pacificnet_10k-123107.htm
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF
1934 FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2007
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR
THE TRANSITION PERIOD FROM _________ TO __________
COMMISSION
FILE NUMBER: 000-24985
PACIFICNET
INC.
(Exact
name of registrant in its charter)
DELAWARE
|
91-2118007
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification Number)
|
|
|
23/F,
TOWER A, TIMECOURT, NO.6 SHUGUANG XILI,
CHAOYANG
DISTRICT, BEIJING, CHINA 100028
|
N/A
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant's
Telephone Number: 0086-10-59225000
Room
4203, Jinzhonghuan Business Building, Futian District, Shenzhen, China. Postal
Code: 518040
(Former
Name and Address)
Securities
Registered under Section 12(b) of the Exchange Act: NONE
Securities
Registered under Section 12(g) of the Exchange Act: Common Stock, par value
$0.0001
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act YES o NO x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act YES o NO x
Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days YES x NO o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is contained herein, and will not be contained, to the best of
the registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
Indicate
by check mark if the registrant is a large accelerated filer, an accelerated
filer or a non- accelerated filer.
Large
Accelerated Filer o
|
Accelerated
Filer o
|
Non-Accelerated
Filer x
|
Small
Reporting Company o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12(b) of the Exchange Act). Yes o No x
TABLE OF
CONTENTS
PART
I
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3
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ITEM
1. BUSINESS
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3
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ITEM
2. PROPERTIES
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35
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ITEM
3. LEGAL PROCEEDINGS
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35
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ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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37
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PART
II
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38
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ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
PURCHASES OF EQUITY SECURITIES
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38
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ITEM
6. SELECTED FINANCIAL DATA
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40
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ITEM
7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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40
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ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
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53
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ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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F-1
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ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
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54
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ITEM
9A. CONTROLS AND PROCEDURES
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54
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ITEM
9B. OTHER INFORMATION
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55
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PART
III
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55
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ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
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55
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ITEM
11. EXECUTIVE COMPENSATION
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59
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ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
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65
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ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
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66
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ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
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66
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PART
IV
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67
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ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
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67
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This
annual report contains forward-looking statements within the meaning of the
federal securities laws. These include statements about our expectations,
beliefs, intentions or strategies for the future, which we indicate by words or
phrases such as "anticipate," "expect," "intend," "plan," "will," "we believe,"
"the Company believes," "management believes" and similar language. The
forward-looking statements are based on our current expectations and are subject
to certain risks, uncertainties and assumptions, including those set forth in
the discussion under "Description of Business," including the "Risk Factors"
described in that section, and "Management's Discussion and Analysis or Plan of
Operation." Our actual results may differ materially from results anticipated in
these forward-looking statements. We base our forward-looking statements on
information currently available to us, and we assume no obligation to
update them.
PART I
ITEM
1. BUSINESS
As used
in this report, "we", "us," "our," "Company", "PacificNet" or "PACT" refers to
PacificNet Inc., a Delaware corporation.
OVERVIEW
PacificNet,
Inc. (NASDAQ: PACT) is a leading developer and provider of gaming technology for
the land-based, online and mobile game operators in Asia. Established in 2000 as
a provider of e-commerce and Customer Relationship Management (CRM) solutions
for the China market, the company changed focus in 2006 and has been divesting
its legacy telecom and CRM business while pursuing a strategy to focus on gaming
technology and games development for the global gaming market. Due to the
contribution of the highly experienced executives of our gaming subsidiaries,
including PacificNet Games (PactGames) and Take1 Technologies (Take 1),
PacificNet is able to offer world-leading solutions in casino equipment supply
and in the development, installation and support of systems and game content for
the casino, lottery and Amusement With Prizes (AWP) markets. Positioning itself
as a systems integrator for the gaming industry, with a special focus on the
emerging markets, PacificNet enables customers to integrate gaming operations,
linking electronic gaming machines, tables and larger networks so that operators
can build efficient and highly attractive gaming operations that drive revenue
growth and profit opportunity and enhance the customer experience. PacificNet's
gaming clients include leading hotels, casinos, and gaming operators in Asia,
Europe, and other gaming markets around the world. The Company employs
approximately 500 staff in its various subsidiaries with offices in Macau, Hong
Kong, China, Philippines, and the US.
During
the year we took decisive measures to address the negative impact on our overall
profitability as a result of China Mobile’s VAS policy change and the
increasingly competitive telecom products market in China. These measures
included considering strategic alternatives for our low-margin telecom
businesses, such as sales, spin-offs and mergers and turning our focus to the
higher margin and rapidly expanding gaming and entertainment industries. To do
this, in September 2006, we opened an office in Macau. By leveraging the
entertainment software and hardware development expertise of our CRM and telecom
businesses in combination with the access to market of our newly-acquired
PacificNet Games Limited subsidiary, we seek to brand ourselves as a leading
gaming technology provider in the emerging gaming markets in Macau and Asia. We
believe that due to the success of our new generation Asian oriented gaming
software, our gaming business has begun to draw the attention of some other
first tier gaming operators in Macau, North Asia, South America and Italy. Going
forward, while we are focused on increasing market share in the aforementioned
rapidly growing gaming markets, we intend to take full benefit of our
first-mover advantage in the Asian market by entering into long term gaming
software licensing and servicing agreements with both land-based and on-line
gaming operators in those less developed South-East Asian gaming markets, in
particular the Philippines and Cambodia.
PacificNet’s
Operations include the following four groups:
1. Software Outsourcing
Services. We provide (1) Business Process Outsourcing (BPO), such as call
centers, CRM and telemarketing services and (2) IT Outsourcing (ITO), such as
outsourced software programming and development services in our CMM3 Certified
software development center in China. Our business process outsourcing services
generate revenues from call center services, call center management software
sales, and training and consulting. We invoice our call center clients monthly
at per seat monthly rates, a base price plus commission per call, or a per hour
charge rate, depending on the client's preference. Our call center software
clients pay per license, for which there is usually a one-time charge on sale of
the software and annual maintenance fees for service.
2. Telecom Value-Added Services
(VAS). We are value-added resellers and providers of Content Providing
(CP), Platform Providing (PP) and Service Providing (SP) telecom VAS, such as
Interactive VoiceResponse (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). We charge per
project for our consulting and training services and for our telecom VAS, which
are invoiced throughout the project. Our telecom VAS often includes a post-sale
service contract for systems integration and consulting services for which we
bill separately.
3. Telecom and Gaming Products
and Services. Our telecom and gaming products and services include
distribution services, multimedia interactive self-service kiosk distribution,
online mobile phone distribution, and the design, manufacture, and marketing of
gaming machines (Asian multi-player electronic gaming machines). In addition to
gaming machines, we also offer the leading hotel, casino and slot hall operators
based in Macau, China and other Asian gaming markets a wide range of gaming
technology solutions including gaming related maintenance. Our
products (telecom & gaming) and services group generates revenue from two
main streams. We generate revenue from the sale of entertainment kiosks and cell
phones (which are sold cash-on-delivery) and we generate revenue from the sale
of Asian multi-player electronic gaming machines and gaming technology
solutions. Going forward, we intend to earn gaming operations revenue from
offering our customers a wide range of lease and rental options and earn royalty
income from game content licensing agreements.
4. Other Business
Services. We have a number of subsidiaries that we use primarily for
administration, internal control and acquisition purposes.
CORPORATE
STRUCTURE
We
conduct our business operations through operating subsidiaries in our Gaming
Technology Business Unit and our Legacy Business Unit:
(I)
GAMING TECHNOLOGY BUSINESS
TAKE1 TECHNOLOGIES GROUP
LIMITED ("TAKE1")
Take1
Technologies (http://www.take1technologies.com), is in the business of designing
and manufacturing electronic multimedia entertainment kiosks, coin-op kiosks and
machines, Electronic Gaming Machines (EGM), bingo and slot machines, Amusements
With Prizes(AWP) games, server-based downloadable games systems, and Video
Lottery Terminals (VLT) such as Keno and Bingo machines, including hardware,
software, client-server systems and cabinets. Take1 is a leading designer,
developer and manufacturer of multimedia entertainment and communication kiosk
products including photo and video entertainment kiosks, digital camera photo
development stations, Multimedia Messaging Services (MMS) and mobile content
download stations for mobile phones, and other coin-operated peripherals and
consumables. Take1 Technologies is based in Hong Kong and markets and
distributes its products around the world including the USA, Canada, Mexico,
Europe, China, and Southeast Asia.
PACIFICNET GAMES LIMITED
(PactGames)
PacificNet
Games Limited (“PactGames”, www.PactGame.com) is a leading provider of Asian
multi-player electronic gaming machines, gaming technology solutions, gaming
related maintenance, IT and distribution services for the leading hotel, casino
and slot hall operators based in Macau, China and other Asian gaming
markets.
(II)
LEGACY TELECOM AND CRM BUSINESS
(A)
SOFTWARE & OUTSOURCING SERVICES GROUP
1) PACIFICNET EPRO HOLDINGS
LIMITED: PacificNet Epro Holdings Limited (referred to herein as "Epro"),
a company incorporated in the Hong Kong Special Administrative Region of the
PRC, is engaged in the business of providing call center and Customer
Relationship Management (CRM) services, mobile marketing and promotion services,
call center training, management and consulting services. Epro was sold on April
18, 2008 for an aggregate purchase price of HK$21 million.
2) PACIFIC SMARTIME
SOLUTIONS LIMITED / PACIFIC SOLUTIONS TECHNOLOGY (SHENZHEN) CO. LTD. (PactSo):
Pacific Smartime Solutions Limited (referred to herein as "Smartime") is
an IT outsourcing company incorporated in Hong Kong that operates through its
China subsidiary Pacific Solutions Technology (Shenzhen) Co. Ltd. (referred to
herein as: PactSo), which is a leading provider of outsourcing services
including software development, R&D, and project management services in
China. Smartime employs over 280 staff and provides outsourcing services to the
leading telecom, banking and financial services companies in China, including
Huawei, IBM, and Bank of East Asia. In December 2004, Smartime launched a new
software development outsourcing center in Shenzhen, currently occupying one
floor with 13,000 square feet. PacificNet's software R&D and outsourcing
unit, Pacific Solutions Technology, is a CMM Level 3 certified software
development center with over 200 software programmers and specializes in the
development of high-end client-server application software, internet e-commerce
software, online and casino gaming systems and slot machines, banking and
telecom applications using Microsoft Visual C++, Java, and other rapid
application development tools.
(B)
TELECOM VALUE-ADDED SERVICES (VAS) PROVIDER
GUANGZHOU WANRONG
INFORMATION TECHNOLOGY CO., LIMITED (Incorporated in the
PRC)
Guangzhou
Wanrong Information Technology Co., Ltd. ("Guangzhou Wanrong,) is one of the
leading value-added telecom service providers in China. Since its inception in
2003, Guangzhou Wanrong has achieved strong growth in its VAS including SMS,
WAP, JAVA, MMS, IVR, multimedia entertainment download services, media
interactive products, mobile email services, life, sports, entertainment, and
business information services. Guangzhou Wanrong was granted nationwide SMS
service numbers "2388" for China Mobile and "9928" for China
Unicom.
