ownership interest
|
Community
media co.
|
$4
|
5%
ownership interest
|
Total
|
$
34
|
|
15.
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 ("Yueshen"), Ms. Li Yan Kuan and Mr.Wu Yi
Wen 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 rane 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.
16. 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 performed 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 were 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
|
|
|
-
|
|
|
(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
|
|
|
-
|
|
|
282
|
|
|
-
|
|
|
1,246
|
|
|
-
|
|
|
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
|
|
17.
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.
ITEM
2. MANAGEMENT
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
THE
FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE INFORMATION
CONTAINED IN THE FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO
APPEARING ELSEWHERE HEREIN AND IN CONJUNCTION WITH THE MANAGEMENT'S DISCUSSION
AND ANALYSIS SET FORTH IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
YEAR
ENDED DECEMBER 31, 2006, AS AMENDED.
PRELIMINARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The
statements contained in this Form 10-Q that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934,
as amended. These include statements about the Company's expectations, beliefs,
intentions or strategies for the future, which are indicated by words or phrases
such as "anticipate," "expect," "intend," "plan," "will," "the Company
believes," "management believes" and similar words or phrases. The
forward-looking statements are based on the Company's current expectations
and
are subject to certain risks, uncertainties and assumptions, 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." The Company's actual results could differ materially from
results anticipated in these forward-looking statements. All forward-looking
statements included in this document are based on information available to
the
Company on the date hereof, and the Company assumes no obligation to update
any
such forward-looking statements.
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;
|
—
|
customer
demands;
|
—
|
market
and industry conditions,
|
—
|
the
success of product development and new product introductions into
the
marketplace;
|
—
|
the
departure of key members of management, and
|
—
|
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 Hong Kong and 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;
and
|
—
|
increasing
competition of call center solutions in the Hong Kong and PRC
markets.
|
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis or plan of operations 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 estimates and judgments that affect
the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities.
On
an
on-going basis, we evaluate our estimates, including those related to accounts
receivable reserves, provisions for impairment losses of affiliated companies
and other intangible assets, income taxes and contingencies. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form
the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from
these estimates under different assumptions or conditions.
Management
believes the following critical accounting policies reflect our more significant
estimates and assumptions used in the preparation of our consolidated financial
statements:
Allowance
For Doubtful Accounts
We
evaluate the collectibility of our trade receivables based on a combination
of
factors. We regularly analyze our significant customer accounts, and, when
we
become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration
in
the customer's operating results or financial position, we record a specific
reserve for bad debt to reduce the related receivable to the amount we
reasonably believe is collectible. We also record reserves for bad debt for
all
other customers based on a variety of factors including the length of time
the
receivables are past due, the financial health of the customer, macroeconomic
considerations and historical experience. If circumstances related to specific
customers change, our estimates of the recoverability of receivables could
be
further adjusted. In the event that our trade receivables become uncollectible,
we would be forced to record additional adjustments to receivables to reflect
the amounts at net realizable value. The accounting effect of this entry would
be a charge to earnings, thereby reducing our net earnings. 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.
In
the
beginning of the third quarter of 2006, the Chinese government announced that
it
would implement several new policies regarding mobile phone value-added service
providers effective from July 10, 2006. These policies include a “double
confirmation” policy and the requirement that value-added service providers
provide one-month trial subscriptions. By requiring that mobile phone customers
“double-confirm” their intention to purchase services, and by requiring free
subscriptions, the Chinese government has negatively affected value-added
service providers.
Inventory
Our
inventory purchases and commitments are made in order to build inventory to
meet
forecasted demand for our products. We perform a detailed assessment of
inventory for each period, which includes a review of, among other factors,
demand requirements, product life cycle and development plans, component cost
trends, product pricing and quality issues. Based on this analysis, we record
adjustments to inventory for excess, obsolescence or impairment, when
appropriate, to reflect inventory at net realizable value. Revisions to our
inventory adjustments may be required if actual demand, component costs or
product life cycles differ from our estimates. In the event we were unable
to
sell our products, the demand for our products diminished, and/or other
competitors offered similar or better products, we would be forced to record
an
adjustment to inventory for impairment or obsolescence to reflect inventory
at
net realizable value. The accounting effect of this entry would be a charge
to
earnings, thereby reducing our net earnings.
