PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(In
thousands of United States dollars, except par values and share
numbers)
ASSETS
|
|
September
30,
2007
(Unaudited)
|
|
|
December
31,
2006 (Audited)
Restated
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
4,889
|
|
|
$ |
1,900
|
|
Restricted
cash - pledged bank deposit
|
|
|
239
|
|
|
|
234
|
|
Accounts
receivables
|
|
|
6,665
|
|
|
|
8,141
|
|
Inventories
|
|
|
553
|
|
|
|
201
|
|
Loan
receivable from related parties
|
|
|
2,227
|
|
|
|
1,706
|
|
Loan
receivable from third parties
|
|
|
2,260
|
|
|
|
128
|
|
Marketable
equity securities - available for sale
|
|
|
1,059
|
|
|
|
558
|
|
Loans
to employees
|
|
|
1,884
|
|
|
|
770
|
|
Other
receivables, net
|
|
|
2,900
|
|
|
|
170
|
|
Other
current assets
|
|
|
6,659
|
|
|
|
3,233
|
|
Total
Current Assets
|
|
|
29,335
|
|
|
|
17,041
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
5,794
|
|
|
|
4,711
|
|
Investments
in affiliated companies and subsidiaries
|
|
|
353
|
|
|
|
1,257
|
|
Intangible
assets, net
|
|
|
337
|
|
|
|
323
|
|
Goodwill
|
|
|
6,258
|
|
|
|
5,601
|
|
Other
assets
|
|
|
76
|
|
|
|
471
|
|
Net
assets held for disposition
|
|
|
810
|
|
|
|
7,522
|
|
TOTAL
ASSETS
|
|
|
42,963
|
|
|
|
36,926
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$ |
181
|
|
|
$ |
855
|
|
Bank
loans-current portion
|
|
|
768
|
|
|
|
576
|
|
Capital
lease obligations - current portion
|
|
|
90
|
|
|
|
120
|
|
Accounts
payable
|
|
|
2,166
|
|
|
|
1,266
|
|
Accrued
expenses and other payables
|
|
|
2,950
|
|
|
|
1,828
|
|
Customer
deposits
|
|
|
430
|
|
|
|
352
|
|
Loans
payable to related party
|
|
|
681
|
|
|
|
638
|
|
Convertible
debenture
|
|
|
6,218
|
|
|
|
8,945
|
|
Warrant
liability
|
|
|
761
|
|
|
|
904
|
|
Liquidated
damages liability
|
|
|
2,697
|
|
|
|
2,837
|
|
Total
Current Liabilities
|
|
|
16,942
|
|
|
|
18,321
|
|
|
|
|
|
|
|
|
|
|
Long-term
liabilities:
|
|
|
|
|
|
|
|
|
Bank
loans - non current portion
|
|
|
2,051
|
|
|
|
1,635
|
|
Capital
lease obligations - non current portion
|
|
|
62
|
|
|
|
124
|
|
Convertible
Debenture- non current portion
|
|
|
4,908
|
|
|
|
-
|
|
Total
long-term liabilities
|
|
|
7,021
|
|
|
|
1,759
|
|
Total
liabilities
|
|
|
23,963
|
|
|
|
20,080
|
|
|
|
|
|
|
|
|
|
|
Minority
interest in consolidated subsidiaries
|
|
|
4,032
|
|
|
|
2,869
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
Stockholders'
Equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, par value $0.0001, Authorized 5,000,000 shares
|
|
|
|
|
|
|
|
|
Issued
and outstanding - none
|
|
|
|
|
|
|
|
|
Common
stock, par value $0.0001, Authorized 125,000,000 shares;
|
|
|
|
|
|
|
|
|
Issued
and outstanding:
|
|
|
|
|
|
|
|
|
September
30, 2007: 14,557,041 shares issued, 11,984,072 outstanding
|
|
|
|
|
|
|
|
|
December
31, 2006: 14,155,597 issued, 11,538,664 outstanding
|
|
|
1
|
|
|
|
1
|
|
Treasury
stock, at cost (2007 Q3: 2,572,969 shares, 2006: 2,616,933
shares)
|
|
|
(145 |
) |
|
|
(272 |
) |
Additional
paid-in capital
|
|
|
67,409
|
|
|
|
65,757
|
|
Cumulative
other comprehensive income (loss)
|
|
|
(84 |
) |
|
|
(42 |
) |
Accumulated
deficit
|
|
|
(51,729 |
) |
|
|
(51,090 |
) |
Less:
stock subscription receivable
|
|
|
(484 |
) |
|
|
(377 |
) |
Total
Stockholders' Equity
|
|
|
14,968
|
|
|
|
13,977
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
42,963
|
|
|
$ |
36,926
|
|
The
accompanying 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 loss per share and share
amounts)
|
|
Three
months ended
September
30,
|
|
|
Nine
months ended
September
30,
|
|
|
|
2007
Unaudited
|
|
|
2006
Unaudited
Restated
|
|
|
2007
Unaudited
|
|
|
2006
Unaudited
Restated
|
|
Net
Revenues
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Services
|
|
|
4,497
|
|
|
|
3,938
|
|
|
|
13,361
|
|
|
|
11,420
|
|
Product
sales
|
|
|
5,305
|
|
|
|
6,587
|
|
|
|
14,729
|
|
|
|
20,912
|
|
Total
Net Revenues
|
|
|
9,802
|
|
|
|
10,525
|
|
|
|
28,090
|
|
|
|
32,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
3,441
|
|
|
|
3,076
|
|
|
|
9,626
|
|
|
|
8,203
|
|
Product
sales
|
|
|
3,987
|
|
|
|
6,342
|
|
|
|
11,190
|
|
|
|
19,507
|
|
Total
Cost of Revenues
|
|
|
7,428
|
|
|
|
9,418
|
|
|
|
20,816
|
|
|
|
27,710
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
2,374
|
|
|
|
1,107
|
|
|
|
7,274
|
|
|
|
4,622
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
2,030
|
|
|
|
1,580
|
|
|
|
5,395
|
|
|
|
4,067
|
|
Provision
for doubtful accounts
|
|
|
|
|
|
|
312
|
|
|
|
|
|
|
|
310
|
|
Depreciation
and amortization
|
|
|
207
|
|
|
|
145
|
|
|
|
595
|
|
|
|
303
|
|
Total
Operating Expenses
|
|
|
2,237
|
|
|
|
1,725
|
|
|
|
5,990
|
|
|
|
4,370
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME(LOSS)
FROM OPERATIONS
|
|
|
137
|
|
|
|
(618 |
) |
|
|
1,284
|
|
|
|
252
|
|
Other
Income(Expenses):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income (Expenses),
net
|
|
|
(223 |
) |
|
|
(252 |
) |
|
|
(655 |
) |
|
|
(649 |
) |
Gains(Loss)
in change in fair value of derivatives
|
|
|
62
|
|
|
|
1,004
|
|
|
|
143
|
|
|
|
1,212
|
|
Liquidated
damages expense
|
|
|
-
|
|
|
|
(800 |
) |
|
|
-
|
|
|
|
(800 |
) |
Sundry
income, net
|
|
|
245
|
|
|
|
9
|
|
|
|
291
|
|
|
|
77
|
|
Total
Other Income (Expenses)
|
|
|
84
|
|
|
|
(39 |
) |
|
|
(221 |
) |
|
|
(160 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income(Loss)
before Income Taxes and Minority Interest
|
|
|
221
|
|
|
|
(657 |
) |
|
|
1,063
|
|
|
|
92
|
|
Provision
for income taxes
|
|
|
46
|
|
|
|
(40 |
) |
|
|
-
|
|
|
|
(70 |
) |
Share
of earnings of associated companies
|
|
|
(23 |
) |
|
|
80
|
|
|
|
(23 |
) |
|
|
129
|
|
Minority
interests
|
|
|
(130 |
) |
|
|
(12 |
) |
|
|
(1,004 |
) |
|
|
(527 |
) |
|
|
|
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income(Loss)
from Continued Operations
|
|
|
114
|
|
|
|
(629 |
) |
|
|
36
|
|
|
|
(376 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
on disposal
|
|
|
(356 |
) |
|
|
-
|
|
|
|
(925 |
) |
|
|
-
|
|
Income
from discontinued operations
|
|
|
22
|
|
|
|
(486 |
) |
|
|
250
|
|
|
|
980
|
|
Total
discontinued operations income (loss)
|
|
|
(334 |
) |
|
|
(486 |
) |
|
|
(675 |
) |
|
|
980
|
|
Net
Income (Loss)
|
|
|
(220 |
) |
|
|
(1,115 |
) |
|
|
(639 |
) |
|
|
604
|
|
Unrealized gain
on marketable securities
|
|
|
114
|
|
|
|
-
|
|
|
|
114
|
|
|
|
-
|
|
Foreign
exchange gain (loss)
|
|
|
(38 |
) |
|
|
- |
|
|
|
(135 |
) |
|
|
- |
|
Net
Comprehensive Loss
|
|
$ |
(144 |
) |
|
$ |
(1,115 |
) |
|
$ |
(660 |
) |
|
$ |
604
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
Earnings (Loss) per share-Continued Operations
|
|
$ |
0.01
|
|
|
$ |
(0.05 |
) |
|
$ |
0.00
|
|
|
$ |
(0.03 |
) |
Basic
Earnings (Loss) per share-Discontinued Operations
|
|
$ |
(0.03 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.05
|