(C)
PRODUCTS GROUP
1) PACIFICNET COMMUNICATIONS
LIMITED
PacificNet
Communications Limited (referred to herein as "PactCom"), incorporated in Hong
Kong, is a wholly owned subsidiary of PacificNet that specializes in the sales
and distribution of mobile communication products, accessories, phone cards and
mobile SIM cards, and telecom related services in Hong Kong and Greater
China.
2) PACIFICNET IMOBILE
(BEIJING) TECHNOLOGY CO., LIMITED (Incorporated in the PRC)
PacificNet
iMobile (Beijing) Technology Co., Ltd ("iMobile") is the leading internet
e-commerce distributor of mobile products in China. It provides Internet, email,
customer service centers, pre and post-sale services, logistics and Cash On
Delivery (COD) services to mobile consumers in China. iMobile's 18900.com
e-commerce operations combine online internet services with its offline customer
services network comprised of a nationwide chain of logistics and customer
service centers covering 21 provinces and 40 major cities in China including
Beijing, Shanghai, Chongqing, Tianjin, Chengdu, Dalian, Qingdao, Guangzhou,
Shenzhen, Zhuhai, Dongguan, Hangzhou, Suzhou, Ningbo, Wenzhou, Nanjing, Wuhan,
Xian, Harbin, Qiqihaer, Hunan and Changsha. iMobile has developed into the
largest online mobile phone sales company in China and has partnered with Sina,
Netease, China.com, joyo.com, and 263.net on e-commerce cooperation. iMobile's
18900.com operation is the designated Internet distributor for Motorola, Nokia,
and NEC's mobile products in China.
OTHER
BUSINESS ENTITIES
1) PACIFICNET LIMITED
(INCORPORATED IN HONG KONG)
PacificNet
Limited is incorporated in Hong Kong as a wholly owned subsidiary of PacificNet
Inc. Its primary purpose is to handle the general administrative operations of
PacificNet in Hong Kong.
2) PACIFICNET STRATEGIC
INVESTMENT HOLDINGS LIMITED (Incorporated in the BVI)
PacificNet
Strategic Investment Holdings Limited (referred to herein as "PactInvest"),
incorporated in the British Virgin Islands (BVI), is a wholly owned subsidiary
of PacificNet that specializes in strategic investment, direct investment,
mergers and acquisitions, joint venture development, and other financial and
investment services in Hong Kong and Greater China. Its primary purpose is to
help PacificNet identify strategic investment opportunities, process deal flow,
conduct due diligence, negotiate terms and valuation, monitor investment
performance and conduct synergy development, with a focus in China investment
opportunities related to PacificNet's business.
3) PACIFICNET TECHNOLOGY
(SHENZHEN) LIMITED (Incorporated in the PRC)
PacificNet
Technology (Shenzhen) Limited (referred to herein as "PactSZ") incorporated in
the PRC as a Wholly Owned Foreign Enterprise (WOFE), is a wholly owned
subsidiary of PacificNet Limited Hong Kong. Its primary purpose is to provide
administrative support back-office, IT support and software development
services, to support PacificNet's operations in China and to conduct the general
administrative operations of PacificNet in China.
4) PACIFICNET BEIJING
LIMITED (Incorporated in the PRC)
PacificNet
Beijing Limited (referred to herein as "PactBJ") incorporated in the PRC as a
wholly owned foreign enterprise (WOFE) is a wholly owned subsidiary of
PacificNet Limited Hong Kong. Its primary purpose is to provide administrative
back-office support, IT support and software development services, to support
PacificNet's operations in China, and to conduct the administrative operations
of PacificNet in China.
DEVELOPMENTS
DURING FISCAL YEAR 2007
1) JOINT VENTURE WITH
BELLSYSTEM24 JAPAN TO PROVIDE CALL CENTER & CRM SERVICES IN SHANGHAI, CHINA
(BELL-PACT)
On
January 5, 2007, we entered into a joint venture agreement with Bellsystem24,
the largest telemarketing call center in Japan, to form a new joint venture
company called BELL-PACT Consulting Limited. The new joint venture company is
jointly owned 40% by PacificNet and 60% by Bellsystem24. The joint venture
offers CRM call center consulting and training services, technical and business
consulting services, network product sales, software development, system
integration, as well as value-added services and other relevant services out of
Shanghai catering to the Greater China markets.
2) ACQUISITION OF ADDITIONAL
SHARES IN TAKE1 TECHNOLOGIES IN Q1 2007
On
January 5, 2007, we entered into a Securities Subscription Agreement to exercise
an option to acquire an additional 31% interest in Take 1 Technologies Limited
"Take 1". On May 3, 2007, we consummated the purchase for $594,847 (to be paid
entirely with shares of PacificNet: 149,459 PACT Shares, valued at $3.98 per
share). As a result, we became the majority and controlling shareholder of Take1
with our ownership percentage increased from 20% to 51%.
3) COMPLETION OF $5 MILLION
PRIVATE PLACEMENT FINANCING FOR GAMING TECHNOLOGY EXPANSION IN MACAU AND
ASIA
On
February 6, 2007, PactGames entered into a definitive agreement for a $5 million
financing in the form of a secured convertible note with Pope Asset Management,
LLC (Pope), an institutional investor. Proceeds from the financing were used to
provide PactGames with additional working capital to expand its gaming
technology operations, funding for strategic acquisitions in China and funding
for general corporate purposes. The $5 million convertible note issued by
PactGames to Pope matures on February 6, 2010, and may be converted into 26% to
32% ownership interest in PactGames based on reaching certain net income
milestones during fiscal year 2007. The interest rate on the convertible note
will initially be set at 8%, and shall increase to 15% if the note is not
converted prior to maturity.
4) PRIVATE PLACEMENT OF
CONVERTIBLE DEBENTURES AND WARRANTS
On March
13, 2006, we completed a private placement in which we sold $8,000,000 in
convertible debentures and issued warrants to purchase up to an aggregate of
400,000 shares of common stock. The debentures are convertible at any time into
shares of our common stock at an initial fixed conversion price of $10.00 per
share, subject to adjustments for certain dilutive events. The debentures are
due March 13, 2009. The warrants are exercisable for a period of five years at
an exercise price of $12.20 per share. We will pay interest in shares, provided
that certain conditions are met, or in cash at the rate of 6% for the second
year the debentures are outstanding and then 7% for the third year.
Under the
terms of a registration rights agreement entered into at the time of the private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April 30,
2006, and have the registration statement declared effective by the SEC no later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to the investors
at the rate of 2% of the principal amount of the debenture each month beginning
on June 28, 2006 up to a maximum of 20% per holder, in the event we suspend use
of the prospectus for longer than 15 consecutive calendar days or more than an
aggregate of 30 calendar days during any 12-month period. Moreover, at the
election of the debenture holder, our debenture could be declared in default,
resulting in acceleration of the amounts due, if such suspension continues more
than 20 consecutive trading days or 60 non-consecutive trading days during any
12-month period, which was equal to $1,120,000, in the aggregate as at December
31, 2006.
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 debentures
increased from $320,000 to $ 363,638. All other terms and conditions of the
original debenture remain in full force and effect.
In July
2007, we failed to timely make scheduled principal and interest payments under
the Amended Debenture in the aggregate amount of $8,000,000. Pursuant to the
terms of the Amended Debenture, we were obligated to make monthly redemption
payments commencing on January 1, 2007, until the Amended Debenture was redeemed
in full. On August 1, 2007, the Company made the July monthly redemption and
interest payments to all of the debenture holders. The Company has
calculated the amount of the direct financial obligation as accelerated and
increased to be $3,079,091.
5) SALE OF GUANGZHOU
3G
As part
of our strategy to move away from telecom VAS, on April 30, 2007, through our
wholly-owned subsidiary, PacificNet Strategic Investment Holdings Limited (“PSI
Holdings”), we entered into a stock purchase and sale agreement with Heyspace
International Limited to sell PSI Holdings’ 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. Heyspace paid an initial purchase price of $1,000,000. On November 25,
2007, we entered into a memorandum of understanding (“MOU”) with Heyspace.
Pursuant to the MOU, we agreed with Heyspace that for a period commencing on
November 25, 2007 through March 31, 2008, we are free to seek new buyers to
purchase PSI Holdings’ share ownership in Guangzhou 3G at a consideration and
term which at a minimum will not cause any disposal loss to us. In addition,
Heyspace agreed to return to us as part of the collateral the 46% ownership of
Guangzhou3G which Heyspace had agreed to purchase, but did not complete its
payment obligations under the stock purchase and sale agreement.
PacificNet
and Heyspace entered into a Supplement Agreement for 3G’s deal on 20th March,
2008. According to this supplement agreement, Heyspace should pay the remaining
USD$5,000,000 on or before 31 March, 2009, otherwise PacificNet has right to
reclaim the unpaid 46% shares of Pacific 3G Information & Technology Co.,
Limited, and demand for an annual interest rate of 12%.
RECENT
DEVELOPMENTS
1) SALE OF EPRO TELECOM -
CRM CALL CENTER
On April
18, 2008, PacificNet, consummated the sale of the Company's subsidiary,
PacificNet Epro Holdings Limited, a company incorporated in the Hong Kong
Special Administrative Region of the PRC ("Epro"), which is primarily engaged in
the business of providing call center telecom and customer relationship
management services as well as other business outsourcing services in China.
Pursuant to the terms of the Sales and Purchase Agreement (the "Agreement")
entered into between the Company and Epro Group International Limited (the "Epro
Group International"), PacificNet sold its entire share ownership of 7,766,993
shares in Epro for HK$21 million.
Upon
execution of the Agreement, the Company received a payment of HK$3 million.
PacificNet shall receive the remaining purchase price in installments over the
next twenty-four months.
Pursuant
to the terms of the Agreement, within sixty days of the closing, Epro shall
repay PacificNet HK$2 million for an interest bearing loan granted from
PacificNet to Epro.
2) NOTICE OF DELISTING OR
FAILURE TO SATISFY A CONTINUED LISTING RULE OR STANDARD; TRANSFER OF
LISTING.
On April
16, 2008, PacificNet received a letter from The NASDAQ Stock Market indicating
that as a result of the Company's failure to file with the Securities and
Exchange Commission the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2007, the Company is not in compliance with the NASDAQ
requirements for continued listing set forth in NASDAQ Marketplace Rule
4310(c)(14). NASDAQ Marketplace Rule 4310(c)(14) which requires the Company to
make on a timely basis all filings with the Securities and Exchange Commission,
as required by the Securities Exchange Act of 1934, as amended.
As a
result of failure to timely file the Annual Report on Form 10-K, PacificNet’s
securities were subject to delisting from the NASDAQ Stock Market at the opening
of business on April 25, 2008, unless PacificNet appealed such determination.
PacificNet has appealed the NASDAQ Staff's determination and requested a hearing
before the NASDAQ Listing Qualifications Panel, which automatically stayed the
delisting of PacificNet's common stock pending the Panel's review and
determination. The hearing has been set for June 12, 2008.
Although
there can be no assurance that the Panel will grant the Company's request for
continued listing, once the 10-K and 10-Q are filed, the Company believes the
NASDAQ non-compliance situation will be remedied.