Income
Taxes
We
record
a valuation allowance to reduce our deferred tax assets to the amount that
is
more likely than not to be realized. We have considered future market growth,
forecasted earnings, future taxable income, and 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. We currently
have
recorded a full valuation allowance against net deferred tax assets as we
currently believe it is more likely than not that the deferred tax assets will
not be realized. 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.
Contingencies
We
may be
subject to certain asserted and unasserted claims encountered in the normal
course of business. It is our belief that the resolution of these matters will
not have a material adverse effect on our financial position or results of
operations, however, we cannot provide assurance that damages that result in
a
material adverse effect on our financial position or results of operations
will
not be imposed in these matters. We account for contingent liabilities when
it
is probable that future expenditures will be made and such expenditures can
be
reasonably estimated.
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 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 an 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 earnings, thereby reducing
our
net earnings.
Convertible
Debt
The
fair
value of these derivative instruments, as determined by applying the
Black-Scholes valuation model, is adjusted quarterly. The Black-Scholes
valuation model requires the input of highly subjective assumptions, including
the expected stock price volatility. Additionally, although the Black-Scholes
model meets the requirements of SFAS 133, the fair values generated by the
model may not be indicative of the actual fair values as our derivative
instruments have characteristics significantly different from traded options.
Accordingly, the results obtained could be significantly different if other
assumptions were used. The effect of this entry would be a charge to net
earnings, thereby either increasing or reducing our net earnings based upon
the
assumptions used and the results obtained.
NATURE
OF THE OPERATIONS OF THE COMPANY
NATURE
OF BUSINESS.
PacificNet
Inc. (http://www.PacificNet.com) is a leading provider of gaming technology,
e-commerce, and Customer Relationship Management (CRM) in China. Our gaming
products are specially designed for the Chinese and Asian gamers, and we focus
on integrating localized Chinese and Asian themes and content, advanced
graphics, digital sound effects and popular domestic music, with secondary
bonus
games and jackpots. Our gaming products include: Multi-player Electronic Table
Games - Baccarat, Sicbo, Fish-Prawn-Crab, and Roulette machines, server based
games (SBG) with multiple client betting stations, slot and bingo machines,
video lottery terminals (VLTs), amusement with prices (AWP) machines, gaming
cabinet and client/server system designs, online i-gaming software design,
and
multimedia entertainment kiosks. PacificNet's gaming clients include the leading
hotels, casinos, and gaming operators in Macau, Asia, and Europe, and our
ecommerce and CRM clients include the 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, China and Hong
Kong
government. PacificNet employs about 1,200 staff in its various subsidiaries
throughout China with offices in Hong Kong, Beijing, Shanghai, Shenzhen,
Guangzhou, Macau and Zhuhai China, USA, and the Philippines.
PacificNet's
Gaming Products:
Our
gaming products are specially designed for the Chinese and Asian gamers, and
we
focus on integrating localized Chinese and Asian themes and content, advanced
graphics, digital sound effects and popular domestic music, with secondary
bonus
games and jackpots. Our gaming products include:
•
Multi-player Electronic Table Games: Baccarat, Sicbo, Fish-Prawn-Crab, and
Roulette Machines, server based games (SBG) with multiple client betting
stations.
•
Slot
Machines
•
Bingo
and Keno Machines
•
Video
Lottery Terminals (VLTs)
•
Server-Based Gaming Machines (SBG)
•
Amusement With Prices (AWP) Machines
•
Online
iGaming Software Development
•
Client-Server Gaming Systems
•
CMM
Level 3 Certified Gaming Software Development Center in China with 200
Professional Software Developers
•
Gaming
Systems, Cabinet Design and Sales, Parts Sales, OEM Games. We design and sell
gaming machine cabinets, replacement parts.
PacificNet's
Business Units:
1.
Gaming
Technology: Electronic Gaming Machines, Mobile Games, i-Gaming
Software.
2.
Legacy
Business: CRM, E-commerce and Telecom Products
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.
