pact_10qa1-033107.htm
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q/A
(Amendment
No. 1)
x QUARTERLY
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2007
o TRANSITION
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR
THE TRANSITION PERIOD FROM __________ TO ___________
COMMISSION
FILE NUMBER: 000-24985
PACIFICNET
INC.
(Exact
name of registrant in its charter)
Delaware
|
|
91-2118007
|
(State
or other jurisdiction of
incorporation
or organization)
|
|
(I.R.S.
Employer
Identification
Number)
|
23/F,
TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,
|
|
|
CHAOYANG
DISTRICT, BEIJING, CHINA 100028
|
|
N/A
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
Registrant’s
telephone number, including area code: 0086-10-59225000
Indicate
by check mark whether the registrant (1) has filed all reports required by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past
90 days. YES o NO þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
the
Exchange Act).
Large
Accelerated Filer o
Accelerated Filer
o
Non-accelerated filer þ
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES o NO þ
As
of May
30, 2007, there were 11,782,072 shares of the issuer’s common stock, par value
$0.0001 per share, outstanding.
EXPLANATORY
NOTE:
This
Quarterly Report on Form 10-Q/A ("Form 10-Q/A") is being filed as Amendment
No. 1 to our Quarterly Report on Form 10-Q for the period ended March
31,
2007, which was originally filed with the Securities and Exchange Commission
("SEC") on May 31, 2007. We are amending and restating
the following specific items in this Form 10-Q/A:
1. Part
I. Item 1. Financial Statements - to restate the financial statements as of,
and
for the three months ended March 31, 2007, and to restate the balance sheet
as
of December 31, 2006;
2. Part
I. Item 2. Management's Discussion And Analysis of Financial Condition and
Results of Operations.
3. Part
II. Item 6 - to update the officer certifications for this Form
10-Q/A.
PACIFICNET
INC.
Form 10-Q/A
for the Quarterly Period Ended March 31, 2007
TABLE
OF CONTENTS
PART I.
|
FINANCIAL
INFORMATION
|
|
|
|
|
Item
1.
|
Financial
Statements (Unaudited)
|
4
|
|
|
|
|
Consolidated
Balance Sheets
|
4
|
|
|
|
|
Consolidated
Statements of Operations
|
5
|
|
|
|
|
Consolidated
Statements of Cash Flows
|
6
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
7
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
23
|
|
|
|
PART II.
|
OTHER
INFORMATION
|
|
|
|
|
Item
6.
|
Exhibits
|
30
|
|
|
|
Signatures
|
|
31
|
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)
|
|
March
31,
2007
Unaudited
Restated
|
|
|
December
31,
2006
Audited
Restated
|
|
ASSETS
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
4,041
|
|
|
$ |
1,900
|
|
Restricted
cash - pledged bank deposit
|
|
|
235
|
|
|
|
234
|
|
Accounts
receivables, net
|
|
|
8,411
|
|
|
|
8,141
|
|
Inventories
|
|
|
428
|
|
|
|
201
|
|
Loan
receivable from related parties
|
|
|
713
|
|
|
|
1,706
|
|
Loan
receivable from third parties
|
|
|
178
|
|
|
|
128
|
|
Marketable
equity securities - available for sale
|
|
|
568
|
|
|
|
558
|
|
Loans
to employees
|
|
|
1,341
|
|
|
|
770
|
|
Other
receivables, net
|
|
|
290
|
|
|
|
170
|
|
Other
current assets
|
|
|
2,796
|
|
|
|
3,233
|
|
Total
Current Assets
|
|
|
19,001
|
|
|
|
17,041
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
6,656
|
|
|
|
4,711
|
|
Investments
in affiliated companies and subsidiaries
|
|
|
34
|
|
|
|
1,257
|
|
Intangible
assets, net
|
|
|
400
|
|
|
|
323
|
|
Goodwill
|
|
|
6,258
|
|
|
|
5,601
|
|
Other
assets
|
|
|
-
|
|
|
|
471
|
|
Net
assets held for disposition
|
|
|
8,876
|
|
|
|
7,522
|
|
TOTAL
ASSETS
|
|
$ |
41,225
|
|
|
$ |
36,926
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$ |
404
|
|
|
$ |
855
|
|
Bank
loans-current portion
|
|
|
933
|
|
|
|
576
|
|
Capital
lease obligations - current portion
|
|
|
110
|
|
|
|
120
|
|
Accounts
payable
|
|
|
1,277
|
|
|
|
1,266
|
|
Accrued
expenses and other payables
|
|
|
1,711
|
|
|
|
1,828
|
|
Customer
deposits
|
|
|
341
|
|
|
|
352
|
|
Loans
payable to related party
|
|
|
577
|
|
|
|
638
|
|
Convertible
debenture
|
|
|
7,854
|
|
|
|
8,945
|
|
Warrant
liability
|
|
|
844
|
|
|
|
904
|
|
Liquidated
damages liability
|
|
|
2,697
|
|
|
|
2,837
|
|
Total
Current Liabilities
|
|
|
16,748
|
|
|
|
18,321
|
|
|
|
|
|
|
|
|
|
|
Long-term
liabilities:
|
|
|
|
|
|
|
|
|
Bank
loans - non current portion
|
|
|
2,280
|
|
|
|
1,635
|
|
Capital
lease obligations - non current portion
|
|
|
104
|
|
|
|
124
|
|
Convertible
Debenture- non current portion, net
|
|
|
2,307
|
|
|
|
-
|
|
Total
long-term liabilities
|
|
|
4,691
|
|
|
|
1,759
|
|
Total
liabilities
|
|
|
21,439
|
|
|
|
20,080
|
|
|
|
|
|
|
|
|
|
|
Minority
interest in consolidated subsidiaries
|
|
|
4,206
|
|
|
|
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: March 31, 2007: 14,355,041 shares issued, 11,782,072
outstanding December 31, 2006: 14,155,597 issued, 11,538,664
outstanding
|
|
|
1
|
|
|
|
1
|
|
Treasury
stock, at cost (2007 Q1: 2,572,969 shares, 2006: 2,616,933
shares)
|
|
|
(145 |
) |
|
|
(272 |
) |
Additional
paid-in capital
|
|
|
67,003
|
|
|
|
65,757
|
|
Cumulative
other comprehensive income (loss)
|
|
|
(13 |
) |
|
|
(42 |
) |
Accumulated
deficit
|
|
|
(50,782 |
) |
|
|
(51,090 |
) |
Less:
stock subscription receivable
|
|
|
(484 |
) |
|
|
(377 |
) |
Total
Stockholders' Equity
|
|
|
15,580
|
|
|
|
13,977
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
41,225
|
|
|
$ |
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 earnings per share and share
amounts)
|
|
Three
months ended March 31
|
|
|
|
2007
Unaudited
Restated
|
|
|
2006
Unaudited
Restated
|
|
Net
Revenues
|
|
|
|
|
|
|
Services
|
|
$ |
4,565
|
|
|
$ |
3,736
|
|
Product
sales
|
|
|
4,702
|
|
|
|
2,936
|
|
Total
Net Revenues
|
|
|
9,267
|
|
|
|
6,672
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
|
|
|
|
|
|
|
|
Services
|
|
|
3,353
|
|
|
|
2,577
|
|
Product
sales
|
|
|
3,375
|
|
|
|
2,743
|
|
Total
Cost of Revenues
|
|
|
6,728
|
|
|
|
5,320
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
2,539
|
|
|
|
1,352
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
1,567
|
|
|
|
1,079
|
|
Stock-based
compensation expenses
|
|
|
-
|
|
|
|
182
|
|
Depreciation
and amortization
|
|
|
172
|
|
|
|
29
|
|
Total
Operating Expenses
|
|
|
1,739
|
|
|
|
1,290
|
|
|
|
|
|
|
|
|
|
|
INCOME(LOSS)
FROM OPERATIONS
|
|
|
800
|
|
|
|
62
|
|
Other
Income (Expenses):
|
|
|
|
|
|
|
|
|
Interest
income (Expenses), net
|
|
|
(200 |
) |
|
|
(52 |
) |
Gain
(Loss) in change in fair value of derivatives
|
|
|
61
|
|
|
|
-
|
|
Sundry
income, net
|
|
|
19
|
|
|
|
15
|
|
Total
Other Income (Expenses)
|
|
|
(120 |
) |
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
Income
(Loss) before Income Taxes and Minority Interest
|
|
|
680
|
|
|
|
25
|
|
Provision
for income taxes
|
|
|
(68 |
) |
|
|
(17 |
) |
Share
of earnings of associated companies
|
|
|
-
|
|
|
|
(3 |
) |
Minority
interests
|
|
|
(534 |
) |
|
|
(86 |
) |
|
|
|
|
|
|
|
|
|
Income
(Loss) from Continued Operations
|
|
|
78
|
|
|
|
(81 |
) |
|
|
|
|
|
|
|
|
|
Income
from discontinued operations
|
|
|
230
|
|
|
|
882
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
|
308
|
|
|
|
801
|
|
Other
comprehensive item:
|
|
|
|
|
|
|
|
|
Foreign
exchange gain (loss)
|
|
|
29
|
|
|
|
(20 |
) |
Net
Comprehensive Income
|
|
$ |
337
|
|
|
$ |
781
|
|
|
|
|
|
|
|
|
|
|
Basic
Earnings (Loss) per share-Continued Operations
|
|
$ |
0.01
|
|
|
$ |
(0.01 |
) |
Basic
Earnings per share-Discontinued Operations
|
|
$ |
0.02
|
|
|
$ |
0.08
|
|
Basic
Earnings per share
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
|
|
|
|
|
|
|
|
|
Diluted
Earnings (Loss) per share-Continued Operations
|
|
$ |
0.01
|
|
|
$ |
(0.01 |
) |
Diluted
Earnings per share-Discontinued Operations
|
|
$ |
0.02
|
|
|
$ |
0.08
|
|
Diluted
Earnings per share
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares - Basic
|
|
|
11,703,376
|
|
|
|
10,834,299
|
|
Weighted
average number of shares - Diluted
|
|
|
11,997,317
|
|
|
|
10,834,299
|
|
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)
|
|
FOR
THE THREE MONTH
PERIODS
ENDED
|
|
|
|
2007
Unaudited
Restated
|
|
|
2006
Unaudited
Restated
|
|
Cash
Flows from operating activities
|
|
|
|
|
|
|
Net
income
|
|
$ |
308
|
|
|
$ |
801
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Equity
loss of associated companies
|
|
|
-
|
|
|
|
3
|
|
Provision
for allowance for doubtful accounts
|
|
|
(378 |
) |
|
|
-
|
|
Minority
Interest
|
|
|
534
|
|
|
|
86
|
|
Unrealized
losses/(gain) on marketable equity securities
|
|
|
-
|
|
|
|
(2 |
) |
Depreciation
and amortization
|
|
|
306
|
|
|
|
29
|
|
(Gain)
loss from discontinued operations
|
|
|
(230 |
) |
|
|
-
|
|
Stock-based
compensation
|
|
|
-
|
|
|
|
182
|
|
Change
in fair value of derivatives
|
|
|
(61 |
) |
|
|
-
|
|
Changes
in current assets and liabilities net of effects from purchase
of
subsidiaries:
|
|
|
|
|
|
|
|
|
Accounts
receivable and other current assets
|
|
|
(573 |
) |
|
|
(6,310 |
) |
Inventories
|
|
|
(227 |
) |
|
|
76
|
|
Accounts
payable and other accrued expenses
|
|
|
294
|
|
|
|
2,527
|
|
Net
cash used in operating activities of continued
operations
|
|
|
(27 |
) |
|
|
(2,608 |
) |
Net
provided by operating activities of discontinued
operations
|
|
|
872
|
|
|
|
4,756
|
|
Net
cash provided by operating activities