PRODUCTS
AND SERVICES OFFERED
Gaming
Technology Operations
Through our gaming technology
subsidiaries in Macau, China, we design, manufacture and market innovative
electronic gaming machines, bingo machines, AWP and VLTs for customers in
legalized gaming jurisdictions in Macau, Asia, and Europe. Our video gaming
machines include localized Chinese and Asian themes, content, advanced graphics
and digital sound effects and music. Amusing, entertaining or familiar graphics
and musical themes with Chinese and Asian contents add to the player appeal of
our games in Asia.
For our
gaming technology operations, we generate revenue in two principal ways. First,
we generate product sales revenues from the sale to casinos and other licensed
gaming machine operators of new and used gaming machines and VLTs, conversion
kits (including theme and/or operating system conversions), parts, and original
equipment manufacturing (“OEM”) for third parties. Second, we earn gaming
operations revenues from leasing participation gaming machines and VLTs, and
earn royalties that we receive from third parties under license agreements to
use our game content.
Product
Sales
We offer
the following gaming technology products for sale:
Electronic
Gaming Machines (EGM). Our line of electronic gaming machines combine localized
Chinese and Asian themes and content, advanced graphics, digital sound effects
and music, and secondary bonus games.
• Multi-player
Electronic Table Games, eTable Series of Multiplayer Gaming
Machines
• Multi-player
Electronic Baccarat Machines
• Multi-player
Electronic Sicbo Machines
• Multi-player
Electronic Roulette Machines
• Multi-player
Electronic Fish-Prawn-Crab Machines
• Slot
Machines
• Electronic
Bingo Machines
• Video
Lottery Terminals (VLTs)
• Server-Based
Gaming Machines (SBG)
• Amusement
With Prizes (AWP) Machines
• Online
Gaming Software Development
• Client-Server
Gaming Systems
• CMM
Level 3 Certified Gaming Software Development Center in China
• Cabinet
Design and Sales, Parts Sales, OEM Games. We design and sell gaming machine
cabinets, replacement parts.
PACT
Gaming Technology
1. Participation games:
Company-owned gaming machines that we lease to casino operators based
upon any of the following payment methods: (1) a percentage of the net win of
the gaming machines, (2) fixed daily fees, or (3) in the case of wide-area
progressive gaming machines, a percentage of the amount wagered or a combination
of a fixed daily fee and a percentage of the amount wagered.
2. Wide Area Game Network, Community
Gaming: Electronically linked gaming machines that are located across
multiple casinos within a gaming jurisdiction contribute to and compete for
large, system-wide progressive jackpots. They are designed to increase gaming
machine play for participating casinos by giving the players the opportunity to
win a larger jackpot than on a stand-alone gaming machine.
3. Local Area Progressive Jackpots
(LAP) participation games: Electronically linked gaming machines that are
located within a single casino to a progressive jackpot for that specific
casino.
4. Lottery Products, Video Lottery
Terminals, Mobile Lottery Terminals, Online Paperless Lottery Sales
Systems: Video gaming machines featuring with localized Chinese and Asian
themes and content, advanced graphics, digital sound effects and many of the
same features as our other gaming machines.
5. Server-based Gaming: A
gaming system in which game content and peripherals are configured, maintained
and refreshed over a network that links groups of gaming machines to a remote
server that also enables custom configuration by operators and central
determination of game outcomes.
Legacy
Business Operations
Customer
Relationship Management (CRM) and gaming technology, are both rapidly expanding
business sectors in Asia. The services offered by each of our subsidiaries can
be classified within one of the following three business groups:
1.
OUTSOURCING SERVICES
A) BUSINESS PROCESS
OUTSOURCING
Epro
operated our call center offering 24 hour answering and automatic-answering
service hotlines in our service areas, handling customer inquiries regarding
services, billing, and technical support, as well as customer complaints. Epro
was sold on April 18, 2008. See “Recent Developments”.
B) SOFTWARE DEVELOPMENT
OUTSOURCING
Pacific
Solutions Technology (PactSo) provides outsourced consulting services and
programming services, including software development, R&D, and project
management to leading telecom, banking and financial services companies that
include Huawei, IBM, Bank of East Asia and others. PacSo specializes in software
application development and software outsourcing services for the telecom and
gaming industries. The scope of PactSo's products and services includes smart
card solutions, web-based front-end applications and web-based connections to
backend enterprise planning systems.
2)
TELECOM PRODUCTS
PacificNet
Communications Limited (referred to herein as "PactCom"), incorporated in Hong
Kong, is a wholly owned subsidiary of PacificNet that specializes in the sale
and distribution of mobile communication products, accessories, phone cards and
mobile SIM cards, and telecom related services in Hong Kong and Greater
China.
iMobile's
Internet portal has been one of the top ranked traffic sites and has achieved
5.4 million registered online users and over 1,200,000 active users, with 10
million daily page views and 40,000 blog postings per day, which makes iMobile
the top ranked site in its category in China.
FINANCIAL INFORMATION ABOUT
OUR BUSINESS SEGMENTS
We
identify and classify our operating segments based on reporting entities that
exhibit similar long-term financial performance based on the nature of the
products and services with similar economic characteristics such as margins,
business practices and target market. The operating segments are classified into
four major segments which include outsourcing services, telecom value-added
services, products (telecom & gaming) and services and other business. For
financial information about these operating segments, see Note 15 to our
Consolidated Financial Statements.
PRINCIPAL
CUSTOMERS
Our
principal customers in each of our business groups are located in Hong Kong,
mainland China and other regions of Asia. Our key clients consist of leading
telecom operators, banks, insurance, travel, marketing, government, services
companies and telecom consumers, casinos and gaming operators.
1. GAMING
CUSTOMERS
Our
gaming customers include some of the leading casinos, hotels, gaming operators,
bingo, slot and AWP operators in Macau, SE Asia, and Europe. Some of the famous
casinos that are using our gaming products include Sociedade de Jogos de Macau
(SJM), Sociedade de Turismo e Diversoes de Macau (STDM), Casino Lisboa, SJM
Slot, Macau Jockey Club, Paradise Casino, Jai Alai Casino Macau, Galaxy Waldo
Casino Macau (Galaxy Entertainment Group), and other land-based gaming operators
and bingo operators in Asia and Europe. Our lottery customers include the
leading lottery operators in China and Asia, including the China Welfare
Lottery.
2. OUTSOURCING SERVICES
(INCLUDING BPO, ITO, CALL CENTER SERVICES) CUSTOMERS
The
following is a brief description of some of the Company's customers in the
outsourcing services group:
BELLSYSTEM24,
Japan - Established in 1982, Bellsystem24 (http://www.bell24.com) is the largest
telemarketing call center services company in Japan, with over 5,000 clients,
27,348 communication service representatives and 33 offices in Japan.
Bellsystem24 has built a client base of multinational firms and industry leaders
by developing and nurturing long-term relationships. Bellsystem24's commitment
to quality, technological innovation, and value-added services has made it the
leading provider of outsourced customer care and marketing solutions in Japan.
Bellsystem24 focuses on developing long-term strategic relationships with
clients in customer-intensive industries, including telecommunications, cable,
broadband, satellite broadcasting, Internet services, technology, and financial
services. Through a nationwide network of contact centers utilizing a unique
blend of one-on-one marketing media, knowledge-based tools, advanced technology,
and expert recruiting, staffing, training, and certifications, Bellsystem24 has
fostered a leading position in the customer care industry.
3. TELECOM VALUE-ADDED
SERVICES CUSTOMERS
CHINA
TELECOM - The largest fixed service telecommunications provider in China, which
includes data, Internet, and the XiaoLingTong PAS wireless system.
CHINA
NETCOM - One of the four major telecom carriers in China, which includes fixed
line, data, Internet, and the XiaoLingTong wireless system.
CHINA
MOBILE - The largest mobile operator in China.
CHINA
UNICOM - One of the major mobile operators in China operating both GSM and CDMA
mobile networks, long-distance and local landlines, data communication including
Internet service and IP phones, value-added telecom services, wireless paging
and a variety of relevant services.
NOKIA -
Nokia is the world leader in mobile communications, driving the growth and
sustainability of the broader mobile communications industry. Nokia connects
people to each other and the information that matters to them with easy-to-use
and innovative products like mobile phones, devices, and solutions for imaging,
games, media and businesses. Nokia provides equipment, solutions and services
for network operators and corporations.
MOTOROLA
- Motorola is one of the top mobile brands in China in terms of both popularity
and market share.
4. TELECOM
PRODUCTS
Our
telecom products customers include China Telecom, China Netcom, China Mobile,
China Unicom, and major mobile phone manufacturers such as Motorola and
Nokia.
SALES
AND MARKETING
We
advertise our services by attending various internet, gaming, e-commerce,
telecom, CRM and VAS trade shows and conferences in China. There are a limited
number of competitors in our industry; accordingly, new business opportunities
are generated mainly through business contacts and by word of mouth. We rely on
our reputation for quality and efficiency among our customers and leveraging our
strategic investors to obtain new business.
GOVERNMENT
REGULATION
We
operate our business in Macau, Hong Kong, China, and Asia under several
regulators, ministries and agencies under a number of government jurisdictions,
including:
• The
Macau Gaming Inspection and Coordination Bureau (“Direcção de Inspecção e
Coordenação de Jogos”, “DICJ”), provides guidance and assistance to the Chief
Executive of Macao SAR on the definition and execution of the economic policies
for the operation of casino games of fortune or other ways of gaming,
Pari-Mutuels and gaming activities offered to the public. For more information,
please visit http://www.dicj.gov.mo/
• The
Philippine Amusement and Gaming Corporation (PAGCOR, http://www.pagcor.ph) is
the government-owned and controlled corporation established to regulate all
games of chance in the Philippines. It was created in 1976 to oversee the
operation of gaming casinos, to generate funds for the government's
developmental projects, and to help curb illegal gambling. Currently, PAGCOR
operates 13 Casinos, 8 VIP clubs and 3 slot machine arcades in major cities
across the Philippines. It also oversees and regulates more than 180 bingo
parlors across the country. PAGCOR employs more than 11,000
employees.
• China:
the State Council is the highest authority of the executive branch of the PRC
central government, and several ministries and agencies under its leadership,
including:
• The
Ministry of Information Industry (MII)
• The
China Securities Regulatory Commission (CSRC)
• The
Ministry of Culture
• The
General Administration of Press and Publication of the P.R. China
• The
State Copyright Bureau
• The
State Administration of Industry and Commerce (SAIC)
• The
Ministry of Public Security
• The
Ministry of Commerce
The State
Council and these ministries and agencies have issued a series of rules that
regulate a number of different substantive areas of our business, which are
discussed below.
FOREIGN OWNERSHIP
RESTRICTION ON BUSINESSES ENGAGED IN PROVIDING INTERNET
CONTENT
PRC
regulations currently limit foreign ownership of companies that provide Internet
content services to 50%. This limitation extends to our IVR, call center
e-commerce and telecom VAS and to our business of providing financial
information and data to Internet users. To comply with this foreign ownership
restriction, with respect to our Internet content services, we operate our
website in China for example, through Beijing Xing Chang Xin Science and
Technology Development Co. Limited ("Xinchangxin"), which is 100% owned by Mr.
