|
Report
of Independent Registered Public Accounting
Firm
|
F-1
|
|
|
|
|
Consolidated
Balance Sheets – As of December 31, 2006 and
2005-Restated
|
F-2
|
|
|
|
|
Consolidated
Statements of Operations – For the Years Ended
December
31, 2006, 2005 and 2004-Restated
|
F-3
|
|
|
|
|
Consolidated
Statements of Changes in Stockholders’ Equity
-
For the Years Ended December 31, 2006, 2005 and
2004-Restated
|
F-4
|
|
|
|
|
Consolidated
Statements of Cash Flows
-
For the Years Ended December 31, 2006, 2005 and
2004-Restated
|
F-5
|
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Notes
to Consolidated Financial Statements-Restated
|
F-6
|
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
To the
Board of Directors and Stockholders of Pacific Net Inc.
We have
audited the accompanying consolidated balance sheets of PacificNet Inc. (a
Delaware Corporation) and Subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of operations, changes in stockholders’ equity
and cash flows for each of the three years in the period ended December 31,
2006. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We
conducted our audits in accordance with the standards established by the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of PacificNet Inc. and
Subsidiaries as of December 31, 2006 and 2005, and the results of their
consolidated operations and cash flows for each of the three years in the period
ended December 31, 2006 in conformity with accounting principles generally
accepted in the United States of America.
The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. During the year ended
December 31, 2006, the Company incurred net losses of $12,415,000. In
addition, the Company had a negative cash flow in operating activities amounting
to negative $8,190,000 in the year ended December 31, 2006, and the Company’s
accumulated deficit was $51,090,000 as of December 31, 2006. In addition, the
Company is in default on its convertible debenture obligation. These factors,
among others, as discussed in Note 1 to the consolidated financial statements,
raise substantial doubt about the Company’s ability to continue as a going
concern. Management’s plans in regard to these matters are also described in
Note 1. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
As
discussed in Note 18, the financial statements for the years ended December 31,
2006 and 2005 have been restated.
/s/
KABANI & COMPANY, INC.
LOS
ANGELES, CA
March 30,
2007, except for notes 1, 2, 4, 6, 9, 10, 11, 12, 13, 14, 16, & 18 are as of
November 5, 2007
PACIFICNET INC. AND
SUBSIDIARIES
CONSOLIDATED BALANCE
SHEETS–RESTATED
AS AT DECEMBER 31, 2006 AND
2005
(In
thousands of United States dollars, except par values and share
numbers)
|
|
As at December
31,
|
|
|
|
2006
|
|
|
2005
|
|
ASSETS
|
|
Restated
|
|
|
Restated
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
1,900
|
|
|
$ |
3,486
|
|
Restricted
cash - pledged bank deposit
|
|
|
234
|
|
|
|
163
|
|
Accounts
receivables, net of allowances for doubtful accounts
|
|
|
8,141
|
|
|
|
3,841
|
|
Inventories
|
|
|
201
|
|
|
|
203
|
|
Loan
receivable from related parties
|
|
|
1,706
|
|
|
|
2,328
|
|
Loan
receivable from third parties
|
|
|
128
|
|
|
|
1,062
|
|
Marketable
equity securities - available for sale
|
|
|
558
|
|
|
|
539
|
|
Other
current assets
|
|
|
4,173
|
|
|
|
1,375
|
|
Total
Current Assets
|
|
|
17,041
|
|
|
|
12,997
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
4,711
|
|
|
|
958
|
|
Intangible
assets, net
|
|
|
323
|
|
|
|
0
|
|
Investments
in affiliated companies and subsidiaries
|
|
|
115
|
|
|
|
1,161
|
|
Goodwill
|
|
|
5,601
|
|
|
|
3,964
|
|
Net
assets held for disposition
|
|
|
8,664
|
|
|
|
8,854
|
|
Other
assets
|
|
|
471
|
|
|
|
-
|
|
TOTAL
ASSETS
|
|
$ |
36,926
|
|
|
$ |
27,934
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$ |
855
|
|
|
$ |
1,059
|
|
Bank
loans-current portion
|
|
|
576
|
|
|
|
188
|
|
Capital
lease obligations - current portion
|
|
|
120
|
|
|
|
126
|
|
Accounts
payable
|
|
|
1,266
|
|
|
|
628
|
|
Accrued
expenses and other payables
|
|
|
1,828
|
|
|
|
704
|
|
Customer
deposits
|
|
|
352
|
|
|
|
335
|
|
Convertible
debenture
|
|
|
8,000
|
|
|
|
-
|
|
Warrant
liability
|
|
|
904
|
|
|
|
-
|
|
Liquidated
damages liability
|
|
|
2,837
|
|
|
|
-
|
|
Loan
payable to related party
|
|
|
638
|
|
|
|
759
|
|
Total
Current Liabilities
|
|
|
17,376
|
|
|
|
3,799
|
|
|
|
|
|
|
|
|
|
|
Bank
loans - noncurrent portion
|
|
|
1,635
|
|
|
|
6
|
|
Capital
lease obligations - noncurrent portion
|
|
|
124
|
|
|
|
78
|
|
Convertible
debenture - non current portion
|
|
|
945
|
|
|
|
-
|
|
Total
long-term liabilities
|
|
|
2,704
|
|
|
|
84
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
20,080
|
|
|
|
3,883
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
2,869
|
|
|
|
846
|
|
Commitments
and contingencies
|
|
|
-
|
|
|
|
-
|
|
Stockholders'
Equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, par value $0.0001, Authorized
5,000,000 shares
|
|
|
|
|
|
|
|
|
Issued
and outstanding - none
|
|
|
-
|
|
|
|
-
|
|
Common
stock, par value $0.0001, Authorized 125,000,000 shares
|
|
|
|
|
|
|
|
|
Issued
and outstanding:
|
|
|
|
|
|
|
|
|
December
31, 2006 - 14,155,597 issued; 11,541,202 outstanding; December 31, 2005:
12,000,687 issued, 10,809,562 outstanding
|
|
|
1
|
|
|
|
1
|
|
Treasury
stock, at cost (2006: 2,614,395 Shares, 2005: 1,191,125
shares)
|
|
|
(272 |
) |
|
|
(134 |
) |
Additional
paid-in capital
|
|
|
65,757
|
|
|
|
61,979
|
|
Cumulative
other comprehensive income
|
|
|
(42 |
) |
|
|
(15 |
) |
Accumulated
deficit
|
|
|
(51,090 |
) |
|
|
(38,627 |
) |
Less:
stock subscription receivable
|
|
|
(377 |
) |
|
|
-
|
|
Total
Stockholders' Equity
|
|
|
13,977
|
|
|
|
23,204
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY
|
|
$ |
36,926
|
|
|
$ |
27,934
|
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- RESTATED
FOR THE YEARS ENDED DECEMBER 31,
2006, 2005 AND 2004
(In
thousands of United States dollars, except loss per share and share
amounts)
|
|
For the Years Ended December
31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Restated
|
|
|
Restated
|
|
|
Restated
|
|
Net
Revenues
|
|
|
|
|
|
|
|
|
|
Services
|
|
$ |
16,790
|
|
|
$ |
14,091
|
|
|
$ |
10,008
|
|
Product
sales
|
|
|
25,948
|
|
|
|
3,216
|
|
|
|
849
|
|
Total
net revenue
|
|
|
42,738
|
|
|
|
17,307
|
|
|
|
10,857
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
(12,155 |
) |
|
|
(10,380 |
) |
|
|
(7,046 |
) |
Product
sales
|
|
|
(24,062 |
) |
|
|
(2,841 |
) |
|
|
(841 |
) |
Total
cost of revenue
|
|
|
(36,217 |
) |
|
|
(13,221 |
) |
|
|
(7,887 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
6,521
|
|
|
|
4,086
|
|
|
|
2,970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
General and Administrative expenses
|
|
|
(11,126 |
) |
|
|
(5,447 |
) |
|
|
(5,244 |
) |
Stock-based
compensation expenses
|
|
|
(242 |
) |
|
|
(282 |
) |
|
|
(1,246 |
) |
Depreciation
and amortization
|
|
|
(1,463 |
) |
|
|
(276 |
) |
|
|
(94 |
) |
Impairment
of goodwill
|
|
|
- |
|
|
|
(3,689 |
) |
|
|
(2,628 |
) |
Impairment
of investment |
|
|
(1,233 |
) |
|
|
- |
|
|
|
- |
|
Total Operating
expenses
|
|
|
(14,064 |
) |
|
|
(9,694 |
) |
|
|
(9,212 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from
operations
|
|
|
(7,533 |
) |
|
|
(5,608 |
) |
|
|
(6,242 |
) |
Other income
(expenses):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income/(expense), net
|
|
|
(1,192 |
) |
|
|
100
|
|
|
|
(57 |
) |
Gain/(loss)
in change in fair value of derivatives
|
|
|
(214 |
) |
|
|
-
|
|
|
|
-
|
|
Liquidated
damages expense
|
|
|
(3,817 |
) |
|
|
-
|
|
|
|
-
|
|
Sundry
income, net
|
|
|
105
|
|
|
|
289
|
|
|
|
176
|
|
Total other income
(expense)
|
|
|
(5,118 |
) |
|
|
389
|
|
|
|
119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations before
Income Taxes and Minority Interests
|
|
|
(12,661 |
) |
|
|
(5,219 |
) |
|
|
(6,123 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
(63 |
) |
|
|
(55 |
) |
|
|
(106 |
) |
Share
of earnings from investment on equity method
|
|
|
17
|
|
|
|
855
|
|
|
|
87
|
|
Minority
Interests
|
|
|
153
|
|
|
|
(1,461 |
) |
|
|
(296 |
) |
Loss from continued
operations
|
|
|
(12,554 |
) |
|
|
(5,880 |
) |
|
|
(6,438 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income/(loss) from discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on disposal
|
|
|
530
|
|
|
|
-
|
|
|
|
-
|
|
Loss
on disposal |
|
|
(504 |
) |
|
|
- |
|
|
|
- |
|
Income
from discontinued operations
|
|
|
113
|
|
|
|
735
|
|
|
|
1,014
|
|
Total income/(loss) from
discontinued operations
|
|
|
139
|
|
|
|
735
|
|
|
|
1,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET LOSS
|
|
|
(12,415 |
) |
|
|
(5,145 |
) |
|
|
(5,424 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income
(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
exchange gain (loss)
|
|
|
(27 |
) |
|
|
7
|
|
|
|
(22 |
) |
Net comprehensive
loss
|
|
$ |
(12,442 |
) |
|
$ |
(5,138 |
) |
|
$ |
(5,446 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC & DILUTED
LOSS PER COMMON SHARE:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
per common share continued operations
|
|
$ |
(1.08 |
) |
|
$ |
(0.58 |
) |
|
$ |
(0.92 |
) |
Earnings
per common share discontinued operations |
|
$ |
0.00 |
|
|
$ |
0.07 |
|
|
$ |
0.14 |
|
Loss
per common share - basic & diluted |
|
$ |
(1.08 |
) |
|
$ |
(0.51 |
) |
|
$ |
(0.78 |
) |
*Weighted
average number of shares - basic & diluted
|
|
|
11,538,664
|
|
|
|
10,156,809
|
|
|
|
7,015,907
|
|
*Weighted
average number of shares used to calculate basic and diluted loss per share is
considered same as the effect of dilutive shares is anti-dilutive.
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY – RESTATED
(In
thousands of United States dollars, except number of shares)
|
|
Common
Stock
Outstanding
|
|
|
Additional
Paid-in
Capital
|
|
|
Cumulative
Other
Comprehensive
Income/(loss)
|
|
|
Accumulated
Deficit
(Restated)
|
|
|
Treasury
Stock
|
|
|
Stock
Subscription
Receivable
|
|
|
Total
Stockholders'
Equity
(Restated)
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
|
Balance at December 31, 2003,
as restated
|
|
|
5,363,977
|
|
|
$ |
1
|
|
|
$ |
31,790
|
|
|
$ |
(24 |
) |
|
$ |
(28,056 |
) |
|
|
800,000
|
|
|
$ |
(5 |
) |
|
$ |
-
|
|
|
$ |
3,706
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
1,756,240
|
|
|
|
-
|
|
|
|
9,938
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9,938
|
|
Proceeds
from the sale of common stock, net of related costs
|
|
|
2,205,697
|
|
|
|
-
|
|
|
|
12,330
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
12,330
|
|
PIPE
related Expenses
|
|
|
-
|
|
|
|
-
|
|
|
|
(205 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(205 |
) |
Issuance
of common stock for acquisition of affiliate
|
|
|
149,459
|
|
|
|
-
|
|
|
|
1,547
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,547
|
|
Repurchase
of common stock
|
|
|
(33,616 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
33,616
|
|
|
|
(114 |
) |
|
|
-
|
|
|
|
(114 |
) |
Stock
issued for services
|
|
|
50,000
|
|
|
|
-
|
|
|
|
132
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
132
|
|
Stock
issued in error
|
|
|
83,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Stock
options expense
|
|
|
-
|
|
|
|
-
|
|
|
|
1,246
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,246
|
|
Exercise
of stock options and warrants for cash
|
|
|
219,364
|
|
|
|
-
|
|
|
|
606
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
606
|
|
Foreign
currency translation gain
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2
|
|
Excess
finders fee charged adjusted
|
|
|
-
|
|
|
|
-
|
|
|
|
345
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
345
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,425 |
) |
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
(5,425 |
) |
Balance at December 31,
2004
|
|
|
9,794,121
|
|
|
|
1
|
|
|
|
57,730
|
|
|
|
(22 |
) |
|
|
(33,482 |
) |
|
|
833,616
|
|
|
|
(119 |
) |
|
|
-
|
|
|
|
24,108
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
515,900
|
|
|
|
-
|
|
|
|
3,971
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,971
|
|
Stock
issued for services
|
|
|
20,000
|
|
|
|
-
|
|
|
|
63
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
63
|
|
Repurchase
of common stock for acquisition of affiliate
|
|
|
(149,459 |
) |
|
|
-
|
|
|
|
(1,547 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
149,459
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,547 |
) |
Cancellation
of common stock
|
|
|
(45,000 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
45,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Repurchase
of common shares
|
|
|
(2,000 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000
|
|
|
|
(15 |
) |
|
|
|
|
|
|
(15 |
) |
Stock
options expense
|
|
|
-
|
|
|
|
-
|
|
|
|
282
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
282
|
|
Exercise
of stock options and warrants for cash
|
|
|
676,000
|
|
|
|
-
|
|
|
|
966
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
966
|
|
Holdback
shares as contingent consideration due to performance targets not yet
met
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
298,550
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
Share
consideration for acquisition of subsidiary deemed issued under
S&P
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(137,500 |
) |
|
|
-
|
|
|
|
|
|
|
|
-
|
|
Excess
finders fee charged adjusted
|
|
|
-
|
|
|
|
-
|
|
|
|
455
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
455
|
|
Option
exercise price adjusted
|
|
|
-
|
|
|
|
-
|
|
|
|
60
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
60
|
|
Foreign
currency translation gain
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
7
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
-
|
|
|
|
(5,145 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
(5,145 |
) |
BALANCE AT DECEMBER 31,
2005
|
|
|
10,809,562
|
|
|
|
1
|
|
|
|
61,979
|
|
|
|
(15 |
) |
|
|
(38,627 |
) |
|
|
1,191,125
|
|
|
|
(134 |
) |
|
|
|
|
|
|
23,204
|
|
Exercise
of stock options for cash and receivable
|
|
|
418,000
|
|
|
|
-
|
|
|
|
834
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(24,000
|
) |
|
|
-
|
|
|
|
-
|
|
|
|
834
|
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
618,112
|
|
|
|
-
|
|
|
|
4,346
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,142,798
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,346
|
|
Cancellation
of common stock
|
|
|
(275,000 |
) |
|
|
-
|
|
|
|
(1,672 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
275,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,672 |
) |
Repurchase
of common shares (Treasury shares)
|
|
|
(29,472 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
29,472
|
|
|
|
(138 |
) |
|
|
-
|
|
|
|
(138 |
) |
Foreign
currency translation loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(27 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(27 |
) |
Stock
options expense
|
|
|
-
|
|
|
|
-
|
|
|
|
242
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
242
|
|
Goodwill
opening balance adjustment
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(48 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(48 |
) |
Issuance
of warrants for issuing fee of convertible debts
|
|
|
-
|
|
|
|
-
|
|
|
|
28
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
28
|
|
Stock
subscription receivable
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(377 |
) |
|
|
(377 |
) |
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(12,415 |
) |
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
(12,415 |
) |
BALANCE AT DECEMBER 31,
2006
|
|
|
11,541,202
|
|
|
$ |
1
|
|
|
$ |
65,757
|
|
|
$ |
(42 |
) |
|
$ |
(51,090 |
) |
|
|
2,614,395
|
|
|
$ |
(272 |
) |
|
$ |
(377 |
) |
|
$ |
13,977
|
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
–RESTATED
(In
thousands of United States dollars)
Cash Flows from operating
activities
|
|
For
the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Restated
|
|
|
Restated
|
|
|
Restated
|
|
Net
loss
|
|
$ |
(12,415 |
) |
|
$ |
(5,145 |
) |
|
$ |
(5,424 |
) |
Adjustment to reconcile net
loss to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for allowance for doubtful accounts
|
|
|
6,173
|
|
|
|
3,425
|
|
|
|
777
|
|
Minority
Interest
|
|
|
(153 |
) |
|
|
1,461
|
|
|
|
296
|
|
Depreciation
and amortization
|
|
|
1,463
|
|
|
|
276
|
|
|
|
94
|
|
Goodwill/Investment
impairment
|
|
|
1,233
|
|
|
|
3,689
|
|
|
|
2,628
|
|
Stock-based
compensation
|
|
|
242
|
|
|
|
282
|
|
|
|
1,246
|
|
Issuance
of shares for services
|
|
|
-
|
|
|
|
63
|
|
|
|
132
|
|
Change
in fair value of derivatives
|
|
|
214
|
|
|
|
-
|
|
|
|
-
|
|
Amortization
of interest discount
|
|
|
690
|
|
|
|
-
|
|
|
|
-
|
|
Liquidated
damages expense
|
|
|
3,817
|
|
|
|
-
|
|
|
|
-
|
|
Changes in current assets
& liabilities net of effects from purchase of
subsidiaries:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable and other current assets