|
|
|
845
|
|
|
|
2,148
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Decrease
in restricted cash
|
|
|
(1 |
) |
|
|
(1,490 |
) |
Increase
in purchase of marketable securities
|
|
|
(10 |
) |
|
|
(24 |
) |
Acquisition
of property and equipment
|
|
|
(819 |
) |
|
|
(3,794 |
) |
Acquisition
of subsidiaries and affiliated companies
|
|
|
88
|
|
|
|
(4 |
) |
Loans
receivable from third parties
|
|
|
(50 |
) |
|
|
-
|
|
Loans
receivable from related party
|
|
|
(33 |
) |
|
|
(246 |
) |
Net
cash used in investing activities of continued
operations
|
|
|
(825 |
) |
|
|
(5,558 |
) |
Net
cash provided by investing activities of discontinued
operations
|
|
|
-
|
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(825 |
) |
|
|
(5,558 |
) |
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Decrease
in loan receivables
|
|
|
-
|
|
|
|
(43 |
) |
Loan
payable to related party
|
|
|
(61 |
) |
|
|
(723 |
) |
Stock
subscription receivable
|
|
|
-
|
|
|
|
(13 |
) |
Repayments
under bank line of credit
|
|
|
(451 |
) |
|
|
(48 |
) |
Repayments
of amount borrowed under capital lease obligations
|
|
|
(30 |
) |
|
|
(34 |
) |
(Purchase)
sale of treasury shares
|
|
|
127
|
|
|
|
-
|
|
Proceeds
from subscription received, exercise of stock options and
warrants
|
|
|
-
|
|
|
|
42
|
|
Net
proceeds from issuance of convertible debenture
|
|
|
2,290
|
|
|
|
8,000
|
|
Advances
under bank loans
|
|
|
217
|
|
|
|
1,792
|
|
Net
cash provided by financing activities of continued
operations
|
|
|
2,092
|
|
|
|
8,973
|
|
Net
cash provided by financing activities of discontinued
operations
|
|
|
-
|
|
|
|
-
|
|
Net
cash provided by financing activities
|
|
|
2,092
|
|
|
|
8,973
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate change on cash and cash
equivalents
|
|
|
29
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
|
|
2,141
|
|
|
|
5,563
|
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
|
|
|
1,900
|
|
|
|
3,486
|
|
CASH
AND CASH EQUIVALENTS, END OF THE PERIOD
|
|
$ |
4,041
|
|
|
$ |
9,049
|
|
CASH
PAID FOR:
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
221
|
|
|
$ |
87
|
|
Income
taxes
|
|
$ |
-
|
|
|
$ |
32
|
|
NON-CASH
INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceed
from option exercised for shares receivable
|
|
$ |
-
|
|
|
$ |
35
|
|
Property
& equipment acquired under banking loan
|
|
$ |
785
|
|
|
$ |
-
|
|
Investments
in subsidiaries acquired through the issuance of common
stock
|
|
$ |
-
|
|
|
$ |
397
|
|
The
accompanying notes are an integral part of these unaudited consolidated
financial statements.
PACIFICNET
INC. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
expressed in United States dollars unless otherwise stated)
1.
BASIS OF PRESENTATION
Description
of Operations - PacificNet Inc. (referred to herein as
"PacificNet" or the "Company") is a leading provider of gaming technology,
e-commerce, and Customer Relationship Management (CRM) in China. Our gaming
products are specially designed for the Chinese and Asian gamers, and we focus
on integrating localized Chinese and Asian themes and content, advanced
graphics, digital sound effects and popular domestic music, with secondary
bonus
games and jackpots. Our gaming products include: Multi-player Electronic Table
Games - Baccarat, Sicbo, Fish-Prawn-Crab, and Roulette machines, server based
games (SBG) with multiple client betting stations, slot and bingo machines,
video lottery terminals (VLTs), amusement with prices (AWP) machines, gaming
cabinet and client/server system designs, online i-gaming software design,
and
multimedia entertainment kiosks. PacificNet's gaming clients include the leading
hotels, casinos, and gaming operators in Macau, Asia, and Europe, and our
ecommerce and CRM clients include the leading telecom companies, banks,
insurance, travel, marketing and business services companies and telecom
consumers in Greater China such as China Telecom, China Mobile, Unicom, PCCW,
Hutchison Telecom, Bell24, Motorola, Nokia, SONY, TCL, Huawei, American Express,
Citibank, HSBC, Bank of China, Bank of East Asia, DBS, TNT, China and Hong
Kong
government. PacificNet employs about 1,200 staff in its various subsidiaries
throughout China with offices in Hong Kong, Beijing, Shanghai, Shenzhen,
Guangzhou, Macau and Zhuhai China, 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 prior period amounts have been reclassified to conform
to the current period presentation.
Going
Concern
As
shown
in the accompanying consolidated financial statements, the Company incurred
accumulated losses of $50.8 million and $51.1 million as of March 31, 2007
and
December 31, 2006, respectively. These matters raise substantial doubt about
the
Company’s ability to continue as a going concern.
In
view
of the matters described in the preceding paragraph, recoverability of a major
portion of the recorded asset amounts shown in the accompanying balance sheet
is
dependent upon continued operations of the Company, which in turn is dependent
upon the Company’s ability to raise additional capital, obtain financing and to
succeed in its future operations. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The
Company has taken certain restructuring steps to provide the necessary capital
to continue its operations. These steps included, but 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
17).
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 17).
2.
RECENT 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
(Novell’s fiscal 2008), 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 first quarter 2007 financial
statements.
The
new
Statement allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item's fair value in subsequent reporting
periods must be recognized in current earnings. FAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. The management is currently evaluating the effect of this
pronouncement on financial statements.
In
September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
employer to recognize the over funded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income
of a
business entity or changes in unrestricted net assets of a not-for-profit
organization. The requirement to measure plan assets and benefit obligations
as
of the date of the employer’s fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. The Company currently
does not have any defined benefit plan and so FAS 158 will not affect the
financial statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is
the
relevant measurement attribute. Accordingly, this Statement does not require
any
new fair value measurements. However, for some entities, the application of
this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
3.
EARNINGS PER SHARE
Basic
and
diluted earnings or loss per share (EPS) amounts in the financial statements
are
computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS is
based on the weighted average number of common shares outstanding. Diluted
EPS
is based on the weighted average number of common shares outstanding plus
dilutive common stock equivalents. Basic EPS is computed by dividing net
income/loss available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period Diluted
EPS
is calculated by dividing net earnings by the weighted average number of common
shares outstanding and other dilutive securities. Dilutive earnings per share
for the period ended March 31, 2007 exclude the potential dilutive effect of
889,456 warrants because their impact would be anti-dilutive based on current
market prices. 690,909 convertible debentures are tested by using if-converted
method. The result shows when convertible debentures are included in the
computation, diluted EPS increases. According to SFAS No.128, those convertible
debentures are ignored in the computation of diluted EPS. All per share and
per
share information are adjusted retroactively to reflect stock splits and changes
in par value.
The
reconciliation of the numerators and denominators of the basic and diluted
EPS
calculations was as follows:
|
|
Three
Months Ended March 31,
|
|
(IN
THOUSANDS OF UNITED STATES DOLLARS, EXCEPT WEIGHTED SHARES AND
PER SHARE
AMOUNTS)
|
|
2007
|
|
|
2006
|
|
Numerator:
Net Income
|
|
$ |
308
|
|
|
$ |
801
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average
shares used to compute basic EPS
|
|
|
11,703,376
|
|
|
|
10,834,299
|
|
Weighted-average
shares used to compute diluted EPS
|
|
|
11,997,317
|
|
|
|
10,834,299
|
|
Basic
earnings per common share:
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
Diluted
earnings per common share:
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
4.
OTHER CURRENT ASSETS
Other
current assets consist of the following (in thousands):
|
|
March
31,
2007
|
|
|
December
31, 2006
|
|
|
|
Unaudited
Restated
|
|
|
Audited
Restated
|
|
Prepayment
|
|
$ |
725
|
|
|
$ |
1,048
|
|
Utilities
deposit
|
|
|
1,326
|
|
|
|
1,292
|
|
Receivable
from Lion Zone Holdings Ltd
|
|
|
385
|
|
|
|
485
|
|
Prepaid
expenses
|
|
|
360
|
|
|
|
408
|
|
Total
|
|
$ |
2,796
|
|
|
$ |
3,233
|
|
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
Restated
|
|
Balance
as of December 31, 2006
|
|
$ |
3,964
|
|
|
$ |
461
|
|
|
$1,176
|
|
|
$5,601
|
|
Goodwill
acquired during this quarter
|
|
|
-
|
|
|
|
-
|
|
|
|
657
|
|
|
|
657
|
|
Balance
as of March 31, 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 12).