Liu Lei and Gao Chunhui, the Chairman and CEO of Xinchangxin, who are both PRC
citizens. Under PRC law, BEIJING PACIFICNET IMOBILE TECHNOLOGY CO., LTD., PRC registered
wholly owned foreign enterprise (IMOBILE-WOFE), conducts its VAS and e-commerce
operations with Beijing Xing Chang Xin Science and Technology Development Co.
Limited ("IMobile-DE"), a PRC registered Domestic Enterprise (DE), through a
series of contractual agreements. Under these agreements, the shareholders of
iMobile-DE are required to transfer their ownership in these entities to our
subsidiaries when permitted by PRC laws and regulations and all voting rights
are assigned to us. Through iMobile-WOFE, we have also entered into a consulting
and services agreements with iMobile-DE, under which iMobile-WOFE provides
technical services and other services to iMobile-DE in exchange for all of the
net income of iMobile-DE. In addition, the shareholders of iMobile-DE have
pledged their shares in iMobile-DE as collateral for non-payment of fees for the
services we provide.
There are
substantial uncertainties regarding the interpretation and application of
current or future PRC laws and regulations with respect to foreign ownership of
internet content providing companies. In the opinion of our in-house PRC legal
counsel, our current ownership structure, the contractual arrangements among our
wholly owned subsidiaries and the operating company and their shareholders
comply with all existing applicable PRC laws, rules and regulations. We cannot
assure that the PRC regulatory authorities will not ultimately take a view that
is contrary to the opinion of our PRC legal counsel. If the PRC government finds
that the agreements that establish the structure of our operations in China do
not comply with PRC government restrictions on foreign investment in our
industry, we could be subject to severe penalties.
LICENSES AND
PERMITS
There are
a number of aspects of our business which require us to obtain licenses from a
variety of PRC regulatory authorities. For example, in order to host our
website, Xinchangxin is required to hold an Internet content provider, or ICP,
license issued by the Ministry of Information Industry or its local offices.
Xinchangxin currently holds an ICP license issued by Ministry of Information
Industry Beijing department.
REGULATION OF INTERNET
CONTENT
The PRC
government has promulgated measures relating to Internet content through a
number of ministries and agencies, including the Ministry of Information
Industry, the Ministry of Culture and the State Press and Publications
Administration. These measures specifically prohibit Internet activities that
result in the publication of any content which is found to, among other things,
propagate obscenity, gambling or violence, instigate crimes, undermine public
morality or the cultural traditions of the PRC, or compromise State security or
secrets. If an ICP license holder violates these measures, the PRC government
may revoke its ICP license and shut down its websites. Xinchangxin's ICP license
expressly states that it is not allowed to publish news, among other things, in
relation to its Internet content provision. Specifically, Shenzhen, Beijing and
Guangzhou branches of the General Administration of Press and Publication of the
PRC, the government authority regulating news publication, confirmed with us
that so long as we do not provide general news on politics, society or culture,
or establish a "news column," or provide such information under express heading
of "news," we are not required to obtain a license to publish financial or
economic related news content.
REGULATION OF INFORMATION
SECURITY
Internet
content in China is also regulated and restricted by the PRC government to
protect State security. The National People's Congress, China's national
legislative body has enacted a law that may subject to criminal punishment in
China any effort to: (1) gain improper entry into a computer or system of
strategic importance; (2) disseminate politically disruptive information; (3)
leak State secrets; (4) spread false commercial information; or (5) infringe on
intellectual property rights.
The
Ministry of Public Security has promulgated measures that prohibit use of the
Internet in ways which, among other things, would result in a leakage of State
secrets or a spread of socially destabilizing content. The Ministry of Public
Security has supervision and inspection rights in this regard and we may be
subject to the jurisdiction of the local security bureaus. If an ICP license
holder violates these measures, the PRC government may revoke its ICP license
and shut down its websites.
INTELLECTUAL PROPERTY
RIGHTS
The State
Council and the State Copyright Bureau have promulgated various regulations and
rules relating to protection of software in China. Under these regulations and
rules, software owners, licensees and transferees should register their rights
in software with the State Copyright Bureau or its local offices and obtain
software copyright registration certificates. Although such registration is not
mandatory under PRC law, software owners, licensees and transferees are
encouraged to go through the registration process. Therefore persons with
registered software rights may receive better protection. We have registered all
of our self-developed software with the State Copyright Bureau.
PRC law
requires owners of Internet domain names to register their domain names with
qualified domain name registration agencies approved by the Ministry of
Information Industry and obtain a registration certificate from such
registration agencies. A registered domain name owner has an exclusive use right
over its domain name. Unregistered domain names may not receive proper legal
protections and may be misappropriated by unauthorized third
parties.
PRIVACY
PROTECTION
PRC law
does not prohibit Internet content providers from collecting and analyzing
personal information from their users. On our website, our users are required to
accept a user agreement whereby they agree to provide certain personal
information to us. PRC law prohibits Internet content providers from disclosing
to any third parties any information transmitted by users through their networks
unless otherwise permitted by law. If an Internet content provider violates
these regulations, the Ministry of Information Industry or its local offices may
impose penalties and the Internet content provider may be liable for damages
caused to its users.
ADVERTISING
REGULATION
PRC law
requires entities conducting advertising activities to obtain an advertising
permit from the SAIC's local offices. Entities conducting advertising activities
without such permit may be charged a fine or imposed other penalties by the
SAIC's local offices. Currently, foreign investors cannot own more than 70%
equity interest in an advertising agency.
INTERNATIONAL
REGULATION
Many
foreign jurisdictions permit the importation, sale and/or operation of gaming
equipment in casino and non-casino environments. Where importation is permitted,
some countries prohibit or restrict the payout feature of the legacy slot
machine or limit the operation of slot machines to a controlled number of
casinos or casino-like locations. Each gaming machine must comply with the
individual jurisdiction’s regulations. Some jurisdictions require the licensing
of gaming machine operators and manufacturers. We manufacture and supply gaming
equipment to various international markets including Asia, Australia, Canada,
Europe, South America and South Africa with our partners who have the required
licenses to manufacture and distribute our products in the foreign jurisdictions
in which we do business.
COMPETITION
Competition
in Gaming Technology Business:
Electronic
Gaming Machine Competitors
PACT’s
primary focus areas are gaming technology products for land-based casinos and
Internet casinos. For land-based casino operators, the Electronic Gaming Machine
(EGM) market is intensely competitive and is characterized by the continuous
introduction of new game titles and new technologies. Our ability to compete
successfully in this market is based, in large part, upon our ability
to:
|
●
|
Create
an expanding and constantly refreshed portfolio of games with high
earnings performance
|
|
●
|
Offer
gaming machines that consistently out-perform gaming machines manufactured
by our competitors
|
|
●
|
Identify
and develop or obtain rights to commercially marketable intellectual
properties
|
|
●
|
Adapt
our products for use with new
technologies
|
In
addition, successful competition in this market is based upon:
|
●
|
Engineering
innovation and reliability
|
|
●
|
Mechanical
and electronic reliability
|
|
●
|
Brand
recognition
|
|
●
|
Marketing
and customer support
|
|
●
|
Competitive
prices and lease terms
|
We
estimate that about 25 companies in the world manufacture gaming machines and
video lottery terminals (VLTs) for legalized gaming markets. Of these companies,
we believe that International Game Technology (“IGT”), Shuffle Master/StarGames,
WMS Industries, Bally Technologies (formerly Alliance Gaming), Aristocrat
Technologies, Novomatic, Atronic, Casino Technology, DEQ, and Lottomatica’s
recently acquired subsidiary G-Tech Holdings have a majority of this worldwide
market. In the video gaming machine market, we compete with market leader IGT,
as well as Aristocrat Technologies, Bally Technologies, Atronic, Casino
Technology, Progressive Gaming, Konami, Aruze, Franco and Unidesa. In the VLT
market, we compete primarily with IGT, G-Tech Holdings and Scientific Games.
Aruze Corp. is a world leader in the manufacturing of Pachi-Slot, Pachi-Com,
Reel Spinning Slots and Video Gaming Devices. Aruze Corp. also develops Arcade
Games, Amusement Games and Consumer Game Software.
Our
competitors vary in size from small companies with limited resources to a few
large corporations with greater financial, marketing and product development
resources than ours. The larger competitors, particularly IGT, have an advantage
in being able to spend greater amounts than us to develop new technologies,
games and features that are attractive to players and customers. In addition,
some of our competitors have developed, sell or otherwise provide to customers
security, centralized player tracking and accounting systems which allow casino
operators to accumulate accounting and performance data about the operation of
gaming machines. We do not currently offer these systems. Several of our
competitors pooled their intellectual property patents that provide cashless
gaming alternatives, specifically ticket-in ticket-out technology, so that when
a casino patron cashes out from a gaming machine they may receive a printed
ticket instead of coins.
PACT has
been extending its international reach into Asia. In 2006 and 2007, we acquired
interests in several Asian internet and mobile game developers in China.
Industry experts expect Asia to be the fastest growing and ultimately the
largest online gaming market in the world. China alone has over 135 million
Internet users, making it the world's second largest user group after the U.S.
While we believe that Asia will be the next major Internet gaming market, there
are currently regional legislative issues and limited payment forms to
adequately support the industry.
Online
Gaming Software Competitors
Online
casinos were first developed more than a decade ago and are a new development
area for PACT. Internet casinos constituted 33.5% of the global online gaming
market in 2006 (excluding the U.S.) (source: GBGC). Online casino growth outside
the U.S. is predicted to remain healthy at over 21% per year in the next two
years (source: GBGC). Industry experts forecast Internet casino revenue to reach
$3.9 billion by 2012, excluding the U.S. (source: GBGC).
In the
online gaming software market, we compete with CryptoLogic (CRYP) and Gigamedia
(GIGM). Online gaming is a rapidly-growing industry and has become increasingly
competitive and sophisticated. GBGC, a U.K. consulting firm focused on the
land-based and online interactive gaming industries, estimates that the global
market for online gaming, which is comprised of casino games, sports betting,
poker, bingo, and lotteries, reached $7.2 billion in annual revenue in 2006
(excluding the U.S.), up from $2.7 billion in 2003. While it is difficult to
confirm the exact number of Internet gaming sites since most companies are
private, current estimates are around 2,400 online gaming properties, down from
more than 2,800 (source: GBGC) several years ago. This decrease points to
industry consolidation. As Internet gaming has developed and increased in
sophistication, so have the players who can choose from a proliferation of
sites. Competition for players’ attention and share of wallet is intensifying,
and players are demanding more value, more games and a better entertainment
experience.
We
compete with a number of public and private companies, which provide electronic
commerce and/or Internet gaming software. Given the stage of development of the
industry and the number of private organizations operating in the industry,
information about the nature of our competitors, their operations and their
resources is difficult to compile. In addition to current known competitors,
traditional land-based gaming operators and other entities, many of which have
significant financial resources and name brand recognition, may provide Internet
gaming services in the future, and thus become competitors of the Company.