PaificNet’s
Major Operating Subsidiaries
|
PacificNet
Games Limited (PacGames),
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.
|
|
Take1
Technologies (www.take1technologies.com) , 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, and cabinets.
|
|
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 client-server systems, 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.
|
|
PacificNet
Epro (www.EproTel.com.hk): CRM Call Center and Customer Services
Outsourcing
|
|
PacificNet
Clickcom (www.clickcom.com.cn), MOABC.com : VAS,SP,( SMS,
WAP)
|
|
Guangzhou
Wanrong (www.my2388.com) : VAS, SP, (SMS,MMS,IVR,WAP, Java
Games)
|
|
PacificNet
Communications Limited,
|
|
iMobile,
(www.imobile.com.cn, www.18900.com,
wap.17wap.com)
|
PacificNet
Gaming Technology
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:
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:
electronically links gaming machines that are located within a single casino
to
a progressive jackpot for that specific casino.
4.
Video Lottery Terminals:
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.
5.
Server-based Gaming:
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.
Gaming
Market Overview on Macau, China
As
of the
end of 2006, Macau (a Special Administrative Region of the People's Republic
of
China) has become the largest and fastest-growing gaming market in the world,
and surpassed the Las Vegas Strip in total revenues. According to statistics
provided by Macau government, in 2006, Macau's gaming revenues exceeded US$7
billion (MOP 56.2 billion patacas), surpassing the Las Vegas Strip gaming
revenues of US$6.6 billion. Macau borders Zhuhai City of Guangdong Province
of
China, one of the country's wealthiest and most developed regions and is an
hour
away from Hong Kong via ferry. In 2006, the number of tourists visiting Macau
reached an all-time record of 22 million, an increase of 17 percent compared
with 2005, of which 55% or 12 million visitors were from mainland China. At
the
end of 2006, there were 22 casinos, 83 hotels and similar establishments in
Macau with close to 13,000 rooms. By 2010, the number of tourists is expected
to
nearly double to nearly 30 million visitors per year. Approximately one billion
people live within a three-hour flight of Macau. Numerous hotel, gaming, and
other projects are in the works in Macau which are expected to add over 10,000
guest rooms and over 20,000 live entertainment seats in eight separate venues.
The number of hotel-casinos in operation and in development in Macau continues
to grow, including well-known Chinese names such as Galaxy and Melco, and famous
Las Vegas names such as the Sands, the Venetian, Wynn Resort and Crown Macau.
With the disposable income of the average Chinese on the rise, Macau's gaming
and entertainment market is expected to grow for years to come. Macau is the
only area in China where gambling is legal.
RESULTS
OF OPERATIONS
REVENUES.
Revenues for the three months ended March 31, 2007 were amounted to $9,267,000,
which represented a quarter-over-quarter increase of 39% from $6,672,000 for
the
three months ended March 31, 2006.
The
increase in revenues was mainly due to the Products (Telecom & Gaming),
primarily driven by the Company’s high growth gaming technology businesses, and
organic growth in Outsourcing Services Group, which posted a
quarter-over-quarter increase of 42.3% and 31.1% respectively. The
revenues in services and product sales during the first quarter of 2007
increased by 60.1% and 22.2% compared to the same periods of 2006. Segmented
financial information of the three business operating groups is set out below
followed by a brief discussion of each business group.
FOR
THE THREE MONTHS ENDED
|
|
Group
1
Outsourcing
Services
|
|
Group
2
Telecom
Value-Added Services
|
|
Group
3
Products
(Telecom
& Gaming)
|
|
Other
|
|
TOTAL
|
|
MARCH
31, 2007 (in
thousands, except percentages)
|
|
($)
|
|
($)
|
|
($)
|
|
($)
|
|
($)
|
|
Revenues
|
|
|
3,963
|
|
|
527
|
|
|
4,773
|
|
|
4
|
|
|
9,267
|
|
Earnings
/ (Loss) from Operations
|
|
|
400
|
|
|
-3
|
|
|
1,196
|
|
|
-793
|
|
|
800
|
|
|
|
Group
1
|
|
Group
2
|
|
Group
3
|
|
|
|
|
|
FOR
THE THREE MONTHS ENDED
|
|
Outsourcing
Services
|
|
Telecom
Value-Added Services
|
|
Products
(Telecom & Gaming)
|
|
Other
|
|
TOTAL
|
|
MARCH
31, 2006 (in
thousands, except percentages)
|
|
($)
|
|
($)
|
|
($)
|
|
($)
|
|
($)
|
|
Revenues
|
|
|
3,022
|
|
|
295
|
|
|
3,355
|
|
|
0
|
|
|
6,672
|
|
Earnings
/ (Loss) from Operations
|
|
|
206
|
|
|
15
|
|
|
359
|
|
|
-518
|
|
|
62
|
|
|
(1)
|
Outsourcing
services: The quarter-over-quarter increase of 31.1% in outsourcing
services for the three months ended March 31, 2007 was primarily
due to
the growth in outsourcing contact center in Hong Kong. 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. Outsourcing revenues made up 42.8%
of the
Company's total revenues for the first quarter of the
year.