6.
ACCRUED EXPENSES & OTHER PAYABLES
Accrued
expenses and other payables comprises of the following as of March 31, 2007
and
December 31, 2006.
(in
thousands of US Dollars):
|
|
2007
Unaudited
Restated
|
|
|
2006
Audited
Restated
|
|
Professional
fee
|
|
$ |
695
|
|
|
$ |
321
|
|
Director
fee
|
|
|
88
|
|
|
|
100
|
|
Salaries
and benefit payable
|
|
|
156
|
|
|
|
792
|
|
Marketing
expense
|
|
|
588
|
|
|
|
389
|
|
Others
|
|
|
184
|
|
|
|
226
|
|
Total
|
|
$ |
1,711
|
|
|
$ |
1,828
|
|
7.
STOCKHOLDERS' EQUITY
a)
COMMON
STOCK
For
the
three month period ended March 31, 2007, the Company had the following equity
transactions: (i) 199,444 shares of common stock were issued as the monthly
principal redemption shares for 8 million convertible debentures from January
to
March. Such shares are valued at $ 1,090,914; (ii) 41,426 treasury shares were
sold to the open market with total consideration $127,000.
b)
STOCK
OPTION PLAN
Prior
to
January 1, 2006, PacificNet accounted for awards granted under stock-based
compensation plans following the recognition and measurement principles of
APB
25, Accounting for Stock Issued to Employees, and related
interpretations. Accordingly, compensation expense was recognized for awards
granted at an exercise price less than fair market value of the underlying
common stock on the date of grant. Effective January 1, 2006, PacificNet adopted
the fair value recognition provisions of SFAS 123(R). See Note 2 for a
description of the Company’s adoption of SFAS 123R. The fair value of stock
options is determined using the Black-Scholes option pricing model, which is
consistent with the valuation techniques previously utilized for options in
footnote disclosures required under SFAS 123, as amended by FASB Statement
No. 148, “Accounting for Stock-Based Compensation - Transition and
Disclosure.” The determination of the fair value of stock-based compensation
awards on the date of grant using an option-pricing model is affected by the
Company’s stock price as well as assumptions regarding a number of complex and
subjective variables, including the expected volatility of the Company’s stock
price over the term of the awards, actual and projected employee stock option
exercise behaviors, risk-free interest rate and expected dividends. The
valuation provisions of SFAS 123(R) apply to new grants and unvested grants
that
were outstanding as of the effective date. For the three months ended March
31,
2007, no new options were granted and no options were vested, thus the
compensation costs is zero. PacificNet elected the modified prospective method
and therefore has not restated results for prior periods due to
123R.
The
status of the Stock Option Plan as of March 31, 2007, is as
follows:
|
|
OPTIONS
OUTSTANDING
|
|
|
WEIGHTED
AVERAGE EXERCISE PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
756,100
|
|
|
$ |
3.99
|
|
Granted
|
|
|
500,000
|
|
|
$ |
4.75
|
|
Cancelled
|
|
|
(491,600 |
) |
|
$ |
4.75
|
|
Exercised
|
|
|
(394,000 |
) |
|
$ |
2.12
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
370,500
|
|
|
$ |
2.00
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING
MARCH 31, 2007
|
|
|
370,500
|
|
|
$ |
2.00
|
|
Following
is a summary of the status of options outstanding at March 31,
2007:
Grant
Date
|
Total
Options
Outstanding
|
Aggregate
Intrinsic
Value
|
Weighted
Average Remaining
Life
(Years)
|
Total
Weighted
Average
Exercise
Price
|
Option
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-7-26
|
370,500
|
$1,237,470
|
0.32
|
$2.00
|
370,500
|
$2.00
|
The
370,500 outstanding options, which granted during year 2004, will be expired
at
July 26 of 2007. Those options were vested from July 1st of 2005
with 10
months vesting period, and the corresponding compensation cost have been
recorded within the vesting period. The weighted-average fair value of such
options was $1.41.The assumptions used in calculating the fair value of options
granted using the Black-Scholes option- pricing model are as
follows:
Risk-free
interest rate
|
2.75%
|
|
Expected
life of the options
|
1.65
years
|
|
Expected
volatility
|
61.33%
|
|
Expected
dividend yield
|
0%
|
|
No
options were granted, cancelled and exercised during the three month period
ended March 31, 2007.
c)
WARRANTS
At
March
31, 2007, the Company had outstanding and exercisable warrants to purchase
an
aggregate of 1,007,138 shares of common stock. The weighted average remaining
life is 3.09 years and the weighted average exercise price per share is $10.61
per share.
Following
is a summary of the warrant activity:
|
|
Warrants
outstanding
|
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
|
Aggregate
Intrinsic
Value
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
591,138
|
|
|
$ |
9.50
|
|
|
$ |
-
|
|
Granted
|
|
|
416,000
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
1,007,138
|
|
|
$ |
10.61
|
|
|
$ |
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING,
MARCH 31, 2007
|
|
|
1,007,138
|
|
|
$ |
10.61
|
|
|
$ |
-
|
|
Following
is a summary of the status of warrants outstanding at March 31,
2007:
|
Total
warrants
Outstanding
|
Weighted
Average
Remaining
Life (Years)
|
Total
Weighted
Average
Exercise
Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-1-15
|
123,456
|
1.79
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
2.63
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
2.69
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
3.95
|
$12.20
|
416,000
|
$12.20
|
On
March
13, 2006, we issued 400,000 warrants to several institutional investors in
connection with a private placement of $8 million in convertible debentures.
On
the same day we issued another 16,000 warrants to our placement agent for the
transaction. Those warrants have a term of 5 years and immediately vesting.
The
assumptions used in calculating the fair value of such warrants granted using
the Black-Scholes option- pricing model are as follows:
Risk-free
interest rate
|
4.78%
|
|
Expected
life of the options
|
5.00
years
|
|
Expected
volatility
|
37.08%
|
|
Expected
dividend yield
|
0%
|
|
No
warrants were granted, cancelled and exercised during quarter ended March 31
of
2007.
d)
TREASURY STOCK
The
following is a summary of the movement of the Company's shares held as treasury
stock as at March 31 of 2007:
|
|
Number
of shares
|
|
Escrow
shares returned to treasury in 2003
|
|
|
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
(1)
|
|
|
529,848
|
|
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,
March 31, 2007
|
|
|
2,572,969
|
|
Shares
outstanding at March 31, 2007
|
|
|
11,782,072
|
|
Shares
issued at March 31, 2007
|
|
|
14,355,041
|
|
_________
(1)
|
Includes
shares related to Clickcom 78,000, Guangzhou (Wanrong) 138,348, IMobile
153,500 and Games 160,000
|
From
January 24th,
2007 to Jan 30th, 2007, we
sold
41,426 treasury shares to the open market with total consideration
$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 six month anniversary
of the effective date of the registration statement, we may force the holders
to
convert up to 50% of the then outstanding principal amount of the debentures,
subject to certain trading conditions being met. If any event of default occurs
under the debentures or other related documents, the holders may elect to
accelerate the payment of the outstanding principal amount of the debenture,
plus accrued, but unpaid interest, liquidated damages and penalties, which
shall
become immediately due and payable.
Under
the
terms of a registration rights agreement entered into at the time of the private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April
30,
2006, and have the registration statement declared effective by the SEC no
later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to
the investors at the rate of 2% of the principal amount of the debenture
each month beginning on June 28, 2006 until the effectiveness of the
registration statement, which was equal to $1,120,000, in the
aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of accrued
liquidated damages, the Company signed a Settlement and Release Agreement with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding Fund
Ltd., and Basso Private Opportunities Holding Fund Ltd. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
in cash, with the remaining liquidated damages in the amount of $105,000 paid
in
the form of a new convertible debenture due February 2009, on substantially
the
same terms as the original debentures, except that interest only is paid on
the
new debentures until October 2008 and beginning in November 2008 until February
2009, when the new debentures are due, the monthly redemption amount under
the
new debentures shall be equal to $315,000. The remaining investors also agreed
to accept the aggregate $840,000 in liquidated damages owed to them in the
form
of the new convertible debentures for the amount of their respective portion
of
the liquidated damages. The Company also agreed to amend the original debentures
to shorten the term for payment of the original principal amount to a 22 month
term. As a result the monthly redemption amount for the original debenture
increased from $320,000 to $ 363,638. All other terms and conditions of the
original debenture remain in full force and effect. The outstanding original
principal amount as at March 31, 2007 is $6,909,086.
C.E.
Unterberg, Towbin L.L.C. acted as placement agent and received a negotiated
cash
fee in the amount of $449,500 and a warrant to purchase up to 16,000 shares
at
an exercise price of $12.20 per share, which expire five years from the date
of
issuance. The fair value of these warrants totaled $28,141. Such amount was
charged to other assets, net, and credited to additional paid-in capital and
will be amortized over the life of the debentures. Maxim Group also acted as
Placement Agent and received a cash fee in the amount of $50,000.
In
connection with the issuance of the debentures, the Company incurred $1,106,135
of issuance costs, which primarily consisted of investment banker fees, legal
and other professional fees. These costs have been recorded as additional
expense during year 2006.
The
gross
proceeds of $8,000,000 are recorded as a current debenture liability. In
addition, fair values attributed to the Investors’ warrants in accordance with
EITF issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to
and Potentially Settled in a Company’s Own Stock” are recorded as liabilities.
The initial value related to the Investors’ warrants is $690,642. An aggregate
gain of $60,694 representing the change in fair value of warrants was recognized
during the three months ended March 31, 2007.