|
|
|
(7,098 |
) |
|
|
(297 |
) |
|
|
(2,743 |
) |
Inventories
|
|
|
2
|
|
|
|
(55 |
) |
|
|
(72 |
) |
Accounts
payable and accrued expenses
|
|
|
(2,219 |
) |
|
|
2,671
|
|
|
|
1,098
|
|
Net cash provided by (used in)
operating activities of continued operations
|
|
|
(8,051 |
) |
|
|
6,370
|
|
|
|
(1,968 |
) |
Net cash provided by (used in)
operating activities of discontinued operations |
|
|
(139 |
) |
|
|
(735 |
) |
|
|
(1,014 |
) |
Net cash provided by (used in)
operating activities |
|
|
(8,190 |
) |
|
|
5,635 |
|
|
|
(2,982 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in restricted cash
|
|
|
(71 |
) |
|
|
49
|
|
|
|
-
|
|
Increase
in purchase of marketable securities
|
|
|
(19 |
) |
|
|
(510 |
) |
|
|
(29 |
) |
Acquisition
of property and equipment
|
|
|
(2,608 |
) |
|
|
(2,966 |
) |
|
|
(477 |
) |
Acquisition
of subsidiaries and affiliated companies |
|
|
(667 |
) |
|
|
(3,958 |
) |
|
|
(991 |
) |
Net
increase (decrease) in assets held for disposition
|
|
|
190
|
|
|
|
(3,493 |
) |
|
|
264
|
|
Acquisition
of subsidiaries and affiliated companies
|
|
|
(667 |
) |
|
|
(3,958 |
) |
|
|
(991 |
) |
Repurchase
of treasury shares
|
|
|
(138 |
) |
|
|
(15 |
) |
|
|
(114 |
) |
Net cash used in investing
activities of continued operations |
|
|
(3,503 |
) |
|
|
(7,400 |
) |
|
|
(1,611 |
) |
Net cash provided by (used in)
investing activities of discontinued operations |
|
|
190 |
|
|
|
(3,493 |
) |
|
|
264 |
|
Net cash used in investing
activities
|
|
|
(3,313 |
) |
|
|
(10,893 |
) |
|
|
(1,347 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS PROVIDED BY
FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
receivable from third parties
|
|
|
934
|
|
|
|
(1,024 |
) |
|
|
(38 |
) |
Loans
receivable from related parties
|
|
|
622
|
|
|
|
(868 |
) |
|
|
(1,460 |
) |
Loans
payable to related party
|
|
|
(121 |
) |
|
|
575
|
|
|
|
184
|
|
Advances
(repayments) under bank line of credit
|
|
|
(204 |
) |
|
|
1,113
|
|
|
|
(1,253 |
) |
Repayment
of amount borrowed under capital lease obligations
|
|
|
40
|
|
|
|
(5 |
) |
|
|
(92 |
) |
Proceeds
from exercise of stock options and warrants
|
|
|
237
|
|
|
|
966
|
|
|
|
606
|
|
Advances
under bank loans
|
|
|
935
|
|
|
|
(1,453 |
) |
|
|
(135 |
) |
Net
proceeds from issuance of convertible debenture
|
|
|
7,500
|
|
|
|
-
|
|
|
|
-
|
|
Payment
of certain PIPE related expenses
|
|
|
-
|
|
|
|
-
|
|
|
|
(205 |
) |
Proceeds
from sale of common stock for cash
|
|
|
-
|
|
|
|
-
|
|
|
|
12,330
|
|
Net cash provided by(used in)
financing activities of continued operations
|
|
|
9,943
|
|
|
|
(696 |
) |
|
|
9,937
|
|
Net cash provided by (used in)
financing activities of discontinued operations |
|
|
- |
|
|
|
- |
|
|
|
- |
|
Net cash provided by (used in)
financing activities |
|
|
9,934 |
|
|
|
(696 |
) |
|
|
9,937 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate change on cash and cash equivalents
|
|
|
(27 |
) |
|
|
7
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS
|
|
|
(1,586 |
) |
|
|
(5,947 |
) |
|
|
5,610
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD
|
|
|
3,486
|
|
|
|
9,433
|
|
|
|
3,823
|
|
CASH AND CASH EQUIVALENTS, END
OF PERIOD
|
|
$ |
1,900
|
|
|
$ |
3,486
|
|
|
$ |
9,433
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL CASH FLOW
INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$ |
664
|
|
|
$ |
229
|
|
|
$ |
178
|
|
Income
taxes paid
|
|
$ |
5
|
|
|
$ |
(53 |
) |
|
$ |
3
|
|
NONCASH INVESTING AND FINANCING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
in subsidiaries and affiliate through issuance of common
stock
|
|
$ |
4,346
|
|
|
$ |
3,971
|
|
|
$ |
9,938
|
|
Investment
in affiliate through issuance of common stock |
|
$ |
- |
|
|
$ |
- |
|
|
$ |
1,547 |
|
Property
& equipment acquired under bank loans |
|
$ |
1,082 |
|
|
$ |
- |
|
|
$ |
- |
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS – RESTATED
(Amounts
expressed in United States dollars unless otherwise stated)
1. NATURE OF OPERATIONS AND SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
PacificNet
Inc. (referred to herein as “PacificNet” or the “Company”) was originally
incorporated in the State of Delaware on April 8, 1987. Through our subsidiaries
we provide outsourcing services, value-added telecom services (VAS) and products
(telecom and gaming) services. Our business process outsourcing (BPO) services
include call centers, providing customer relationship management (CRM), and
telemarketing services, and our information technology outsourcing (ITO)
includes software programming and development. We are value-added resellers and
providers of telecom VAS, which is comprised of interactive voice response (IVR)
systems, call center management systems, and voice over Internet protocol
(VOIP), as well as mobile phone VAS, such as short messaging services (SMS) and
multimedia messaging services (MMS). Our products (telecom and gaming) include
gaming technology and communication products distribution. The Company’s
operations are primarily targeted in Greater China and certain Asian country
markets.
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES
OF CONSOLIDATION AND BASIS OF PRESENTATION
The
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America and present the
financial statements of the Company and its wholly owned and majority-owned
subsidiaries including variable interest entities (“VIEs”) for which the Company
is the primary beneficiary. All significant inter-company accounts and
transactions have been eliminated. Investments in entities in which the Company
can exercise significant influence, but which are less than majority owned and
not otherwise controlled by the Company, are accounted for under the equity
method.
The
Company has adopted FASB Interpretation No. 46R “Consolidation of Variable
Interest Entities” (“FIN 46R”), an Interpretation of Accounting Research
Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
consolidated by a company if that company is subject to a majority of the risk
of loss for the VIE or is entitled to receive a majority of the VIE’s residual
returns. VIEs are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the company is the primary
beneficiary of these entities. Acquisitions of subsidiaries or variable interest
entities are accounted for using the purchase method of accounting. The results
of subsidiaries or variable interest entities acquired during the year are
included in the consolidated income statements from the effective date of
acquisition.
INITIAL
MEASUREMENT OF VIE- The Company initially measures the assets, liabilities, and
non-controlling interests of the VIEs at their fair values at the date of the
acquisitions. Goodwill is recorded for the excess of the fair value of the newly
consolidated assets and the reported amount of assets transferred by the primary
beneficiary to the VIE over the sum of the fair value of the consideration paid,
the reported amount of any previously held interests, and the fair value of the
newly consolidated liabilities and non-controlling interests are allocated and
reported as a pro rata adjustment of the amounts that would have been assigned
to all of the newly consolidated assets as if the initial consolidation had
resulted from a business combination.
ACCOUNTING
AFTER INITIAL MEASUREMENT OF VIE – Subsequent accounting for the assets,
liabilities, and non-controlling interest of a consolidated variable interest
entity are accounted for as if the entity were consolidated based on voting
interests and the usual accounting rules for which the VIE operates are applied
as they would to a consolidated subsidiary as follows:
|
Carrying
amounts of the VIE are consolidated into the financial statements of
PacificNet as the primary beneficiary (referred as “Primary Beneficiary”
or “PB”)
|
|
|
Inter-company
transactions and balances, such as revenues and costs, receivables and
payables between or among the Primary Beneficiary and the VIE(s) are
eliminated in their entirety
|
|
|
There
is no direct ownership interest by the Primary Beneficiary in the VIE,
equity of the VIE is eliminated with an offsetting credit to minority
interest
|
PRC laws
and regulations restrict us, as a foreign entity, from having a direct
controlling interest in entities such as Beijing Xing Chang Xin Sci –tech
Development Co. Ltd (IMOBILE-DE) and Guangzhou Sunroom Information Industry Co.,
Ltd. (Sunroom-DE) that hold operating licenses to engage in domestic online
ecommerce and telecom value-added services in China. As a result, we conduct
substantially all of our operations through Beijing PacificNet IMOBILE
Technology Co., Ltd (WOFE) and Technology Ltd. And Guangzhou 3G Information
Technology Co., Ltd. (WOFE). We own 51% of the shares in each of the WOFEs and
each WOFE signed Consulting and Services Agreements with IMOBILE-DE and
Sunroom-DE (the entities that actually carry out the operating activities).
These agreements provide that all of the DE profits will flow through to the
respective WOFEs. Pursuant to these agreements, the Company guarantees any
obligations undertaken by these companies under their contractual agreements
with third parties, and the Company is entitled to receive service fees in an
amount equal to 51% of the net income of these companies. Accordingly, we bear
the risks of and enjoy the rewards associated with the investments in the
WOFEs.
The
operations of Des are managed by their original management teams, however, the
Company has the power to appoint or change directors and senior management
because it indirectly ultimately controls the voting power of the shareholders
of each DE through the Power of Attorney given to PacificNet’s President
according to the operating agreements between the Des and WOFEs. Pursuant to the
Consulting and Service Agreements signed between each WOFE and their respective
DE, the WOFE (“Party A”) agrees to be the exclusive provider of telecom
consulting services to the DE (“Party B”). During the term of the agreement,
Party B shall not accept technical and consulting services provided by any third
party. Party B agrees to pay a fee to Party A equal to 100% of its monthly net
income for the services provided. Payment of the service fees has been secured
through a share pledge agreement with the shareholders of each of the Des,
whereby they pledged all of their shares to the respective WOFE.
(1) Each
of the Des, by design, is thinly capitalized because a substantial portion of
PacificNet’s invested amounts or consideration were paid or payable directly to
previous owners of Sunroom-DE and Imobile-DE for entering into the acquisition
transactions while none of the investment consideration was injected into the
Des. Therefore, additional funding from PacificNet is needed to support the Des’
business development and working capital.
(2) Fees
from Service Contracts are substantial, but are not commensurate with the level
of service provided by the WOFEs to the Des. The contractual and funding
arrangements with the Des evidence that PacificNet has closely participated in
the majority of the Des’ economics. PacificNet is the primary beneficiary
through its WOFE subsidiaries since PacificNet is the only enterprise with a
sufficiently large interest in the VIEs. In compliance with PRC’s foreign
investment restrictions on Internet Content Provider and Value Added Telecom
Services Provider’s laws and regulations, the Company conducts all of its
value-added services for telecom in China via the following significant domestic
VIEs below. The respective management agreements between the VIE’s and WOFE’s
create a variable interest and accordingly, these two Vies are consolidated as
VIE through their respective WOFEs from the date of acquisition.
The following is a summary of all the
VIEs of the Company:
Beijing Xing Chang Xin Sci –tech
Development Co. Ltd (the “Imobile-VIE”), a China company controlled through
business agreement. Through Imobile-VIE, a variable interest entity, PacificNet
is able to engage in the business of ICP, and operates mobile distribution and
value-added service in the PRC. The business of the VIE is managed by their
original management teams. Imobile-VIE is owned by Gao Chunhui, CEO 51% and Liu
Lei, COO 49%, of the Company. The registered capital of the VIE is RMB
2,000,000. The VIE’s board of directors has the power to appoint the General
Manager of the VIE who in turn has the power to appoint other members of the
management. PacificNet does not directly participate in the daily operation of
the VIE. It however has the power to change the management, if needed, because
PacificNet is directly or indirectly controlling the board of this
VIE.
Guangzhou
Sunroom Information Industrial Co., Ltd. (“Sunroom-VIE”), a PRC registered
domestic enterprise, controlled by PacificNet through a series of contractual
agreements. It is responsible for VAS in China under its ICP and VAS licenses.
It is 31% owned by Mr. Wang Yongchao (CEO), 41.4% owned by Mr. Liao Mengjiang
(COO) and 27.6% owned by non-participating shareholder, Mr. Sun Zhengquan. The
registered capital of the VIE Company is $4.0 million. Sunroom-VIE is required
to transfer their ownership in these entities to our subsidiaries when permitted
by PRC laws and regulations and all voting rights are assigned to us. As of
December 31, 2005, Sunroom-VIE’s revenues and net loss accounted for
approximately 17% and (96) % of our consolidated revenues and net earnings
before minority interests, respectively.
The
initial capital investments in these VIEs were not funded by us but we have
provided loans to these VIEs to fund their R&D and expansion plans. As of
December 31, 2005, the amount of loans to Clickcom VIE and Sunroom VIE were
approximately US$262,695 (low interest at 2%) and US$246,216 (interest free)
respectively. None of the VIEs’ assets were collateralized for our loans. Given
the fact that we do not have direct ownership interests in these VIEs, the
creditors of these VIEs will not have recourse to the general credit of our
group being the primary beneficiary.
Under
various contractual agreements, employee shareholders of the VIEs are required
to transfer their ownership in these entities to our subsidiaries in China when
permitted by PRC laws and regulations or to our designees at any time for the
amount of the outstanding loans. All voting rights of the VIEs are then assigned
to us. We have the power to appoint all directors and senior management
personnel of the VIEs. Through our wholly owned subsidiaries in China, we have
also entered into exclusive technical agreements and other service agreements
with the VIEs, under which these subsidiaries provide technical
services.
BUSINESS
COMBINATIONS
The
Company accounts for its business combinations using the purchase method of
accounting. This method requires that the acquisition cost to be allocated to
the assets and liabilities the Company acquired based on their fair values. The
Company makes estimates and judgments in determining the fair value of the
acquired assets and liabilities, based on valuations using management’s
estimates and assumptions including its experience with similar assets and
liabilities in similar industries. If different judgments or assumptions were
used, the amounts assigned to the individual acquired assets or liabilities
could be materially different.
GOODWILL AND PURCHASED INTANGIBLE
ASSETS
Goodwill
represents the excess of the purchase price over the fair value of the
identifiable assets and liabilities acquired as a result of the Company’s
acquisitions of interests in its subsidiaries and VIEs. Fair market value of the
identifiable assets and liabilities, including tangible and intangible, is
primarily ascertained with replacement cost method. At time of acquisition,
based on market research and discussion with management, a benchmark is
established with reference to comparable replacement cost in open market.
Occasionally, net book value is used as a fair market value equivalent if the
assets and liabilities of the newly acquired subsidiaries and/or VIEs were
either current in nature or newly established.
Under
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
Other Intangible Assets (“SFAS 142”),” goodwill is no longer amortized, but
tested for impairment upon first adoption and annually, thereafter, or more
frequently if events or changes in circumstances indicate that it might be
impaired. The Company assesses goodwill for impairment annually in accordance
with SFAS 142. The assessment includes first comparing implied P/E valuation of
the goodwill carrying subsidiaries (adjusted by R&D expenses written off) to
benchmarks as found in comparable publicly traded companies. If a comfortable
buffer over the public benchmark does not exist, more sophisticated DCF
analysis, based on 5 year cash flows forecasts, will follow to ascertain if
goodwill impairment is warranted.