|
Basic
Earnings (Loss) per share
|
|
$ |
(0.02 |
) |
|
$ |
(0.09 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
Earnings (Loss) per share-Continued Operations
|
|
$ |
0.01
|
|
|
$ |
(0.05 |
) |
|
$ |
0.00
|
|
|
$ |
(0.03 |
) |
Diluted
Earnings (Loss) per share-Discontinued Operations
|
|
$ |
(0.03 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.05
|
|
Diluted
Earnings (Loss) per share
|
|
$ |
(0.02 |
) |
|
$ |
(0.09 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares-Basic
|
|
|
11,931,094
|
|
|
|
11,619,010
|
|
|
|
11,805,686
|
|
|
|
11,171,608
|
|
Weighted
average number of shares-Diluted
|
|
|
12,027,315
|
|
|
|
11,619,010
|
|
|
|
11,858,870
|
|
|
|
11,171,608
|
|
The
accompanying 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, except earnings per share and share
amounts)
|
|
For
the Nine Month Periods Ended September 30,
|
|
|
|
2005
(Unaudited)
|
|
|
2006
(Unaudited)
(Restated)
|
|
Cash
Flows from operating activities
|
|
|
|
|
|
|
Net
income (loss)
|
|
$ |
(639 |
) |
|
$ |
604
|
|
Adjustment
to reconcile net income/(loss) to net cash provided by (used
in) operating
activities:
|
|
|
|
|
|
|
|
|
Equity
earnings of associated companies
|
|
|
23
|
|
|
|
(129 |
) |
Provision
for allowance for doubtful accounts
|
|
|
1,391
|
|
|
|
310
|
|
Minority
Interest
|
|
|
1,004
|
|
|
|
527
|
|
Depreciation
and amortization
|
|
|
595
|
|
|
|
303
|
|
Stock-based
compensation
|
|
|
-
|
|
|
|
120
|
|
Change
in fair value of derivatives
|
|
|
(143 |
) |
|
|
(1,212 |
) |
Amortization
of interest discount
|
|
|
-
|
|
|
|
307
|
|
Liquidated
damages expense
|
|
|
-
|
|
|
|
800
|
|
Changes
in current assets and liabilities net of effects from purchase
of
subsidiaries:
|
|
|
|
|
|
|
|
|
Accounts
receivable and other current assets
|
|
|
(5,794 |
) |
|
|
(2,753 |
) |
Inventories
|
|
|
(352 |
) |
|
|
(119 |
) |
Accounts
payable and other accrued expenses
|
|
|
945
|
|
|
|
(1,528 |
) |
Loans
receivable from third parties
|
|
|
(2,132 |
) |
|
|
(1,091 |
) |
Net
cash used in operating activities of continued
operations
|
|
|
(5,102 |
) |
|
|
(3,861 |
) |
Net
cash used in operating activities of discontinued
operations
|
|
|
6,712
|
|
|
|
(8,283 |
) |
Net
cash provided by (used in) operating
activities
|
|
|
1,610
|
|
|
|
(12,144 |
) |
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
(Increase)
/ Decrease in restricted cash
|
|
|
(5 |
) |
|
|
2
|
|
Increase
in purchase of marketable securities
|
|
|
(501 |
) |
|
|
13
|
|
Acquisition
of property and equipment
|
|
|
(828 |
) |
|
|
(1,713 |
) |
Acquisition
of subsidiaries and affiliated companies
|
|
|
-
|
|
|
|
(419 |
) |
Net
cash used in investing activities of continued
operations
|
|
|
(1,334 |
) |
|
|
(2,117 |
) |
Net
cash used in investing activities of discontinued
operations
|
|
|
925
|
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(409 |
) |
|
|
(2,117 |
) |
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Loan
payable to related party
|
|
|
43
|
|
|
|
(265 |
) |
Loans
receivable from related party
|
|
|
(521 |
) |
|
|
(889 |
) |
Advances
(repayments) under bank line of credit
|
|
|
(674 |
) |
|
|
22
|
|
Advances
(repayments) of bank loans
|
|
|
608
|
|
|
|
1,152
|
|
Increase
(repayments) of amount borrowed under capital lease
obligations
|
|
|
(92 |
) |
|
|
77
|
|
Sale
(Repurchase) of treasury shares
|
|
|
127
|
|
|
|
(124 |
) |
Proceeds
from exercise of stock options and warrants
|
|
|
96
|
|
|
|
174
|
|
Repayment
of convertible debenture
|
|
|
(3,672 |
) |
|
|
-
|
|
Net
proceeds from issuance of convertible debenture
|
|
|
5,853
|
|
|
|
7,500
|
|
Net
cash provided by financing activities of continued
operations
|
|
|
1,768
|
|
|
|
7,647
|
|
Net
cash provided by financing activities of discontinued
operations
|
|
|
-
|
|
|
|
-
|
|
Net
cash provided by financing activities
|
|
|
1,768
|
|
|
|
7,647
|
|
Effect
of exchange rate change on cash and cash
equivalents
|
|
|
20
|
|
|
|
282
|
|
|
|
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
2,989
|
|
|
|
(6,332 |
) |
CASH
AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
|
|
|
1,900
|
|
|
|
9,579
|
|
CASH
AND CASH EQUIVALENTS, END OF THE PERIOD
|
|
$ |
4,889
|
|
|
$ |
3,247
|
|
|
|
|
|
|
|
|
|
|
CASH
PAID FOR:
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
385
|
|
|
$ |
744
|
|
Income
taxes
|
|
$ |
-
|
|
|
$ |
502
|
|
|
|
|
|
|
|
|
|
|
NON-CASH
INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Fixed
assets acquired under banking loan
|
|
$ |
-
|
|
|
$ |
1,082
|
|
Options
exercised for shares receivable
|
|
$ |
484
|
|
|
$ |
434
|
|
Investments
in subsidiaries acquired through the issuance of common
stock
|
|
$ |
-
|
|
|
$ |
3,578
|
|
Redemption
of convertible debenture
|
|
$ |
1,091
|
|
|
$ |
-
|
|
The
accompanying notes are an integral part of these unaudited consolidated
financial statements.
PACIFICNET
INC. AND SUBSIDIARIES
NOTES
TO 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, in the USA, and in 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 $52 million and $51.1 million as of September 30, 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 were 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; and 5) issuance
and/or
restructure of new long-term convertible debentures.
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. The deal
was
subsequently reopened for renegotiation in November 2007 (See note
12).
On
May 15
& 20, 2007, the Company entered into various definitive agreements to reduce
its equity interests in certain unprofitable subsidiaries to 15%, namely:
Linkhead, Clickcom, PacTelso, PacSo and PacPower (See note 12).
2.
RECENT ACCOUNTING PRONOUNCEMENTS
In
March 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on
issue number 06-10, “Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance
Arrangements,” (“EITF 06-10”). EITF 06-10 provides guidance to help companies
determine whether a liability for the postretirement benefit associated with
a
collateral assignment split-dollar life insurance arrangement should be recorded
in accordance with either SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” (if, in substance, a postretirement
benefit plan exists), or Accounting Principles Board Opinion No. 12 (if the
arrangement is, in substance, an individual deferred compensation contract).
EITF 06-10 also provides guidance on how a company should recognize and measure
the asset in a collateral assignment split-dollar life insurance contract.
EITF
06-10 is effective for fiscal years beginning after December 15, 2007,
though early adoption is permitted. The management is currently evaluating
the
effect of this pronouncement on financial statements.
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 third 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.