In
accordance with recent FASB guidance, due to certain factors, including a
liquidated damages provision in the registration rights agreement, the Company
values and accounts for the embedded conversion feature and the warrants related
to the debentures as derivatives. Accordingly, these derivative liabilities
are
measured at fair value with changes in fair value reported in earnings as long
as they remain classified as liabilities. The Company reassesses the
classification at each balance sheet date. If the classification required under
EITF No. 00-19 changes as a result of events during the period, the contract
should be reclassified as of the date of the event that caused the
reclassification.
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 can
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 remaining principal amount of the Debenture of
$6,909,086 and the principal amount of the new Debentures of $945,000 to current
liabilities.
The
Company accrued 2% as liquidated damages and 30% as mandatory default amount
from the date of ineffectiveness of registration statement as
follows:
($,000)
|
|
Liquidated
damages
|
2%
|
|
$450
|
Mandatory
default
|
30%
|
|
2,247
|
Total
|
|
|
$2,697
|
Such
amounts have been recorded as liquidated damages liability as of March 31,
2007.
The
Company issued 199,444 shares to redeem $1,090,909 of convertible note as of
March 31, 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%
to 32% . The interest rate of the convertible note has initially been set at
8%,
and shall increase to 15% if the note is not converted prior to maturity.
PacGames received the first payment of $2.5 million during the first quarter
of
2007.
In
connection with the issuance of the note, PacGames incurred issuance costs
of
$204,121, which primarily consisted of investment banker fees, legal and other
professional fees. These costs have been capitalized and will be amortized
over
three years, the life of the note. Interest accrual as of March 31, 2007
amounted to $29,041.
Following
is the summary of convertible debenture:
|
|
|
|
March
31,
2007
|
|
($,000) |
|
|
|
|
|
Convertible
debenture
|
|
|
$ |
2,500
|
|
Unamortized
financing cost
|
|
|
|
(193 |
) |
|
|
|
$ |
2,307
|
|
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 ChinaGoHi (discontinued), Linkhead
(discontinued), Clickcom (discontinued) and Guangzhou 3G/Sunroom. For example,
Linkhead is a master reseller of NMS hardware and software platforms in China,
and its voice cards are used as an integral part of voice hardware using CPCI
industry control machines, and also by Media Servers to support access from
PSTN
and VoIP, Softswitch and 3G networks.
(3)
Product (Telecom & Gaming) Services Group - involves communication and
gaming products, GSM/CDMA/3G Products, Multimedia Communication Kiosks. This
Group includes the following subsidiaries: PacificNet Communications Limited,
iMobile, Allink, Take1 and PacificNet Games. PacificNet Games Limited (PacGames)
is a leading developer of Asian electronic gaming machines, multi-player
electronic gaming technology solutions and gaming related maintenance, IT,
and
distribution services for the leading hotel and casino operators based in the
Macau and other Asian gaming markets.
(4)
Other
Business - other administrative, financial and investment services and non-core
businesses such as PacificNet Power Limited (PacPower), Pacific Financial
Services Limited, etc.
The
Company's reportable segments are operating units, which represent the
operations of the Company's significant business operations. Summarized
financial information concerning the Company's reportable segments is shown
in
the following table. The "Other" column includes the Company's other
insignificant services and corporate related items, and, as it relates to
segment earnings/(loss), income and expense not allocated to reportable
segments.
For
the three months ended March 31, 2007
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
(in
thousands, except percentages)
|
Outsourcing
Services
|
Telecom
Value-Added Services
|
Products
(Telecom & Gaming)
|
Other
Business
|
(Restated)
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
3,963
|
527
|
4,773
|
4
|
9,267
|
(%
of Total Revenues)
|
43%
|
6%
|
52%
|
|
100%
|
Income
/ (Loss) from Operations
|
400
|
(3)
|
1,196
|
(793)
|
800
|
(%
of Total Profit)
|
50%
|
|
150%
|
(99)%
|
100%
|
Total
Assets
|
8,322
|
(2,140)
|
15,875
|
19,168
|
41,225
|
(%
of Total Assets)
|
20%
|
(5)%
|
39%
|
46%
|
100%
|
Goodwill
|
3,964
|
461
|
1,833
|
|
6,258
|
Geographic
Area
|
HK,
PRC
|
HK,
PRC
|
HK,
PRC, Macau
|
HK,PRC
|
|
For
the three months ended March 31, 2006
|
Group
1.
|
Group
2.
|
Group
3.
|
Group
4.
|
Total
|
(in
thousands, except percentages)
|
Outsourcing
Services
|
Telecom
Value-Added Services
|
Products
(Telecom & Gaming)
|
Other
Business
|
(Restated)
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
3,022
|
295
|
3,355
|
|
6,672
|
(%
of Total Revenues)
|
45%
|
4%
|
50%
|
|
100%
|
Income
/ (Loss) from Operations
|
206
|
15
|
359
|
(518)
|
62
|
%
of Total Profit)
|
332%
|
24%
|
579%
|
(835)%
|
100%
|
Total
Assets
|
12,088
|
15,011
|
6,089
|
13,221
|
46,409
|
(%
of Total Assets)
|
26%
|
32%
|
13%
|
28%
|
100%
|
Goodwill
|
3,964
|
|
|
|
3,964
|
Geographic
Area
|
HK,PRC
|
HK,PRC
|
HK,PRC,
Macau
|
HK,PRC
|
|
Product
and service revenues classified by major geographic areas are as follows (in
thousands of US Dollars):
For
the three months ended
March
31, 2007
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(Restated)
|
Product
revenues
|
2,137
|
1,550
|
1,015
|
4,702
|
Service
revenues
|
3,492
|
1,073
|
-
|
4,565
|
For
the three months ended
March
31, 2006
|
Hong
Kong, Macau
|
PRC
|
United
States
|
Total
(Restated)
|
Product
revenues
|
2,936
|
-
|
-
|
2,936
|
Service
revenues
|
3,027
|
709
|
-
|
3,736
|
10.
RELATED PARTY TRANSACTIONS
LEASE
AGREEMENT
In
November 2004, the Company entered into a lease agreement with EPRO for rental
space in the amount of $1,923 per month. The term of the lease was one year
and
renewable by either party.
LOAN
DUE FROM RELATED PARTIES
At
March
31, 2007, there was a total loan receivable of approximately $713,000 due from
related parties. Included in which were $279,000 from MOABC, an affiliated
company that is 15% owned by PacificNet, and $434,000 from shareholders and
directors of certain of the Company’s subsidiaries in connection with the
acquisition of those subsidiaries. The amounts due from shareholders and
directors of subsidiaries are comprised of $254,000 due from a shareholder
of
Yueshen, $64,000 due from a director of Soluteck and $116,000 due from a
director of PACT Communications. Terms of these related parties loan receivables
and payables are summarized below:
LOAN
TO MOABC
MOABC
is
an affiliated company, 15% owned by PacificNet, as of March 31, 2007. A
convertible loan of $279,000 is outstanding from MOABC as of March 31, 2007.
Terms of the convertible loan provide PacificNet an option at any time during
the term of the loan to convert in part or in whole of the then outstanding
loan
principle into equity interest of MOABC, at $23,160 for each 1% of MOABC
shares.
LOAN
TO YUESHEN’S SHAREHOLDER
As
of
March 31, 2007, there was a loan outstanding of $254,000 receivable from the
shareholder of Yueshen. This loan is secured by 106,240 PacificNet shares.
Further discussion of the Company’s legal dispute with Yueshen can be found
under Part II of this 10Q document - Item1: Legal Proceedings.
LOAN
TO SOLUTECK’S DIRECTOR
As
of
March 31, 2007, there was a loan outstanding of $64,000 receivable from a
director of Soluteck, due on December 14 for three consecutive years ending
2007. The interest rate for the loan is 8% per annum plus 5% penalty interest
in
case it has not been timely paid. The loan is collateralized with 100,000
PacificNet’s shares owned by the borrowing director and Ms Iris Lo, and the
remaining assets of Smartime Holding Ltd.
LOAN
TO COMMUNICATIONS' DIRECTOR
As
of
March 31, 2007, there was a loan outstanding of $116,000 receivable from a
director of Communications, due on August 31, 2007. The interest rate for the
loan is 10% per annum plus 1% penalty interest per month in case of delinquency.
The loan is secured by 30,000 PacificNet shares.
LOAN
DUE TO RELATED PARTIES
As
of
March 31, 2007, there was an outstanding loan payable of $577,000 due to
related parties. Included in which was a loan payable of $292,000 to a
shareholder of EPRO. The loan was advanced to Epro by a shareholder of EPRO
on
behalf of the Company for working capital purposes. The loan is due on August
4,
2010. Interest is charged at Hong Kong prime lending rate.
As
of
March 31, 2007, a loan of $285,000 was payable to a shareholder of Smartime.
The
loan was advanced to Smartime by a shareholder of Smartime on behalf of the
Company for working capital purposes.
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 Q1 amounted to $152,000 (2006
Q1:
$128,000). Future minimum lease payments under non-cancelable operating leases
are $655,000 for the period from January 2007 to December 2008 and $684,000
for
the period from January 2008 to December 2011, respectively.
RESTRICTED
CASH - Term deposit of $235,000 has been pledged to certain financial
institutions for bank line overdraft protection of Epro.