The
Company applies the criteria specified in SFAS No. 141, “Business Combinations”
to determine whether an intangible asset should be recognized separately from
goodwill. Intangible assets acquired through business acquisitions are
recognized as assets separate from goodwill if they satisfy either the
“contractual-legal” or “separability” criterion. Per SFAS 142, intangible assets
with definite lives are amortized over their estimated useful life and reviewed
for impairment in accordance with SFAS No. 144, “Accounting for the Impairment
or Disposal of Long-lived Assets.” Intangible assets, such as purchased
technology, trademark, customer list, user base and non-compete agreements,
arising from the acquisitions of subsidiaries and variable interest entities are
recognized and measured at fair value upon acquisition. Intangible assets are
amortized over their estimated useful lives from one to ten years. The Company
reviews the amortization methods and estimated useful lives of intangible assets
at least annually or when events or changes in circumstances indicate that it
might be impaired. The recoverability of an intangible asset to be held and used
is evaluated by comparing the carrying amount of the intangible asset to its
future net undiscounted cash flows. If the intangible asset is considered to be
impaired, the impairment loss is measured as the amount by which the carrying
amount of the intangible asset exceeds the fair value of the intangible asset,
calculated using a discounted future cash flow analysis. The Company uses
estimates and judgments in its impairment tests, and if different estimates or
judgments had been utilized, the timing or the amount of the impairment charges
could be different.
We currently have nine reporting units: EPRO, Smartime/Soluteck,
Guangzhou 3G-WOFE (assets held for disposition), iMobile-WOFE, Shanghai Classic
(including discontinued subsidiary – Yueshen), Wangrong, Clickcom (discontinued
operation), PacificNet Games, Linkhead (discontinued operation), but those that
are marked either assets held for disposition or discontinued are excluded for
the purposes of goodwill assessment. We determined our reporting units if the
entity constituted a business, financial information was available, and segment
management can regularly review the operating results of that component.
Excluding investment holding vehicles and self-developed units, reporting units
only include those operating units that PacificNet holds 50% or more through
acquisition and maintain effective control. Units such as PacificNet Solution,
PacificNet Limited, and PacificNet Communication are 100% owned by PacificNet
through self-development and not through acquisition. Therefore, there is no
goodwill allocation to these self-developed units.
We
allocated goodwill amongst the reporting units based on the consideration paid
in shares and cash minus the proportional share of the fair value of net assets
and liabilities at the time of acquisition specific to each reporting unit. The
fair value of each reporting unit represents the amount at which the unit as a
whole could be bought or sold in a current transaction between willing parties
in an open marketplace. At the time of acquisition, the fair value of assets and
liabilities was determined based on book value minus any potential write-down,
if any, to reflect the fair value of the assets and liabilities acquired in the
transaction. The Company has one class of goodwill arising from business
combination resulting from the acquisitions of our subsidiaries. Goodwill
has been revised to reflect certain expenses that should have been written off
prior to certain acquisitions, not subsequent to the acquisitions, to better
reflect the assets acquired and liabilities assumed in certain business
combinations during 2003 in accordance with SFAS No. 141, “Business
Combinations”. Originally, the Company had acquired certain intangible assets
such as research and development costs and related party receivables that were
considered as part of the purchase price allocation, then subsequently expensed
them at year end.
The total
carrying amount of goodwill recorded on the balance sheets at December 31, 2006
is $5,601,000 and the changes in the carrying amount of goodwill for the
following reporting periods are summarized below:
(US$'000s) |
|
Group
1.
Outsourcing
Services
|
|
|
Group
2.
Telecom
Value-Added
Services
|
|
|
Group
3.
Products
(Telecom
&
Gaming)
|
|
|
Total
goodwill on the restated balance sheet
|
|
Balance as of December 31,
2003
|
|
$ |
420
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
420
|
|
Goodwill
acquired during the year
|
|
|
3,575
|
|
|
|
4,831
|
|
|
|
1,438
|
|
|
|
9,844
|
|
Goodwill
reclassified to net assets held for disposition
|
|
|
-
|
|
|
|
(3,672 |
) |
|
|
-
|
|
|
|
(3,672 |
) |
Goodwill
impaired during the year
|
|
|
(31 |
) |
|
|
(1,159 |
) |
|
|
(1,438 |
) |
|
|
(2,628 |
) |
Balance as of December 31,
2004-Restated
|
|
|
3,964
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,964
|
|
Goodwill
acquired during the year
|
|
|
-
|
|
|
|
5,183
|
|
|
|
-
|
|
|
|
5,183
|
|
Goodwill
reclassified to net assets held for disposition
|
|
|
-
|
|
|
|
(1,494 |
) |
|
|
-
|
|
|
|
(1,494 |
) |
Goodwill
impaired during the year
|
|
-
|
|
|
|
(3,689 |
) |
|
-
|
|
|
|
(3,689 |
) |
Balance as of December 31,
2005-Restated
|
|
|
3,964
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,964
|
|
Goodwill
acquired during the year
|
|
|
-
|
|
|
|
1,694
|
|
|
|
1,176
|
|
|
|
2,870
|
|
Balance as of December 31,
2006-Restated
|
|
$ |
3,964
|
|
|
$ |
461
|
|
|
$ |
1,176
|
|
|
$ |
5,601
|
|
The
Company assesses the need to record impairment losses on our goodwill assets at
least annually or when an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount. The assessment includes using a combination of qualitative and
quantitative analyses such as DCF/PE multiples based on 5 year profit forecasts,
and published comparables, where applicable. The Company concluded that there
have been no material adverse changes on the operating environments during the
reporting periods that would have otherwise affected the carrying value of the
goodwill. In addition, there has been no disposal of any reporting subsidiaries
and, as a result, no gain or loss is recognized during those reporting
periods.
The
following table summarizes goodwill from the Company's acquisitions during 2006
and 2005:
|
|
For
the years ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
(USD$'000s)
|
|
Restated
|
|
|
Restated
|
|
Epro
|
|
$ |
3,949
|
|
|
$ |
3,949
|
|
Smartime
(Soluteck)
|
|
|
15
|
|
|
|
15
|
|
iMobile
|
|
|
430
|
|
|
|
-
|
|
Wanrong
|
|
|
461
|
|
|
|
-
|
|
PacificNet
Games
|
|
|
746
|
|
|
|
-
|
|
Total
|
|
$ |
5,601
|
|
|
$ |
3,964
|
|
The
following table summarizes the intangible assets acquired from PacificNet
Games:
(USD000s)
|
|
December
31,
2006
|
|
Technology
|
|
$ |
353
|
|
Less:
Accumulated amortization
|
|
|
(30 |
) |
Net
|
|
$ |
323
|
|
Amortization
expense related to intangible assets was $30,000 in the year ended December 31,
2006.
IMPAIRMENT OF LONG-LIVED
ASSETS
The
Company periodically assesses the need to record impairment losses on long-lived
assets, such as property, plant and equipment, and purchased intangible assets,
used in operations and its investments when indicators of impairment are present
indicating the carrying value may not be recoverable. An impairment loss is
recognized when estimated undiscounted future cash flows expected to result from
the use of the asset plus net proceeds expected from disposition of the asset
(if any) are less than the carrying value of the asset. When impairment is
identified, the carrying amount of the asset is reduced to its estimated fair
value. All goodwill will no longer be amortized and potential impairment of
goodwill and purchased intangible assets with indefinite useful lives will be
evaluated using the specific guidance provided by SFAS No. 142 and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."
This
impairment analysis is performed at least annually. For investments in
affiliated companies that are not majority-owned or controlled, indicators or
value generally include revenue growth, operating results, cash flows and other
measures. Management then determines whether there has been a permanent
impairment of value based upon events and circumstances that have occurred since
acquisition. It is reasonably possible that the impairment factors evaluated by
management will change in subsequent periods, given that the Company operates in
a volatile environment. This could result in material impairment charges in
future periods.
During
the year ended December 31, 2005 the Company impaired goodwill as
follows:
(USD$'000s)
|
|
2005
|
|
|
|
Restated
|
|
Linkhead
|
|
$ |
3,423
|
|
Clickom
|
|
|
266
|
|
GZ3G(Sunroom)
|
|
|
-
|
|
Lion
Zone (ChinaGoHi)
|
|
|
-
|
|
Total
|
|
$ |
3,689
|
|
There was
no impairment of goodwill in the year ended December 31,
2006.
INVESTMENTS IN AFFILIATED
COMPANIES
The
Company's investments in affiliated companies for which its ownership exceeds
20%, but is not majority-owned or controlled, are accounted for using the equity
method. The Company's investments in affiliated companies for which its
ownership is less than 20% are accounted for using the cost method.
COMPREHENSIVE INCOME
(LOSS)
Comprehensive
income (loss) consists of net earnings and other gains (losses) affecting
stockholders' equity that, under generally accepted accounting principles are
excluded from net earnings in accordance with Statement of Financial Accounting
Standards ("SFAS") 130, Reporting Comprehensive Income.
REVENUE
RECOGNITION
Revenues
are derived from the following categories as classified by our operating
segments (see Note 15): (1) outsourcing services including Business Process
Outsourcing (BPO), call center, IT Outsourcing (ITO) and software development
services; (2) Telecom Value-Added Telecom Services (VAS) including Content
Providing (CP), Interactive Voice Response (IVR), Platform Providing (PP) and
Service Providing (SP); and (3) Products (telecom & gaming) Services,
including calling cards, GSM/ CDMA/ XiaoLingTong products, and multimedia
self-service kiosks.
Revenues
from outsourcing services are recognized when the services are rendered.
Revenues from license agreements are recognized when a signed non-cancelable
software license exists, delivery has occurred, the Company's fee is fixed or
determinable, and collectability is probable at the date of sale. Revenues from
software development services are recognized when the customer accepts the
installation and no significant modification or customization work is involved,
in accordance with SOP 97-2 "Software Revenue Recognition." Revenues from
support services such as consulting, implementation and training services are
recognized when the services are performed, collectability is probable and such
revenues are contractually nonrefundable.
Revenues
from value-added telecom services are derived principally from providing mobile
phone users with short messaging service ("SMS"), multimedia messaging service
("MMS"), color ring back tone ("CRBT"), wireless application protocol ("WAP")
and interactive voice response system ("IVR"). These services include news and
other content subscriptions, mobile dating service, picture and logo download,
ring tones, ring back tones, mobile games, chat rooms and access to music files.
These revenues from are charged on a monthly or per-usage basis and are
recognized in the period in which the service is performed, provided that no
significant Company obligations remain, collection of the receivables is
reasonably assured and the amounts can be accurately estimated. In accordance
with EITF No. 99-19, "Reporting Revenues Gross as a Principal Versus Net as an
Agent," revenues are recorded on a gross basis when the Company is considered
the primary obligor to the VAS users. Under the gross method, the amounts billed
to VAS users are recognized as revenues and the fees charged or retained by the
third-party operators are recognized as cost of revenues.
Revenues
from the sale of products and systems are recognized when the product and system
is completed, shipped, and the risks and rewards of ownership have
transferred.
Revenues
from the distribution of all types of calling cards and product sales is
recognized in accordance with EITF No. 99-19, "Reporting Revenues Gross as a
Principal Versus Net as an Agent," where revenues are recorded on a gross basis
when the Company is considered the primary obligor to the users, maintains an
inventory of products before the products are ordered by customers, has latitude
in establishing the pricing power of products, is subject to physical inventory
loss risk, and has credit risk as it is responsible for collecting the sales
price from the customer and is responsible for paying the supplier regardless of
whether or not the sales price is fully collectible.
ALLOWANCE FOR DOUBTFUL
ACCOUNTS
The
Company presents accounts receivable, net of allowances for doubtful accounts
and returns. The allowances are calculated based on a detailed review of certain
individual customer accounts, historical rates and an estimate of the overall
economic conditions affecting the Company's customer base. The Company
frequently monitors its customers' financial condition and credit worthiness and
only sells products, licenses or services to customers where, at the time of the
sale, collection is reasonably assured. If the financial condition of its
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required. The Company also records
reserves for doubtful accounts for all other customers based on a variety of
factors including the length of time the receivables are past due, the financial
health of the customer, macroeconomic considerations and historical experience.
If circumstances related to specific customers change, the Company's estimates
of the recoverability of receivables could be further adjusted. Allowance
for doubtful accounts at December 31, 2006 was approximately $3,400,000
(2005: $168,000).
PROPERTY AND
EQUIPMENT
Property
and equipment is stated at cost and depreciated using the straight-line method
over the shorter of the estimated useful life of the asset or the lease term,
ranging from three to five years. Significant improvements and betterments are
capitalized. Routine repairs and maintenance are expensed when incurred. When
property and equipment is sold or otherwise disposed of, the asset account and
related accumulated depreciation account are relieved, and any gain or loss is
included in operations.
INVENTORIES
Inventories
consist of finished goods and are stated at the lower of cost or market value.
Cost is computed using the first-in, first-out method and includes all costs of
purchase and other costs incurred in bringing the inventories to their present
location and condition. Market value is determined by reference to the sales
proceeds of items sold in the ordinary course of business after the balance
sheet date or management estimates based on prevailing market conditions. The
inventories consist of finished goods and represent telecommunication products
such as mobile phone, rechargeable phone cards, smart chip, and interactive
voice response cards.
Income
taxes are accounted for using an asset and liability approach, which requires
the recognition of income taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in the Company's consolidated financial statements or
tax returns. The measurement of current and deferred tax liabilities and assets
is based on provisions of the enacted tax laws; the effects of future changes in
tax laws or rates are not anticipated. The measurement of deferred tax assets is
reduced, if necessary, by the amount of any tax benefits that, based on
available evidence assessed using the criteria in SFAS No. 109, "Accounting for
Income Taxes," will not more-likely-than-not be realized.
The
Company records a valuation allowance for deferred tax assets, if any, based on
estimates of its future taxable income as well as its tax planning strategies
when it is more likely than not that a portion or all of its deferred tax assets
will not be realized. If the Company is able to utilize more of its deferred tax
assets than the net amount previously recorded when unanticipated events occur,
an adjustment to deferred tax assets would be reflected in income when those
events occur.
CONTINGENCIES
The
Company accounts for contingency using SFAS 5 ‘Accounting for Contingencies’.
This statement requires accrual by a charge to income (and disclosure) for an
estimated loss from a loss contingency if two conditions are met: (a)
information available prior to issuance of the financial statements indicates
that it is probable that an asset had been impaired or a liability had been
incurred at the date of the financial statements, and (b) the amount of loss can
be reasonably estimated. Accruals for general or unspecified business risks
("reserves for general contingencies") are no longer permitted. As at December
31, 2006 the Company recorded ‘Liquidated Damages’ liability on suspension of
use of registration statement as an ‘Event of default’ under this
statement.
RESEARCH AND DEVELOPMENT
COSTS AND CAPITALIZED SOFTWARE COSTS
Expenditures
related to the research and development of new products and processes, including
significant improvements and refinements to existing products are expensed as
incurred, unless they are required to be capitalized.
Software
development costs are required to be capitalized when a product's technological
feasibility has been established by completion of a detailed program design or
working model of the product, and ending when a product is available for release
to customers. For the years ended December 31, 2006 and 2005, the Company did
not capitalize any costs related to the purchase of software and related
technologies and content.
EARNINGS PER SHARE
(EPS)
The
reconciliation of the numerators and denominators of the basic and diluted EPS
calculations was as follows:
(In
thousands of US Dollars, except weighted shares and per share
amounts)
|
|
FY
2006
Restated
|
|
|
FY
2005
Restated
|
|
Numerator:
Net loss
|
|
$ |
(12,415 |
) |
|
$ |
(5,145 |
) |
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average
shares used to compute basic & diluted loss per share
|
|
|
11,538,664
|
|
|
|
10,156,809
|
|
Basic
& Diluted loss per common share:
|
|
$ |
(1.08 |
) |
|
$ |
(0.51 |
) |
Prior to
January 1, 2006, PacificNet accounted for awards granted under stock-based
compensation plans following the recognition and measurement principles of APB
25, Accounting for Stock
Issued to Employees, and related interpretations. Compensation expense,
if any, is recognized for awards granted at an exercise price less than fair
market value of the underlying common stock on the date of grant.
Effective
January 1, 2006, PacificNet adopted the fair value recognition provisions of
SFAS 123(R). See Item 6 for a description of the Company’s adoption of SFAS
123R.The fair value of stock options is determined using the Black-Scholes
option pricing model, which is consistent with the valuation techniques
previously utilized for options in footnote disclosures required under SFAS
123,as amended by FASB Statement No. 148, “Accounting for Stock-Based
Compensation - Transition and Disclosure.” The determination of the fair value
of stock-based compensation awards on the date of grant using an option-pricing
model is affected by the Company’s stock price as well as assumptions regarding
a number of complex and subjective variables, including the expected volatility
of the Company’s stock price over the term of the awards, actual and projected
employee stock option exercise behaviors, risk-free interest rate and expected
dividends. The compensation costs, which approximated $242,473 for year 2006,
are recognized on a straight-line base over the option vesting term and the
amortized cost is included in selling, general and administrative expenses. The
valuation provisions of SFAS 123(R) apply to new grants and unvested grants that
were outstanding as of the effective date.