Increased competition and expenditures from current and future competitors have
and could continue to result in the reduction of our margins or could result in
the loss of our market share.
Competition
in our Legacy Business
We expect
competition to persist and intensify in the future. Our competitors include
small firms offering specific applications, divisions of large entities and
large independent firms. A number of competitors have or may develop greater
capabilities and resources than ours. We face the risk that new competitors with
greater resources than ours will enter our market. Our competitors are mainly
leaders in the CRM and VAS markets. Competitive pressures from current or future
competitors could cause our services to lose market acceptance or require a
significant reduction in the price of our services.
1. OUTSOURCING SERVICES
(INCLUDING BPO, ITO, AND CALL CENTER SERVICES) COMPETITORS:
Chinasoft
International Limited, or ICSS, is a leading e-government solution provider and
software developer in the PRC, and has entered the software outsourcing,
interrelated systems integration, consultancy and training services
industry.
2. TELECOM VALUE-ADDED
SERVICES (VAS) COMPETITORS:
SINA
Corporation (NASDAQ: SINA), is a leading online media company and Value-Added
information Service (VAS) provider for China and for Chinese communities
worldwide offering Internet users and government and business clients an array
of services.
GAMING
MACHINE MANUFACTURING
We
manufacture all of our gaming machines at our facilities in Shenzhen and
Guangdong, China. In 2007, we began reconfiguring our assembly lines in order to
lower our product lead times and effectively increase our practical capacity
with added production efficiencies.
Manufacturing
commitments are generally based on sales orders from customers. In some cases,
however, component parts are purchased and assembled into finished goods that
are inventoried in order to be able to quickly fill anticipated customer orders.
Our manufacturing process generally consists of assembling component parts to
complete a gaming machine. We generally warranty our gaming machines sold
internationally for a period of 180 days to one year.
The raw
materials used in manufacturing our gaming machines include various metals,
plastics, wood, glass and numerous component parts, including electronic
subassemblies, main boards and circuit boards, money acceptors, and LCD screens.
We believe that our sources of supply of component parts and raw materials are
generally adequate.
In order
to improve the efficiency of our manufacturing processes and reduce time to
market, we continue to make improvements in sourcing and supply management, in
inventory and warehouse management, and other manufacturing processes. We also
have ongoing manufacturing initiatives, such as enhanced strategic sourcing and
supplier management, engineering the product for maximum customer value and
designing product for both ease of manufacturability and installation, which we
expect will help improve gross margins in future quarters.
The
European Union (“EU”) has adopted the Restriction on the Use of Certain
Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive
to facilitate the recycling of electrical and electronic equipment sold in the
EU. The RoHS directive restricts the use of lead, mercury, and certain other
substances in electrical and electronic products placed on the market in the EU
after July 1, 2006. We have worked with our suppliers to develop RoHS-compliant
products and, as of the effective date of the directive, we were able to provide
RoHS-compliant gaming machines to the EU. We expect that any cost increases
incurred due to the RoHS directive will be offset by savings from design and
other changes we made to our component parts.
EMPLOYEES
As of
March 31, 2008, together with our subsidiaries, we had approximately 545
employees and contractors. We have not experienced any labor stoppages. None of
our employees are covered by collective bargaining agreements. The breakdown of
number of employees for each of the business units of the Company is as
follows:
COMPANY
AND SUBSIDIARIES
|
NUMBER
OF
EMPLOYEES
|
Smartime
/ PactSo (Soluteck)
|
300
|
iMobile
|
70
|
PacificNet
Games Limited
|
50
|
Wanrong
|
40
|
PacificNet
Beijing
|
30
|
PacificNet
Shenzhen
|
25
|
PacificNet
Limited (Hong Kong)
|
12
|
Take
1 Technologies
|
12
|
PacificNet
Inc. (USA)
|
3
|
PacificNet
Guangzhou
|
3
|
Total
|
545
|
RESEARCH
AND DEVELOPMENT
Our
gaming research and development department is dedicated to developing fun and
exciting electronic table games and slot machines that focus on enhancing Asian
player entertainment value and to introducing leading, innovative systems
products that increase our customers’ revenue stream and facilitate operating
efficiencies. Our dedicated China R&D center has approximately 300 employees
who possess significant experience in software development and content design.
Our current emphasis is on developing new technologies to expand and improve the
functionalities of Multiplayer Electronic Gaming Machines, Online Game Software
Development, Slot Machines, including software, hardware and cabinets, and
developing new game content through third parties to refresh and grow our
installed base of gaming devices.
We
conduct extensive testing on the products we offer to ensure they meet the key
performance and quality standards as required by gaming regulators. In addition,
our R&D personnel constantly work with our customers on responding to their
needs and to also ensure compatibility with other products currently available
in the market. Moreover, we closely monitor the evolving standards in the gaming
industry so that we are able to respond and address new technologies as they
emerge.
INTELLECTUAL
PROPERTY
We
believe that our trademarks, intellectual property rights, and propriety Asian
gaming software product development expertise are significant assets. Currently,
we have over five customized Asian gaming products. This portfolio took over
three years to develop and is expected to continue to be a main focus of our
R&D resources. Our company will continue to evolve as we look towards the
next generation of server-based gaming products. In addition to internally
developed and acquired emerging gaming technologies, we will also rely on
strategic partnerships to obtain access to intellectual property.
We intend
to vigorously protect the investment in our intellectual property and the unique
features of our products and services by actively applying intellectual property
patent protection. However, we cannot ensure that intellectual property rights
will not be infringed upon.
EXECUTIVE
OFFICES
Our
executive offices are located in Hong Kong, Macau, Beijing, Shenzhen and
Guangzhou, China and in Aberdeen, South Dakota, USA.
PacificNet
Limited Hong Kong Office: Rm. 2702, Richmond Commercial Building, 107 - 111
Argyle Street, Mong Kok, Kowloon, Hong Kong. Tel: +852-2876-2900, Fax:
+852-27930689 and E-mail: HKOffice@PacificNet.com.
PacificNet
Macau office: Unit A-C, 12th Floor, Edificio Commercial I Tak, No. 126, Rua Da
Pequim, Macau, China.
PacificNet
Beijing Office: 23/F, Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang
District, Beijing, China Postal Code: 100028. Tel: +86-010-59225000, Fax:
+86-010-59225001 and Email: BJ-Office@PacificNet.com.
PacificNet
Shenzhen Office: Room 4203, JinZhongHuan Business Center, Futian District,
Shenzhen, China 518026 Tel: +86-755-33222088, Fax: +86-755-33222098 and Email:
SZ-Office@PacificNet.com.
PacificNet
Guangzhou Office: 15/F, Building A, Huajian Plaza, No. 233 Tianfu Road, Tianhe
District, Guangzhou, China Postal Code: 510630. Tel: +86-020-85613432, Fax:
+86-020-81613659 and Email: GZ-Office@PacificNet.com.
PacificNet
Inc. South Dakota Office: 416 Production Street North, Aberdeen, SD 57401,
USA. Tel: +1 (605) 229-6678, Fax: +1 (605)
229-0394 Email: investor@PacificNet.com
We
maintain a website at http://www.PacificNet.com.
Information contained on or accessed through our website is not intended to
constitute and shall not be deemed to constitute part of this Annual Report on
Form 10-K..
ITEM
1A. RISK FACTORS
Investing
in our securities involves a great deal of risk. Careful consideration should be
made of the following factors as well as other information included in this
annual report on Form 10-k before deciding to purchase our common stock. You
should pay particular attention to the fact that we conduct a majority of our
operations in China and are governed by a legal and regulatory environment that
in some respects differs significantly from the environment that may prevail in
other countries. Our business, financial condition or results of operations
could be affected materially and adversely by any or all of these
risks.
THE
FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL
CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR
OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A
FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT
ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR
STATEMENTS.
RISKS
RELATED TO OUR BUSINESS
The
adoption of new laws or changes to or the application of existing laws relating
to Internet commerce may affect the growth of our business.
In
addition to regulations pertaining specifically to online gaming, we may become
subject to any number of laws and regulations that may be adopted with respect
to the Internet and electronic commerce. New laws and regulations that address
issues such as user privacy, pricing, online content regulation, taxation,
advertising, intellectual property, information security, and the
characteristics and quality of online products and services may be enacted. As
well, current laws, which predate or are incompatible with the Internet and
electronic commerce, may be applied and enforced in a manner that restricts the
electronic commerce market. The application of such pre-existing laws regulating
communications or commerce in the context of the Internet and electronic
commerce is uncertain. Moreover, it may take years to determine the extent to
which existing laws relating to issues such as intellectual property ownership
and infringement, libel and personal privacy are applicable to the
Internet.
The
adoption of new laws or regulations relating to the Internet, or particular
applications or interpretations of existing laws, could decrease the growth in
the use of the Internet, decrease the demand for our products and services,
increase our cost of doing business or could otherwise have a material adverse
effect on our business, revenues, operating results and financial
condition.
Our
business has been and may continue to be materially affected by changes to, or
interpretation of, government regulation around the world that may apply to
online gaming.
The
Company and our licensees are subject to applicable laws in the jurisdictions in
which they operate. Our licensees hold government licenses to operate Internet
gaming sites in the Philippines. Some jurisdictions have introduced regulations
attempting to restrict or prohibit Internet gaming, while other jurisdictions
have taken the position that Internet gaming is legal and have adopted or are in
the process of considering legislation to regulate Internet gaming.
As
companies and consumers involved in Internet gaming are located around the
globe, including our licensees and their players, there is uncertainty regarding
which government has authority to regulate or legislate the industry. On October
13, 2006, the Unlawful Internet Gambling Enforcement Act (“UIGEA”) legislation
designed to prohibit Internet gaming was enacted in the United States (“U.S.”),
and similar legislation may be adopted in other jurisdictions.
Future
government actions may have a material impact on our operations and financial
results. There is a risk that governmental authorities may view us or our
licensees as having violated the local law of their end users, despite the
Company’s requirement that each licensee is licensed to operate an Internet
gaming business by the governmental authority of the country in which the gaming
servers associated with the licensees’ gaming operations are located. Therefore,
there is a risk that civil and criminal proceedings, including class actions
brought by or on behalf of public entities or private individuals, could be
initiated against us, our licensees, Internet service providers, credit card
processors, advertisers and others involved in the Internet gaming industry and
could involve substantial litigation expense, penalties, fines, injunctions or
other remedies or restrictions being imposed upon us or our licensees or others
while diverting the attention of our key executives. Such proceedings could have
a material adverse effect on our business, revenues, operating results and
financial condition.
There can
be no assurance that legislation prohibiting Internet gaming or regulating
various aspects of Internet gaming or the Internet gaming industry will not be
proposed and passed in potentially relevant jurisdictions. The burden of
compliance with any such legislation may have a material adverse effect on our
business, financial condition and results of operations.
The
Unlawful Internet Gambling Enforcement Act (“UIGEA”), enacted in the USA in
October 2006, made it illegal to accept any funds connected with unlawful
Internet gaming. Although the Company historically derived a majority of its
product and licensing revenues from sources outside of the U.S., the UIGEA may
still impact the business of the company.
We
are subject to risks associated with a significant portion of our business
conducted in non-North American jurisdictions.