BANK
LINE
OF CREDIT - As of March 31, 2007, the Company’s outstanding bank line of credit
were as follows:
|
(i)
|
Epro
has an overdraft banking facility of up to $294,000 with certain
banking
institutions, which is secured by a pledge of its fixed deposits
of
$235,000. Interest is charged at Hong Kong Prime Rate and payable
at the
end of each calendar month or the date of settlement, whichever is
earlier.
|
|
(ii)
|
Smartime
has an overdraft banking facility of up to $110,000 with a Hong Kong
banking institution. This overdraft facility is secured by a personal
deposit account of a director of
Smartime.
|
BANK
LOANS - Tabulated below are bank loans outstanding (in
thousands):
|
|
March
31,
2007
|
|
|
December
31, 2006
|
|
|
|
|
Unaudited
Restated
|
|
|
|
Audited
Restated
|
|
Secured
[1]
|
|
$ |
2,476
|
|
|
$ |
1,668
|
|
Unsecured
|
|
|
737
|
|
|
|
543
|
|
Current
portion
|
|
|
(933 |
) |
|
|
(576 |
) |
Non
current portion
|
|
$ |
2,280
|
|
|
$ |
1,635
|
|
[1]
The
loans were secured by the following: joint and several personal guarantees
executed by certain directors of the subsidiary of the Company; corporate
guarantee executed by a subsidiary of the Company; second legal charge over
a
property owned by a subsidiary of the Company; and pledged bank deposits of
$235,000 (2006: $234,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as follows (in
thousands of US Dollars):
|
|
April
2007 to
March
2008
|
|
|
April
2008 to
March
2009
|
|
|
April
2009 to March 2010
|
|
|
April
2010 to
March
2011
|
|
|
April
2011 to
March
2012
|
|
|
Thereafter
|
|
|
TOTAL
|
|
Beijing
PACT office mortgage (1)
|
|
$ |
51
|
|
|
$ |
54
|
|
|
$ |
57
|
|
|
$ |
43
|
|
|
$ |
81
|
|
|
$ |
761
|
|
|
$ |
1,047
|
|
Shenzhen
PACT office mortgage (2)
|
|
|
21
|
|
|
|
23
|
|
|
|
24
|
|
|
|
26
|
|
|
|
28
|
|
|
|
648
|
|
|
|
770
|
|
Sub-total
|
|
|
72
|
|
|
|
77
|
|
|
|
81
|
|
|
|
69
|
|
|
|
109
|
|
|
|
1,409
|
|
|
|
1,817
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank
loans (3)
|
|
|
437
|
|
|
|
404
|
|
|
|
131
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
972
|
|
AR
factoring loans (3)
|
|
|
424
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
424
|
|
Sub-total
|
|
|
861
|
|
|
|
404
|
|
|
|
131
|
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$ |
933
|
|
|
$ |
481
|
|
|
$ |
212
|
|
|
$ |
69
|
|
|
$ |
109
|
|
|
$ |
1,409
|
|
|
$ |
3,213
|
|
_________
|
(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 three years are as follows: 2007: $110,000; 2008: $80,000;
2009:$24,000, and thereafter: none.
|
|
Aggregate
future lease payments
|
|
2007
|
|
$ |
110,000
|
|
2008
|
|
|
80,000
|
|
2009
|
|
|
24,000
|
|
Thereafter
|
|
|
-
|
|
Total
|
|
|
224,000
|
|
Current
portion
|
|
|
(110,000
|
) |
Non-current
portion
|
|
$ |
104,000
|
|
12.
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:
|
|
|
|
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
March
31, 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 profit of US$128,205 for the quarter ended March 31, 2007 is
available. Accordingly, the contingent consideration of 149,459 shares has
not
been reflected in the consolidated financial statements of the Company as of
March 31, 2007.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE QUARTER ENDED
MARCH 31, 2007 AND 2006
The
following is an un-audited pro forma consolidated financial information for
the
quarter ended March 31, 2006 and 2007, as presented below, reflects the
results of operations of the Company assuming the acquisition occurred on
January 1, 2006 and 2007, respectively, and after giving effect to the
purchase accounting adjustments. These pro forma results have been prepared
for
information purposes only and do not purport to be indicative of what operating
results would have been had the acquisitions actually taken place on January
1, 2006 and 2007, respectively, and may not be indicative of future
operating results.
|
|
Three
months ended September 30
|
|
(un-audited and in thousands of U.S. dollars)
|
|
2007
|
|
|
2006
|
|
Revenue
|
|
$ |
9,267
|
|
|
$ |
6,916
|
|
Operating
income
|
|
$ |
800
|
|
|
$ |
47
|
|
Net
profit
|
|
$ |
308
|
|
|
$ |
796
|
|
Earnings
per share – basic
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
Earnings
per share – diluted
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
Accordingly,
PacificNet included the financial results of Take 1 in its consolidated 2007
financial results from January 5, 2007 through March 31, 2007.
13.
INVESTMENTS IN AFFILIATED COMPANIES
Investments
in affiliated companies consists of the following as of March 31,
2007:
(US$
thousands)
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
AMOUNT
|
DESCRIPTION
|
INVESTMENTS
IN AFFILIATED COMPANIES:
|
|
|
Glad
Smart
|
$30
|
15%
ownership interest
|
Community
media co.
|
$4
|
5%
ownership interest
|
Total
|
$
34
|
|
14.
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.
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 13, 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
case
is now in the discovery stage before 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 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. 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.
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 argue
that: (i) they had carried out the works according to the Contract terms; (ii)
the works had been approved by PKL Consultants Limited, the consultant
representative of the Employer; and (iii) a sum of HK$30,000 is still due and
owing by PacificNet Power to JCHKL.
The
case
is now in the discovery stage before 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.
15. RESTATEMENT
On
March
19, 2007 our predecessor auditor withdrew their opinion on our previously filed
financial statements for the years ended December 31, 2005 and 2004 due to
uncertainties around certain option grants during the said period. An
independent investigation in this connection has been performed by our Audit
Committee to address this matter.
In
its
May 3, 2007 Report, the Audit Committee concluded that, “…the Audit Committee
did indeed find that, although the number and terms of option grants were being
fixed by the Compensation Committee who deferred to the Board merely for a
secondary review approval; whereby the Board of Directors still maintained
the
authority to cancel a prerequisite grant consummated by the Compensation
Committee, therefore that Grant could likely be interpreted only as final at
the
date of approval of the company’s Board of Directors. Hence, with this approach
which seems to be more aligned with the SEC interpretation, financial
restatement would be required to account for the granting of options that were
“in the money” due to procedural administrative delay and the difference in the
Compensation Committee grant date and the Board of Directors approval date.
Accordingly, the Audit Committee recommended to the Board of Directors of
Pacificnet, Inc. to charge additional stock based compensation expense to the
company’s financial statements for the fiscal years ended December 31, 2003,
2004 and 2005 respectively...”
Based
on
the Audit Committee Recommendations, extra stock-based compensation charges
of
approximately $0.3 million, $1.2 million and $0.1 million were charged to each
of the years ended December 31, 2005, 2004 and 2003, respectively. Also, for
the
years ended December 31, 2005 and 2004, the Company determined that its
allowance for bad debts on the accounts receivable was understated by $3.5
Million and $0.28 million in the years ended December 31, 2005 and 2006,
respectively. The Company also restated impairment of goodwill for certain
subsidiaries ($3.7 million and $2.6 million in the years ended December 31,
2005
and 2004, respectively) and accrued certain 2005 bonus payable in 2006 amounting
to $600,000. Also, the Company concluded that the consolidation of certain
entity (Yueshen) was wrongly reflected as the Company did not have control
over
the management of the entity.
Following
the reaudit of its financial statements for the years ended December 31, 2005
and 2004, the Company restated its financials statements for the year ended
December 31, 2006.
In
the
course of the financial statements restatement for the year ended December
31,
2006, management has decreased total non-current assets by $1 million worth
of
goodwill as a result of the re-audit restatement to the ending goodwill balances
as at December 31, 2005. Further, management has also decreased total selling,
general and administrative expenses by an aggregate of $6.3 million. Said
decrease comprises of extra goodwill impairment amounting to approximately
$3.7
million and $2.6 million, respectively, already charged to the restated Selling,
General and Administrative expenses for the years ended December 31, 2005 and
2004. An impairment of investment of $1.2 million was also recorded for the
year
ended December 31, 2006 for an entity disposed in 2006.
Following
the restatements of its financials statements for the years ended December
31,
2006, December 31, 2005 and December 31, 2004 the Company is restating its
first
quarter review for the year 2007 to account for the effects of its prior year’s
restatements.