|
|
(2)
|
Telecom
Value-added Services (VAS): Revenue for the three months ended March
31,
2007 was $527,000, a quarter-over-quarter increase of 78.6% as compare
to
the same period of 2006. VAS revenues made up 5.7% of the Company's
total
revenues for the first quarter of the
year.
|
|
(3)
|
Products
(Telecom & Gaming): Revenue for the three months ended March 31, 2007
was $4,773,000, a quarter-over-quarter increase of 42.3% as compare
to the
same period of 2006. Products revenues made up 51.5% of the Company's
total revenues for the first quarter of the year. During the quarter,
the
Company’s mobile phone distribution business in Greater China remained
steady. The Company owned one of the largest on-line mobile phone
distribution portals in China and was one of the top five largest
mobile
phone wholesalers in Hong Kong. Increase is primarily due to buildup
of
revenues derived from the Company’s emerging gaming technology businesses.
Significant traction has been gained from continued winning of high
profile gaming orders from the fast growing Asian gaming technology
provider market. Company managed to continue build up excellent
relationships with leading casino operators in Macau and the rest
of Asia
with its world class multi-player electronic table game machines
customized to the taste of Asian gaming customers. In addition, winning
the bid of providing electronic slot machines to various leading
gaming
operators’ slot halls in Europe also pushed revenues during the
quarter.
|
COST
OF
REVENUES. Cost of revenues for the three months ended March 31, 2007 was
$6,728,000, an increase of 26% from $5,320,000 for the three months ended March
31, 2006, respectively. The cost of revenues in services sales and
product sales for the three months ended March 31, 2007 increased by 30% and
23%, respectively, in each case compared with the respective period in 2006.
The
increase in cost of revenues lagged behind the corresponding increase in
revenues, which amounted to approximately 39%. Cost of revenues savings were
primarily due to the contribution from higher margin gaming technology
businesses.
GROSS
PROFIT. Gross profit for the three months ended March 31, 2007 was $2,539,000,
a
significant increase of 88% as compared to $1,352,000 for the three months
ended
March 31, 2006. Gross margin was 27% for the three months ended March 31, 2007,
compared to 20% for the three months ended March 31, 2006. The
improvement in gross margin for the quarter was primarily due to increased
contributions from higher margin gaming technology subsidiaries. Out of their
19% revenue mix, gross profit of the Company’s gaming technology businesses
represented 39% of the quarter’s total gross profit. Gross margins of the
Company’s gaming technology businesses averaged more than 50%.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative
expenses totaled $1,567,000 for the three months ended March 31, 2007, an
increase of 45% from $1,079,000 for the three months ended March 31, 2006.
Selling, general and administrative expenses as a percentage of revenue,
however, recorded only a small quarter-over-quarter increase from 16% to 17%.