During
year 2006, we had 370,500 stock options exercisable, 394,000 options were
exercised, and 680,000 options granted in year 2005 were cancelled. The board
also authorized to issue 500,000 options on September 21, 2006. However due to
the increasing cost of option administration, the board of directors decided to
cancel all options authorized during year 2005 and 2006, and plan to issue
restricted stock or stock appreciation right (SAR) for future executive and
employee incentive compensation. See note 12 b) for the status of the Company’s
stock option plan.
Additional
information on options outstanding as of December 31, 2006 is as
follows:
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
OPTIONS
|
WEIGHTED
AVERAGE
REMAINING
CONTRACTUAL
LIFE
|
Options
outstanding
|
$2.00
|
370,500
|
0.57 years
|
Options
exercisable
|
$2.00
|
370,500
|
0.57
year
|
CONVERTIBLE
DEBENTURES
On March
13, 2006, we completed a private placement in which we sold $8,000,000 in
convertible debentures and issued warrants to purchase up to an aggregate of
400,000 shares of common stock. The debentures are convertible at any time into
shares of our common stock at an initial fixed conversion price of $10.00 per
share, subject to adjustments for certain dilutive events. The debentures are
due March 13, 2009. The warrants are exercisable for a period of five years at
an exercise price of $12.20 per share. At the closing of the private placement,
we prepaid the first year's interest on debentures equal to 5% of the aggregate
principal amount of debentures. We will pay interest in cash or shares, provided
that certain conditions are met, at the rate of 6% for the second year the
debentures are outstanding and then 7% for the third. Beginning January 1, 2007,
we are obligated to redeem up to $320,000 every month, plus accrued, but unpaid
interest, liquidated damages and penalties. We also have the option to prepay
the debentures at any time, provided that certain conditions have been met,
after the 12 month anniversary of the effective date of the registration
statement that has been filed with the Securities and Exchange Commission with
respect to the common stock issuable upon conversion of the debentures, some or
all of the outstanding debentures for cash in an amount equal to 120% of the
principal amount outstanding, plus accrued, but unpaid interest, liquidated
damages and penalties outstanding. At any time after the six month anniversary
of the effective date of the registration statement, we may force the holders to
convert up to 50% of the then outstanding principal amount of the debentures,
subject to certain trading conditions being met. If any event of default occurs
under the debentures or other related documents, the holders may elect to
accelerate the payment of the outstanding principal amount of the debenture,
plus accrued, but unpaid interest, liquidated damages and penalties, which shall
become immediately due and payable.
Under the
terms of a registration rights agreement entered into at the time of the private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April 30,
2006, and have the registration statement declared effective by the SEC no later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to
the investors at the rate of 2% of the principal amount of the debenture
each month beginning on June 28, 2006 until the effectiveness of the
registration statement, which was equal to $1,120,000, in the
aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of accrued
liquidated damages, the Company signed a Settlement and Release Agreement with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding Fund
Ltd. and Basso Private Opportunities Holding Fund Ltd.. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
in cash, with the remaining liquidated damages in the amount of $105,000 paid in
the form of a new convertible debenture due February 2009, on substantially the
same terms as the original debentures, except that interest only is paid on the
new debentures until October 2008 and beginning in November 2008 until February
2009, when the new debentures are due, the monthly redemption amount under the
new debentures shall be equal to $315,000. The remaining investors also agreed
to accept the aggregate $840,000 in liquidated damages owed to them in the form
of the new convertible debentures for the amount of their respective portion of
the liquidated damages. The Company also agreed to amend the original debentures
to shorten the term for payment of the original principal amount to a 22 month
term. As a result the monthly redemption amount for the original debenture
increased from $320,000 to $ 363,638. All other terms and conditions of the
original debenture remains in full force and effect.
C.E.
Unterberg, Towbin L.L.C. acted as placement agent and received a negotiated cash
fee in the amount of $449,500 and a warrant to purchase up to 16,000 shares at
an exercise price of $12.20 per share, which expire five years from the date of
issuance. The fair value of these warrants totaled $28,141. Such amount was
charged to other assets, net, and credited to additional paid-in capital and
will be amortized over the life of the debentures. Maxim Group also acted as
Placement Agent and received a cash fee in the amount of $50,000.
In
connection with the issuance of the debentures, the Company incurred $1,106,135
of issuance costs, which primarily consisted of investment banker fees, legal
and other professional fees. These costs have been recorded as additional
expense during year 2006.
The gross
proceeds of $8,000,000 are recorded as a current debenture liability. In
addition, fair values attributed to the Investors’ warrants in accordance with
EITF issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to
and Potentially Settled in a Company’s Own Stock” are recorded as liabilities.
The initial value related to the Investors’ warrants is $690,642. An aggregate
loss of $213,692 representing the change in fair value of warrants was
recognized during the twelve months ended December 31, 2006.
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, the 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.
|
The
provisions mentioned above and as per the terms of the Debenture, the Company
has reclassified the principal amount of the Debenture of $8,000,000 and the
principal amount of the new Debenture of $945,000 and the interest accrued
thereon to the current liability.
The
Company accrued 2% as liquidated damages and 30% as mandatory default amount
from the date of ineffectiveness of registration statement as
follows:
($,000) |
|
|
2006
|
|
Liquidated
damages
|
|
|
$ |
450
|
|
Mandatory
default
|
30%
|
|
|
2,247
|
|
Total
|
|
|
$ |
2,697
|
|
The
Company also expensed the unamortized discount of $691,000 to expense for the
year ended December 31, 2006.
Advertising
expenses consist primarily of costs of promotion for corporate image and product
marketing and costs of direct advertising. The Company expenses all advertising
costs as incurred and classify these costs under selling, general and
administrative expenses, which amounted to $31,052 in 2006 (2005:
$129,000).
CASH
EQUIVALENTS
Cash and
cash equivalents comprise cash at bank and on hand, demand deposits with banks
and other financial institutions, and short-term, highly liquid investments that
are readily convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value. Bank overdrafts that are repayable on
demand and form an integral part of the PacificNet's cash management are also
included as a component of cash and cash equivalents for the purpose of the cash
flow statement. Highly liquid investments with original maturities of three
months or less are considered cash equivalents.
RELATED PARTY
TRANSACTIONS
A related
party is generally defined as (i) any person that holds 10% or more of the
Company's securities including such person's immediate families, (ii) the
Company's management, (iii) someone that directly or indirectly controls, is
controlled by or is under common control with the Company, or (iv) anyone who
can significantly influence the financial and operating decisions of the
Company. A transaction is considered to be a related party transaction when
there is a transfer of resources or obligations between related parties. (See
Note 14)
Certain
prior period amounts have been reclassified to conform to the current year
presentation. These changes had no effect on previously reported results of
operations or total stockholders' equity.
FAIR VALUE OF FINANCIAL
INSTRUMENTS
Fair
value is described as the amount at which the instrument could be exchanged in a
current transaction between informed willing parties, other than a forced
liquidation. Cash and cash equivalents, accounts receivable and payable, accrued
expenses and other current liabilities are reported on the consolidated balance
sheets at carrying value which approximates fair value due to the short-term
maturities of these instruments. The Company does not have any off balance sheet
financial instruments.
CONCENTRATION OF CREDIT
RISK
CASH HELD
IN BANKS. For those financial institutions that the Company maintains cash
balances in the United States, the amounts are insured by the Federal Deposit
Insurance Corporation up to $100,000.
GEOGRAPHIC
RISK. All of the Company's revenues are derived in Asia and Greater China and
its operations are governed by Chinese laws and regulations. The operations in
China are carried out by the subsidiaries and VIEs. If the Company was unable to
derive any revenue from Asia and Greater China, it would have a significant,
financially disruptive effect on the normal operations of the
Company.
SIGNIFICANT
RELATIONSHIPS. A substantial portion of the operations of the Company's VIEs
(Dianxun-DE and Sunroom-DE) business operations depend on mobile
telecommunications operators (operators) in China and any loss or deterioration
of such relationship may result in severe disruptions to their business
operations and the loss of a significant portion of the Company's revenue. The
VIEs rely entirely on the networks and gateways of these operators to provide
its wireless value-added services. Specifically these operators are the only
entities in China that have platforms for wireless value-added services. The
Company's agreements with these operators are generally for a period of less
than one year and generally do not have automatic renewal provisions. If neither
of them is willing to continue to cooperate with the Company, it would severely
affect the Company's ability to conduct its existing wireless value-added
services business.
MARKETABLE EQUITY
SECURITIES
Marketable
equity securities are classified as available-for-sale and are recorded at fair
value in other assets on the balance sheet, with the change in fair value during
the period excluded from earnings and recorded net of tax as a component of
other comprehensive income. Realized gains or losses are charged to the income
statement during the period in which the gain or loss is realized. Investments
classified as available-for-sale securities include marketable equity securities
of Unit Trust Funds and are based primarily on quoted market prices at December
31, 2006. The component costs of these securities are summarized as follows:
cost of $559,000, gross unrealized losses of $1,000 and estimated fair value of
$558,000 as at December 31, 2006 and cost of $586,000, gross unrealized losses
of $47,000 and estimated fair value of $539,000 as at December 31, 2005. The
acquisition of marketable securities and unrealized losses on marketable equity
securities are recorded on consolidated statements of cash flows.
FOREIGN
CURRENCY
The
Company's reporting currency is the U.S. dollar. The Company's operations in
China and Hong Kong use their respective currencies as their functional
currencies. The financial statements of these subsidiaries are translated into
U.S. dollars using period-end rates of exchange for assets and liabilities and
average rates of exchange in the period for revenue and expenses. Translation
gains and losses are recorded in accumulated other comprehensive income or loss
as a component of shareholders' equity. Net gains and losses resulting from
foreign exchange transactions are included in General and Administrative
Expenses an amount of US $16,000. During the year ended December 31, 2006, the
foreign currency translation adjustments to the Company's comprehensive income
was $27,000 and the currency translation gain was approximately $72,000,
primarily as a result of the Hong Kong dollars appreciating against the U.S.
dollar.
The
Company determines and classified its operating segments in accordance with SFAS
No. 131 "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION"
based on the following considerations: (a) each of the Company's operating
segments is a discrete business unit that earns revenues and incurs expenses;
(b) the operating results are regularly reviewed by PacificNet's chief operating
decision makers for the purposes of fine-tuning its strategies going forward,
making resource allocation decisions such as whether further working capital
advances are required and assessing individual performance; and (c) discrete
financial information for each subsidiary within each operating segment is
available. The chief operating decision makers are the Company's President and
CEO and its Chairman, and their decisions are based on discussions with each
segment's senior management and financial controllers regarding non-financial
indicators such as customer satisfaction, loyalty and new marketplace
competition as well as financial indicators such as internally generated
financial statements, to assess overall financial performance.
GOING
CONCERN
As shown
in the accompanying consolidated financial statements, the Company incurred
accumulated losses of $51.1 million and $38.6 million as of December 31, 2006
and December 31, 2005, respectively. Negative cash flows from the operations of
$8.2 million were noted for the year ended December 31, 2006. These matters
raise substantial doubt about the Company’s ability to continue as a going
concern.
In view
of the matters described in the preceding paragraph, recoverability of a major
portion of the recorded asset amounts shown in the accompanying balance sheet is
dependent upon continued operations of the Company, which in turn is dependent
upon the Company’s ability to raise additional capital, obtain financing and to
succeed in its future operations. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The
Company has taken certain restructuring steps to provide the necessary capital
to continue its operations. These steps included, but not limited to: 1)
accelerate disposal and spin-off of unprofitable or unfavorable
return-on-investment non-gaming operations. On April 30, 2007, the Company
entered into a sale and purchase agreement to dispose of its interest in
Guangzhou3G for a consideration of US$6 million. On May 5, 2007, the Company
also entered into a sale and purchase agreement to dispose of the real estate in
HK for approximately US$1 million; 2) focus on execution of the new high
potential gaming business initiatives; 3) acquisition of profitable and/or
strategic operations through issuance of equity instruments; 4) formation of
strategic relationship with key gaming operators in Asia; 5) issuance and/or
restructure of new long-term convertible debentures.
Recent
Pronouncements
In
February 2007, FASB issued FASB Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal
years beginning after November 15, 2007. Early adoption is permitted subject to
specific requirements outlined in the new Statement. Therefore, calendar-year
companies may be able to adopt FAS 159 for their first quarter 2007 financial
statements.
The new
Statement allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item's fair value in subsequent reporting
periods must be recognized in current earnings. FAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. The management is currently evaluating the effect of this
pronouncement on financial statements.
In
September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
employer to recognize the over funded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income of a
business entity or changes in unrestricted net assets of a not-for-profit
organization. The Company currently does not have any defined benefit plan and
so FAS 158 will not affect the financial statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
In March
2006 FASB issued SFAS 156 “Accounting for Servicing of Financial Assets.” This
Statement amends FASB Statement No. 140, “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,” with respect to the
accounting for separately recognized servicing assets and servicing liabilities.
The Company does not have any servicing assets and therefore the statement will
not have any impact on the financial statements.
In
February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments.” SFAS No. 155 amends SFAS No 133, “Accounting for
Derivative Instruments and Hedging Activities,” and SFAF No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.” SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. The management is currently evaluating the effect of this
pronouncement on financial statements.
2. BUSINESS
ACQUISITIONS
During
2006 and 2005, PacificNet acquired various entities in accordance with the
Company's strategy to grow via mergers and acquisitions. The entities acquired
met various PacificNet acquisition criteria, which include reasonable
expectations for positive earnings and cash flow within two years of acquisition
and reputation for high quality and performance in the customer relationship
management, brand name recognition, and well-established relationships with
clients. Several factors contributed to the determination of the negotiated
purchase price and deal structure. Among them were the value of assets acquired
and liabilities assumed, historical EBITDA and projected EBITDA. The assets
acquired and liabilities assumed were recorded at estimated fair values as
determined by the Company's management based on information currently available
and on current assumptions as to future operations
A summary
of business acquisitions for the periods presented follows:
On
January 31, 2006, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of a 51% controlling
interest in Guangzhou Wanrong Information Technology Co. Limited (Guangzhou
Wanrong), one of the leading value-added telecom service providers in China,
located in PRC Guangzhou. Since its inception in 2003, Guangzhou Wanrong has
achieved strong growth in its VAS including SMS, WAP, JAVA, MMS, IVR, multimedia
entertainment download services, media interactive products, mobile email
services, life, sports, entertainment, and business information services.
Guangzhou Wanrong was granted nationwide SMS service numbers "2388" for China
Mobile and "9928" for China Unicom. Wanrong's integrated value-added mobile
services system is valuable for the implementation of PacificNet's "iPACT
program", a standard service-mark for PacificNet's VAS profit-sharing alliance
partnership program.
The
consideration was paid as follows:
(i) The
purchase consideration for 51% of the equity interest of Guangzhou Wanrong was
approximately US $1.75million, payable 21% in cash and 79% in restricted shares
of PacificNet common stock valued at $8 per share, or about 173,000 restricted
shares.
(ii)
Under the purchase agreement, Guangzhou Wanrong has made a guarantee to generate
US $500,000 in annual net income. In the event of a shortfall, the purchase
price will be adjusted accordingly.
(iii)
PacificNet will also invest approximately RMB 3 million (or about US $370,000)
in Guangzhou Wanrong for general corporate purposes. The purchase price is
payable upon achievement of certain quarterly earn-out targets based on net
income.
The cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A summary
of the assets acquired and liabilities for Guangzhou Wangrong assumed in the
acquisition follows:
Estimated fair
values:
|
|
Restated
|
|
Current
Assets
|
|
$ |
185,050
|
|
Property
Plan and equipment
|
|
|
- |
|
Current
Liabilities assumed
|
|
|
- |
|
Net
asset acquired
|
|
|
185,050
|
|
Consideration
paid:
|
|
|
646,158
|
|
Shares
|
|
|
- |
|
Cash
paid
|
|
|
- |
|
Goodwill
|
|
$ |
461,108
|
|
As of
December 31, 2006, goodwill of $461,108 represents the excess of the purchase
price over the fair value of the assets acquired and is not deductible for tax
purposes. The total amount of goodwill by reportable segment for Telecom
Value-added Services was $461,000 (see Note 15).
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for Guangzhou Wanrong
acquisition is based on a management's estimates and overall industry
experience. Immediately after the signing of the definitive agreement, the
Company obtained effective control over Guangzhou Wanrong. Accordingly, the
operating results of Guangzhou Wanrong have been consolidated with those of the
Company starting January 31, 2006. Pursuant to SFAS 141 "Business Combinations",
the earn-out consideration was considered contingent consideration and after the
audited combined after-tax profit of US $500,000 for the 12 months ended
December 31, 2006 is available. Accordingly, the contingent consideration of
138,348 shares has not been reflected in the consolidated financial statements
of the Company as of December 31, 2006.