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 September 30, 2007 exclude the potential dilutive effect
of
889,456 warrants because their impact would be anti-dilutive based on current
market prices. 472,728 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
September
30
|
|
|
Nine
Months Ended
September
30
|
|
(IN
THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
PER SHARE
AMOUNTS)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
Net Income (Loss)
|
|
$ |
(220 |
) |
|
$ |
(1,115 |
) |
|
$ |
(639 |
) |
|
$ |
604
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares used to compute basic EPS
|
|
|
11,931,094
|
|
|
|
11,619,010
|
|
|
|
11,805,686
|
|
|
|
11,171,608
|
|
Weighted-average
shares used to compute diluted EPS
|
|
|
12,027,315
|
|
|
|
11,619,010
|
|
|
|
11,858,870
|
|
|
|
11,171,608
|
|
Basic
earnings (loss) per common share:
|
|
$ |
(0.02 |
) |
|
$ |
(0.09 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.02
|
|
Diluted
earnings (loss) per common share:
|
|
$ |
(0.02 |
) |
|
$ |
(0.09 |
) |
|
$ |
(0.06 |
) |
|
$ |
0.02
|
|
4.
OTHER CURRENT ASSETS
Other
current assets consist of the following at September 30, 2007 (in
thousands):
Other
current assets
|
|
September
30, 2007
|
|
|
December
31, 2006
|
|
|
|
Unaudited
|
|
|
Audited
Restated
|
|
Prepayment
|
|
$ |
832
|
|
|
$ |
1,048
|
|
Utilities
deposit
|
|
|
396
|
|
|
|
1,292
|
|
Receivable
from Lion Zone Holdings Ltd & HeySpace (1)
|
|
|
5,260
|
|
|
|
485
|
|
Prepaid
expenses
|
|
|
171
|
|
|
|
408
|
|
Total
|
|
$ |
6,659
|
|
|
$ |
3,233
|
|
(1)
As of September 30, 2007 receivable from Lion Zone is $132,000 and From HeySpace
is $5,128,000
5.
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.
|
|
|
|
|
(US$000s)
|
|
Outsourcing
Services
|
|
|
Telecom
Value-Added
Services
|
|
|
Products
(Gaming
and
Technology)
|
|
|
Total
(Unaudited)
|
|
Balance
as of December 31, 2006
|
|
$3,964
|
|
|
$461
|
|
|
$1,176
|
|
|
$5,601
|
|
Goodwill
acquired during the first quarter
|
|
|
-
|
|
|
|
-
|
|
|
|
657
|
|
|
|
657
|
|
Balance
as of September 30, 2007
|
|
$3,964
|
|
|
$461
|
|
|
$1,833
|
|
|
$6,258
|
|
The
Company acquired additional 31% interest in Take 1 Technology Ltd on January
5,
2007 and recorded additional goodwill amounting to $657,000. Prior to
acquisition of additional interest, the Company owned 20% interest in Take
1
Technology Ltd (See note 13).
6.
ACCRUED EXPENSES & OTHER PAYABLES
Accrued
expenses and other payables comprises of the following as of September 30,
2007
and December 31, 2006.
(in
thousands of US Dollars):
|
|
2007
Unaudited
|
|
|
2006
Audited
Restated
|
|
Professional
fee
|
|
$ |
1,534
|
|
|
$ |
321
|
|
Director
fee
|
|
|
233
|
|
|
|
100
|
|
Salaries
and benefit payable
|
|
|
281
|
|
|
|
792
|
|
Marketing
expense
|
|
|
838
|
|
|
|
389
|
|
Income
tax payable
|
|
|
7
|
|
|
|
-
|
|
Others
|
|
|
57
|
|
|
|
226
|
|
Total
|
|
$ |
2,950
|
|
|
$ |
1,828
|
|
7.
STOCKHOLDERS' EQUITY
a)
COMMON
STOCK
For
the
nine months period ended September 30, 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) 41,426 treasury
shares were sold to the open market with total consideration $127,000; (iii)
202,000 shares as a results of exercise of stock options with cash consideration
of $406,000. As of September 30, 2007, the Company received $196,000 from
exercise of stock options.
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 nine months ended September
30, 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 September 30, 2007, is as
follows:
|
|
OPTIONS
OUTSTANDING
|
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
370,500
|
|
|
$ |
2.00
|
|
Granted
|
|
|
--
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING,
MARCH 31, 2007
|
|
|
370,500
|
|
|
$ |
2.00
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING,
JUNE 30, 2007
|
|
|
370,500
|
|
|
$ |
2.00
|
|
Granted
|
|
|
788,000
|
|
|
$ |
4.31
|
|
Cancelled
|
|
|
168,500
|
|
|
$ |
2.00
|
|
Expired
without exercising
|
|
|
68,500
|
|
|
$ |
2.00
|
|
Exercised
|
|
202,000
|
|
|
$2.00
|
|
OUTSTANDING,
SEPTEMBER 30, 2007
|
|
788,000
|
|
|
$4.31
|
|
Following
is a summary of the status of options outstanding at September 30,
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
|
2007-8-13
|
788,000
|
$441,280
|
5.86
|
$4.31
|
-
|
$4.31
|
The
788,000 outstanding options, which were granted on August 11, 2007, will
be
vested from August 8, 2008 with a 5% per quarter vesting schedule, and the
corresponding compensation costs will be recorded within the vesting period.
The
weighted-average fair value of such options was $2.75.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
|
4.51%
|
Expected
life of the options
|
5.86
years
|
Expected
volatility
|
67.44%
|
Expected
dividend yield
|
0%
|
788,000
options were granted and 202,000 were exercised during the nine month period
ended September 30, 2007. No options were vested during the nine month period
ended September 30, 2007.
c)
WARRANTS
At
September 30, 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 2.59 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
|
|
|
$ |
9.5
|
|
|
$ |
-
|
|
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
|
|
|
$ |
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
OUTSTANDING,
JUNE 30, 2007
|
|
|
1,007,138
|
|
|
$ |
10.61
|
|
|
$ |
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
OUTSTANDING,
SEPTEMBER 30, 2007
|
|
|
1,007,138
|
|
|
$ |
10.61
|
|
|
$ |
-
|
|
Following
is a summary of the status of
warrants outstanding at September 30, 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
|
1.29
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
2.13
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
2.19
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
3.45
|
$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 the nine months period
ended September 30, 2007.
d)
TREASURY STOCK
The
following is a summary of the movement of the Company's shares held as treasury
stock for the quarterly ended September 30 of 2007:
|
Number
of shares
|
|
Mark
|
Escrow
shares returned to treasury on
|
800,000
|
|
|
Repurchase
in the open market
|
40,888
|
|
|
Repurchase
of shares from Take1
|
149,459
|
|
|
Cancellation
of former employee shares
|
45,000
|
|
|
Holdback
shares as contingent consideration due to performance targets not
yet
met
|
529,848
|
|
(1)
|
Termination
with ChinaGoHi
|
825,000
|
|
|
Incomplete
acquisition of Allink
|
200,000
|
|
|
Repurchase
of shares from Yueshen
|
24,200
|
|
|
Shares
sold to the open market
|
(41,426)
|
|
|
Balance,
September 30, 2007
|
2,572,969
|
|
|
Shares
outstanding at September 30, 2007
|
11,984,072
|
|
|
Shares
issued at September 30, 2007
|
14,557,041
|
|
|
|
(1) Includes
shares related to Clickcom 78,000, Guangzhou (Wanrong) 138,348,
IMobile
153,500 and Games 160,000
|
From
January 24, 2007 to January 30, 2007, we sold 41,426 treasury shares to the
open
market for total consideration of $127,000.
8.
CONVERTIBLE DEBENTURES
8.1
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 nine months 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 September 30, 2007 is $6,217,718.
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 $61,954 and $142,718 representing the change in fair value of warrants
recognized during the three and nine months ended September 30, 2007,
respectively.
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.
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, triggered an event of default under the registration rights agreement
and the convertible debentures, and if any of the holders so elect, they
could
accelerate and demand payment under the debentures, in accordance with the
registration rights agreement 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)
|
|
September
30, 2007
(unaudited)
|
|
Liquidated
damages
|
|
|
2%
|
|
$
|
450
|
|
Mandatory
default
|
|
|
30%
|
|
|
2,247
|
|
Total
|
|
|
|
|
$
|
2,697
|
|
Such
amounts have been recorded as liquidated damages liability as of September
30,
2007.