Selling, general and administrative expenses consist primarily of staff
salaries, rent, insurance and traveling costs. The quarter-over-quarter increase
in total general and administrative expenses during the three months ended
March
31, 2007 was mainly due to the increase in consultant and labor costs as a
result of new product development as well as rental and utilities expenses
for
the expansion of the Company’s gaming technology subsidiaries and call centers
in Hong Kong and China.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
(in
thousands, except percentages)
|
|
Total
for the three months ended
March
31, 2007
($)
|
|
Total
for the three months ended
March
31, 2006
($)
|
|
Percentage
Change
(%)
|
|
Remuneration
and related
|
|
|
1,041
|
|
|
581
|
|
|
79
|
|
Office
|
|
|
300
|
|
|
215
|
|
|
40
|
|
Travel
|
|
|
91
|
|
|
40
|
|
|
128
|
|
Entertainment
|
|
|
40
|
|
|
16
|
|
|
150
|
|
Professional
(legal and consultant)
|
|
|
290
|
|
|
65
|
|
|
346
|
|
Audit
|
|
|
20
|
|
|
18
|
|
|
11
|
|
Selling
|
|
|
111
|
|
|
52
|
|
|
113
|
|
Other
|
|
|
52
|
|
|
94
|
|
|
(45
|
)
|
Recovery
of provisions for doubtful accounts
|
|
|
(378
|
)
|
|
-
|
|
|
N/A
|
|
Total
|
|
|
1,567
|
|
|
1,081
|
|
|
45
|
|
INCOME
/
(LOSS) FROM OPERATIONS. On a quarter-over-quarter basis, income from operations
increased 1,100% for the three months ended March 31, 2007. Segmented operating
incomes of $400,000, $3,000, and $1,196,000 for the three months ended March
31,
2007 were generated from the Company's three business groups: (1) CRM
Outsourcing Services, (2) Telecom Value-Added Services, and (3) Products
(Telecom & Gaming) Services, respectively. This compares to operating
incomes of $206,000, $15,000 and $359,000 from the same groups for the same
period last year, respectively. Improved profitability of continuing operations
evidenced the success of the Company’s new gaming technology strategy, as
reflected by the significant gaming technology operating income.
INCOME
TAXES. Income tax provision was $68,000 for the three months ended March 31,
2007, as compared to $17,000 for the three months ended March 31, 2006. Interim
income tax provisions are based upon management’s estimate of taxable income and
the resulting consolidated effective income tax rate for the full year. As
a
result, such interim estimates are subject to change as the year progresses
and
more information becomes available. We expect our income taxes to increase
as
our net income increases and the tax holidays we have benefited from in Hong
Kong and the PRC expire.
MINORITY
INTERESTS. Minority interests for the three months ended March 31, 2007 totaled
$534,000 compared with $86,000 for the same period of the prior year,
representing minority ownership interests in subsidiaries consolidated in the
Company’s consolidated financial statements.
NET
INCOME. Net income recorded a quarter-over-quarter decrease of 62% for the
three
months ended March 31, 2007 as compared to the same period of prior year. This
was solely due to diminishing income from discontinued operations as a result
of
the Company shifting from VAS businesses that are highly susceptible to adverse
billing policy changes administered by China Mobile.
CASH
Net
cash
and cash equivalents at March 31, 2007 were approximately $4.04 million, an
increase of approximately $1.80 million compared to December 31, 2006. This
was primarily due to successful collection of certain doubtful debts of
approximately $300,000 and 50% net proceeds ($2.3 million) from issuance of
convertible debenture for the Company’s gaming technology business, net of
acquisition of property and equipment of approximately $900,000.
CONTRACTUAL
OBLIGATIONS
Contractual
obligations as of March 31, 2007 are detailed below:
Payments
Due by Period
Contractual
Obligations
|
|
Total
|
|
Less
than 1 year
|
|
1-5
years
|
|
After
5 years
|
|
Line
of credit
|
|
$
|
404,000
|
|
$
|
404,000
|
|
|
0
|
|
|
0
|
|
Bank
Loans
|
|
$
|
3,213,000
|
|
$
|
933,000
|
|
$
|
870,000
|
|
$
|
1,410,000
|
|
Operating
leases
|
|
$
|
1,339,000
|
|
$
|
655,000
|
|
$
|
684,000
|
|
|
0
|
|
Capital
leases
|
|
$
|
214,000
|
|
$
|
110,000
|
|
$
|
104,000
|
|
|
0
|
|
Total
cash contractual obligations
|
|
$
|
5,170,000
|
|
$
|
2,102,000
|
|
$
|
1,658,000
|
|
$
|
1,410,000
|
|
In
addition to above, as previously disclosed in the paragraph under the
sub-heading of PROBABLE EVENT OF DEFAULT under Item 7 - CONVERTIBLE DEBENTURES,
the terms of the convertible note obligate the Company to pay monthly 2% of
outstanding principal as liquidated damages and 30% of the outstanding principal
as mandatory default amount from the date of ineffectiveness of registration
statement. As of March 31, 2007, the Company has accrued three months of
liquidated damages and mandatory amount or approximately $2,697,000, although
the Company may not have to pay the full amount of liquidated damages The amount
has been reflected in the consolidated financial statements as a separate line
item on the consolidated balance sheet as “liquidated damages
liability”.