As
companies and consumers involved in Internet gaming, including the players of
our licensees, are located around the globe, there is uncertainty regarding
exactly which government has jurisdiction or authority to regulate or legislate
with respect to various aspects of the industry. The uncertainty surrounding the
regulation of Internet gaming in the various jurisdictions in which we operate
could have a material adverse effect on our business, revenues, operating
results and financial condition.
There are
certain difficulties and risks inherent in doing business internationally,
including the burden of complying with multiple and conflicting regulatory
requirements, foreign exchange controls, potential restrictions or tariffs on
gaming activities that may be imposed, potentially adverse tax consequences and
tax risks, and changes in the political and economic stability, regulatory and
taxation structures, and the interpretation thereof, of jurisdictions in which
we, our subsidiaries and our licensees operate, and in which our licensees’
customers are located, all of which could have a material adverse effect on our
business, revenues, operating results and financial condition.
There can
be no assurance that we will be able to sustain or increase revenue derived from
international operations or that we will be able to penetrate linguistic,
cultural or other barriers to new foreign markets.
Our
financial results are reported in U.S. currency, which is subject to
fluctuations in respect of the currencies of the countries in which we operate,
including Hong Kong Dollars (HKD), Macau Pataca (MOP), China Yuan or Renminbi
(CNY or RMB), Philippine Peso (PHP), Malaysian Ringgit (MYR), New Taiwan Dollar
(NT$ or TWD), Thai Baht (THB), Vietnamese Dong (VND), Cambodia Riel (KHR), Lao
Kip (LAK), Euros, and US Dollars. Accordingly, fluctuations in the exchange rate
of world currencies could have a positive or negative effect on our reported
results. We may utilize a hedging program from time to time and/or take
advantage of the natural hedge in having operations in multiple currencies to
mitigate a portion of our currency risks, but there can be no assurance that we
will not experience currency losses in the future, which could have a material
adverse effect on our business, revenues, operating results and financial
condition.
Our
business depends on the reliability of the infrastructure that supports the
Internet and the viability of the Internet.
The
growth of Internet usage has caused frequent interruptions and delays in
processing and transmitting data over the Internet. There can be no assurance
that the Internet infrastructure or the Company’s own network systems will
continue to be able to support the demands placed on it by the continued growth
of the Internet, the overall online gaming industry or that of our customers.
The Internet’s viability could be affected if the necessary infrastructure is
not sufficient, or if other technologies and technological devices eclipse the
Internet as a viable channel.
End-users
of our software depend on Internet Service Providers (“ISPs”), online service
providers and our system infrastructure for access to the Internet gaming sites
operated by our licensees. Many of these services have experienced service
outages in the past and could experience service outages, delays and other
difficulties due to system failures, stability or interruption. Our licensees
may lose customers as a result of delays or interruption in service, including
delays or interruptions relating to high volumes of traffic or technological
problems. As a result, we may not be able to meet a level of service that we
have contracted for, and we may be in breach of our contractual commitments,
which could materially adversely affect our business, revenues, operating
results and financial condition.
Internet
gaming is a developing industry and therefore, we do not know if the market will
continue to develop and our products and services will continue to be in
demand.
The
Internet gaming industry continues to evolve rapidly and is characterized by an
increasing number of market entrants. The demand and acceptance for new products
and services are subject to a level of uncertainty and growing competition, and
if our production services do not continue to receive market acceptance, our
business, revenues, operating results and financial condition could be
materially adversely affected.
Internet
gaming software and electronic commerce services are subject to security risks,
which may inhibit the growth of the industry and the acceptance of our products
and services.
Our
Internet gaming software and electronic commerce services are reliant on
technologies and network systems to securely handle transactions and user
information over the Internet, which may be vulnerable to system intrusions,
unauthorized access or manipulation. As users become increasingly sophisticated
and devise new ways to commit fraud, our security and network systems may be
tested and subject to attack. We have experienced such system attacks in the
past and implemented measures to protect against these intrusions. However,
there is no assurance that all such intrusions or attacks will or can be
prevented in the future, and any system intrusion/attack may cause a delay,
interruption or financial loss, which could have a material adverse effect on
our business, revenue, operating results and financial condition.
We
may be vulnerable to delays or interruptions due to our reliance on other
parties.
Our
electronic commerce product relies on ISPs to allow our licensees’ customers and
servers to communicate with each other. If ISPs experience service
interruptions, it may prevent communication over the Internet and impair our
ability to carry on business. In addition, our ability to process e-commerce
transactions depends on bank processing and credit card systems. In order to
prepare for system problems, we are strengthening and enhancing our current
facilities and the capability of our system infrastructure and support.
Nevertheless, any system failure as a result of reliance on third parties,
including network, software or hardware failure, which causes a delay or
interruption in our e-commerce services could have a material adverse effect on
our business, revenues, operating results and financial condition.
We
face growing competition from known competitors and new entrants in the Internet
gaming, e-commerce and broader entertainment industries.
Customers
and licensees of our software compete with existing and established recreational
services and products, in addition to other forms of entertainment. Our success
will depend, in part, upon our ability to enhance our products and services to
keep pace with technological developments, respond to evolving customer
requirements and achieve continued market acceptance.
We
compete with a number of public and private companies, which provide electronic
commerce and/or Internet gaming software. In addition to known current
competitors, traditional land-based casino operators and other entities, many of
which have significant financial resources, an entrenched position in the market
and name-brand recognition, may provide Internet gaming services in the future,
and thus become our competitors. As well, such companies may be able to require
that their own software, rather than the software of others, including our
gaming software or our e-cash systems and support, be used in connection with
their payment mechanisms.
The
barriers to entry into most Internet markets are relatively low, making them
accessible to a large number of entities and individuals. We believe the
principal competitive factors in our industry that create certain barriers to
entry include reputation, technology, financial stability and resources, proven
track record of successful operations, critical mass (particularly relating to
online poker), regulatory compliance, independent oversight and transparency of
business practices. While these barriers will limit those able to enter or
compete effectively in the market, it is likely that new competitors will be
established in the future, in addition to our known current
competitors.
Increased
competition from current and future competitors has and may in the future result
in price reductions and reduced margins, or may result in the loss of our market
share, any of which could materially adversely affect our business, revenues,
operating results and financial condition.
If
a third-party asserts that we are infringing its intellectual property, whether
successful or not, it could subject us to costly and time-consuming litigation
or expensive licenses, which could harm our business.
There is
considerable patent and other intellectual property development activity in our
industry. Our success depends, in part, upon our ability not to infringe upon
the intellectual property rights of others. Our competitors, as well as a number
of other entities and individuals, own or claim to own intellectual property
relating to our industry. From time to time, third parties have asserted and may
continue to claim that we are infringing upon their intellectual property
rights, and we may be found to be infringing upon such rights. Third-parties
have in the past sent us correspondence regarding their intellectual property
and in the future we may receive claims that our products infringe or violate
their intellectual property rights. Furthermore, we may be unaware of the
intellectual property rights of others that may cover some or all of our
technology or products. Any claims or litigation could cause us to incur
significant expenses and, if successfully asserted against us, could require
that we pay substantial damages or royalty payments, prevent us from selling our
products, or require that we comply with other unfavorable terms. In addition,
we may decide to pay substantial settlement costs and/or licensing fees in
connection with any claim or litigation, whether or not successfully asserted
against us. Even if we were to prevail, any litigation regarding our
intellectual property could be costly and time-consuming and divert the
attention of our management and key personnel from our business operations. As
such, the outcome of such matters cannot be predicted with certainty, and could
have a material adverse affect on our business, revenues, operating results and
financial condition.
We
may fail to protect our intellectual property and thereby reduce our competitive
position.
We rely
on a combination of laws and contractual provisions to establish and protect our
rights in our software and proprietary technology. We believe that our
competitive position is dependent in part upon our ability to protect our
proprietary technology. We generally enter into non-disclosure and invention
agreements with employees, licensees, consultants and customers, and
historically have restricted access to our software products' source codes. We
regard our source codes as proprietary information, and attempt to protect the
source code versions of our products as trade secrets and unpublished
copyrighted works. Despite our precautions and measures implemented to protect
against such attempts, unauthorized parties may have or could in the future copy
or otherwise reverse engineer portions of our products or otherwise obtain and
use information that we regard as proprietary.
Our
Company has patent and trademarks in certain jurisdictions and is in the process
of applying for further trademark registrations and patents, which may provide
such protection in relevant jurisdictions. However, there can be no assurance
that this will be sufficient to fully protect our proprietary technology. In
addition, certain provisions of our license agreements, including provisions
protecting against unauthorized use, transfer and disclosure, may be found to be
unenforceable in certain jurisdictions.
We
believe that patent, trademark, copyright and other legal protections are less
significant to our success than other factors such as the knowledge, ability and
experience of our personnel, new product and service developments, frequent
product enhancements, customer service and ongoing product support.
We also
have a proprietary interest in our name. The names The names “PacificNet”,
“iMobile”, “PACT” and “PacificNet Games” have become known in the Internet and
gaming industry. Accordingly, our competitive position could be affected if our
name was misappropriated and our reputation in any way compromised.
There can
be no assurance that the steps we have taken to protect our proprietary rights
will be adequate to deter misappropriation of our technology or independent
development by others of technologies that are substantially equivalent or
superior to our technology. Any misappropriation of our name, technology or
development of competitive technologies could have a material adverse effect on
our business, revenues, operating results and financial condition.
Due to
the complex, sophisticated and global nature of the business, there can be no
assurance that there has been no breach of third parties’ intellectual property
rights by the Company, and any adverse judgment in this regard could have a
material adverse effect on our business, revenues, operating results and
financial condition.
We
may fail to maintain effective internal controls in accordance with Section 404
of the Sarbanes-Oxley Act of 2002
The
Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and
directors. Our efforts to comply with the requirements of Section 404 have
resulted in increased general and administrative expense and a diversion of
management time and attention, and we expect these efforts to require the
continued commitment of resources. Section 404 of the Sarbanes-Oxley Act
requires (i) management’s annual review and evaluation of our internal control
over financial reporting and (ii) a statement by management that its independent
registered public accounting firm has issued an attestation report on our
internal control over financial reporting, in connection with the filing of the
annual report on Form 10-K for each fiscal year. Failure to maintain effective
internal controls over financial reporting could result in investigation or
sanctions by regulatory authorities, and could have a material adverse effect on
our operating results, investor confidence in our reported financial
information, and the market price of our securities shares.
Our
stock price has been and may continue to be volatile.
The
market price of our Common Shares has experienced significant fluctuation and
may continue to fluctuate significantly. The market price of our Common Shares
may be adversely affected by various factors, such as proposed Internet gaming
legislation or enforcement of existing laws, the loss of a customer, the
announcement of new products or enhancements, innovation and technological
changes, quarterly variations in revenue and results of operations, changes in
earnings estimates by financial analysts, speculation in the press or analyst
community and general market conditions or market conditions specific to
particular industries, including the Internet and gaming. In addition, the stock
market has from time to time experienced extreme price and volume fluctuations.
These company-specific or broad market fluctuations may adversely affect the
market price for our Common Shares. Anti-gaming or anti-online gaming
legislation could also impact our ability to remain listed.