Following
is the summary of convertible debenture:
($,000)
|
|
$8
million convertible debenture
|
|
|
$945,000
convertible debenture
|
|
|
Total
(unaudited)
|
|
Balance
December 31, 2006
|
|
$ |
8,000
|
|
|
$ |
945
|
|
|
$ |
8,945
|
|
Principal
payment:
|
|
|
|
|
|
|
|
|
|
|
|
|
Redemption
through shares
|
|
|
1,091
|
|
|
|
-
|
|
|
|
1,091
|
|
Cash
payment
|
|
|
1,636
|
|
|
|
-
|
|
|
|
1,636
|
|
Balance
September 30, 2007
|
|
$ |
5,273
|
|
|
$ |
945
|
|
|
$ |
6,218
|
|
The
Company issued 199,444 shares to redeem $1,090,909 of convertible note as
of
September 30, 2007.
8.2
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%
and 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.
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. Interest accrual as of September 30, 2007
amounted to $212,603.
Following
is the summary of convertible debenture:
($,000)/(unaudited)
|
|
|
|
Convertible
debenture
|
|
$ |
5000
|
|
Accrued
interest
|
|
|
218
|
|
Unamortized
financing cost
|
|
|
(310 |
) |
Balance
September 30, 2007
|
|
$ |
4,908
|
|
9.
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 AD, Wanrong, ChinaGoHi (discontinued), Linkhead
(discontinued), Clickcom (discontinued) and Guangzhou 3G/Sunroom (discontinued).
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, Poly, 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.
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
For
The Three Months Ended
September
30, 2007
|
Outsourcing
Services
|
Telecom
Value-Added
Services
|
Products
(Telecom
& Gaming)
|
Other
Business
|
(unaudited)
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Net
Revenues
|
3,971
|
470
|
5,305
|
56
|
9,802
|
(%
of Total Revenues)
|
41%
|
5%
|
54%
|
1%
|
100%
|
Income
/ (Loss) from Operations
|
189
|
444
|
201
|
(697)
|
137
|
(%
of Total Income)
|
138%
|
324%
|
147%
|
(509)%
|
100%
|
Total
Assets
|
8,090
|
9,029
|
19,178
|
6,667
|
42,963
|
(%
of Total Assets)
|
19%
|
21%
|
45%
|
16%
|
100%
|
Goodwill
|
3,964
|
461
|
1,833
|
-
|
6,258
|
Geographic
Area
|
HK,
PRC
|
PRC
|
Macau,
HK, PRC
|
HK,
PRC, USA
|
|
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
For
The Three Months Ended
September
30, 2006
|
Outsourcing
Services
|
Telecom
Value-
Added
Services
|
Products
(Telecom
& Gaming)
|
Other
Business
|
(unaudited)
|
($)
|
($)
|
($)
|
($)
|
($)
|
Net
Revenues
|
3,733
|
40
|
6,411
|
341
|
10,525
|
(%
of Total Revenues)
|
35%
|
|
61%
|
3%
|
100%
|
Income
/ (Loss) from Operations
|
188
|
1
|
(191)
|
(616)
|
(618)
|
(%
of Total Income)
|
(30)%
|
1%
|
31%
|
100%
|
100%
|
Total
Assets
|
9,159
|
19,011
|
12,813
|
22,954
|
63,937
|
(%
of Total Assets)
|
14%
|
30%
|
20%
|
36%
|
100%
|
Goodwill
|
3,936
|
12,920
|
1,529
|
|
18,385
|
Geographic
Area
|
HK,
PRC
|
PRC
|
Macau,
HK, PRC
|
HK,
PRC, USA
|
|
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
For
The Nine Months Ended
September
30, 2007
|
Outsourcing
Services
|
Telecom
Value-
Added
Services
|
Products
(Telecom
& Gaming)
|
Other
Business
|
(unaudited)
|
($)
|
($)
|
($)
|
($)
|
($)
|
Net
Revenues
|
11,700
|
1,429
|
14,729
|
232
|
28,090
|
(%
of Total Revenues)
|
42%
|
5%
|
52%
|
1%
|
100%
|
Income
/ (Loss) from Operations
|
830
|
793
|
1,824
|
(2,163)
|
1,284
|
(%
of Total Income)
|
65%
|
62%
|
142%
|
(168)%
|
100%
|
Total
Assets
|
8,090
|
9,029
|
19,178
|
6,667
|
42,963
|
(%
of Total Assets)
|
19%
|
21%
|
45%
|
16%
|
100%
|
Goodwill
|
3,964
|
461
|
1,833
|
-
|
6,258
|
Geographic
Area
|
HK,
PRC
|
PRC
|
Macau,
HK, PRC
|
HK,
PRC, USA
|
|
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
For
The Nine Months Ended
September
30, 2006
|
Outsourcing
Services
|
Telecom
Value-
Added
Services
|
Products
(Telecom
& Gaming)
|
Other
Business
|
(unaudited)
|
($)
|
($)
|
($)
|
($)
|
($)
|
Net
Revenues
|
10,312
|
106
|
18,262
|
3,652
|
32,332
|
(%
of Total Revenues)
|
32%
|
|
56%
|
11%
|
100%
|
Income
/ (Loss) from Operations
|
734
|
4
|
98
|
(584)
|
252
|
(%
of Total Income)
|
291%
|
2%
|
39%
|
(232%)
|
100%
|
Total
Assets
|
9,159
|
19,011
|
12,813
|
22,954
|
63,937
|
(%
of Total Assets)
|
14%
|
30%
|
20%
|
36%
|
100%
|
Goodwill
|
3,936
|
12,920
|
1,529
|
|
18,385
|
Geographic
Area
|
HK,
PRC
|
PRC
|
Macau,
HK, PRC
|
HK,
PRC, USA
|
|
Product
and service revenues classified by major geographic areas are as follows
(in
US$):
For
the three months ended September 30, 2007
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(unaudited)
|
Product
revenues
|
2,731
|
2,574
|
--
|
5,305
|
Service
revenues
|
3,609
|
888
|
--
|
4,497
|
For
the three months ended September 30, 2006
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(unaudited)
|
Product
revenues
|
3,435
|
503
|
--
|
3,938
|
Service
revenues
|
5,261
|
1,326
|
--
|
6,587
|
For
the nine months ended September 30, 2007
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(unaudited)
|
Product
revenues
|
9,221
|
5,508
|
--
|
14,729
|
Service
revenues
|
10,471
|
2,890
|
--
|
13,361
|
For
the nine months ended September 30, 2006
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(unaudited)
|
Product
revenues
|
17,355
|
3,557
|
--
|
20,912
|
Service
revenues
|
9,970
|
1,450
|
--
|
11,420
|
10.
RELATED PARTY TRANSACTIONS
LOAN
DUE FROM RELATED PARTIES
At
September 30, 2007, there was a total loan receivable of approximately
$2,227,000 due from related parties. Included in which were $845,000 due
from
PACT Power, $150,000 due from PACT Solutions, $604,000 due from PACT Linkhead
and $628,000 due 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
$449,000 due from a shareholder of Yueshen, $64,000 due from a director of
Smartime and $115,000 from a director of PACT Communications. Terms of these
related parties loan receivables and payables are summarized below:
LOAN
TO POWER
PacPower
is an affiliated company, 15% owned by PacificNet, as of September 30, 2007.
A
convertible loan of $845,000 is outstanding from PacPower. The maturity date
of
loan was September 9, 2007. The loan is currently due on demand, non-interest
bearing and unsecured.
LOAN
TO SOLUTION
PacSo
is
an affiliated company, 15% owned by PacificNet, as of September 30, 2007.
A
convertible loan of $150,000 is outstanding from PacSo. The maturity date
of
loan was January 6,2007.
The loan
is currently due on demand, non-interest bearing and unsecured.
LOAN
TO LINKHEAD
Linkhead
is an affiliated company, 15% owned by PacificNet, as of September 30, 2007.
A
convertible loan of $604,000 is outstanding from Linkhead. The maturity date
of
loan is January 1, 2008.
LOAN
TO YUESHEN’S SHAREHOLDER
As
of
September 30, 2007, there was a loan outstanding of $449,000 receivable from
the
shareholder of Yueshen. This loan is secured by 106,240 PacificNet shares.
The
maturity date of loan was February 16,2006.
The loan
is currently due on demand and non-interest bearing.
LOAN
TO SOLUTECK’S DIRECTOR
As
of
September 30, 2007, there was a loan outstanding of $64,000 receivable from
a
director of Soluteck, due on January 17 for three consecutive years ending
2008.
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
September 30, 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. The loan is currently in
default.