Following
are the effects of the restatement on the period ended March 31, 2007 and the
year ended December 31, 2006:
|
|
Three
Months ended
March
31, 2007
|
|
|
Year
ended
December
31, 2006
|
|
Consolidated
Balance Sheets:
|
|
As
reported
|
|
|
As
restated
|
|
|
As
reported
|
|
|
As
restated
|
|
ASSETS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets
|
|
$ |
19,126
|
|
|
$ |
19,001
|
|
|
$ |
17,041
|
|
|
$ |
17,041
|
|
Non-current
assets
|
|
|
26,285
|
|
|
|
22,224
|
|
|
|
24,841
|
|
|
|
19,885
|
|
Total
assets
|
|
$ |
45,411
|
|
|
$ |
41,225
|
|
|
$ |
41,882
|
|
|
$ |
36,926
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
$ |
14,959
|
|
|
$ |
16,748
|
|
|
$ |
17,376
|
|
|
$ |
18,321
|
|
Non-current
liabilities
|
|
|
6,480
|
|
|
|
4,691
|
|
|
|
2,704
|
|
|
|
1,759
|
|
Total
liabilities
|
|
|
21,439
|
|
|
|
21,439
|
|
|
|
20,080
|
|
|
|
20,080
|
|
Minority
interest
|
|
|
7,126
|
|
|
|
4,206
|
|
|
|
6,874
|
|
|
|
2,869
|
|
STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
1
|
|
|
|
1
|
|
|
|
1
|
|
|
|
1
|
|
Treasury
stock
|
|
|
(130 |
) |
|
|
(145 |
) |
|
|
(257 |
) |
|
|
(272 |
) |
Additional
paid-in capital
|
|
|
64,560
|
|
|
|
67,003
|
|
|
|
63,124
|
|
|
|
65,757
|
|
Cumulative
other comprehensive income (loss)
|
|
|
249
|
|
|
|
(13 |
) |
|
|
220
|
|
|
|
(42 |
) |
Accumulated
deficit
|
|
|
(47,431 |
) |
|
|
(50,782 |
) |
|
|
(47,739 |
) |
|
|
(51,090 |
) |
Stock
subscription receivable
|
|
|
(403 |
) |
|
|
(484 |
) |
|
|
(421 |
) |
|
|
(377 |
) |
TOTAL
STOCKHOLDERS' EQUITY
|
|
|
16,846
|
|
|
|
15,580
|
|
|
|
14,928
|
|
|
|
13,977
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
45,411
|
|
|
$ |
41,225
|
|
|
$ |
41,882
|
|
|
$ |
36,926
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months ended
March
31, 2007
|
|
|
Three
Months ended
March
31, 2006
|
|
|
|
As
reported
|
|
|
As
restated
|
|
|
As
reported
|
|
|
As
restated
|
|
Consolidated
Statements of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenue
|
|
$ |
9,267
|
|
|
$ |
9,267
|
|
|
$ |
6,672
|
|
|
$ |
6,672
|
|
Cost
of sales
|
|
|
(6,728 |
) |
|
|
(6,728 |
) |
|
|
(5,320 |
) |
|
|
(5,320 |
) |
Gross
profit
|
|
|
2,539
|
|
|
|
2,539
|
|
|
|
1,352
|
|
|
|
1,352
|
|
Selling,
General and Administrative expenses
|
|
|
(1,567 |
) |
|
|
(1,567 |
) |
|
|
1,079
|
|
|
|
1,079
|
|
Stock-based
compensation expenses
|
|
|
-
|
|
|
|
-
|
|
|
|
(182 |
) |
|
|
(182 |
) |
Income
from operations
|
|
|
800
|
|
|
|
800
|
|
|
|
62
|
|
|
|
62
|
|
Income
before income taxes, minority interest and discontinued
operations
|
|
|
680
|
|
|
|
680
|
|
|
|
25
|
|
|
|
25
|
|
Income/(loss)
before discontinued operations
|
|
|
78
|
|
|
|
78
|
|
|
|
(81 |
) |
|
|
(81 |
) |
Income from
discontinued operations |
|
|
230
|
|
|
|
230
|
|
|
|
882
|
|
|
|
882
|
|
Net
income available to common stockholders
|
|
$ |
308
|
|
|
$ |
308
|
|
|
$ |
801
|
|
|
$ |
801
|
|
Earnings
per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.03
|
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
|
$ |
0.07
|
|
Diluted
|
|
$ |
0.03
|
|
|
$ |
0.03
|
|
|
$ |
0.07
|
|
|
$ |
0.07
|
|
Shares
used in computing earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
11,719,168
|
|
|
|
11,703,376
|
|
|
|
10,855,761
|
|
|
|
10,834,299
|
|
Diluted
|
|
|
12,013,109
|
|
|
|
11,997,317
|
|
|
|
11,526,945
|
|
|
|
10,834,299
|
|
Consolidated
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
308
|
|
|
$ |
308
|
|
|
$ |
801
|
|
|
|
4801
|
|
Stock-based
compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
182
|
|
|
|
182
|
|
Net
cash provided by (used in) operating activities
|
|
|
(100 |
) |
|
|
845
|
|
|
|
(157 |
) |
|
|
2,148
|
|
Net
cash used in investing activities
|
|
|
(913 |
) |
|
|
(825 |
) |
|
|
(2,190 |
) |
|
|
(5,558 |
) |
Net
cash provided by financing activities
|
|
|
2,271
|
|
|
|
2,092
|
|
|
|
7,619
|
|
|
|
8,973
|
|
Effect
of exchange rate on cash & cash equivalent
|
|
|
29
|
|
|
|
29
|
|
|
|
18
|
|
|
|
-
|
|
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
|
$ |
4,041
|
|
|
$ |
4,041
|
|
|
$ |
3,778
|
|
|
$ |
5,563
|
|
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
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.
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.
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 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 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.
Information
relating to the operations of the subsidiaries up to the periods of disposal
during the three month period ended March 31, 2007 is as follows (in thousands
of US Dollars):
|
Linkhead
|
Power
|
Clickcom
|
PacTelso
|
Solutions
|
MOABC
|
3G
|
Total
|
Income(loss)
from discontinued operations
|
(8)
|
-
|
(1)
|
-
|
1
|
(23)
|
261
|
230
|
Net
assets held for disposition
|
1,134
|
-
|
812
|
-
|
1
|
(42)
|
6,971
|
8,876
|
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..
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.
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 in the pleadings stage. We are unable to predict the outcome of these
actions, or a reasonable estimate of the range of possible loss, if
any.
Pacificnet
Inc. vs Iroquois Master Fund, Ltd.
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 DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE
FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE INFORMATION
CONTAINED IN THE FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO
APPEARING ELSEWHERE HEREIN AND IN CONJUNCTION WITH THE MANAGEMENT'S DISCUSSION
AND ANALYSIS SET FORTH IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K/A ( Amendment
No.1) FOR THE YEAR ENDED DECEMBER 31, 2006 .
PRELIMINARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The
statements contained in this Form 10-Q/A 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
of
Financial Condition and Results of Operations." The Company's actual results
could differ materially from results anticipated in these forward-looking
statements. All forward-looking statements included in this document are based
on information available to the Company on the date hereof, and the Company
assumes no obligation to update any such forward-looking statements.
FACTORS
THAT COULD AFFECT FUTURE RESULTS
Factors
that might cause actual results, performance or achievements to differ
materially from those projected or implied in such forward-looking statements
include, among other things:
—
|
the
impact of competitive products;
|
—
|
changes
in laws and regulations;
|
—
|
adequacy
and availability of insurance coverage;
|
—
|
limitations
on future financing;
|
—
|
increases
in the cost of borrowings and unavailability of debt or equity
capital;
|
—
|
the
inability of the Company to gain and/or hold market
share;
|
—
|
exposure
to and expense of resolving and defending liability claims and other
litigation;
|
—
|
consumer
acceptance of the Company's
products;
|
—
|
managing
and maintaining growth;
|
—
|
customer
demands;
|
—
|
market
and industry conditions,
|
—
|
the
success of product development and new product introductions into
the
marketplace;
|
—
|
the
departure of key members of management, and
|
—
|
the
effect of the United States War on Terrorism, as well as other risks
and
uncertainties that are described from time to time in the Company's
filings with the Securities and Exchange
Commission.
|
Regarding
one of our subsidiaries, for example, Epro is engaged in the business of
providing outsourced call center services with over 15 years of field experience
in Hong Kong and China. The factors that could affect current and future results
are as follows:
—
|
insufficient
sales forces for business development & account
servicing;
|
—
|
lack
of PRC management team in operation;
|
—
|
less
familiarity on partners' product knowledge;
|
—
|
deployment
costs of a new HR application and the costs to upgrade the call center
computer system;
|
—
|
increasing
operations costs (cost of salaries, rent, interest rates & inflation)
under rising economy in Hong Kong;
|
—
|
insufficient
brand awareness initiatives in the market;
|
—
|
salary
increases due to an active labor market in Hong Kong and GuangZhou;
and
|
—
|
increasing
competition of call center solutions in the Hong Kong and PRC
markets.
|
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis or plan of operations is based upon our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect
the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities.
On
an
on-going basis, we evaluate our estimates, including those related to accounts
receivable reserves, provisions for impairment losses of affiliated companies
and other intangible assets, income taxes and contingencies. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form
the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from
these estimates under different assumptions or conditions.
Management
believes the following critical accounting policies reflect our more significant
estimates and assumptions used in the preparation of our consolidated financial
statements:
Allowance
For Doubtful Accounts
We
evaluate the collectibility of our trade receivables based on a combination
of
factors. We regularly analyze our significant customer accounts, and, when
we
become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration
in
the customer's operating results or financial position, we record a specific
reserve for bad debt to reduce the related receivable to the amount we
reasonably believe is collectible. We also record reserves for bad debt for
all
other customers based on a variety of factors including the length of time
the
receivables are past due, the financial health of the customer, macroeconomic
considerations and historical experience. If circumstances related to specific
customers change, our estimates of the recoverability of receivables could
be
further adjusted. In the event that our trade receivables become uncollectible,
we would be forced to record additional adjustments to receivables to reflect
the amounts at net realizable value. The accounting effect of this entry would
be a charge to earnings, thereby reducing our net earnings. Although we consider
the likelihood of this occurrence to be remote based on past history and the
current status of our accounts, there is a possibility of this
occurrence.
In
the
beginning of the third quarter of 2006, the Chinese government announced that
it
would implement several new policies regarding mobile phone value-added service
providers effective from July 10, 2006. These policies include a “double
confirmation” policy and the requirement that value-added service providers
provide one-month trial subscriptions. By requiring that mobile phone customers
“double-confirm” their intention to purchase services, and by requiring free
subscriptions, the Chinese government has negatively affected value-added
service providers.
Inventory
Our
inventory purchases and commitments are made in order to build inventory to
meet
forecasted demand for our products. We perform a detailed assessment of
inventory for each period, which includes a review of, among other factors,
demand requirements, product life cycle and development plans, component cost
trends, product pricing and quality issues. Based on this analysis, we record
adjustments to inventory for excess, obsolescence or impairment, when
appropriate, to reflect inventory at net realizable value. Revisions to our
inventory adjustments may be required if actual demand, component costs or
product life cycles differ from our estimates. In the event we were unable
to
sell our products, the demand for our products diminished, and/or other
competitors offered similar or better products, we would be forced to record
an
adjustment to inventory for impairment or obsolescence to reflect inventory
at
net realizable value. The accounting effect of this entry would be a charge
to
earnings, thereby reducing our net earnings.
Income
Taxes
We
record
a valuation allowance to reduce our deferred tax assets to the amount that
is
more likely than not to be realized. We have considered future market growth,
forecasted earnings, future taxable income, and the mix of earnings in the
jurisdictions in which we operate and prudent and feasible tax planning
strategies in determining the need for a valuation allowance. We currently
have
recorded a full valuation allowance against net deferred tax assets as we
currently believe it is more likely than not that the deferred tax assets will
not be realized. In the event we determine that we would not be able to realize
all or part of our net deferred tax assets in the future, an adjustment to
the
deferred tax assets would be charged to earnings in the period such
determination is made. Likewise, if we later determine that it is more likely
than not that the net deferred tax assets would be realized, the previously
provided valuation allowance would be reversed.