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
March
31,
2007.
Further, the Company had not engaged in any non-exchange trading activities
during first quarter of 2007.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We
are
exposed to various market risks arising from adverse changes in market rates
and
prices, such as foreign exchange fluctuations and interest rates, which could
impact our results of operations and financial position. We do not currently
engage in any hedging or other market risk management tools, and we do not
enter
into derivatives or other financial instruments for trading or speculative
purposes.
Foreign
Currency Exchange Rate Risk.
Fluctuations
in the rate of exchange between the U.S. dollar and foreign currencies,
primarily the Hong Dollar and the Chinese Renminbi, could adversely affect
our
financial results. During the quarter ended June 30, 2006, approximately all
of
our sales are denominated in foreign currencies. We expect that foreign
currencies will continue to represent a similarly significant percentage of
our
sales in the future. Selling, marketing and administrative costs related to
these sales are largely denominated in the same respective currency, thereby
mitigating our transaction risk exposure. We therefore believe that the risk
of
a significant impact on our operating income from foreign currency fluctuations
is not substantial. However, for sales not denominated in U.S. dollars, if
there
is an increase in the rate at which a foreign currency is exchanged for U.S.
dollars, it will require more of the foreign currency to equal a specified
amount of U.S. dollars than before the rate increase. In such cases and if
we
price our products in the foreign currency, we will receive less in US. dollars
than we did before the rate increase went into effect. If we price our products
in U.S. dollars and competitors price their products in local currency, an
increase in the relative strength of the U.S. dollar could result in our price
not being competitive in a market where business is transacted in the local
currency. All of our sales denominated in foreign currencies are denominated
in
the Hong Dollar and the Chinese Renminbi. Our principal exchange rate risk
therefore exists between the U.S. dollar and these two currencies. Fluctuations
from the beginning to the end of any given reporting period result in the
re-measurement of our foreign currency-denominated receivables and payables,
generating currency transaction gains or losses that impact our non-operating
income/expense levels in the respective period and are reported in other
(income) expense, net in our combined consolidated financial statements. We
do
not currently hedge our exposure to foreign currency exchange rate fluctuations.
We may, however, hedge such exposure to foreign currency exchange rate
fluctuations in the future.
All
of
our sales denominated in foreign currencies are denominated in the Hong Dollar
and the Chinese Renminbi. Our principal exchange rate risk therefore exists
between the U.S. dollar and these two currencies. Fluctuations from the
beginning to the end of any given reporting period result in the re-measurement
of our foreign currency-denominated receivables and payables, generating
currency transaction gains or losses that impact our non-operating
income/expense levels in the respective period and are reported in other
(income) expense, net in our combined consolidated financial statements. We
do
not currently hedge our exposure to foreign currency exchange rate fluctuations.
We may, however, hedge such exposure to foreign currency exchange rate
fluctuations in the future.
Interest
Rate Risk.
Changes
in interest rates may affect the interest paid (or earned) and therefore affect
our cash flows and results of operations. We are exposed to interest rate change
risk with respect to Epros' (one of our subsidiaries) credit facility with
a
commercial lender. However, we do not believe that this interest rate change
risk is significant.
Inflation.
Inflation
has not had a material impact on the Company's business in recent years.
Currency
Exchange Fluctuations.
All
of
the Company's revenues are denominated either in U.S. dollars or Hong Kong
dollars, while its expenses are denominated primarily in Hong Kong dollars
and
Chinese renminbi ("RMB"). The value of the RMB-to-U.S. dollar or Hong Kong
dollar-to-United States dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Since 1994, the conversion of renminbi into foreign currencies, including U.S.
dollars, has been based on rates set by the People's Bank of China, which are
set daily based on the previous day's inter-bank foreign exchange market rates
and current exchange rates on the world financial markets. Since 1994, the
official exchange rate 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.
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
4. 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
former chief financial officer concluded that our disclosure controls and
procedures were inadequate, need to be strengthened and were not sufficiently
effective to ensure that information required to be disclosed by us in our
reports that we filed or submitted under the Exchange Act was recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms.