UNAUDITED PRO FORMA CONSOLIDATED
FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2006 AND
2005
The
following un-audited pro forma consolidated financial information for the years
ended December 31, 2006 and 2005, as presented below, reflects the results of
operations of the Company assuming the acquisition occurred on January 1, 2005
and 2006 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would have
been had the acquisitions actually taken place on January 1, 2005 and 2006
respectively, and may not be indicative of future operating
results.
Guangzhou
Wanrong
|
|
Years
ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
(In
thousands of U.S Dollars, except for earnings per share)
|
|
Restated
(Unaudited)
|
|
|
Restated
(Unaudited)
|
|
|
Restated
(Unaudited)
|
|
Revenues
|
|
$ |
43,692
|
|
|
$ |
18,271
|
|
|
$ |
11,598
|
|
Operating
loss
|
|
|
(6,354 |
) |
|
|
(5,610 |
) |
|
|
(6,547 |
) |
Net
loss attributable to shareholders
|
|
|
(12,437 |
) |
|
|
(5,145 |
) |
|
|
(5,581 |
) |
Loss
per share – basic & diluted
|
|
$ |
(1.08 |
) |
|
$ |
(0.51 |
) |
|
$ |
(0.80 |
) |
PacificNet
included the financial results of Guangzhou Wanrong in its consolidated 2006
financial results from the date of the purchase, January 31, 2006 through
December 31, 2006.
PACIFICNET IMOBILE (BEIJING)
TECHNOLOGY CO., LIMITED (INCORPORATED IN THE PRC)
On
February 26, 2006, PacificNet acquired a 51% majority interest in PacificNet
iMobile (Beijing) Technology Co., Ltd ("iMobile"), one of the leading Internet
information portal and e-commerce distributors for mobile phone and accessories
and mobile related value-added service providers in China. iMobile operates its
e-commerce business via two Internet portals, "http://www.iMobile.com.cn" and
"http://www.18900.com" and one WAP portal "17wap.com" for mobile phone browsing.
In addition, iMobile's 18900.com operation is the designated Internet
distributor for Motorola, Nokia, and NEC's mobile products in China. iMobile's
Internet portal has been one of the top ranked traffic sites and has achieved
about 5.4 million registered online users and over 1,200,000 active users, with
10 million daily page views and 40,000 blog postings per day, which makes
iMobile the top ranked site in its category in China. This acquisition was
structured in the same manner as our other acquisitions, that are classified and
accounted for as variable interest entities in accordance with FASB
Interpretation No. 46R "Consolidation of Variable Interest Entities" ("FIN
46R"), an Interpretation of Accounting Research Bulletin No. 51.), with
operation and services agreements between Beijing Xing Chang Xin Science and
Technology Development Co. Limited Incorporated DE and PacificNet Imobile
(Beijing) Technology, Co. Ltd. WOFE. The results of variable interest entities
acquired during the period are included in the consolidated income statements
from the effective date of the acquisition.
The
consideration was paid as follows:
(i) The
purchase consideration for 51% of the equity interest of iMobile is
approximately US $1.8 million, which represents approximately seven times the
anticipated future annual net income of iMobile.
(ii) The
purchase consideration is payable 14% in cash and 86% in restricted shares of
PacificNet valued at $8 per share, or about 191,875 restricted shares The
purchase price is payable upon achievement of certain quarterly earn-out targets
based on net income.
(iii)
Under the purchase agreement, iMobile has committed to generate US $500,000 in
annual net income. In the event of a shortfall, the purchase price will be
adjusted accordingly.
(iv)
PacificNet will also invest approximately RMB 2 million (about US $250,000) in
iMobile for general corporate and working capital purposes to support growth.
The purchase price is payable upon achievement of certain quarterly earn-out
targets based on net income.
The cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A summary
of the assets acquired and liabilities for iMobile assumed in the acquisition
follows:
Estimated fair
values:
|
|
Restated
|
|
Current
Assets
|
|
$ |
127,500
|
|
Property
Plan and equipment
|
|
|
- |
|
Current
Liabilities assumed
|
|
|
- |
|
Net
asset acquired
|
|
|
127,500
|
|
Consideration
paid:
|
|
|
557,000
|
|
Goodwill
|
|
$ |
429,500
|
|
At
December 31, 2006, goodwill of $429,500 represents the excess of the purchase
price over the fair value of the net tangible and identifiable intangible assets
acquired and is not deductible for tax purposes and the total amount of goodwill
by reportable segment for Products (Telecom & Gaming) was $2,155,000. (See
Note 15)
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for iMobile acquisition is
based on a management's estimates and overall industry experience. Immediately
after the signing of the definitive agreement, the Company obtained effective
control over iMobile. Accordingly, the operating results of iMobile have been
consolidated with those of the Company starting February 26, 2006. Pursuant to
SFAS 141 "Business Combinations", the earn-out consideration is considered
contingent consideration, which will not become certain until the audited
combined after-tax profit of US $500,000 for the 12 months ended December 31,
2006 is available. Accordingly, the contingent consideration of 153,500 shares
has not been reflected in the consolidated financial statements of the Company
as of December 31, 2006.
UNAUDITED PRO FORMA CONSOLIDATED
FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2006 AND
2005
The
following un-audited pro forma consolidated financial information for the years
ended December 31, 2005 and 2006, as presented below, reflects the results of
operations of the Company assuming the acquisition occurred on January 1, 2005
and 2006 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would have
been had the acquisitions actually taken place on January 1, 2005 and 2006
respectively, and may not be indicative of future operating
results.
iMobile
|
|
Years
ended December 31
|
|
(In
thousands of U.S Dollars, except for earnings per share)
|
|
2006
Restated
(Unaudited)
|
|
|
2005
Restated
(Unaudited)
|
|
|
2004
Restated
(Unaudited)
|
|
Revenues
|
|
$ |
43,285
|
|
|
$ |
24,201
|
|
|
$ |
16,303
|
|
Operating
loss
|
|
|
(6,221 |
) |
|
|
(5,695 |
) |
|
|
(6,221 |
) |
Net
loss attributable to shareholders
|
|
|
(12,407 |
) |
|
|
(5,181 |
) |
|
|
(5,413 |
) |
Loss
per share – basic & diluted
|
|
$ |
(1.08 |
) |
|
$ |
(0.51 |
) |
|
$ |
(0.77 |
) |
PacificNet
included the financial results of iMobile in its consolidated 2006 financial
results from the date of the purchase, February 26, 2006 through December 31,
2006.
PACIFICNET GAMES
LIMITED
On August
3, 2006, PacificNet’s wholly owned subsidiary PacificNet Games Limited
(“PacGames”, [太平洋网络游戏有限公司]) completed the
acquisition of 100% of Able Entertainment Technology Ltd., a leading gaming
technology provider based in the Macau Special Administrative Region of China.
Upon completion of this transaction, the Company owned 35% of PacificNet Games
Limited. Under the purchase agreement, Able Entertainment Technology Ltd
represented that is expects to generate an annual profit of USD $1,600,000 and
will provide for an adjustment to the purchase price if PacGames does not
achieve an annual net profit of USD $1,600,000 during the first 12-month period
ended June 30, 2007, and USD $3,000,000 during the second 12-month period ended
June 30, 2008.
The
purchase price consideration is 200,000 restricted PACT shares in exchange for
100% of the issued and outstanding shares of Able Entertainment Technology Ltd.
or a 35% ownership interest in PacGames. As of December 31, 2006, 40,000 total
restricted shares of PacificNet had been issued for the acquisition and 160,000
shares were held back as contingent consideration payable upon completion of
certain earnings criteria pursuant to the purchase agreement.
On
September 22, 2006, PACT acquired another 10% of PacGames in exchange for 57,100
restricted shares of the Company’s common stock. Those shares have been issued
out according to sale and purchase agreement.
On
November 9, 2006, we acquired an additional 6% interest in PacificNet Games
Limited (PacGames) for a consideration of $504,000 (paid entirely with shares of
PacificNet: 90,000 PACT Shares, valued at $5.60 per share, price on the day of
transaction). Those shares have been issued out according to sale and purchase
agreement. The company currently owns 51% of PacGames.
The cash
portion of the purchase consideration was paid from working capital of the
Company. The value of the common shares issued was determined based on the
average market price of PacificNet's common shares over a reasonable period
before and after the terms of the acquisition were agreed to and
announced.
A summary
of the assets acquired and liabilities for PacGames assumed in the acquisition
follows:
Estimated fair
values:
|
|
Restated
|
|
Current
Assets
|
|
$ |
642,111
|
|
Property
Plan and equipment
|
|
|
25,051
|
|
Intangible
asset
|
|
|
179,858
|
|
Current
Liabilities assumed
|
|
|
(291,598 |
) |
Net
asset acquired
|
|
|
555,422
|
|
Consideration
paid:
|
|
|
1,301,811
|
|
Goodwill
|
|
$ |
746,389
|
|
At
December 31, 2006, goodwill of $746,389 represents the excess of the purchase
price over the fair value of the net tangible and identifiable intangible assets
acquired and is not deductible for tax purposes and the total amount of goodwill
by reportable segment for Products (Telecom & Gaming) was
$2,155,000.
In
accordance with SFAS 142, goodwill is not amortized but is tested for impairment
at least annually. The purchase price allocation for PacGames acquisition is
based on a management's estimates and overall industry experience. Immediately
after the signing of the definitive agreement, the Company obtained effective
control over PacGames. Accordingly, the operating results of PacGames have been
consolidated with those of the Company starting March 30, 2006. Pursuant to SFAS
141 "Business Combinations", the earn-out consideration is considered contingent
consideration, which will not become certain until the audited combined
after-tax profit of US $700,000 for the year ended December 31, 2006 is
available. Accordingly, the contingent consideration of 160,000 shares has not
been reflected in the consolidated financial statements of the Company as of
December 31, 2006.
The
following table summarizes the intangible assets acquired from PacificNet
Games:
(USD000s)
|
|
December
31,
2006
|
|
|
December
31,
2005
|
|
Technology
|
|
$ |
353
|
|
|
$ |
-
|
|
Less:
Accumulated amortization
|
|
|
(30 |
) |
|
|
-
|
|
Net
|
|
$ |
323
|
|
|
$ |
- |
|
Amortization expense related to
intangible assets was $30,000 in the year ended December 31,
2006.
UNAUDITED PRO FORMA CONSOLIDATED
FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED DECEMBER 31, 2006 AND
2005
The
following un-audited pro forma consolidated financial information for the years
ended December 31, 2005 and 2006, as presented below, reflects the results of
operations of the Company assuming the acquisition occurred on January 1, 2005
and 2006 respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would have
been had the acquisitions actually taken place on January 1, 2005 and 2006
respectively, and may not be indicative of future operating
results.
PACT
Games
|
|
Years
ended December 31
|
|
(In
thousands of U.S Dollars, except for earnings per share)
|
|
2006
Restated
(Unaudited)
|
|
|
2005
Restated
(Unaudited)
|
|
|
2004
Restated
(Unaudited)
|
|
Revenues
|
|
$ |
44,176
|
|
|
$ |
17,307
|
|
|
$ |
10,857
|
|
Operating
loss
|
|
|
(5,585 |
) |
|
|
(5,608 |
) |
|
|
(6,242 |
) |
Net
loss attributable to shareholders
|
|
|
(12,381 |
) |
|
|
(5,145 |
) |
|
|
(5,424 |
) |
Loss
per share – basic & diluted
|
|
$ |
(1.07 |
) |
|
$ |
(0.51 |
) |
|
$ |
(0.77 |
) |
Accordingly,
PacificNet included the financial results of PacGames in its consolidated 2006
financial results from August 3, 2006 through December 31, 2006.
3. INVESTMENT IN AFFILIATED
COMPANIES
Investments
Investments
in affiliated companies consist of the following as of December 31, 2006
(in thousands):
(USD000s)
|
COLLATERAL/OWNERSHIP
% AND BUSINESS DESCRIPTION
|
|
AMOUNT
|
DESCRIPTION
|
INVESTMENTS
IN AFFILIATED COMPANIES:
|
|
|
Take1
(Cheer Era Limited) [1]
|
$
100
|
2 20%
ownership interest; trader of vending machine located in Hong
Kong
|
MOABC
|
(19)
|
20%
ownership interest
|
Glad
Smart
|
30
|
15%
ownership interest
|
Community
media co.
|
4
|
5%
ownership interest
|
Total
|
$
115
|
|
TAKE 1 TECHNOLOGIES GROUP
LIMITED (FORMERLY KNOWN AS: CHEER ERA LIMITED
"CHEERERA")
On
January 05, 2007, we entered into an agreement for PacificNet to exercise the
option to acquire an additional 31% interest in Take 1. The completion date for
the new Securities Subscription Agreement was March 5, 2007, with a
consideration of $721,887 (paid entirely with shares of PacificNet: 149,459 PACT
Shares, valued at $4.83 per share). As a result, PacificNet has become the
majority and controlling shareholder of Take1 with our ownership percentage
increased from 20% to 51%.
Initial
equity investment of 30% in Take 1 was made in April 2004 by the Company,
through its subsidiary PacificNet Strategic Investment Holdings Limited for an
aggregate consideration of $385,604 in cash and 149,459 PacificNet shares.
PacificNet’s interest in Take 1 was reduced to 20% in the year 2005 from 30% as
a result of PacificNet repurchasing an aggregate of 149,459 at nominal
value.
As of December 31, 2006, there was an
outstanding inter-company convertible loan of $1,026,000 due from Take 1. The
Convertible Loan, expiring on October 17, 2008, is guaranteed personally and
jointly by the two minority shareholders of Take 1, and bears an interest rate
of 8% per annum or 6-month Prime Rate of Hong Kong.
4. PROPERTY AND EQUIPMENT,
NET
Property
and equipment consists of the following as of December 31 (in thousands of US
Dollars):
|
|
2006
Restated
|
|
|
2005
Restated
|
|
Office
furniture, fixtures and leasehold improvements
|
|
$ |
908
|
|
|
$ |
1,259
|
|
Computers
and office equipment
|
|
|
1,720
|
|
|
|
2,691
|
|
Motor
Vehicles
|
|
|
130
|
|
|
|
97
|
|
Software
|
|
|
395
|
|
|
|
747
|
|
Electronic
Equipment
|
|
|
68
|
|
|
|
1,174
|
|
Land
and buildings
|
|
|
2,805
|
|
|
|
68
|
|
Less:
Accumulated depreciation
|
|
|
(1,315 |
) |
|
|
(5,078 |
) |
Property
and Equipment, Net
|
|
$ |
4,711
|
|
|
$ |
958
|
|
For the
years ended December 31, 2006 and 2005, the total depreciation and amortization
expenses were $2,521,000 and $1,126,000, of which $1,058,000 and $872,000 was
included in the cost of revenues, respectively.
The
significant increase of the office furniture, fixtures and leasehold
improvements was mainly due to most of the computers and office equipment in
2006 are derived from the expansion of our business including Epro ($200,000).
Additionally, Beijing office purchased through Inc ($1,617,000) during 2006 and
the real estate in Hong Kong recorded in PacCom ($1,053,000) are accounted under
Land and Buildings.
OPERATING
LEASES - The Company leases warehouse and office space under operating leases
with fixed monthly rentals. None of the leases included contingent rentals.
Lease expense charged to operations for 2006 amounted to $571,000 (2005:
$516,000). Future minimum lease payments under non-cancelable operating leases
are $680,000 for 2007, $764,000 for 2008 through 2011
RESTRICTED
CASH - The Company has a $234,000 and $163,000 pledged bank deposit for Epro for
the years ended December 31, 2006 and 2005 respectively, which represents
overdraft protections with certain financial institutions.
BANK LINE
OF CREDIT (2006): As of December 31, 2006, the Company’s outstanding bank lines
of credit were as follows:
|
|
(i)
|
Epro
has an overdraft banking facility with certain major financial
institutions in the aggregate amount of $744,000, which is secured by a
pledge of its fixed deposits of $234,000, pursuant to the following terms:
interest will be charged at the Hong Kong Prime Rate per annum and payable
at the end of each calendar month or the date of settlement, whichever is
earlier.
|
|
(ii)
|
Smartime
has an overdraft banking facility with a large Hong Kong bank in the
aggregate amount of $111,000. This overdraft facility is personally
pledged by the deposit account of a director of
Smartime.
|
BANK LINE OF CREDIT (2005): As of December 31, 2005, the Company
utilized $1,059,000 of the banking facility including $944,000 from Epro and
$115,000 from Smartime. Epro has an overdraft banking facility with certain
major financial institutions in the aggregate amount of $1,218,000, which is
secured by a pledge of its fixed deposits of $163,000, pursuant to the following
terms: interest will be charged at the Hong Kong Prime Rate per annum and
payable at the end of each calendar month or the date of settlement, whichever
is earlier. For Smartime, there is no due date payment stipulated by Hong Kong
Hang Seng Bank because its overdraft banking facility was borrowed directly from
one of its directors personal fixed deposit account as a mortgage. The detailed
payment period is based on its funding condition.