Contingencies
We
may be
subject to certain asserted and unasserted claims encountered in the normal
course of business. It is our belief that the resolution of these matters will
not have a material adverse effect on our financial position or results of
operations, however, we cannot provide assurance that damages that result in
a
material adverse effect on our financial position or results of operations
will
not be imposed in these matters. We account for contingent liabilities when
it
is probable that future expenditures will be made and such expenditures can
be
reasonably estimated.
Valuation
of Long-Lived Assets Including Goodwill and Purchased Intangible
Assets
We
review
property, plant and equipment, goodwill and purchased intangible assets for
impairment whenever events or changes in circumstances indicate the carrying
value of an asset may not be recoverable. Our asset impairment review assesses
the fair value of the assets based on the future cash flows the assets are
expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset
plus
net proceeds expected from disposition of the asset (if any) are less than
the
carrying value of the asset. This approach uses our estimates of future market
growth, forecasted revenue and costs, expected periods the assets will be
utilized and appropriate discount rates. Such evaluations of impairment of
long-lived assets including goodwill arising on a business combination and
purchased intangible assets are an integral part of, but not limited to, our
strategic reviews of our business and operations performed in conjunction with
restructuring actions. When an impairment is identified, the carrying amount
of
the asset is reduced to its estimated fair value. Deterioration of our business
in a geographic region or within a business segment in the future could also
lead to impairment adjustments as such issues are identified. The accounting
effect of an impairment loss would be a charge to earnings, thereby reducing
our
net earnings.
Convertible
Debt
The
fair
value of these derivative instruments, as determined by applying the
Black-Scholes valuation model, is adjusted quarterly. The Black-Scholes
valuation model requires the input of highly subjective assumptions, including
the expected stock price volatility. Additionally, although the Black-Scholes
model meets the requirements of SFAS 133, the fair values generated by the
model may not be indicative of the actual fair values as our derivative
instruments have characteristics significantly different from traded options.
Accordingly, the results obtained could be significantly different if other
assumptions were used. The effect of this entry would be a charge to net
earnings, thereby either increasing or reducing our net earnings based upon
the
assumptions used and the results obtained.
NATURE
OF THE OPERATIONS OF THE COMPANY
NATURE
OF BUSINESS
PacificNet
Inc. (http://www.PacificNet.com) is a leading provider of gaming technology,
e-commerce, and Customer Relationship Management (CRM) in China. Our gaming
products are specially designed for the Chinese and Asian gamers, and we focus
on integrating localized Chinese and Asian themes and content, advanced
graphics, digital sound effects and popular domestic music, with secondary
bonus
games and jackpots. Our gaming products include: Multi-player Electronic Table
Games - Baccarat, Sicbo, Fish-Prawn-Crab, and Roulette machines, server based
games (SBG) with multiple client betting stations, slot and bingo machines,
video lottery terminals (VLTs), amusement with prices (AWP) machines, gaming
cabinet and client/server system designs, online i-gaming software design,
and
multimedia entertainment kiosks. PacificNet's gaming clients include the leading
hotels, casinos, and gaming operators in Macau, Asia, and Europe, and our
ecommerce and CRM clients include the leading telecom companies, banks,
insurance, travel, marketing and business services companies and telecom
consumers in Greater China such as China Telecom, China Mobile, Unicom, PCCW,
Hutchison Telecom, Bell24, Motorola, Nokia, SONY, TCL, Huawei, American Express,
Citibank, HSBC, Bank of China, Bank of East Asia, DBS, TNT, China and Hong
Kong
government. PacificNet employs about 1,200 staff in its various subsidiaries
throughout China with offices in Hong Kong, Beijing, Shanghai, Shenzhen,
Guangzhou, Macau and Zhuhai China, USA, and the Philippines.
PacificNet's
Gaming Products:
Our
gaming products are specially designed for the Chinese and Asian gamers, and
we
focus on integrating localized Chinese and Asian themes and content, advanced
graphics, digital sound effects and popular domestic music, with secondary
bonus
games and jackpots. Our gaming products include:
•
Multi-player Electronic Table Games: Baccarat, Sicbo, Fish-Prawn-Crab, and
Roulette Machines, server based games (SBG) with multiple client betting
stations.
•
Slot
Machines
•
Bingo
and Keno Machines
•
Video
Lottery Terminals (VLTs)
•
Server-Based Gaming Machines (SBG)
•
Amusement With Prices (AWP) Machines
•
Online
iGaming Software Development
•
Client-Server Gaming Systems
•
CMM
Level 3 Certified Gaming Software Development Center in China with 200
Professional Software Developers
•
Gaming
Systems, Cabinet Design and Sales, Parts Sales, OEM Games. We design and sell
gaming machine cabinets, replacement parts.
PacificNet's
Business Units:
1.
Gaming
Technology: Electronic Gaming Machines, Mobile Games, i-Gaming
Software.
2.
Legacy
Business: CRM, E-commerce and Telecom Products
Our
goal
is to take a leading role in providing customer relationship management (CRM)
and gaming technology, which are rapidly expanding business sectors in
Asia.
PaificNet’s
Major Operating Subsidiaries
—
|
PacificNet
Games Limited (PacGames), is a leading provider of Asian
multi-player electronic gaming machines, gaming technology solutions,
gaming related maintenance, IT and distribution services for the
leading
hotel, casino and slot hall operators based in Macau, China and other
Asian gaming markets.
|
—
|
Take1
Technologies (www.take1technologies.com) , is in the business of
designing
and manufacturing electronic multimedia entertainment kiosks, coin-op
kiosks and machines, electronic gaming machines (EGM), bingo and
slot
machines, AWP (Amusements With Prizes) games, server-based downloadable
games systems, and Video Lottery Terminals (VLT) such as Keno and
Bingo
machines, including hardware, software, and
cabinets.
|
—
|
Pacific
Solutions Technology, is a CMM Level 3 certified software development
center with over 200 software programmers located in Shenzhen, China,
and
specializes in the development of client-server systems, internet
e-commerce software, online and casino gaming systems and slot machines,
banking and telecom applications using Microsoft Visual C++, Java,
and
other rapid application development tools.
|
—
|
PacificNet
Epro (www.EproTel.com.hk): CRM Call Center and Customer Services
Outsourcing
|
—
|
PacificNet
Clickcom (www.clickcom.com.cn), MOABC.com : VAS,SP,( SMS,
WAP)
|
—
|
Guangzhou
Wanrong (www.my2388.com) : VAS, SP, (SMS,MMS,IVR,WAP, Java
Games)
|
—
|
PacificNet
Communications Limited,
|
—
|
iMobile,
(www.imobile.com.cn, www.18900.com,
wap.17wap.com)
|
PacificNet
Gaming Technology
1.
Participation games: company-owned gaming machines that we lease based
upon any of the following payment methods are referred to as participation
games: (1) a percentage of the net win of the gaming machines, (2) fixed daily
fees, or (3) in the case of wide-area progressive gaming machines, a percentage
of the amount wagered or a combination of a fixed daily fee and a percentage
of
the amount wagered.
2.
Wide Area Game Network, Community Gaming: electronically link gaming
machines that are located across multiple casinos within a gaming jurisdiction.
The linked gaming machines contribute to and compete for large, system-wide
progressive jackpots and are designed to increase gaming machine play for
participating casinos by giving the players the opportunity to win a larger
jackpot than on a stand-alone gaming machine.
3.
Local Area Progressive Jackpots (LAP) participation games:
electronically links gaming machines that are located within a single casino
to
a progressive jackpot for that specific casino.
4.
Video Lottery Terminals: video gaming machines featured with localized
Chinese and Asian themes and contents, advanced graphics, digital sound effects
and music and incorporate many of the same features from our other gaming
machines.
5.
Server-based Gaming: a gaming system in which game content and
peripherals are configured, maintained and refreshed over a network that links
groups of gaming machines to a remote server that also enables custom
configuration by operators and central determination of game
outcomes.
Gaming
Market Overview on Macau, China
As
of the
end of 2006, Macau (a Special Administrative Region of the People's Republic
of
China) has become the largest and fastest-growing gaming market in the world,
and surpassed the Las Vegas Strip in total revenues. According to statistics
provided by Macau government, in 2006, Macau's gaming revenues exceeded US$7
billion (MOP 56.2 billion patacas), surpassing the Las Vegas Strip gaming
revenues of US$6.6 billion. Macau borders Zhuhai City of Guangdong Province
of
China, one of the country's wealthiest and most developed regions and is an
hour
away from Hong Kong via ferry. In 2006, the number of tourists visiting Macau
reached an all-time record of 22 million, an increase of 17 percent compared
with 2005, of which 55% or 12 million visitors were from mainland China. At
the
end of 2006, there were 22 casinos, 83 hotels and similar establishments in
Macau with close to 13,000 rooms. By 2010, the number of tourists is expected
to
nearly double to nearly 30 million visitors per year. Approximately one billion
people live within a three-hour flight of Macau. Numerous hotel, gaming, and
other projects are in the works in Macau which are expected to add over 10,000
guest rooms and over 20,000 live entertainment seats in eight separate venues.
The number of hotel-casinos in operation and in development in Macau continues
to grow, including well-known Chinese names such as Galaxy and Melco, and famous
Las Vegas names such as the Sands, the Venetian, Wynn Resort and Crown Macau.
With the disposable income of the average Chinese on the rise, Macau's gaming
and entertainment market is expected to grow for years to come. Macau is the
only area in China where gambling is legal.
RESULTS
OF OPERATIONS
REVENUES
Revenues
for the three months ended March 31, 2007 were amounted to $9,267,000, which
represented a quarter-over-quarter increase of 39% as compared to $6,672,000
for
the three months ended March 31, 2006. The increase in revenues was mainly
due
to the Products (Telecom & Gaming), primarily driven by the Company’s high
growth gaming technology businesses, and organic growth in Outsourcing Services
Group, which posted a quarter-over-quarter increase of 42.3% and 31.1%
respectively. The revenues in services and product sales during the first
quarter of 2007 increased by 60.1% and 22.2% compared to the same periods of
2006. Segmented financial information of the three business operating groups
is
set out below followed by a brief discussion of each business
group.