There
is no assurance that there will always be a liquid market for our
shares.
Although
our Common Shares are listed and traded on the NASDAQ Market, there may not be a
liquid market in our Common Shares. Company-specific or broader market
fluctuations may adversely affect the market price of the Common Shares, and
there can be no assurance that there will continue to be an active market for
these securities.
Growth
in revenues may be slow as a result of the disposition of our legacy business
and the transition to gaming business operations
Although
our revenues have grown rapidly in past years, primarily as a result of our
acquisition activity, we cannot assure investors that we will maintain our
profitability or that we will not incur net losses in the future as a result of
recent dispositions. Furthermore, we expect that our operating expenses will
increase as we continue to move the focus of our business to the gaming
industry. Any significant failure to realize anticipated revenue growth could
result in significant operating losses. We will continue to encounter risks and
difficulties in implementing our business model, including our potential failure
to:
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Increase
awareness of our brands, protect our reputation and develop customer
loyalty
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Manage
our expanding operations and service offerings, including the integration
of any future acquisitions
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Maintain
adequate control of our expenses
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Anticipate
and adapt to changing conditions in the markets in which we operate as
well as the impact of any changes in government regulation, mergers and
acquisitions involving our competitors, technological developments and
other significant competitive and market
dynamics
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If we are
not successful in addressing any or all of these risks, our business may be
materially and adversely affected.
The
acquisition of new businesses is costly and such acquisitions may not enhance
our financial condition.
Our
growth strategy is to acquire companies and identify and acquire assets and
technologies from businesses in greater China that have services, products,
technologies, industry specializations or geographic coverage that extend or
complement our existing business. The process to undertake a potential
acquisition is time-consuming and costly. We expend significant resources to
undertake business, financial and legal due diligence on our potential
acquisition target and there is no guarantee that we will acquire the company
after completing due diligence. Any future acquisitions will be subject to a
number of challenges, including:
• Diversion
of management time and resources and the potential disruption of our ongoing
business
• Difficulties
in maintaining uniform standards, controls, procedures and policies
• Potential
unknown liabilities associated with acquired businesses
• Difficulty
of retaining key alliances on attractive terms with partners and
suppliers
• Difficulty
of retaining and recruiting key personnel and maintaining employee
morale
Our
acquisitions could result in the use of substantial amounts of cash, potentially
dilutive issuances of equity securities, significant amortization expenses
related to goodwill and other intangible assets and exposure to undisclosed or
potential liabilities of acquired companies. To the extent that the goodwill
arising from the acquisitions carried on the financial statements do not pass
the annual goodwill impairment test, excess goodwill will be charged to future
earnings.
We
intend to operate each of our acquired businesses on a standalone
basis.
We do not
intend to integrate the information or communications systems, management, or
other aspects of the businesses we acquire. If we integrated the businesses, we
might be able to reduce expenses by eliminating duplicative personnel,
facilities, or technology and other costs. In addition, facilities and
technology integration might make inter-company communications and transactions
more efficient. By declining to integrate the acquired businesses, we might
forego opportunities to operate more profitably. Furthermore, our decision not
to integrate these businesses might result in difficulties in evaluating the
effectiveness of our internal control over financial reporting, which could
complicate compliance with Section 404 of the Sarbanes-Oxley Act of
2002.
Because
we do not have employment agreements with management of the acquired companies,
our business operations might be interrupted if they were to
resign.
As part
of our acquisition strategy, we do not use our own employees or members of our
management team to operate the acquired companies. Key management at these
companies has been in place for several years and has established solid
relationships with their customers. Competition in our industry for
executive-level personnel is strong and we can make no assurance that we will be
able to retain the highly effective executive employees. Although we provide
incentives to management to stay with the acquired business, we have not entered
into employment agreements with them. If such key persons were to resign we
might face impairment of relationships with remaining employees or customers,
which might result in further resignation by employees, and might cause
long-term clients to terminate their relationship with us. Furthermore, we have
not entered into any non-competition and confidentiality agreements with these
employees and management. Due to the limited enforceability of these types of
agreements in China, we face the risk that employees of the acquired
subsidiaries might divulge our software and other protected intellectual
property secrets to competitors.
We
may not be able to attract or retain the management or employees necessary to
remain competitive in our industries.
Tony
Tong, our Chairman and Chief Executive Officer, and Victor Tong, our President,
are essential to our ability to continue to grow through acquisitions. Tong and
Tong have established relationships within our industry. Their business contacts
have been critical in identifying, and negotiating with acquisition candidates
and in developing and expanding our gaming operations.
Our
future success depends on the retention and continued contributions of our key
management, finance, marketing, and staff personnel, many of whom would be
difficult or impossible to replace. Our success is also tied to our ability to
recruit additional key personnel in the future. We may not be able to retain our
current personnel or recruit additional key personnel required. The loss of
services of any of our personnel could have a material adverse effect on our
business, financial condition, results of operations and prospects. If either of
them were to leave our employ, our growth strategy might be hindered, which
could limit our ability to increase revenue.
The
establishment and expansion of international operations require significant
management attention.
All of
our current, as well as any anticipated future revenue, are or are expected to
be mainly derived from Asia. Our international operations are subject to risks,
including the following, which, if not planned and managed properly, could
materially adversely affect our business, financial condition and operating
results:
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Legal
uncertainties or unanticipated changes regarding regulatory requirements,
liability, export and import restrictions, tariffs and other trade
barriers
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Longer
customer payment cycles and greater difficulties in collecting accounts
receivable
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Uncertainties
of laws and enforcement relating to the protection of intellectual
property and potentially uncertain or adverse tax
consequences
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Our
operations could be curtailed if we are unable to obtain required additional
financing.
Since
inception our investments and operations primarily have been financed through
sales of our common stock. In the future we may need to raise additional funds
through public or private financing, which may include the sale of equity
securities, including securities convertible into our common stock. The issuance
of these equity securities could result in dilution to our stockholders. If we
are unable to raise capital when needed, our business growth strategy may be
slowed down, which could severely limit our ability to increase
revenue.
Fluctuations
in the value of the Hong Kong Dollar or RMB relative to foreign currencies could
affect our operating results.
We have
historically conducted transactions with customers outside the United States in
United States dollars. Payroll and other costs of foreign operations are payable
in foreign currencies, primarily Hong Kong dollars and Chinese Renminbi.. To the
extent future revenue is denominated in foreign currencies, we would be subject
to increased risks relating to foreign currency exchange rate fluctuations that
could have a material adverse affect on our business, financial condition and
operating results. The value of Hong Kong dollars and Chinese Renminbi against
the U.S. dollar and other currencies may fluctuate and is affected by changes in
the PRC's political and economic conditions. As our operations are primarily in
Asia, any significant revaluation of Hong Kong dollars or the Chinese Renminbi
may materially and adversely affect our cash flows, revenue and financial
condition. For example, we may need to convert U.S. dollars into Hong Kong
dollars or Chinese Renminbi as appreciation of either currency against the U.S.
dollar could have a material adverse effect on results of our business,
financial condition and operations. Conversely, if we decide to convert our Hong
Kong dollars or Chinese Renminbi into U.S. dollars for other business purposes
and the U.S. dollar appreciates against either currency, the U.S. dollar
equivalent of the respective currency we convert would be reduced. To date, we
have not engaged in any hedging transactions in connection with our
international operations.
We
have never paid cash dividends and are not likely to do so in the foreseeable
future.
We have
never declared or paid any cash dividends on our common stock. We currently
intend to retain any future earnings for use in the operation and expansion of
our business. We do not expect to pay any cash dividends in the foreseeable
future but will review this policy as circumstances dictate.
RISKS
RELATED TO OUR GAMING BUSINESS
If
we fail to keep pace with rapid innovations in product design and related
marketing strategies, or if we are unable to quickly adapt our development and
manufacturing processes to release innovative products or systems, our business
could be negatively impacted.
Our
future success depends to a large extent upon our ability to continue to rapidly
design and market technologically sophisticated and entertaining products that
achieve high levels of player acceptance. Our revenues depend on the earning
power and life span of our games. Newer game themes tend to have a shorter life
span than more legacy game themes, and as a result, we face pressure to design
and deploy successful game themes to maintain our revenue stream and to remain
competitive. Our ability to develop new and innovative products could be
adversely affected by an inability to roll out new games, services or systems on
schedule as a result of delays in connection with regulatory product approval in
the applicable jurisdictions, or otherwise.
Our
future success also depends upon our ability to adapt our manufacturing
capabilities and processes to meet the demands of producing new and innovative
products. Because our newer products are generally more technologically
sophisticated than those we have produced in the past, we must continually
refine our production capabilities to meet the needs of continuing product
innovation. In addition, the shorter lifespan of newer products means that we
must update our production capabilities more frequently and rapidly than in the
past. If we cannot adapt our manufacturing infrastructure to meet the needs of
our product innovations, or if we are unable to make upgrades to our production
capacity in a timely manner, our business could be negatively
impacted.
If
the current popularity and acceptance of gaming declines, our business plans and
operation would be negatively impacted.
The
gaming industry can be affected by public opinion of gaming. Our success depends
on continually developing and successfully marketing new games and gaming
machines with strong and sustained player appeal. A new game or gaming machine
will be accepted by casino operators only if we can show that it is likely to
produce more revenues to the operator than competitors’ products. Gaming
machines can be installed in casinos on a trial basis, and only after a
successful trial period are the machines purchased by the casinos. Participation
gaming machines are replaced by casino operators if the gaming machines do not
meet and sustain revenue and profitability expectations. Therefore, these gaming
machines are particularly susceptible to pressure from competitors, declining
popularity, changes in economic conditions and increased taxation and are at
risk of replacement by the casinos, which would end our recurring revenues from
these machines.
We cannot
assure you that the new products that we introduce will achieve any significant
degree of market acceptance or that the acceptance will be sustained for any
meaningful period. In the event that there is a decline in public acceptance of
gaming, either through unfavorable legislation affecting the introduction of
gaming into emerging markets, or through legislative and regulatory changes,
including tax increases, in existing gaming markets, our ability to continue to
sell and lease our gaming machines in those markets and jurisdictions would be
adversely affected.
The
gaming industry is intensely competitive. We face competition from a number of
companies, some of which have greater resources, and if we are unable to compete
effectively, our business could be negatively impacted.
Competition
among gaming technology developers is based on, among other things, competitive
pricing and financing terms made available to customers, appeal of game themes
and features to the end player and product quality, features and functionality
of hardware and software. The gaming technology provider market includes leading
technology providers such as IGT, Aristocrat, WMS, Bally Gaming and Systems,
Novomatic, Aruze, Konami, Progressive Gaming Corporation, DEQ, CryptoLogic and
Gigamedia comprising the primary competition. The competition is intense due to
the number of providers, as well as the limited number of casino operators and
jurisdictions in which they operate. Pricing, product feature and function,
accuracy and reliability are amongst the factors in determining a provider’s
success in selling its system. Certain of these competitors have access to
greater financial, marketing and product development resources than we do, and
as a result, may be better positioned to compete in the
marketplace.