LOAN
DUE TO RELATED PARTIES
As
of
September 30, 2007, there was an outstanding loan payable of $681,000 due
to related parties. Included in which was a loan payable of $187,000 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
September 30, 2007, a loan of $201,000 was payable to a shareholder of Yueshen.
The loan was advanced to Yueshen by a shareholder of Yueshen on behalf of
the
Company for working capital purposes.
MOABC
is
an affiliated company, 15% owned by PacificNet. As of September 30, 2007,
there
was an outstanding balance of $293,000 due to MOABC. The loan is unsecured,
non-interest bearing and due on demand.
11.
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 Q3 amounted to $562,000 (2006
Q3:
$332,000). Future minimum lease payments under non-cancelable operating leases
are $603,000 for the period from October 2007 to September 2008, and $155,000
for the period from October 2008 to September 2011, respectively.
RESTRICTED
CASH - Term deposit of $239,000 has been pledged to certain financial
institutions for bank line overdraft protection of Epro.
BANK
LINE
OF CREDIT - As of September 30, 2007, the Company’s outstanding bank line of
credit were as follows:
(i)
|
Epro
has an overdraft banking facility of up to $50,000 with certain
banking
institutions, which is secured by a pledge of its fixed deposits
of
$239,000. 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 $131,000 with a Hong
Kong
banking institution. This overdraft facility is secured by a personal
deposit account of a director of
Smartime.
|
BANK
LOANS- Bank loans represent the following at September 30,
2007:
|
|
September
30,
2007
Unaudited
|
|
|
December
31,
2006
Audited
Restated
|
|
Secured
[1]
|
|
$ |
757
|
|
|
$ |
1,668
|
|
Unsecured
|
|
|
2,062
|
|
|
|
543
|
|
Less:
current portion
|
|
|
768
|
|
|
|
576
|
|
Non
current portion
|
|
$ |
2,051
|
|
|
$ |
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; third legal charge over
a
property owned by a subsidiary of the Company; and pledged bank deposits
of
$239,000 (2006: $234,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as
follows:
(US$000s)
|
October
2007 to September 2008
|
|
October
2008 to September 2009
|
|
October
2009 to September 2010
|
|
October
2010 to September 2011
|
|
October
2011 to September 2012
|
|
Thereafter
|
|
TOTAL
(unaudited)
|
Beijing
PACT office mortgage (1)
|
54
|
|
57
|
|
60
|
|
64
|
|
67
|
|
746
|
|
1,048
|
Shenzhen
PACT office mortgage (2)
|
23
|
|
25
|
|
26
|
|
28
|
|
29
|
|
635
|
|
766
|
Sub-total
|
77
|
|
82
|
|
86
|
|
92
|
|
96
|
|
1,381
|
|
1,814
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank
loan of Epro (3)
|
443
|
|
298
|
|
16
|
|
-
|
|
-
|
|
-
|
|
757
|
AR
factoring loans (3)
|
248
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
248
|
Sub-total
|
691
|
|
298
|
|
16
|
|
-
|
|
-
|
|
-
|
|
1,005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
768
|
|
380
|
|
102
|
|
92
|
|
96
|
|
1,381
|
|
2,819
|
(As
at
December 31, 2006, the aggregate future maturities of borrowing for the next
five years were as follows: 2007: $576,000, 2008: $477,000, 2009: $268,000,
2010: $59,000, 2011: $62,000, thereafter: $769,000)
|
(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 2009. Aggregate minimum future lease payments under capital leases
for each of the next two years are as follows: 2008: $90,000, 2009: $62,000,
and
thereafter: none.
|
|
Aggregate
future
lease
payments
(unaudited)
|
|
2008
|
|
$ |
90,000
|
|
2009
|
|
$ |
62,000
|
|
Total
|
|
$ |
152,000
|
|
Current
portion
|
|
$ |
90,000
|
|
Non-current
portion
|
|
$ |
62,000
|
|
12.
NET ASSETS HELD FOR DISPOSITION
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. Absent any explicit closing conditions contained in
the said agreement, the disposal was completed
upon title
transfer during the third quarter of 2007.
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. Absent any explicit
closing conditions contained in the said agreement, the disposal was completed
upon title
transfer during the third quarter of 2007.
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. Absent any explicit closing conditions contained in the
said
agreement, the disposal
was completed upon title transfer during the third quarter of
2007.
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. Absent any explicit closing conditions contained in
the said agreement, the disposal was completed
upon title
transfer during the third quarter of 2007.
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 PacificNet
Clickcom Limited ("Clickcom")
On
May
15, 2007, the Company entered into a definitive agreement to sell its 36%
entire
interest in PacificNet Clickcom Limited. ("Clickcom"), a leading Value-Added
Services (VAS) company in China, to Mr. Ou Zhenbin, a Chinese residence.
Consideration for the 36% interest of Clickcom was RMB10,000 to be paid in
cash
within 90 days after the agreement signing. The Company’s interest in
Clickcom decreased from 51% to 15% after the transaction. On November
22, 2007, the said agreement was revoked by the Seller as a result of
non-payment by the Buyer, Mr. Ou. The Company’s plan to dispose of its interest
in Clickcom remained unchanged and continued as held for disposal as of
September 30, 2007. Since the S&P agreements was terminated in the
subsequent period proforma information is presented as if the Clickcom is
held
for disposal as of September 30, 2007 (See note 17)
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% entire interest in Guangzhou
3G
Information Technology Co., Ltd. ("Guangzhou 3G"), a leading provider of
Customer Relationship Management (CRM), mobile internet, e-commerce and gaming
technology in China, Consideration for the 51% interest of Guangzhou 3G was
US$6
million, to be paid in cash in 5 installments over 7 months after the agreement
signing. The Company acquired 51% controlling interest in Guangzhou 3G in
March of 2005 for US$5.5 million consideration which was paid partially in
cash
and mostly in PACT stock. The Company’s interest in Guangzhou 3G decreased from
51% to 0% after the transaction. Absent any explicit closing conditions
contained in the said agreement, the disposal was completed
upon title
transfer during the second quarter of 2007.
Information
relating to the operations of the subsidiaries up to the periods of disposal
during the nine month period ended September 30, 2007 is as
follows:
(In
US$ thousands)
|
Linkhead
|
Clickcom
|
Power
|
PacTelso
|
Solutions
|
MOABC
|
3G
|
Total
(unaudited)
|
Income
(loss) from discontinued operations
|
(8)
|
(3)
|
-
|
-
|
-
|
-
|
262
|
250
|
Gain
(loss) from discontinued operations
|
(300)
|
-
|
340
|
1
|
(0)
|
5
|
(971)
|
(925)
|
Net
assets held for disposition (remaining interest)
|
|
810
|
-
|
-
|
-
|
-
|
-
|
810
|
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
contingent consideration of $965,505 (to be 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 were the assets acquired and liabilities assumed for Take 1 in the
acquisition:
Estimated
fair values/(unaudited):
|
|
|
|
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
|
|
|
385,604
|
|
Loss
from Investment
|
|
|
(285,260 |
) |
Goodwill
|
|
$ |
657,413
|
|
At
September 30, 2007, goodwill of $657,413 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 loss of US$640,000 for the nine months ended September 30, 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
September 30, 2007.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE QUARTER ENDED
September 30, 2007 AND 2006
The
following is an un-audited pro forma consolidated financial information for
the
nine month ended September 30, 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.
(un-audited and in thousands of U.S. dollars)
|
|
Nine
months ended September 30
|
|
|
|
2007
|
|
|
2006
|
|
Revenue
|
|
|
28,090
|
|
|
|
33,568
|
|
Operating
income
|
|
|
1,284
|
|
|
|
(1,260 |
) |
Net
profit
|
|
$ |
(639 |
) |
|
$ |
503
|
|
Earnings
per share – basic
|
|
$ |
(0.05 |
) |
|
$ |
0.05
|
|
Earnings
per share – diluted
|
|
$ |
(0.05 |
) |
|
$ |
0.05
|
|
Accordingly,
PacificNet included the financial results of Take 1 in its consolidated 2007
financial results from January 5, 2007 through September 30, 2007.
14.
INVESTMENTS IN AFFILIATED COMPANIES
Investments
in affiliated companies are consisted of the following as of September 30,
2007:
(US$
thousands)/(unaudited)
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
INVESTMENTS IN
AFFILIATED COMPANIES:
|
AMOUNT
|
DESCRIPTION
|
Glad
Smart
|
$30
|
15%
ownership interest
|
MOABC
|
$(14)
|
15%
ownership interest
|
Community
Media Co.
|
$4
|
5%
ownership interest
|
Solutions
|
–
|
15%
ownership interest (1)
|
Linkhead
|
$333
|
15%
ownership interest
|
Power
|
–
|
15%
ownership interest (1)
|
Total
|
$353
|
|
(1)
Amounts less than one thousand dollars are excluded.