CONTINGENT
CONSIDERATION: Warrants have not been included as part of the acquisition price
of various S&P Agreements (Note 2) and are no longer considered as part of
the purchase consideration due to (i) the ambiguity of the S&P Agreements
with respect to the issuance of the warrants and (ii) the lack of actual
instruments to transfer the warrants, such as a warrant agreement that is signed
and sealed by the Company and property registered at the Company Registrar of
securities in Hong Kong, and accordingly, there is no irrevocable obligation by
the Company to issue the warrants. Furthermore, the net income milestones were
not achieved as required under the S&P Agreements according to Hong Kong
law. Based on the opinion of the Company's legal counsel in Hong Kong, the
Company does not have an irrevocable obligation to issue the warrants and
therefore the warrants are not considered issued and outstanding. The offer to
issue the warrants is no longer part of the purchase price in the S&P
Agreements due to the failure by the Sellers to satisfy their warranties in the
S&P Agreements. Accordingly, the warrants have not been valued.
6. OTHER CURRENT
ASSETS
Other
current assets comprises of the following as at December 31 (in thousands of US
Dollars):
Other current
assets
|
|
2006
Restated
|
|
|
2005
Restated
|
|
Prepayment
|
|
$ |
1,048
|
|
|
$ |
655
|
|
Utilities
deposit
|
|
|
1,292
|
|
|
|
-
|
|
Receivable
from Lion Zone Holdings Ltd (See note 14)
|
|
|
485
|
|
|
|
-
|
|
Loans
to employees
|
|
|
412
|
|
|
|
-
|
|
Prepaid
expenses
|
|
|
408
|
|
|
|
204
|
|
Others
receivable
|
|
|
170
|
|
|
|
1,504
|
|
Advances
to sales reps
|
|
|
358
|
|
|
|
-
|
|
Provision
for doubtful account of other receivables
|
|
|
-
|
|
|
|
(988 |
) |
Total
|
|
$ |
4,173
|
|
|
$ |
1,375
|
|
Bank
loans represent the following at December 31 (in thousands):
|
|
2006
|
|
|
2005
|
|
Secured
[1]
|
|
$ |
1,668
|
|
|
$ |
108
|
|
Unsecured
|
|
|
543
|
|
|
|
86
|
|
Less:
current portion
|
|
|
(576 |
) |
|
|
(188 |
) |
Noncurrent
portion
|
|
$ |
1,635
|
|
|
$ |
6
|
|
Bank
Loans are generated by two of the Company's subsidiaries. One of the
subsidiaries is PacificNet Epro Holdings Limited, a company incorporated in the
Hong Kong Special Administrative Region of the PRC, primarily engaged in the
business of providing call center and customer relationship management (CRM)
services as well as other business outsourcing services.
[1] The
loans were secured by the following: joint and several personal guarantees
executed by certain directors of the subsidiary of the Company; corporate
guarantee executed by a subsidiary of the Company; second legal charge over a
property owned by a subsidiary of the Company; and pledged bank deposits of
$234,000 (2005: $163,000) of a subsidiary of the Company.
Aggregate
future maturities of borrowing for the next five years are as follows: 2007:
$526,000, 2008: $424,000 and 2009: $213,000, thereafter: none.)
The
remaining bank loans of $1,048,000 are generated by PacificNet Inc. relating to
a fixed asset bought during the first quarter with total cost of $1,648,000. The
repayment of the bank loan was $69,000. (Aggregate future maturities of
borrowing for the following period are as follows: Less than 1 year: $50,000,
1-5 year: $229,000 and after 5 years: $769,000)
8. CAPITAL LEASE
OBLIGATIONS
The
Company leases various equipments under capital leases expiring in various years
through 2008. The assets and liabilities under capital leases are recorded at
the lower of the present value of the minimum lease payments or the fair value
of the asset. The assets are depreciated over the lesser of their related lease
terms or their estimated productive lives and are secured by the assets
themselves. Depreciation of assets under capital leases is included in
depreciation expense for 2006 and 2005
Aggregate
minimum future lease payments under capital leases as of December 31, 2006 for
each of the next five years are as follows: (2007: $132,000; 2008: $89,000; and
2009: $42,000, and thereafter: none.)
Capital
lease obligations represent the following at December 31 (in thousands of US
Dollars):
|
|
2006
|
|
|
2005
|
|
Total
minimum lease payments
|
|
$ |
263
|
|
|
$ |
216
|
|
Interest
expense relating to future periods
|
|
|
(19 |
) |
|
|
(12 |
) |
Present
value of the minimum lease payments
|
|
|
244
|
|
|
|
204
|
|
Less:
current portion
|
|
|
(120 |
) |
|
|
(126 |
) |
Noncurrent
portion
|
|
$ |
124
|
|
|
$ |
78
|
|
Following
is a summary of fixed assets held under capital leases at December 31 (in
thousands of US Dollars):
|
|
2006
|
|
|
2005
|
|
Computers
and office equipment
|
|
$ |
630
|
|
|
$ |
441
|
|
Less:
accumulated depreciation
|
|
|
(391 |
) |
|
|
(286 |
) |
Net
|
|
$ |
239
|
|
|
$ |
155
|
|
Accrued
expenses consist of the following at December 31 (in thousands of US
Dollars):
|
|
2006
Restated
|
|
|
2005
Restated
|
|
Professional
fee
|
|
|
321
|
|
|
|
486
|
|
Director
fee
|
|
|
100
|
|
|
|
|
|
Salaries
and benefit payable
|
|
|
792
|
|
|
|
109
|
|
Marketing
expense
|
|
|
389
|
|
|
|
-
|
|
Others
|
|
|
226
|
|
|
|
109
|
|
Total
|
|
$ |
1,828
|
|
|
$ |
704
|
|
10. STOCKHOLDERS'
EQUITY
a) COMMON
STOCK
During
the year ended December 31, 2006, the Company had the following equity
transactions (i) 394,000 shares as a result of exercise of stock options with
cash consideration of $237,000; (ii) 618,112 shares for acquisition of
subsidiaries valued at $4,346,000; and (iii) 275,000 shares returned by
ChinaGoHi valued at $1,672,000, due to a termination agreement signed with
ChinaGoHi in November 2006 (as filed in an 8K dated Nov 28, 2006); (iv)
repurchase of 24,200 shares from Yueshen with a market value of
$124,223.
For the
year ended December 31, 2005, the Company had the following equity transactions
(i) 676,000 shares as a result of exercise of stock options and warrants with
cash consideration of $966,000; (ii) 515,900 shares for acquisition of
subsidiaries valued at $3,971,000;(iii) 20,000 shares at $63,000 for investor
relations services rendered based on the fair market value of the services
rendered; (iv) repurchase of 45,000 shares fraudulently issued by the former
financial controller of the company in 2004 to herself at par
value; and (v) repurchase of 149,459 shares with a market value of
$1,547,000 related to affiliated company (see Note 3 for details).
For the
year ended December 31, 2004, the Company had the following equity transactions
(i) 219,364 shares as a result of exercise of stock options and warrants with
cash consideration of $606,000; (ii) 1,756,240 shares for acquisition of
subsidiaries valued at $9,938,000; and (iii) 2,205,697 shares for cash proceeds
of $12,330,000 (net of offering costs); (iv) 50,000 shares at $2.64 per share,
or $132,000 for investor relations services rendered; (v) 83,000 shares were
fraudulently issued by the former financial controller of the company to herself
out of which 38,000 could not be cancelled as they had been resold and the
balance were cancelled in 2005 by the company; and (vi) 149,459 shares with a
market value of $1,547,000 for acquisition of affiliated company (see Note 3 for
details)
On
December 23, 2003, stockholders of the Company adopted an amendment to the Stock
Option Plan (the "Plan") to increase the number of shares reserved under the
Plan from 1,666,667 to 2,000,000. On December 30, 2004, stockholders of the
Company approved the new 2005 Stock Option Plan (the "2005 Option Plan"). The
2005 Option Plan provide for the grant to directors, officers, employees and
consultants of the Company (including its subsidiaries) of options to purchase
up to an aggregate of 2,000,000 shares of Common Stock. The 2005 Plan is
administered by the Board of Directors or a committee of the Board of Directors
(in either case, the "Committee"), which has complete discretion to select the
optionees and to establish the terms and conditions of each option, subject to
the provisions of the 2005 Option Plan. Options granted under the 2005 Plan are
"incentive stock options" as defined in Section 422 of the Internal Revenue Code
of 1986, as amended (the "Code"), or nonqualified options.
The
purpose of the Plan is to attract and retain the best available personnel for
positions of responsibility and to provide incentives to such personnel to
promote the success of the business. The Plan provides for the grant to
directors, officers, employees and consultants of the Company (including its
subsidiaries) of options to purchase shares of common stock. Options granted
under the Plan may be "incentive stock options" as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified
options. To date, all options granted have been nonqualified options. The
exercise price of incentive stock options may not be less than 100% of the fair
market value of the common stock as of the date of grant. The number of options
outstanding and the exercise price thereof are subject to adjustment in the case
of certain transactions such as mergers, recapitalizations, stock splits or
stock dividends. Options granted under the Plan fully vest through June
2006.
The
status of the Stock Option Plan as of December 31, 2006, is as
follows:
|
|
Options
outstanding
|
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2003
|
|
|
550,600
|
|
|
$ |
2.87
|
|
Granted
|
|
|
870,000
|
|
|
$ |
3.03
|
|
Cancelled
|
|
|
(400,000 |
) |
|
$ |
4.25
|
|
Exercised
|
|
|
(188,500 |
) |
|
$ |
2.04
|
|
OUTSTANDING,
DECEMBER 31, 2004
|
|
|
832,100
|
|
|
$ |
1.90
|
|
Granted
|
|
|
680,000
|
|
|
$ |
6.57
|
|
Cancelled
|
|
|
(680,000
|
|
|
$ |
6.57
|
|
Exercised
|
|
|
(76,000 |
) |
|
$ |
2.05
|
|
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
|
|
Following
is a summary of the status of options outstanding at December 31,
2006:
Grant
Date
|
Total
Options
Outstanding
|
Aggregate
Intrinsic
Value
|
Weighted
Average Remaining
Life
(Years)
|
Total
Weighted
Average
Exercise
Price
|
Option
Exercisable
|
Weighted
Average
Exercise
Price
|
|
|
|
|
|
|
|
2004-7-26
|
370,500
|
$1,548,690
|
0.57
|
$2.00
|
370,500
|
$2.00
|
There are
370,500 options, which granted during year 2004, were outstanding and vested in
year 2006. Those options have a term of three years and 0.83 year vesting
period. The weighted-average fair value of such options was $1.42.The
assumptions used in calculating the fair value of options granted using the
Black-Scholes option- pricing model are as follows:
Risk-free
interest rate
|
2.75%
|
|
Expected
life of the options
|
1.65
years
|
|
Expected
volatility
|
61.33%
|
|
Expected
dividend yield
|
0%
|
|
There
were 500,000 options authorized on September 21 of 2006 with a $4.75 exercise
price. Such options have a term of 5 years and will be vested 5% per quarter
commencing from January 1st 2007. On December
15, 2006, the board of directors decided to cancel all options previously
granted in 2005 and 2006 due to the increasing cost of option administration.
The board of directors plan to issue restricted stock or stock appreciation
right (SAR) for future executive and employee incentive
compensation.
c)
WARRANTS
At
December 31, 2006, the Company had outstanding and exercisable warrants to
purchase an aggregate of 1,007,138 shares of common stock. The weighted average
remaining life is 3.34 years and the weighted average price per share is
$10.61.
Following
is a summary of the warrant activity:
|
|
|
|
|
WEIGHTED
AVERAGE EXERCISE
PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2003
|
|
|
800,000
|
|
|
$ |
1.53
|
|
Granted
|
|
|
622,002
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
(30,864 |
) |
|
|
-
|
|
OUTSTANDING,
DECEMBER 31, 2004
|
|
|
1,391,138
|
|
|
|
4.93
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
(200,000 |
) |
|
|
-
|
|
Exercised
|
|
|
(600,000
|
|
|
|
-
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
591,138
|
|
|
|
9.5
|
|
Granted
|
|
|
416,000
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
1,007,138
|
|
|
$ |
10.61
|
|
Following
is a summary of the status of warrants outstanding at December 31,
2006:
|
Total
warrants
Outstanding
|
Weighted
Average
Remaining
Life (Years)
|
Total
Weighted
Average
Exercise
Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-1-15
|
123,456
|
3.04
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
3.88
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
3.94
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
4.20
|
$12.20
|
416,000
|
$12.20
|
On March
13, 2006, we issued 400,000 warrants to several institutional investors in
connection with a private placement of $8 million in convertible debentures. On
the same day we issued another 16,000 warrants to our placement agent for the
transaction. See Note 1 for further details. Those warrants have a term of 5
years and immediately vesting. The assumptions used in calculating the fair
value of such warrants granted using the Black-Scholes option- pricing model are
as follows:
Risk-free
interest rate
|
4.78%
|
|
Expected
life of the options
|
5.00
years
|
|
Expected
volatility
|
37.08%
|
|
Expected
dividend yield
|
0%
|
|
d)
TREASURY STOCK
The
following is a summary of the movement of the Company's shares held as treasury
stock for the years ended December 31, 2006:
|
|
|
Number of
shares
|
|
|
Remarks
|
|
Escrowed
shares returned to treasury in 2003
|
|
|
800,000
|
|
|
|
|
Shares
purchased in the open market
|
|
|
40,888
|
|
|
|
|
Repurchase
of shares from Take 1
|
|
|
149,459
|
|
|
|
|
Repurchase
of shares from Yueshen
|
|
|
24,200
|
|
|
|
|
Cancellation
of former employee shares
|
|
|
45,000
|
|
|
|
|
Termination
with ChinaGoHi
|
|
|
825,000
|
|
|
Returned
shares plus Escrow shares
|
|
Incomplete
acquisition of Allink
|
|
|
200,000
|
|
|
|
|
Holdback
shares as contingent consideration due to performance targets not yet
met
|
|
|
529,848
|
|
|
Includes
shares related to Clickcom (78,000); Guangzhou(Wanrong (138,348); iMobile
(153,500); Games (160,000);
|
|
Balance,
December 31, 2006
|
|
|
2,614,395
|
|
|
|
|
Shares
outstanding at December 31, 2006
|
|
|
11,541,202
|
|
|
|
|
Shares
issued at December 31, 2006
|
|
|
14,155,597
|
|
|
|
|
11. INCOME TAXES
The
components of income before income taxes are as follows:
(USD000s)
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
Income
subject to PRC
|
|
$ |
1,662
|
|
|
$ |
1,308
|
|
|
$ |
1,923
|
|
Loss
subject to Hong Kong
|
|
|
(8,053 |
) |
|
|
(4,451 |
) |
|
|
(3,629 |
) |
Loss
subject to United States
|
|
|
(5,961 |
) |
|
|
(1,947 |
) |
|
|
(3,612 |
) |
Income (loss) before
taxes
|
|
|
(12,352 |
) |
|
|
(5,090 |
) |
|
|
(5,318 |
) |
Less:
income taxes
|
|
|
(63 |
) |
|
|
(55 |
) |
|
|
(106 |
) |
Net
income available to common stockholders
|
|
$ |
(12,415 |
) |
|
$ |
(5,145 |
) |
|
$ |
(5,424 |
) |
United States of
America
For
operations in the USA, the Company is subject to United States federal income
tax at a rate of 34%. The Company has incurred net accumulated operating losses
for income tax purposes and there is no provision for U.S. federal income tax
for 2006, 2005 and 2004 due to the Company's loss position. The Company believes
that it is more likely than not that these net accumulated operating losses will
not be utilized in the future because the Parent company is a holding company
with foreign subsidiaries and does not generate income. Therefore, the Company
has provided full valuation allowance for the deferred tax assets arising from
the losses as of December 31, 2006, 2005 and 2004.
The
following table sets forth the significant components of the deferred tax assets
for operation in the United States of America as of December 31, 2006, 2005
and 2004.
|
2006
|
|
2005
|
|
2004
|
Deferred
tax asset credit:
|
|
|
|
|
|
Federal
|
34%
|
|
34%
|
|
34%
|
State
|
6%
|
|
6%
|
|
6%
|
Valuation
allowance
|
(40)%
|
|
(40)%
|
|
(40)%
|
|
0%
|
|
0%
|
|
0%
|
Hong
Kong
Hong Kong
profits tax has been provided at a rate of 17.5% on the estimated assessable
profits arising in Hong Kong for each of the years ended December 31, 2006, 2005
and 2004. Provision for Hong Kong profits tax for 2006, 2005 and 2004 was
approximately $63,000, $40,000 and $36,000.