For
The Three Months Ended March 31, 2007
|
Group
1
|
Group
2.
|
Group
3
|
Group
4
|
TOTAL
|
Outsourcing
|
Telecom
Value-Added
|
Products
|
Other
|
In
thousands of US Dollars
|
Services
|
Services
|
(Telecom
& Gaming)
|
Business
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
3,963
|
527
|
4,773
|
4
|
9,267
|
Earnings
/ (Loss) from Operations
|
400
|
(3)
|
1,196
|
(793)
|
800
|
For
The Three Months Ended March 31, 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
|
3,022
|
295
|
3,355
|
-
|
6,672
|
Earnings
/ (Loss) from Operations
|
206
|
15
|
359
|
(518)
|
62
|
(1)
|
Outsourcing
services: The quarter-over-quarter increase of 31.1% in outsourcing
services for the three months ended March 31, 2007 was primarily
due to
the growth in outsourcing contact center in Hong Kong. Pricing was
highly
competitive but demand for outbound calling lists, in-sourcing operators
and sub-contract call center facilities management, for American
Express
and MetLife, remained strong. Outsourcing revenues made up 42.8%
of the
Company's total revenues for the first quarter of the
year.
|
(2)
|
Telecom
Value-added Services (VAS): Revenue for the three months ended March
31,
2007 was $527,000, a quarter-over-quarter increase of 78.6% as compare
to
the same period of 2006. VAS revenues made up 5.7% of the Company's
total
revenues for the first quarter of the
year.
|
(3)
|
Products
(Telecom & Gaming): Revenue for the three months ended March 31, 2007
was $4,773,000, a quarter-over-quarter increase of 42.3% as compare
to the
same period of 2006. Products revenues made up 51.5% of the Company's
total revenues for the first quarter of the year. During the quarter,
the
Company’s mobile phone distribution business in Greater China remained
steady. The Company owned one of the largest on-line mobile phone
distribution portals in China and was one of the top five largest
mobile
phone wholesalers in Hong Kong. Increase is primarily due to buildup
of
revenues derived from the Company’s emerging gaming technology businesses.
Significant traction has been gained from continued winning of high
profile gaming orders from the fast growing Asian gaming technology
provider market. Company managed to continue build up excellent
relationships with leading casino operators in Macau and the rest
of Asia
with its world class multi-player electronic table game machines
customized to the taste of Asian gaming customers. In addition, winning
the bid of providing electronic slot machines to various leading
gaming
operators’ slot halls in Europe also pushed revenues during the
quarter.
|
COST
OF REVENUES
Cost
of
revenues for the three months ended March 31, 2007 was $6,728,000, an increase
of 26% from $5,320,000 for the three months ended March 31, 2006,
respectively. The cost of revenues in services sales and product sales
for the three months ended March 31, 2007 increased by 30% and 23%,
respectively, in each case compared with the respective period in 2006. The
increase in cost of revenues lagged behind the corresponding increase in
revenues, which amounted to approximately 39%. Cost of revenues savings were
primarily due to the contribution from higher margin gaming technology
businesses.
GROSS
PROFIT
Gross
profit for the three months ended March 31, 2007 was $2,539,000, a significant
increase of 88% as compared to $1,352,000 for the three months ended March
31,
2006. Gross margin was 27% for the three months ended March 31, 2007, compared
to 20% for the three months ended March 31, 2006. The improvement in gross
margin for the quarter was primarily due to increased contributions from higher
margin gaming technology subsidiaries. Out of their 19% revenue mix, gross
profit of the Company’s gaming technology businesses represented 39% of the
quarter’s total gross profit. Gross margins of the Company’s gaming technology
businesses averaged more than 50%.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
Selling,
general and administrative expenses totaled $1,567,000 for the three months
ended March 31, 2007, an increase of 45% as compared to $1,079,000 for the
first
quarter of FY2006. Selling, general and administrative expenses as a percentage
of revenue, however, recorded only a small quarter-over-quarter increase from
16% to 17%. Selling, general and administrative expenses consist primarily
of
staff salaries, rent, insurance and traveling costs. The quarter-over-quarter
increase in total general and administrative expenses during the three months
ended March 31, 2007 was mainly due to the increase in consultant and labor
costs as a result of new product development as well as rental and utilities
expenses for the expansion of the Company’s gaming technology subsidiaries and
call centers in Hong Kong and China.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
|
Three
months ended March 31,
|
|
|
|
|
(in
thousands, except percentages)
|
|
2007
|
|
|
2006
|
|
|
Percentage
Change
|
|
|
|
($)
|
|
|
($)
|
|
|
(%)
|
|
Remuneration
and related
|
|
|
1,041
|
|
|
|
581
|
|
|
|
79
|
|
Office
|
|
|
300
|
|
|
|
215
|
|
|
|
40
|
|
Travel
|
|
|
91
|
|
|
|
40
|
|
|
|
128
|
|
Entertainment
|
|
|
40
|
|
|
|
16
|
|
|
|
150
|
|
Professional
(legal and consultant)
|
|
|
290
|
|
|
|
65
|
|
|
|
346
|
|
Audit
|
|
|
20
|
|
|
|
18
|
|
|
|
11
|
|
Selling
|
|
|
111
|
|
|
|
52
|
|
|
|
113
|
|
Other
|
|
|
52
|
|
|
|
92
|
|
|
|
(43 |
) |
Recovery
of provisions for doubtful accounts
|
|
|
(378 |
) |
|
|
-
|
|
|
|
n/a
|
|
Total
|
|
|
1,567
|
|
|
|
1,079
|
|
|
|
45
|
|
INCOME
/ (LOSS) FROM OPERATIONS
On
a
quarter-over-quarter basis, income from operations for the three months ended
March 31, 2007increased to $800,000, a significant increase of 1,100% as
compared to $62,000 for the same period of prior year. Segmented operating
incomes of $400,000, $3,000, and $1,196,000 for the three months ended March
31,
2007 were generated from the Company's three business groups: (1) CRM
Outsourcing Services, (2) Telecom Value-Added Services, and (3) Products
(Telecom & Gaming) Services, respectively. This compares to operating
incomes of $206,000, $15,000 and $359,000 from the same groups for the same
period last year, respectively. Improved profitability of continuing operations
evidenced the success of the Company’s new gaming technology strategy, as
reflected by the significant gaming technology operating income.
INCOME
TAXES
Income
tax provision was $68,000 for the three months ended March 31, 2007, a
quarter-over-quarter increase of 300% as compared to $17,000 for the same
quarter last 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 expect
our income taxes to increase as our net income increases and the tax holidays
we
have benefited from in Hong Kong and the PRC expire.
MINORITY
INTERESTS
Minority
interests for the three months ended March 31, 2007 totaled $534,000 compared
with $86,000 for the same period of the prior year, representing minority
ownership interests in subsidiaries consolidated in the Company’s consolidated
financial statements.
NET
INCOME
Net
income for the three months ended March 31, 2007 amounted to $308,000, recording
a quarter-over-quarter decrease of 62% as compared to $801,000 for the same
quarter of prior year. This was solely due to diminishing income from
discontinued operations as a result of the Company shifting from VAS businesses
that are highly susceptible to adverse billing policy changes administered
by
China Mobile.
CASH
Net
cash
and cash equivalents at March 31, 2007 were approximately $4.04 million, an
increase of approximately $2.14 million compared to December 31, 2006. This
was primarily due to successful collection of certain doubtful debts of
approximately $300,000 and 50% net proceeds ($2.3 million) from issuance of
convertible debenture for the Company’s gaming technology business, net of
acquisition of property and equipment of approximately $900,000.
CONTRACTUAL
OBLIGATIONS
Contractual
obligations as of March 31, 2007 are detailed below (in thousands of US
Dollars):
Payments
Due by Period
Contractual
Obligations
|
|
Total
|
|
|
Less
than 1 year
|
|
|
1-5
years
|
|
|
After
5 years
|
|
Line
of credit
|
|
$ |
404
|
|
|
$ |
404
|
|
|
|
|
|
|
|
Bank
Loans
|
|
$ |
3,213
|
|
|
$ |
933
|
|
|
$ |
870
|
|
|
$ |
1,410
|
|
Operating
leases
|
|
$ |
1,339
|
|
|
$ |
655
|
|
|
$ |
684
|
|
|
$ |
|
|
Capital
leases
|
|
$ |
214
|
|
|
$ |
110
|
|
|
$ |
104
|
|
|
$ |
|
|
Total
cash contractual obligations
|
|
$ |
5,170
|
|
|
$ |
2,102
|
|
|
$ |
1,658
|
|
|
$ |
1,410
|
|
In
addition to above, as previously disclosed in the paragraph under the
sub-heading of PROBABLE EVENT OF DEFAULT under Item 7 - CONVERTIBLE DEBENTURES,
the terms of the convertible note obligate the Company to pay monthly 2% of
outstanding principal as liquidated damages and 30% of the outstanding principal
as mandatory default amount from the date of ineffectiveness of registration
statement. As of March 31, 2007, the Company has accrued three months of
liquidated damages and mandatory amount or approximately $2,697,000, although
the Company may not have to pay the full amount of liquidated damages The amount
has been reflected in the consolidated financial statements as a separate line
item on the consolidated balance sheet as “liquidated damages
liability”.
OFF-BALANCE
SHEET ARRANGEMENTS
There
were no off-balance sheet guarantees, interest rate swap transactions, foreign
currency forward contracts or long term purchase commitments outstanding as
of
March 31, 2007. Further, the Company had not engaged in any non-exchange trading
activities during first quarter of 2007.
PART
II - OTHER INFORMATION
ITEM
6. EXHIBITS
The
following exhibits are filed as part of this report:
EXHIBIT
NUMBER
|
DESCRIPTION
|
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.
|
PACIFICNET
INC.
|
|
|
|
Date: December
11, 2007
|
By:
|
/s/ TONY
TONG
|
|
Tony
Tong
Chief
Executive Officer
(Principal
Executive Officer)
|
|
|
|
Date:
December 11, 2007
|
By:
|
/s/ DANIEL
LUI
|
|
Daniel
Lui
Chief
Financial Officer
(Principal
Financial Officer)
|
31