15.
LEGAL PROCEEDINGS.
1.
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 now proceeding to the stage of fixing a date for trial in the High Court
of
Hong Kong 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.
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
or
about December, 2005, Johnson Controls Hong Kong Limited approached PacificNet
Power Limited (a 51% owned subsidiary of PacificNet) and made a representation
that they had submitted a tender to “The Incorporated Owners of Nan Fung Centre,
Tsuen Wan (“the Employer”) for the “construction and replacement works of
existing air-cooled chiller plant by new water-cooled chiller plant for Tsuen
Wan Nan Fung Centre and energy saving performance contract” (“the Construction
and Replacement Works Contract”). JCHKL invited and induced PacificNet Power
Limited to act as the main contractor for the Contract and it would then
act as
a sub-contractor.
PacificNet
Power also expressly made known to JCHKL that the said construction and
replacement works and the guaranteed energy saving should meet all the tender
requirements if PacificNet Power accepted the invitation to act as the main
contractor for the Contract, and PacificNet Power further said that if there
should be any quality defects with the system and/ or the construction work,
the
Employer and/ or their prospective tenants would claim against JCHKL and
JCHKL
should compensate.
PacificNet
Power however received some correspondences and complaints from the Employer
about the poor and/ or sub-standard works done by JCHKL. PacificNet Power,
after
separate investigation, discovered the poor workmanship and sub-standard
works
done by JCHKL. Accordingly, the Employer and/ or their representatives have
delayed the monthly installments payment to PacificNet Power.
On
April
23, 2007, we instructed our lawyers issued a letter to the Defendant requesting
and demanding them, being the sub-contractor of the Construction and Replacement
Works Contract, to take immediate rectification action within seven days
from
the date of the said letter to (i) rectify and complete all outstanding
defective works of the Construction and Replacement Works Contract; (ii)
replace
the water-cooled chiller plant and/or equipments which are not conformed
with
the requirements of the tender documents previously submitted by the Defendant
to the Employer; and (iii) improve the poor performance of energy saving
of the
new water-cooled chiller plant so that it would conform with their guarantee
made on 21 December, 2005 to PKL and the employer.
Despite
the said letter, JCHKL had failed and/ or refused to rectify and complete
all
outstanding works and/ or replace the defective system. And therefore PacificNet
Power claims against JCHKL for: (i) refund HK$6,414,300.00, being the Contract
Price paid by PacificNet Power to JCHKL; (ii) costs and expenses incurred
by
Power to rectify all defective works of the Contract; (iii) all damage and
loss
suffered by PacificNet Power, and further and other relief.
On
July
25, 2007, JCHKL issued a Defense and Counterclaim to PacificNet Power to
counter-claim that: (i) a concrete base was discovered after the existing
dismantled radiators was not indicated in tender drawings nor could it be
revealed by site visit; (ii) JCHKL could not have carried out the works under
the Contract without first demolishing the said concrete base; (iii) by a
letter
from JCHKL to PacificNet Power dated 22 May, 2007, PacificNet Power was informed
additional works had been carried out by JCHKL; (iv) a sum of HK$30,000 is
still
due and owing by PacificNet Power to JCHKL.
The
case
is now proceeding to the stage of fixing a date for trial in the High Court
of
Hong Kong. We are unable to predict the outcome of these actions, or a
reasonable estimate of the range of possible loss, if any.
3.
Lawsuit between PacificNet Inc. and HLB Hodgson Impey Cheng (HLB or Defendant),
a firm of Chartered Accountants and Certified Public Accountants in Hong
Kong
On
September 20, 2007, PacificNet Inc. filed a claim against its former auditors
HLB Hodgson Impey Cheng (HLB), a firm of Chartered Accountants and Certified
Public Accountants, in the High Court of the Hong Kong Special Administrative
Region seeking refund of the professional fees, compensation of professional
fees and expenses for Company to engage and deploy new auditors to take over
the
incomplete audit works from the Defendant and returning and/or providing
all
relevant accounting records, vouchers, audit program and working papers retained
by the Defendant and losses and damages incurred.
The
case
is now proceeding to the stage of fixing a date for trial in the High Court
of
Hong Kong. We are unable to predict the outcome of these actions, or a
reasonable estimate of the range of possible loss, if any.
16.
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.
17.
SUBSEQUENT EVENTS
Revocation
of Sale &
Purchase Agreement of PacificNet Clickcom Limited
("Clickcom")
On
May
15, 2007, the Company entered into a definitive agreement to sell its 36%
entire
interest in PacificNet Clickcom Limited. ("Clickcom"), a leading Value-Added
Services (VAS) company in China, to Mr. Ou Zhenbin, a Chinese residence.
Consideration for the 36% interest of Clickcom was RMB10,000 to be paid
in cash
within 90 days after the agreement signing. The Company’s interest in
Clickcom decreased from 51% to 15% after the transaction. On November
22, 2007, the said agreement was revoked by the Seller as a result of
non-payment by the Buyer.
Following
is the unaudited proforma consolidated financial information as if the
Guangzhou
3G was not disposed of as of May 15, 2007 and held for disposal as of September
30, 2007.
(un-audited and in thousands of U.S. dollars)
|
|
Nine
months ended September 30
|
|
|
|
2007
|
|
|
2006
|
|
Income
(loss) from continued operations
|
|
|
17
|
|
|
|
(111 |
) |
Income
(loss) from discontinued operations
|
|
|
250
|
|
|
|
980
|
|
Net
income (loss)
|
|
|
(645 |
) |
|
|
394
|
|
Earnings
per share – basic
|
|
|
(0.05 |
) |
|
|
0.04
|
|
Earnings
per share – diluted
|
|
|
(0.05 |
) |
|
|
0.04
|
|
Acquisition
Of Guangdong Poly Blue Express Communications Co.Ltd (Guangdong
Poly)
On
September 5, 2007, the company entered into an agreement to acquire (subject
to
meeting of certain conditions) an aggregate of 51% equity interest in Guangdong
Poly Blue Express Communications Co., Ltd. (Guangdong
Poly). Guangdong Poly is a leading operator approved by China's
Welfare Lottery Center to develop and operate real-time electronic paperless
lottery services in China, in accordance to the rules and regulations set
by
China's Welfare Lottery Center. Total consideration payable for the purchase
of
Guangdong Poly was US$2 million, in which US$1 million payable in PACT
restricted shares and US$1 million payable in
cash.
Due
to
outstanding closing conditions, the acquisition was not closed until
October 25, 2007.
IROQUOIS
MASTER FUND, LTD. vs. PACIFICNET INC.
On
October 3, 2007 Iroquois Master Fund, Ltd. filed a complaint in the Supreme
Court of the State of New York against PacificNet Inc., claiming that the
Company is in default for failure to pay principal and interest under the
Amended and Restated Convertible Debenture due March 2009 (the Amended
Debenture”) in the principal amount of $3,000,000 and interest on the
Convertible Debenture due February 2009 (the “New Debenture”) in the principal
amount of $420,000.
As
of
October 2, 2007, Iroquois claims that the outstanding principal amount
of the
Amended Debenture was$2,045,452, and accrued but unpaid interest amount
was
$30,682. Iroquois claims that, as of October 2, 2007,
the mandatory default amount, as calculated under the terms of the
Amended Debenture due and owing is
$2,698,974.
As
of
October 2, 2007, Iroquois claims that the outstanding principal
amount of the New Debenture was $420,000,and accrued but unpaid interest
amount
was $6,300.
Iroquois
claims that, as of October 2, 2007, the mandatory default amount, as
calculated under the terms of the New Debenture, due and owing is
$554,190.
As
of the
date of the complaint, Iroquois Master Fund, Ltd. was seeking damages of
$3,253,163.80 in the aggregate, together with any accrued but unpaid interest
through the date of judgment. Iroquois Master Fund, Ltd. also
demanded for the reimbursement of its attorney fees and other costs and
expenses
incurred together with costs and disbursements of this action and such
other and
further relief as to the court seems just and proper.
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
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 and nine months ended
September 30, 2007 amounted to $9,802,000 and $28,090,000, a year-over-year
decline of 7% and 13% as compared to $10,525,000 and $32,332,000 for the
same
periods of prior year, respectively. The year-over-year decrease in revenues
was
mainly due to contraction of the Company’s low margin Mobile phone wholesaling
businesses in Greater China. Segmented financial information of the three
business operating groups is set out below followed by a brief discussion
of
each business group.