PEOPLE'S REPUBLIC OF CHINA
(PRC)
Pursuant
to the PRC Income Tax Laws, the Company's subsidiaries and VIEs are generally
subject to Enterprise Income Taxes ("EIT") at a statutory rate of 33%, which
comprises 30% national income tax and 3% local income tax. Some of these
subsidiaries and VIEs are qualified new technology enterprises and under PRC
Income Tax Laws, they are subject to a preferential tax rate of 15%. In
addition, some of the Company's subsidiaries are Foreign Investment Enterprises
and under PRC Income Tax Laws, they are entitled to either a three-year tax
exemption followed by three years with a 50% reduction in the tax rate,
commencing the first operating year, or a two-year tax exemption followed by
three years with a 50% reduction in the tax rate, commencing the first
profitable year. Provision for PRC business tax expense for 2006 was $257,000
(reclassified to discontinued operations), 2005 was $15,000 ($217,000
reclassified to discontinued operations) and 2004 was $70,000.
No
provision for deferred tax liabilities has been made, since the Company had no
material temporary differences between the tax bases of assets and liabilities
and their carrying amounts.
12. RELATED PARTY
TRANSACTIONS
LEASE
AGREEMENT
In
November 2004, the Company entered a lease agreement with EPRO for rental space
in the amount of $1,923 per month. The term of the lease was one year and
renewable by either party.
LOAN DUE TO AND FROM RELATED
PARTIES
As at the
years ended December 31, 2006 and 2005, there was a total loan receivable of
approximately $1,706,000 and $2,328,00 respectively due from related parties
while the loan due to related party was $638,000 and $759,000.
As at the
year ended December 31, 2005 the related party loans receivable included
$769,000 due from Take 1, an affiliated company that is 20% owned by PacificNet
Strategic Limited. The loans receivable from shareholders and directors of
PacificNet’s subsidiaries comprised of $1,559,000 due from a shareholder of
Smartim and Yueshen.
As at the
year ended December 31, 2006, the related party loan receivables included
$1,026,000 due from Take 1, an affiliated company that is 20% owned by
PacificNet, $196,000 due from MOABC, an affiliated company that is 20% owned by
PacificNet, and $384,000 due from shareholders and directors of certain of the
Company’s subsidiaries in connection with the acquisition of these subsidiaries.
The loans receivable from shareholders and directors of these subsidiaries is
comprised of $256,000 due from a shareholder of Yueshen and $128,000 due from a
director of Soluteck.
The terms
of these related parties loan receivables and payables are summarized
below:
LOAN TO TAKE
1
Take 1 is
an affiliated company and is 20% owned by PacificNet as of December 31, 2006. A
convertible loan of $1,026,000 and $769,000 respectively is outstanding from
Take 1 as of December 31, 2006 and 2005. Conversion terms of the convertible
loan provide PacificNet an option at any time during the Term to convert in part
or in whole of the then outstanding loan principle up to $1,026,000 (or HKD
$8,000,000) into shares of Take 1 to reach 51% ownership of Take 1. The loan was
extended as a working capital loan to finance the expansion of Take 1's business
in Europe and North America.
LOAN TO
MOABC
MOABC is
an affiliated company and is 20% owned by PacificNet as of December 31, 2006. A
convertible loan of $196,000 is outstanding from MOABC as of December 31, 2006.
Conversion terms of the convertible loan provide PacificNet an option at any
time during the Term to convert in part or in whole of the then outstanding loan
principle by using the price of $23,160 (1% of shares). The provision for
doubtful debts of $293,000 for the loan to MOABC was recorded in
2006.
LOAN TO GLAD
SMART
Glad
Smart is an affiliated company and is 15% owned by PacificNet as of December 31,
2006. A loan of $100,000 is outstanding from Glad Smart as of December 31, 2006.
The loan was extended as a working capital loan to finance the expansion of Glad
Smart’s voice card business operation.
LOAN TO YUESHEN’S
SHAREHOLDER
As at the
year ended December 31, 2006, there was a loan outstanding of $256,000
receivable from the shareholder of Yueshen. This loan is
collateralized with 106,240 PacificNet shares owned by the shareholder of
Yueshen. Further discussion of the outcome of our legal dispute with Yueshen is
found under Part II of this 10Q document - Item1: Legal
Proceedings.
As at the
year ended December 31, 2005 there was an unsecured loan of $1,367,000 due from
Ms. Li Yan-Kuan, shareholder of Yueshen.
LOAN TO SMARTIME’S
SHAREHOLDER
As at the
year ended December 31, 2005, there was $192,000 loan receivable due from the
shareholder of PacificNet Smartime.
LOAN TO SOLUTECK’S
DIRECTOR
As at the
year ended December 31, 2006, there was a loan outstanding of $128,000
receivable from a director of Soluteck, due on December 14 for three consecutive
years ending 2007. The interest rate for the loan is 8% per annum plus 5%
penalty interest in case it has not been timely paid. The loan is collateralized
with 100,000 PacificNet’s shares owned by the borrowing director and Ms Iris Lo,
and the remaining assets of Smartime Holding Ltd.
LOAN PAYABLE TO RELATED
PARTY
As at the
year ended December 31, 2006, a loan of $356,000 was payable to a shareholder of
EPRO. The loan was advanced to Epro for working capital purposes. The loan is
due on August 4, 2010. Interest being charged per annum is at Hong Kong Prime
lending rate, which was approximately 6.5% per annum in 2005 and 8% in
2006.
As at the
year ended December 31, 2006, a loan of $282,000 was payable to a shareholder of
Smartime. The loan was advanced to Smartime for working capital
purposes.
As at the
year ended December 31, 2005, a loan of $513,000 was payable to a shareholder of
EPRO. The loan was advanced to Epro for working capital purpose expiring by
August 4, 2010 at Hong Kong Prime lending rate approximately 6.5% interest per
annum prevailing in the year 2005.
As at the
year ended December 31, 2005, a loan of $246,000 was payable to a shareholder of
Yueshen.
13. SEGMENT
INFORMATION
SFAS No.
131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION ("SFAS
131"), establishes standards for reporting information about operating segments
and for related disclosures about products, services and geographic areas.
Operating segments are identified as components of an enterprise about which
separate discrete financial information is available for evaluation by the chief
operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance. PacificNet’s chief
decision-makers, as defined under SFAS 131, are the Chief Executive Officer and
Chairman. During 2006 and 2005, PacificNet had four operating
segments.
The
Company’s reportable segments are operating units, which represent the
operations of the Company’s significant business operations. Summarized
financial information concerning the Company’s reportable segments is shown in
the following table. The “Other” column includes the Company’s other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable
segments.
For
the year ended December 31, 2006 (in thousands of US Dollars,
except percentages)
|
Group
1.
Outsourcing
Service
($)
Restated
|
Group
2.
Telecom
Value-Added Services
($)
Restated
|
Group
3.
Products
(Telecom & Gaming)
($)
Restated
|
Group
4.
Other
Business
($)
Restated
|
Total
($)
Restated
|
Revenues
|
14,146
|
1,555
|
23,385
|
3,652
|
42,738
|
(%
of Total Revenues)
|
33%
|
4%
|
55%
|
9%
|
100%
|
Earnings
/ (Loss) from Operations
|
677
|
(44)
|
(1,054)
|
(5,889)
|
(6,310)
|
(%
of Total Profit)
|
(11)%
|
1%
|
17%
|
96%
|
100%
|
Total
Assets
|
8,365
|
2,747
|
12,673
|
18,244
|
36,535
|
(%
of Total Assets)
|
23%
|
(8)%
|
35%
|
50%
|
100%
|
Goodwill
|
3,964
|
461
|
1,176
|
|
5,601
|
Geographic
Area
|
HK,PRC
|
HK,
PRC
|
HK,PRC,Macau
|
HK,PRC
|
|
For
the year ended December 31, 2005 (in thousands of US Dollars,
except percentages)
|
Group
1.
Outsourcing
Service
($)
Restated
|
Group
2.
Telecom
Value-Added
Services
($)
Restated
|
Group
3.
Products
(Telecom & Gaming)
($)
Restated
|
Group
4.
Other
Business
($)
Restated
|
Total
($)
Restated
|
Revenues
|
13,568
|
-
|
2,880
|
859
|
17,307
|
(%
of Total Revenues)
|
78%
|
-
|
17%
|
5%
|
100%
|
Earnings
/ (Loss) from Operations
|
686
|
-
|
(106)
|
(6,188)
|
(5,608)
|
(%
of Total Profit)
|
(12%)
|
-
|
2%
|
110%
|
100%
|
Total
Assets
|
4,745
|
10,876
|
7,037
|
12,431
|
35,089
|
(%
of Total Assets)
|
14%
|
31%
|
20%
|
35%
|
100%
|
Goodwill
|
3,964
|
-
|
-
|
-
|
3,964
|
Geographic
Area
|
HK,PRC
|
HK,
PRC
|
HK,PRC,Macau
|
HK,PRC
|
|
The
Company identifies and classifies its operating segments based on reporting
entities that exhibit similar long-term financial performance based on the
nature of the products and services with similar economic characteristics such
as margins, business practices and target market. The operating segments are
classified into four major segments which are summarized as
follows:
(1)
Outsourcing Services - involves human voice services such as Business Process
Outsourcing, CRM, call center, IT Outsourcing and software development services.
These types of services are conducted through our subsidiaries EPRO,
Smartime/Soluteck and PacificNet Solution Ltd.
(2)
Telecom Value-Added Services (VAS) - primarily involves machine voice services
such as Interactive Voice Response, SMS and related VAS, which are conducted
through our subsidiaries such as ChinaGoHi (discontinued), Linkhead
(discontinued), Clickcom (discontinued) and Guangzhou 3G/Sunroom. For example,
Linkhead is a master reseller of NMS hardware and software platforms in China,
and its voice cards are used as an integral part of voice hardware using CPCI
industry control machines, and also by Media Servers to support access from PSTN
and VoIP, Softswitch and 3G networks.
(3)
Product (Telecom & Gaming) Services Group - involves communication and
gaming products, GSM/CDMA/3G Products, Multimedia Communication Kiosks. This
Group includes the following subsidiaries: PacificNet Communications Limited,
iMobile, Allink, Take1 and PacificNet Games. PacificNet Games Limited (PacGames)
is a leading developer of Asian electronic gaming machines, multi-player
electronic gaming technology solutions and gaming related maintenance, IT, and
distribution services for the leading hotel and casino operators based in the
Macau and other Asian gaming markets.
(4) Other
Business -other administrative, financial and investment services and non-core
businesses such as PacificNet Power Limited (PacPower), Pacific Financial
Services Limited, etc.
Product
and service revenues classified by major geographic areas are as follows (in
thousands of US Dollars):
For
the year ended December 31, 2006
|
|
Hong
Kong
|
|
|
PRC
|
|
|
Macau
|
|
|
United
States
|
|
|
Total
|
|
Product
revenues
|
|
$ |
19,829
|
|
|
$ |
5,755
|
|
|
$ |
364
|
|
|
$ |
-
|
|
|
$ |
25,948
|
|
Service
revenues
|
|
$ |
13,527
|
|
|
$ |
3,263
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
16,790
|
|
For
the year ended December 31, 2005
|
|
Hong
Kong
|
|
|
PRC
|
|
|
Macau
|
|
|
United
States
|
|
|
Total
|
|
Product
revenues
|
|
$ |
3,216
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
3,216
|
|
Service
revenues
|
|
$ |
10,413
|
|
|
$ |
3,678
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
14,091
|
|
14. DISCONTINUED OPERATIONS/ASSETS
HELD FOR DISPOSITION
Financial
Statements for the year ended December 31, 2003, 2004 & 2005 have been
reclassified to account for the following discontinued operations and/or assets
held for disposition.
1. Guangzhou Yueshen Taiyang Network
Science and Technology Limited (“Yueshen”)
During
the year ended December 31, 2004 the Company impaired its investment in Yueshen.
As of December 31, 2006, the Company recorded disposal loss of
$504,000.
On 12
August, 2006, to recover the loan advanced to Yueshen, we commenced a law suit
in the High Court of the Hong Kong Special Administrative Region ("HKSAR")
against i) Guangzhou Yueshen Taiyang Network Science and Technology Limited as
borrower and both ii) Ms. Li Yan Kuan and iii) Mr. Yi Wen as guarantors for the
loan sum of RMB 2,000,000 ("Debt Sum") together with the agreed interest rate
calculated at 6% per annum all due on 15 November, 2005 according to the
promissory note and guarantee entered into by the three defendants on 15 May,
2005.
2.
Guangzhou Clickcom Digit-net Science and Technology Ltd.
(“Clickcom”)
Operations
of Clickcom were discontinued and became dormant during the year as a result of
poor business and market prospects. Former staffs of Clickcom have been
reassigned to MOABC. Nominal amount of fixed assets are subject to disposition.
Accordingly, Clickcom has been classified as Asset Held for Disposition in 2006.
Approximately $400,000 of goodwill carried for Clickcom has been charged to
impairment by the Company at the year end of 2006.
3.
Beijing Linkhead Technologies Company Limited (“Linkhead”)
Due to
bleak industry prospects, board of directors of Linkhead had resolved a special
board resolution in January 2007 to direct management to engage in active search
for willing buyers to acquire or prepare to enter into liquidation process.
Accordingly, Linkhead has been classified as Asset Held for Disposition in 2006.
Approximately $4 million of goodwill carried for Linkhead has been charged to
impairment by the Company at the year end of 2006.
4.
Guangzhou 3G Information Technology Co. Ltd. (“GZ3G”)
On April
30, 2007, the Company entered into a definitive agreement
with HeySpace International Limited to sell PacificNet’s 51% equity
ownership of GZ3G group of companies for a consideration of $6 million.
Accordingly, GZ3G has been classified as Asset Held for Disposition in 2006.
Approximately $2.1 million in goodwill being carried on the Company’s books had
been written down to level the Company’s total carrying cost of GZ3G to the
intended disposition value.
5. Lion
Zone Holdings Ltd. (“Lion Zone”)
On
November 20, 2006, PacificNet executed an agreement ("Termination Agreement") to
terminate the Sale and Purchase Agreement with Lion Zone, ChinaGoHi and Mr. Wang
Wenming (collectively, the "Sellers"). The Termination Agreement was effective
as of November 1, 2006. In the Termination Agreement, the Sellers agreed to pay
an aggregate of HKD$3,000,000, comprising: USD$100,000 in cash and 275,000 in
restricted shares of PACT, in exchange for 51% interest of Lion Zone, holding
company of ChinaGoHi. Additionally, the Sellers agreed to waive PacificNet's
obligations under the Sale and Purchase Agreement entered into between
PacificNet and the Sellers in December 2005 to issue restricted shares and to
provide certain loans to the Sellers. PacificNet, however, reserves the rights
to re-purchase the said 51% interest of Lion Zone within 2 years of the date of
signing the Termination Agreement for a consideration of 5 times audited net
profit under US GAAP for the 12-month period subsequent to the year of
signing.
The
following is a summary of discontinued operations/ to be discontinued
operations:
|
|
Yueshen
|
|
|
ChinaGoHi
|
|
|
Linkhead
|
|
|
G3G
|
|
|
Clickcom
|
|
|
Total
|
|
Investment
|
|
$ |
-
|
|
|
$ |
4,475
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
4,475
|
|
Impairment
of investment
|
|
|
-
|
|
|
|
(1,233 |
) |
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
(1,233 |
) |
Net
earnings consolidated into PACT
|
|
|
-
|
|
|
|
175
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
175
|
|
Consideration
received/receivable
|
|
|
-
|
|
|
|
3,947
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
3,947
|
|
Gain
on disposal
|
|
|
-
|
|
|
|
530
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
530
|
|
Loss
on disposal
|
|
|
(504 |
) |
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
(504 |
) |
Income/(loss)
from discontinued operations
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,089 |
) |
|
|
1,206
|
|
|
|
(4 |
) |
|
|
113
|
|
Net
assets for disposal /to be sold
|
|
$ |
-
|
|
|
$ |
-
|
|
|
$ |
1,142
|
|
|
$ |
6,709
|
|
|
$ |
813
|
|
|
$ |
8,664
|
|
15. CURRENT VULNERABILITY DUE TO
CERTAIN CONCENTRATIONS
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environments in the PRC, by the general state of
the PRC's economy. The Company's business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation, among other things.
16. EVENTS SUBSEQUENT TO DECEMBER 31,
2006 (UNAUDITED)
1) SALE OF
PACIFICNET TELECOM SOLUTIONS 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.
2) SALE OF
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.
3) SALE OF
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.
4) SALE OF
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.
5) SALE OF
GUANGZHOU 3G (“GZ3G”)
As part
of our strategy to move away from telecom VAS, on April 30,2007 our wholly-owned
subsidiary, PacificNet Strategic Investment Holdings Limited, entered into a
stock purchase and sale agreement with Heyspace International Limited to sell
its 51% interest in Guangzhou 3G's parent company, Pacific 3G Information &
Technology Co. Limited. The purchase price is $6,000,000 payable in installments
over a six month period or earlier if Heyspace completes its initial public
offering prior to October 31, 2007.
6) SALE OF
CONVERTIBLE DEBENTURES BY OUR SUBSIDIARY PACIFICNET GAMES
LIMITED
On
February 9, 2007, the Company through its subsidiary, PacificNet Games Limited
(PacGames) entered into a definitive agreement for a $5 million financing in the
form of a convertible secured note from Pope Asset Management, LLC (Pope), an
institutional investor. Proceeds from the financing will be used to provide
PacGames with additional working capital to expand its gaming technology
operations, to make further synergistic acquisitions in China and for general
corporate purposes.