During
the year, the Company had taken various steps to maintain the accuracy of our
financial disclosures, and improve company internal control. An internal control
team lead by senior managers had been set up to review the entire internal
control system of the Company, including but not limited to risks
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.
PART
II - OTHER INFORMATION
ITEM
1. 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 and Mr.Wu Yi Wen 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 rane 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
1A. RISK FACTORS.
In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in “Risk Factors” in our Annual Report on Form
10-K for the year ended December 31, 2006, and in Part II, Item IA Risk Factors
in our Amendment to Quarterly Report on Form 10-Q for the period ended March
31,
2007 which could materially affect our business, financial condition or future
results. The risks described in our Annual Report on Form 10-K and the Amendment
to our Quarterly Report on Form 10-Q are not the only risks facing us Additional
risks and uncertainties not currently known to us or that we currently deem
to
be immaterial also may materially adversely affect our business, financial
condition and/or operating results.
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:
|
·
|
Increase
awareness of our brands, protect our reputation and develop customer
loyalty
|
|
·
|
Manage
our expanding operations and service offerings, including the integration
of any future acquisitions
|
|
·
|
Maintain
adequate control of our expenses
|
|
·
|
Anticipate
and adapt to changing conditions in the markets in which we operate
as
well as the impact of any changes in government regulation, mergers
and
acquisitions involving our competitors, technological developments
and
other significant competitive and market
dynamics
|
If
we are
not successful in addressing any or all of these risks, our business may be
materially and adversely affected.
The
acquisition of new businesses is costly and such acquisitions may not enhance
our financial condition.
Our
growth strategy is to acquire companies and identify and acquire assets and
technologies from businesses in greater China that have services, products,
technologies, industry specializations or geographic coverage that extend or
complement our existing business. The process to undertake a potential
acquisition is time-consuming and costly. We expend significant resources to
undertake business, financial and legal due diligence on our potential
acquisition target and there is no guarantee that we will acquire the company
after completing due diligence. Any future acquisitions will be subject to
a
number of challenges, including:
|
·
|
Diversion
of management time and resources and the potential disruption of
our
ongoing business
|
|
·
|
Difficulties
in maintaining uniform standards, controls, procedures and
policies
|
|
·
|
Potential
unknown liabilities associated with acquired
businesses
|
|
·
|
Difficulty
of retaining key alliances on attractive terms with partners and
suppliers
|
|
·
|
Difficulty
of retaining and recruiting key personnel and maintaining employee
morale
|
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:
|
·
|
Legal
uncertainties or unanticipated changes regarding regulatory requirements,
liability, export and import restrictions, tariffs and other trade
barriers
|
|
·
|
Longer
customer payment cycles and greater difficulties in collecting accounts
receivable
|
|
·
|
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
|
|
·
|
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:
|
·
|
Shutting
down servers or blocking websites
|
|
·
|
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
March 31, 2007, we had 11,808,993 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
March 31, 2007, we had stock options outstanding to purchase an aggregate of
370,500 shares of common stock, those options were all 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.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM
3. DEFAULTS UPON SENIOR SECURITIES.
On
March
19, 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. Under
the
terms of the registration rights agreement, the Company was obligated to pay
liquidated damages to the convertible debenture investors at the rate of 2%
of
the principal amount of the debenture each month beginning on March
27,
2007
until
the registration statement returns to effect.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM
5. OTHER INFORMATION.
None.
ITEM
6. EXHIBITS
The
following exhibits are filed as part of this report:
EXHIBIT
31.1
|
Rule
13a-14(a) Certification of Chief Executive Officer (Principal Executive
Officer)
|
31.2
|
Rule
13a-14(a) Certification of Chief Financial Officer (Principal Financial
Officer)
|
32.1
|
18
U.S.C. Section 1350 Certifications
|
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
31 , 2007
|
By:
|
/s/ TONY
TONG
|
|
Tony
Tong
Chief
Executive Officer
(Principal
Executive Officer)
|
|
|
|
|
|
|
Date: May
31 , 2007
|
By:
|
/s/ Daniel
Lui
|
|
Daniel
Lui
Chief
Financial Officer
(Principal
Financial Officer)
|
57