THREE
AND
NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 2006
For
The Three Months Ended
September
30, 2007
|
Group
1
|
Group
2.
|
Group
3
|
Group
4
|
TOTAL
|
Outsourcing
|
Telecom
Value-Added
|
Products
|
Other
|
In
thousands of US Dollars
|
Services
|
Services
|
(Telecom
& Gaming)
|
Business
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
3,971
|
470
|
5,305
|
56
|
9,802
|
Earnings
/ (Loss) from Operations
|
189
|
444
|
201
|
(697)
|
137
|
For
The Three Months Ended
September
30, 2006
|
Group
1
|
Group
2.
|
Group
3
|
Group
4
|
TOTAL
|
Outsourcing
|
Telecom
Value-Added
|
Products
|
Other
|
In
thousands of US Dollars
|
Services
|
Services
|
(Telecom
& Gaming)
|
Business
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
3,733
|
40
|
6,411
|
341
|
10,525
|
Earnings
/ (Loss) from Operations
|
188
|
1
|
(191)
|
(616)
|
(618)
|
For
The Nine Months Ended
September
30, 2007
|
Group
1
|
Group
2.
|
Group
3
|
Group
4
|
TOTAL
|
Outsourcing
|
Telecom
Value-Added
|
Products
|
Other
|
In
thousands of US Dollars
|
Services
|
Services
|
(Telecom
& Gaming)
|
Business
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
6,937
|
9,243
|
11,700
|
210
|
28,090
|
Earnings
/ (Loss) from Operations
|
830
|
793
|
1,824
|
(2,163)
|
1,284
|
For
The Nine Months Ended
September
30, 2006
|
Group
1
|
Group
2.
|
Group
3
|
Group
4
|
TOTAL
|
|
Outsourcing
|
Telecom
Value-Added
|
Products
|
Other
|
|
In
thousands of US Dollars
|
Services
|
Services
|
(Telecom
& Gaming)
|
Business
|
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
10,312
|
106
|
18,262
|
3,758
|
32,332
|
Earnings
/ (Loss) from Operations
|
734
|
4
|
98
|
(584)
|
252
|
(1)
|
Outsourcing
services: Revenues for the three and nine months ended September 30,
2007 were $3,971,000 and $11,700,000, representing a year-over-year
increase of 6% and 13% as compared to $3,733,000 and $10,312,000
for the
same periods of last year. The increase was mainly derived from
the inbound service, in-sourcing operations and telemarketing management,
from which the sales revenues amounted to $635,000, $1,136,000
and
$651,000 for the third quarter of this year, a quarter-over-quarter
increase of 32%, 2% and 43%, respectively as compared to the same
period
of prior year. On the other hand, sales revenues from software
business decreased to $518,000, a decrease of 24% as compared to
$667,000
for the same period of prior year. Revenue from outsourcing services
accounted for 41% of the Company's total revenues for the third
quarter of
FY2007.
|
(2)
|
Telecom
Value-added Services (VAS): Revenues for the three and nine months
ended
September 30, 2007 was $470,000 and $1,429,000 respectively, a
significant
year-over-year increase of 1,075% and 1,248% as compared to $40,000
and
$106,000 for the same periods of last year. The increase was mainly
due to
the sales revenues from WAP based mobile phone games and traditional
SP
businesses, which accounted for 77% of the Company's total VAS
revenues
for the third quarter of FY2007.
|
(3)
|
Products
(Telecom & Gaming): Revenues for the three and nine months ended
September 30, 2007 were $5,326,000, and $14,751,000, representing
a
year-over-year decrease of 17% and 19% as compared to $6,411,000
and
$18,262,000 for the same periods of 2006, respectively. Decrease
in
Products revenues, which accounted for 54% of the Company's total
revenues
for the third quarter of FY2007, is largely due to contraction
of the
Company’s mobile phone wholesaling businesses in Greater
China.
|
Gaming
technology revenues derived from selling Multi-player Electronic Gaming Machine
to casino operators amounted to $977,000, and accounted for 18% of total
Products revenues for the third quarter of FY2007. With the internet
gaming license granted by First Cagavan and Cagavan Economic Zone Authority
(CEZA) of the Philippines, the company is widely recognized as a well positioned
emerging gaming technology provider, both online and land-based. Moreover,
successful penetration of the Cambodia gaming market brought some initial
orders
of 150 betting stations for the fourth quarter of 2007, plus further orders
of
500-2000 betting stations in 2008.
Revenues
from sales of Electronic Slot Machines amounted to $456,000, and accounted
for
9% of the total Products Revenues for the third quarter of FY 2007, a sequential
decrease of 64% as compared to the second quarter of FY2007. Decrease
was largely due to allocation of precious technical resources to after-sale
service of the deliveries made during the second quarter and work in progress
of
backlog orders from operators in Europe. The company continued to
take advantage of the Italy’s new Comma 6A gaming legislation in entering the
largest European slot market, Italy, as an exclusive supplier of electronic
slot
machines to various leading gaming operators in Europe. Besides, our
subsidiary, Take 1, has unveiled a new line of gaming machine products,
Electronic Bingo Machines, at the Global Gaming Expo (G2E) Las Vegas, and
received TST Certification for Gaming Accreditation.
As
planned, the company continues to scale down its low-margin mobile phone
wholesaling business and distribution business in Greater China. Revenues
from
sales of mobile phone for the three and nine months ended September 30, 2007,
amounted to $3,893,00 and $9,903,000, a decline of 39% and 46% as compared
to
$6,411,000 and $18,262,000 for the same periods of 2006.
During
the third quarter, the company’s subsidiary - iMobile had signed a new agreement
with Mototola (China) to become the latter’s authorized distributor of MOTO
accessory products for the MOTO Customer Service Network, MOTO Branded Stores
and distribution channels in Southern China.
COST
OF REVENUES
Cost
of
revenues for the three and nine months ended September 30, 2007 were $7,428,000
and $20,816,000, representing a decrease of 21% and 25% from $9,418,000 and
$27,710,000 for the same periods last year, respectively. Cost of revenues
as a percentage of the corresponding revenues was approximately 76% for the
third quarter of FY2007 as compared to 89% for the same period of prior
year.
(1)
|
Outsourcing
services: Cost of revenues from outsourcing services for the three
and
nine months ended September 30, 2007 amounted to $3,270,000 and
$9,128,000, an increase of 9% and 14% respectively as compared
with
2006. Increase in cost of revenues was largely due to headcount
increase at service staff level.
|
(2)
|
Telecom
Value-added Services (VAS): Cost of revenues from VAS for the three
and
nine months ended September 30, 2007 was $161,000 and $475,000,
an
increase of 437% and 533% as compared with 2006. Increase is in
line with sales growth of WAP-based mobile phone
games.
|
(3)
|
Products
(Telecom & Gaming): Cost of revenues derived from Products for the
three months ended September 30, 2007 amounted to $3,987,000 and
$11,190,000, a reduction of 36% and 36% respectively, compared
with the
same periods of 2006. Approximately 92% of the cost of revenues
related to Products for the third quarter of FY2007 was derived
from the
sales of mobile phones, and 8% was derived from the sales of electronic
gaming machines.
|
GROSS
PROFIT
Gross
profit for the three and nine months ended September 30, 2007 was $2,374,000
and
$7,274,000, a year-over-year increase of 114 % and 57%, respectively, as
compared to $1,107,000 and $4,622,000 for the same periods of prior year.
Gross
margin was 24% and 26% for the three and nine months ended September 30,
2007 as
compared to 11% and 12% for the same period of prior year, respectively.
Quarterly improvement in gross margin was attributed to higher margin for
Multiplayer Gaming Machines (57%) and Electronic Slot Machines
(70%).
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
Selling,
general and administrative expenses (SG&A) totaled $2,030,000 and $5,395,000
for the three and nine months ended September 30, 2007, an increase of 28%
and
an increase of 33% respectively as compared to $1,580,000 and $4,067,000
for the
same periods of prior year. SG&A consists primarily of indirect
staff salaries, office rental, insurance, advertising expenditures and
traveling costs.