The $5
million financing, evidenced by a convertible secured note issued by PacGames to
Pope, matures on February 6, 2010, and may be converted into 26% to 32%
ownership interest in PacGames based on reaching certain net income milestones
during fiscal year 2007. The interest rate on the convertible debenture will
initially be set at 8%, and shall increase to 15% if the note is not converted
prior to maturity.
7) SALE OF
BEIJING LINKHEAD TECHNOLOGIES COMPANY LIMITED (“Linkhead”)
Due to
bleak industry prospects, board of directors of Linkhead had resolved a special
board resolution in January 2007 to direct management to engage in active search
for willing buyers to acquire or prepare to enter into liquidation process.
Accordingly, Linkhead has been classified as Asset Held for Disposition in 2006.
Approximately $4 million of goodwill carried for Linkhead has been charged to
impairment by the Company at the year end of 2006.
8) ACQUISITION
OF GUANGDONG POLY BLUE EXPRESS
COMMUNICATIONS CO.LTD. ("Guangdong Poly")
On Sep 5,
2007, we have entered into an agreement to acquire 51% equity interest in
Guangdong Poly Blue Express Communications Co., Ltd. (Guangdong Poly). The
acquisition is expected to enable PacificNet, through its operating subsidiaries
in China, to participate in China's rapidly growing state-sponsored legalized
gaming and electronic lottery operations. 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. The Company expects this
acquisition to be accretive to 2008 earnings.
According
to the agreement, PacificNet Technology (Shenzhen) Limited and PacificNet Games
Limited will acquire 34% and 17% of Guangdong Poly Blue Express Communications
Co., Ltd, respectively. The investment in Guangdong Poly is structured
dependent on the achievement of certain profit milestones. The investment by
PacificNet is subject to the successful completion of customary due diligence
and final documentation. The financial terms of the deal were not
disclosed.
9) ADDDITIONAL
ACQUISITION OF TAKE1 TECHNOLOGIES IN Q1 2007
On
January 05, 2007, we entered into an agreement for PacificNet to exercise the
option to acquire an additional 31% interest in Take1 Technologies Limited
(“Take1”) (formerly known as “CHEER ERA LIMITED”). The completion date for the
new Securities Subscription Agreement was March 5, 2007, with a consideration of
$721,887 (paid entirely with shares of PacificNet: 149,459 PACT Shares, valued
at $4.83 per share). As a result, PacificNet has become the majority and
controlling shareholder of Take1 with our ownership percentage increased from
20% to 51%. Take1 is a leading designer, developer and manufacturer of gaming,
multimedia entertainment and communication kiosk products including casino-use
electronic gaming tables, photo and video entertainment kiosks, digital camera
photo development stations, multimedia messaging services (MMS) and mobile
content download stations for mobile phones, and other coin-operated peripherals
and consumables. Take1 Technologies is based in Hong Kong and markets and
distributes its products around the world including the USA, Canada, Mexico,
Europe, China, and Southeast Asia.
10) PACIFICNET INC., V/S 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., complaining against
non-payment of mandatory default amount on convertible debentures of $3,000,000
and $420,000.
As of
October 2, 2007, the outstanding principal amount of the $3,000,000 debenture is
$2,045,452 and accrued but unpaid interest amount is $30,682.
The
mandatory default amount due to Iroquois Master Fund, Ltd. pursuant to amended
debenture (as amended in February 2007) is $2,698,974 on $3,000,000 convertible
debenture.
As of
October 2, 2007, the outstanding principal amount of the $420,000 debenture is
$420,000 and accrued but unpaid interest amount is $6,300.
The
mandatory default amount due to Iroquois Master Fund, Ltd. is $554,190 on
$420,000 convertible debenture.
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.
17. LEGAL
PROCEEDINGS
1. Legal Proceeding and Judgment
Against Guangzhou Yueshen Taiyang Network Science and Technology Limited, Ms. Li
Yan Kuan, and Mr.Wu Yi Wen
On August
12, 2006, we commenced a law suit in the High Court of the Hong Kong Special
Administrative Region ("HKSAR") against Guangzhou Yueshen Taiyang Network
Science and Technology Limited, Ms. Li Yan Kuan, (PRC ID:
440112195706120967, Residential Address: Room G6-305, West Garden,
FuLiHuanShi, HuanShi West Road, LiWan District, Guangzhou, Guangdong,
China) and Mr.Wu Yi Wen, (PRC ID: 440106196412220919, Residential
Address: Room 906, Number 15, SiHeng Road Number 2, TianHe YuanChun, Guangzhou,
Guangdong, China) for failure to pay amounts owed under a promissory
note. On May 15, 2005, we loaned RMB2,000,000 ("Debt Sum") to Yueshen
to cover operating costs, evidenced by a promissory note due on November 15,
2005. Ms. Kuan and Mr. Wen guaranteed repayment of the note by
Yueshen. The Debt Sum together with the agreed interest rate
calculated at 6% per annum was due on November 15, 2005.
On March
28, 2007, the High Court of HKSAR had adjudged that the three defendants should
pay us the Debt Sum together with interest sum at the rate of 6% per annum
from May 15, 2005 to March 28, 2007, and additional
interest charged at the rate of 5% per annum for the Debt Sum and accrued
interest within 90 days overdue and thereafter at the judgment rate until
payment and fixed costs of HK$3,405.
2. Lawsuit between PacificNet Power
Limited and Johnson Controls Hong Kong Limited (JCHKL), a subsidiary of Johnson
Controls Inc. (NYSE:JCI) (www.jci.com )
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a claim against
PacificNet Power Limited (a 51% owned subsidiary of PacificNet) in the High
Court of the Hong Kong Special Administrative Region seeking HK$4,800,000 as
payment for services rendered to replace 3 sets of trane water-cooled chillers,
together with energy saving performance (the "Chiller System"), at the Fortress
Tower in Hong Kong.
In
connection with the claim, PacificNet Power reviewed a letter from its client,
China Weal Property Management Ltd., dated January 22, 2007 stating that the
construction work by JCHKL had not been completed as of the date of the letter,
and that certain violations itemized in a letter issued by the Hong Kong
Environment Protection Department (EPD) (Noise Abatement Notice No.
N806030) addressed to JCHKL with respect to acoustic problems with JCHKL’s
equipment had not been abated. Further, JCHKL was to pay penalties
between HK$100,000 and HK$200,000 assessed by the JCHKL for failing to fix the
noise problem on the roof of Fortress Tower.
The board
of directors of PacificNet Power Limited has reviewed the case with its client,
China Weal Property Management Ltd., and our Hong Kong legal counsel and it is
our belief that the project work undertaken JCHKL is defective in numerous
aspects, as evidenced by the letter from government letter issued by
EPD. As a result, we believe the construction work was not been
completed by JCHKL, and therefore, JCHKL is not entitled to payment for its
services.
On
February 7, 2007, we instructed our Hong Kong legal counsel to issue a Defense
and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's construction work
has not complied with the applicable rules and regulations of various government
authorities in Hong Kong; (ii) the Chiller System provided by JCHKL was
defective and merchantable unfit and JCHKL has failed and/or refused to rectify
such defective works; and (iii) JCHKL shall return the work deposit in the
amount of HK$1,500,000 to PacificNet Power Limited and shall
compensate and keep PacificNet Power Limited indemnified against all the loss
and damages suffered as a result of any claims from the China Weal Property
Management Ltd, the employer and the potential tenants of Fortress
Tower.
The case
is under review by Hong Kong High Court and we have not received any judgment
from the High Court of the Hong Kong Special Administrative Region as of date of
this report. We are currently proceeding with discovery and counter-claims, and
we intend to vigorously defend ourselves against the allegations. We are unable
to predict the outcome of these actions, or a reasonable estimate of the range
of possible loss, if any.
3. Lawsuit between PacificNet Power
Limited and Johnson Controls Hong Kong Limited (JCHKL), a subsidiary of Johnson
Controls Inc. (NYSE:JCI) (www.jci.com )
On or
about December, 2005, Johnson Controls Hong Kong Limited approached PacificNet
Power Limited (a 51% owned subsidiary of PacificNet) and made a representation
that they had submitted a tender to “The Incorporated Owners of Nan Fung Centre,
Tsuen Wan (“the Employer”) for the “construction and replacement works of
existing air-cooled chiller plant by new water-cooled chiller plant for Tsuen
Wan Nan Fung Centre and energy saving performance contract” (“the Construction
and Replacement Works Contract”). JCHKL invited and induced PacificNet Power
Limited to act as the main contractor for the Contract and it would then act as
a sub-contractor.
PacificNet
Power also expressly made known to JCHKL that the said construction and
replacement works and the guaranteed energy saving should meet all the tender
requirements if PacificNet Power accepted the invitation to act as the main
contractor for the Contract, and PacificNet Power further said that if there
should be any quality defects with the system and/ or the construction work, the
Employer and/ or their prospective tenants would claim against JCHKL and JCHKL
should compensate.
PacificNet
Power however received some correspondences and complaints from the Employer
and/ or their representatives about the poor and/ or sub-standard works done by
JCHKL. PacificNet Power, after separate investigation, discovered the poor
workmanship and sub-standard works done by JCHKL. Accordingly, the Employer and/
or their representatives have delayed the monthly installments payment to
PacificNet Power.
On April
23, 2007, we instructed our lawyers issued a letter to the Defendant requesting
and demanding them, being the sub-contractor of the Construction and Replacement
Works Contract, to take immediate rectification action within seven days from
the date of the said letter to (i) rectify and complete all outstanding
defective works of the Construction and Replacement Works Contract; (ii) replace
the water-cooled chiller plant and/or equipments which are not conformed with
the requirements of the tender documents previously submitted by the Defendant
to the Employer; and (iii) improve the poor performance of energy saving of the
new water-cooled chiller plant so that it would conform with their guarantee
made on 21 December, 2005 to PKL and the employer.
Despite
the said letter, JCHKL had failed and/ or refused to rectify and complete all
outstanding works and/ or replace the defective system. And therefore PacificNet
Power claims against JCHKL for: (i) refund HK$6,414,300.00, being the Contract
Price paid by PacificNet Power to JCHKL; (ii) costs and expenses incurred by
Power to rectify all defective works of the Contract; (iii) all damage and loss
suffered by PacificNet Power, and further and other relief.
On July
25, 2007, JCHKL issued a Defense and Counterclaim to PacificNet Power to
counter-claim that: (i) a concrete base was discovered after the existing
dismantled radiators was not indicated in tender drawings nor could it be
revealed by site visit; (ii) JCHKL could not have carried out the works under
the Contract without first demolishing the said concrete base; (iii) by a letter
from JCHKL to PacificNet Power dated 22 May, 2007, PacificNet Power was informed
additional works had been carried out by JCHKL; (iv) a sum of HK$30,000 is still
due and owing by PacificNet Power to JCHKL.
The case
is now proceeding to the stage of fixing a date for trial in the High Court of
Hong Kong. We are unable to predict the outcome of these actions, or a
reasonable estimate of the range of possible loss, if any.
18.
RESTATEMENT
On
March 19, 2007 the 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. Independent investigation in this connection commissioned by
our Audit Committee resulted in extra stock-based compensation charges of
approximately $0.3 million, $1.2 million and $0.1 million to each of the years
ended December 31, 2005, 2004 and 2003, respectively.
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.
Below
is the detailed effect of the restatement (In thousands of US
Dollars):
|
|
2006
|
|
|
2006
|
|
|
2005
|
|
|
2005
|
|
|
|
As
reported
|
|
|
As
restated
|
|
|
As
reported
|
|
|
As
restated
|
|
Consolidated
Balance Sheets:
|
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets
|
|
$ |
17,041 |
|
|
$ |
17,041 |
|
|
$ |
31,130 |
|
|
$ |
12,997 |
|
Non-current
assets
|
|
|
24,841 |
|
|
|
19,885 |
|
|
|
20,073 |
|
|
|
14,937 |
|
Total
assets
|
|
$ |
41,882 |
|
|
$ |
36,926 |
|
|
$ |
51,203 |
|
|
$ |
27,934 |
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
$ |
17,376 |
|
|
$ |
17,376 |
|
|
$ |
10,620 |
|
|
$ |
3,799 |
|
Non-current
liabilities
|
|
|
2,704 |
|
|
|
2,704 |
|
|
|
84 |
|
|
|
84 |
|
Total
liabilities
|
|
|
20,080 |
|
|
|
20,080 |
|
|
|
10,704 |
|
|
|
3,883 |
|
Minority
interest
|
|
|
6,874 |
|
|
|
2,869 |
|
|
|
8,714 |
|
|
|
846 |
|
STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
Treasury
stock
|
|
|
(257 |
) |
|
|
(272 |
) |
|
|
(119 |
) |
|
|
(134 |
) |
Additional
paid-in capital
|
|
|
63,124 |
|
|
|
65,757 |
|
|
|
57,690 |
|
|
|
61,979 |
|
Cumulative
other comprehensive income (loss)
|
|
|
220 |
|
|
|
(42 |
) |
|
|
247 |
|
|
|
(15 |
) |
Accumulated
deficit
|
|
|
(47,739 |
) |
|
|
(51,090 |
) |
|
|
(25,990 |
) |
|
|
(38,627 |
) |
Stock
subscription receivable
|
|
|
(421 |
) |
|
|
(377 |
) |
|
|
(44 |
) |
|
|
|
|
TOTAL
STOCKHOLDERS' EQUITY
|
|
|
14,928 |
|
|
|
13,977 |
|
|
|
31,785 |
|
|
|
23,204 |
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
41,882 |
|
|
$ |
36,926 |
|
|
$ |
51,203 |
|
|
$ |
27,934 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
Statements of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenue
|
|
$ |
42,738 |
|
|
$ |
42,738 |
|
|
$ |
44,341 |
|
|
$ |
17,307 |
|
Cost
of sales
|
|
|
(36,217 |
) |
|
|
(36,217 |
) |
|
|
(33,439 |
) |
|
|
(13,221 |
) |
Gross
profit
|
|
|
6,521 |
|
|
|
6,521 |
|
|
|
10,902 |
|
|
|
4,086 |
|
Selling,
General and Administrative expenses
|
|
|
(5,810 |
) |
|
|
(11,126 |
) |
|
|
(6,333 |
) |
|
|
(5,447 |
) |
Stock-based
compensation expenses
|
|
|
(242 |
) |
|
|
(242 |
) |
|
|
- |
|
|
|
(282 |
) |
Income/(loss)
from operations
|
|
|
(13,988 |
) |
|
|
(7,533 |
) |
|
|
4,569 |
|
|
|
(5,608 |
) |
Income/(loss)
before income taxes, minority interest and discontinued
operations
|
|
|
(19,106 |
) |
|
|
(12,661 |
) |
|
|
5,645 |
|
|
|
(5,219 |
) |
Income/(loss)
before discontinued operations
|
|
|
(18,999 |
) |
|
|
(12,554 |
) |
|
|
2,498 |
|
|
|
(5,880 |
) |
Net
income available to common stockholders
|
|
$ |
20,093 |
|
|
$ |
(12,415 |
) |
|
$ |
2,489 |
|
|
$ |
(5,145 |
) |
Earnings/(loss)
per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
(1.78 |
) |
|
$ |
(1.08 |
) |
|
$ |
0.25 |
|
|
$ |
(0.51 |
) |
Diluted
|
|
$ |
(1.78 |
) |
|
$ |
(1.08 |
) |
|
$ |
0.23 |
|
|
$ |
(0.51 |
) |
Shares
used in computing earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
11,258,547 |
|
|
|
11,538,664 |
|
|
|
10,154,271 |
|
|
|
10,156,809 |
|
Diluted
|
|
|
11,964,587 |
|
|
|
11,538,664 |
|
|
|
10,701,211 |
|
|
|
10,156,809 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$ |
20,093 |
|
|
$ |
(12,415 |
) |
|
$ |
2,489 |
|
|
$ |
(5,145 |
) |
Stock-based
compensation
|
|
|
242 |
|
|
|
242 |
|
|
|
- |
|
|
|
282 |
|
Net
cash provided by (used in) operating activities
|
|
|
(8,885 |
) |
|
|
(8,190 |
) |
|
|
9,250 |
|
|
|
5,635 |
|
Net
cash used in investing activities
|
|
|
(1,297 |
) |
|
|
(3,313 |
) |
|
|
(6,199 |
) |
|
|
(10,893 |
) |
Net
cash provided by (used in) financing activities
|
|
|
8,638 |
|
|
|
9,943 |
|
|
|
24 |
|
|
|
(696 |
) |
Effect
of exchange rate on cash & cash equivalent
|
|
|
(43 |
) |
|
|
(27 |
) |
|
|
(260 |
) |
|
|
7 |
|
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
|
$ |
(1,587 |
) |
|
$ |
(1,586 |
) |
|
$ |
2,815 |
|
|
$ |
(5,947 |
) |
b
F-37