(1)
|
Outsourcing
services: SG&A attributed to outsourcing services for the three and
nine months ended September 30, 2007 amounted to $480,000 and $1,671,000,
a decrease of 5% and an increase of 13% as compared to $506,000
and
$1,479,000 for the same periods of prior
year.
|
(2)
|
Telecom
Value-added Services (VAS): SG&A attributed to VAS for the three and
nine months ended September 30, 2007 amounted to negative $154,000
and
$68,000, as compared to $9,000 and $27,000 for the same periods
of prior
year.
|
(3)
|
Products
(Telecom & Gaming): SG&A attributed to Products for the three and
nine months ended September 30, 2007 amounted to $1,018,000 and
$1,419,000, an increase of 422% and 191% as compared to $195,000
and
$487,000 for the same periods of prior year. Increase in
SG&A was primarily due to additional headcount and office expenses
incurred by newly opened Zhuhai R&D center and Macau sales center, for
sustained development of the gaming technology business
growth.
|
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Three
months ended September 30, 2007
|
Three
months ended September 30, 2006
|
Percentage
Change
|
(in
thousands, except percentages)
|
($)
|
($)
|
(%)
|
Remuneration
|
1,004
|
690
|
45
|
Office
|
370
|
246
|
50
|
Travel
|
95
|
88
|
7
|
Entertainment
|
66
|
35
|
89
|
Professional
(legal and consultant)
|
139
|
71
|
96
|
Audit
|
583
|
16
|
3,578
|
Selling
|
110
|
51
|
117
|
Recovery
of provisions for doubtful accounts from subsequent
collections
|
(424)
|
(28)
|
1,440
|
Other
|
88
|
98
|
(12)
|
Total
|
2,030
|
1,268
|
60
|
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Nine
months ended September 30, 2007
|
Nine
months ended September 30, 2006
|
Percentage
Change
|
(in
thousands, except percentages)
|
($)
|
($)
|
(%)
|
Remuneration
|
3,222
|
1,908
|
69
|
Office
|
1,015
|
685
|
48
|
Travel
|
358
|
211
|
70
|
Entertainment
|
165
|
90
|
84
|
Professional
(legal and consultant)
|
499
|
273
|
83
|
Audit
|
720
|
154
|
369
|
Selling
|
295
|
187
|
58
|
Recovery
of doubtful accounts from subsequent collections
|
(1,115)
|
-
|
n/a
|
Other
|
236
|
251
|
-6
|
Total
|
5,395
|
3,757
|
44
|
INCOME
/ (LOSS) FROM OPERATIONS
On
a
year-over-year basis, income from operations amounted to $137,000 and $1,284,000
for the three and nine months ended September 30, 2007, as compared to
($618,000) and $252,000 for the same periods of prior year
respectively.
Significant
increase in operating income was mainly derived due to higher margin gaming
revenues, which accounted for 7% of the total operating income for the third
quarter of FY2007.
INCOME
TAXES
The
income tax provisions for the three and nine months ended September 30, 2007
were $46,000 and $0 as compared to ($40,000) and ($70,000) for the same periods
of prior year. 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, however, 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 and nine months ended September 30, 2007 totaled
$130,000 and $1,004,000 respectively as compared with $12,000 and $527,000
for
the same period of prior year, representing minority ownership interests
in
subsidiaries consolidated in the Company’s consolidated financial
statement.
NET
INCOME
On
a
year-over-year basis, Net Income amounted to ($220,000) and ($639,000) for
the
three and nine months ended September 30, 2007 respectively, as compared
to
($1,115,000) and $604,000 for the same period of prior
year. Quarterly Net Loss was directly associated with Loss on
disposal, which amounted to $356,000 for the third quarter of FY 2007. However,
as the company focused on the high-margin Gaming Technology Business, this
year,
Net Income from sales of Electronic Gaming Machines reached $35,000 and $190,000
respectively for the three and nine months ended September 30,
2007.
CASH
Net
cash
and cash equivalents at September 30, 2007 were approximately $4.9 million,
an
increase of approximately $3.0 million as compared to December 31, 2006.
This was primarily due to successful collection of certain doubtful
debts.
CONTRACTUAL
OBLIGATIONS
Contractual
obligations as of September 30, 2007 are detailed below:
Payments
Due by Period
Contractual
Obligations
|
|
Total
|
|
|
Less
than 1 year
|
|
|
1-5
years
|
|
|
After
5 years
|
|
Line
of credit
|
|
$ |
181
|
|
|
$ |
181
|
|
|
$ |
|
|
|
$ |
|
|
Bank
Loans
|
|
|
2,819
|
|
|
|
768
|
|
|
|
670
|
|
|
|
1,381
|
|
Operating
leases
|
|
|
758
|
|
|
|
603
|
|
|
|
155
|
|
|
|
-
|
|
Capital
leases
|
|
|
152
|
|
|
|
90
|
|
|
|
62
|
|
|
|
-
|
|
Total
cash contractual obligations
|
|
$ |
3,910
|
|
|
$ |
1,642
|
|
|
$ |
887
|
|
|
$ |
1,381
|
|
In
addition to above, as previously disclosed in the paragraph under the
sub-heading of PROBABLE EVENT OF DEFAULT under Item 1 - 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 September 30, 2007, the Company has accrued three months
of
liquidated damages and mandatory default 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
We
had no
off-balance sheet guarantees, interest rate swap transactions or foreign
currency forward contracts. We did not engage in trading activities involving
non-exchange traded contracts during the third quarter of 2006.
There
were no off-balance sheet guarantees, interest rate swap transactions, foreign
currency forward contracts or long term purchase commitments outstanding
as of
September 30, 2007. Further, the Company had not engaged in any non-exchange
trading activities during third quarter of 2007.
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
Renminbi ("RMB"), the currency of the People's Republic of China. The value
of
the RMB-to-U.S. dollar or Hong Kong dollar-to-United States dollar and other
currencies may fluctuate and is affected by, among other things, changes
in
political and economic conditions. Since 1994, the conversion of Renminbi
into
foreign currencies, including U.S. dollars, has been based on rates set by
the
People's Bank of China, which are set daily based on the previous day's
interbank foreign exchange market rates and current exchange rates on the
world
financial markets. Since 1994, the official exchange rate generally has been
stable. Recently there has been increased political pressure on the Chinese
government to decouple the RMB from the United States dollar. Although a
devaluation of the Hong Kong dollar or RMB relative to the United States
dollar
would likely reduce the Company's expenses (as expressed in United States
dollars), any material increase in the value of the Hong Kong dollar or RMB
relative to the United States dollar would increase the Company's expenses,
and
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company has never engaged in currency
hedging operations and has no present intention to do so.
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 September 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. Certain internal audit tests performed at the fiscal year-end
of
2006 revealed that there were weaknesses inherent in the Company’s internal
control system. Among which it was noted that there were insufficient checks
and
balances in place for controlling the company’s non-routine transactions,
namely: accuracy and completeness of stock option expense calculation. Such
weaknesses in our controls eventually led to prior period option expense
restatements being charged to the Company’s financial statements for the years
ended December 31, 2003, 2004, and 2005 respectively. As a result, our chief
executive officer and our former chief financial officer concluded that
there was a material weakness in our disclosure controls and
procedures.
As
of the
end of the quarter covered by this report, the company had taken various
steps
to maintain the accuracy of our financial disclosures, and improve company
internal control. An internal control SOX implementation team led by senior
managers had been set up to uncover potential significant deficiencies inherent
in the internal control systems of the company, including but not limited
to
risk identification, control procedure setup, staff training, segregation
of
incompatible job duties, design of management reporting system, definition
and
delegation of signing authority, establishment of documentation system and
implementation of a company-wide SOX compliant ERP system. Based on the current
schedule, the Company is expected to be substantially SOX compliant by the
end
of FY2007.
PART
II - OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
None
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, which could materially affect
our
business, financial condition or future results. The risks described in our
Annual Report on Form 10-K 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.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
None
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
In
July
2007, the Company failed to timely make scheduled principal payments under
an
Amended and Restated Variable Rate Convertible Debenture due March 2009 (the
“Amended Debenture”) in the aggregate amount of $8,000,000. Pursuant to the
terms of the Amended Debenture, the Company was obligated to make monthly
redemption payments commencing on January 1, 2007, until the Amended Debenture
was redeemed in full. On August 1, 2007, the Company made the July monthly
redemption and interest payments to all of the debenture holders.
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: November
27, 2007
|
By:
|
/s/ Tony
Tong
|
|
Tony
Tong
Chief
Executive Officer
(Principal
Executive Officer)
|
|
|
|
|
|
|
Date: November
27, 2007
|
By:
|
/s/ Daniel
Lui
|
|
Daniel
Lui
Chief
Financial Officer
(Principal
Financial Officer)
|
34