In
addition, new competitors may enter our key markets. Obtaining space and
favorable placement on casino gaming floors is a competitive factor in our
industry. Competitors with a larger installed base of gaming machines than ours
have an advantage in retaining the most space and best positions in casinos.
These competitors may also have the advantage of being able to convert their
installed machines to newer models in order to maintain their share of casino
floor space. In addition, some of our competitors have developed and sell or
otherwise provide to customers centralized player tracking and accounting
systems which allow operators to accumulate accounting and performance data
about the operation of gaming machines. We do not offer a centralized player
tracking and accounting system and that has put us at a competitive
disadvantage.
The
unpredictable growth of non−legacy gaming markets may affect our business and
prospects.
The
continued growth of non−legacy gaming markets for gaming machines and systems
depends heavily on the public’s acceptance of gaming in these markets, as well
as the ongoing development of the regulatory approval process by national and
local governmental authorities. A portion of our growth is directly tied to our
ability to access these new markets. We cannot predict which new jurisdictions
or markets, if any, will approve the operation of electronic gaming machines,
the timing of any such approval, the public’s acceptance of our gaming machines
in these markets or our market share or profitability in these markets. Any
decline in the popularity of our gaming products with players, or if we are
unsuccessful in developing new products, services or systems, will have a
negative impact on our revenues.
The
gaming industry is heavily regulated and changes in regulation by gaming
authorities may adversely impact our ability to operate the
business.
The
manufacture and distribution of gaming machines, development of systems and the
conduct of gaming operations are subject to extensive national, provincial local
and foreign regulation by various gaming authorities.
Our
ability to continue to operate in certain jurisdictions could be adversely
affected by:
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Unfavorable
public referendums
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Unfavorable
legislation affecting or directed at manufacturers or gaming operators,
such as referendums to increase taxes on gaming
revenues
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Adverse
changes in, or finding of non-compliance with, applicable governmental
gaming regulations
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Delays
in approvals from regulatory
agencies
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Limitations,
conditioning, suspension or revocation of any of our gaming
licenses
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Unfavorable
determinations or challenges of suitability by gaming regulatory
authorities with respect to our officers, directors, major stockholders or
key personnel
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Although
the laws, rules and regulations of the various jurisdictions in which we operate
vary in their technical requirements, virtually all jurisdictions require
licenses, permits, qualification documentation, including evidence of integrity
and financial stability, and other forms of approval to engage in gaming
operations or the manufacture and distribution of gaming machines. Delays in,
amendments to, or repeals of legislation approving gaming in jurisdictions in
which we operate or plan to commence operations, or delays in approvals of our
customers’ operations, may adversely affect our operations
Our
officers, directors, major stockholders and key personnel are also subject to
significant regulatory scrutiny. In the event that gaming or governmental
authorities determine that any person is unsuitable to act in such capacity with
respect to the Company, we could be required to terminate our relationship with
such person. To our knowledge, the Company and our key personnel have obtained,
or applied for, all government licenses, registrations, findings of suitability,
permits and approvals necessary to conduct their respective activities in the
various jurisdictions that we operate. However, there can be no assurance those
licenses, registrations, findings of suitability, permits or approvals will be
renewed in the future, or that new forms of approval necessary to operate in
emerging or existing markets will be granted.
Furthermore,
some jurisdictions require gaming manufacturers to obtain government approval
before engaging in some transactions, such as business combinations,
reorganizations, borrowings, stock offerings and repurchases. Obtaining licenses
and approvals can be time consuming and costly. We cannot assure you that we
will be able to obtain or maintain all necessary registrations, licenses,
permits, approvals or findings of suitability or that the approval process will
not result in delays or changes to our business plans.
RISKS
RELATED TO OUR INTELLECTUAL PROPERTY
Our
intellectual property protections may be insufficient to properly safeguard our
technology.
We rely
on a combination of patent and other technical security measures to protect our
products and we intend to file patents for protection of such technologies. Our
success may depend in part on our ability to obtain trademark protection for the
names or symbols under which we market our products and to obtain copyright
protection and patent protection for our proprietary software and other game
innovations. We also rely on trade secrets and proprietary know-how. We enter
into confidentiality agreements with our employees regarding our trade secrets
and proprietary information. We cannot assure that we will be able to build and
maintain goodwill in our trademarks or obtain trademark or patent protection,
that any trademark, copyright or issued patent will provide competitive
advantages for us or that our intellectual properties will not be successfully
challenged or circumvented by competitors. Furthermore, despite various
confidentiality agreements and other trade secret protections, our trade secrets
and proprietary know-how could become known to, or independently developed by,
competitors.
Notwithstanding
these safeguards, our competitors may still be able to obtain our technology or
to imitate our products. Furthermore, others may independently develop products
similar or superior to ours.
Expenses
incurred with respect to monitoring, protecting and defending our intellectual
property rights could adversely affect our business.
Competitors
and other third parties may infringe on our intellectual property rights, or may
allege that we have infringed on their intellectual property rights. Monitoring
infringement on and/or misappropriation of intellectual property can be
difficult and expensive and we may not be able to detect any infringement on or
misappropriation of our proprietary rights. We may also incur significant
litigation expenses protecting our intellectual property or defending our use of
intellectual property, reducing our ability to fund product initiatives. These
expenses could have an adverse effect on our future cash flow and results of
operations. Litigation can also divert management focus from running the
day-to-day operations of the business. There can be no assurances that certain
of our products, including those with currently pending patent applications,
will not be determined to have infringed upon an existing third party
patent.
The
intellectual property rights of others may prevent us from developing new
products or entering new markets.
The
gaming industry is characterized by the rapid development of new technologies,
our success depends in part on our ability to continually adapt our products and
systems to incorporate new technologies and to expand into new markets that may
be created by new technologies. However, to the extent technologies are
protected by the intellectual property rights of others, including our
competitors, we may be prevented from introducing products based on these
technologies or expanding into new markets created by these technologies. If our
products use processes or other subject matter that is claimed under existing
patents, or if other companies obtain patents claiming subject matter that we
use, those companies may bring infringement actions against us. We might then be
forced to discontinue such products or be required to obtain licenses from the
company holding the patent, if it is willing to give us a license, to develop,
manufacture or market our products. We also might then be limited in our ability
to market new products. We might also be found liable for treble damage claims
relating to past use of the patented subject matter if the infringement is found
to be willful.
If the
intellectual property rights of others prevent us from taking advantage of
innovative technologies, our financial condition, operating results or prospects
may be harmed.
The
discontinuation or limitation of any existing licenses from third parties could
adversely affect our business.
Some of
our most popular games and gaming machine features, including certain branded
games and ticket-in, ticket-out cashless gaming functionality, are based on
trademarks and other intellectual properties licensed from third parties. Our
future success may depend upon our ability to obtain, retain and/or expand
licenses for additional popular intellectual properties in a competitive market.
In the event that we cannot renew and/or expand this or other existing licenses,
we may be required to discontinue the games using the licensed technology or
bearing the licensed marks, or limit our use of such items.
Our gaming technology, particularly
our wide area progressive networks and centrally determined systems, may
experience losses
due to technical difficulties or fraudulent activities.
Our
success depends on our ability to avoid, detect, replicate and correct software
and hardware errors and fraudulent manipulation of our gaming machines and
associated software. To the extent any of our gaming machines or software
experience errors or fraudulent manipulation, our customers may replace our
products and services with those of our competitors. In addition, the occurrence
of errors in, or fraudulent manipulation of, our gaming machines or software may
give rise to claims for lost revenues and related litigation by our customers
and may subject us to investigation or other action by gaming regulatory
authorities, including suspension or revocation of our gaming licenses or
disciplinary action. Additionally, in the event of such issues with our gaming
machines or software, substantial engineering and marketing resources may be
diverted from other areas to rectify the problem.
Our
business is subject to other economic, market, and regulatory
risks:
We face
risks associated with doing business in international markets related to
political and economic instability and related foreign currency fluctuations.
Unstable governments and changes in current legislation may affect the gaming
market with respect to gaming regulation, taxation, and the legality of gaming
in some markets, as we experienced with the Russian market in fiscal
2007.
Customer
financing is becoming an increasing prevalent component of the sales process and
therefore increases business risk of non-payment, especially in emerging
markets. In some instances, our gaming machines are installed in casinos on a
trial basis, and only after a successful trial period are the machines purchased
by the customers. These customer financing arrangements delay our receipt of
cash and can negatively impact our ability to enforce our rights upon default if
the customer is from a foreign country.
Our
competitors have begun to provide free game theme conversions to customers in
connection with product sales. While we intend to continue to charge our
customers for game theme conversions including CPU-NXT upgrade kits, we cannot
be sure that competitive pressure will not cause us to increase the number of
free game theme conversions we offer to our customers, which would decrease the
revenue we expect to receive for game theme conversions.
RISKS
RELATED TO OUR CRM AND TELECOM VAS PRODUCTS AND SERVICES
A
substantial portion of our business depends on mobile telecommunications
operators in China and any loss or deterioration of such relationships may
result in severe disruptions to our business operations.
We rely
entirely on the networks and gateways of China Mobile and China Unicom to
provide our wireless value-added services. Thus, we face certain risks in
conducting our wireless value-added services business. Currently, China Mobile
and China Unicom are the only mobile telecommunications operators in China that
have platforms for wireless value-added services. Our agreements with them are
generally for a period of less than one year and generally do not have automatic
renewal provisions. If neither of them is willing to continue to cooperate with
us, we will not be able to conduct our existing wireless value-added services
business. Furthermore, our agreements with China Mobile and China Unicom are
subject to negotiation upon expiration. If any of the mobile telecommunications
operators decides to change its content or transmission fees or its share of
revenue, or does not comply with the terms of the agreement, our revenue and
profitability could be materially adversely affected.
Our
financial condition and results of operations may be materially affected by the
changes in policies or guidelines of the mobile telecommunications
operators.
The
mobile telecommunications operators in China may, from time to time, issue
certain operating policies or guidelines, requesting or stating its preference
for certain actions to be taken by all wireless value-added service providers
using their platforms. Due to our reliance on the mobile telecommunications
operators, a significant change in their policies or guidelines may have a
material adverse effect on us. For example, some mobile telecommunications
operators recently revised their billing policies to request all wireless
value-added service providers to confirm the subscription status of those users
who have not been active for three months. Such change in policies or guidelines
may result in lower revenue or additional operating costs for us, and we cannot
assure investors that our financial condition and results of operations will not
be materially adversely affected by any policy or guideline change by the mobile
telecommunications operators in the future.
We
may be subject to adverse actions for any breach or perceived breach by us of
the policies or guidelines imposed by the mobile telecommunications operator
with respect to content provided on or linked through our websites.
The
mobile telecommunications operators in China may impose policies or guidelines
to govern or restrict the content provided by all wireless value-added service
providers, including content developed by us or content supplied by others to
us. The mobile telecommunications operators from time to time have requested
wireless value-added services providers, including us, to remove objectionable
content or links to or from websites with certain categories of content,
including content that they may deem to be sexually explicit. We aggregate and
develop content that we consider attractive to our targeted user base and we
cannot assure investors that the mobile telecommunications operators will not
from time to time find certain portions of our content to be objectionable. In
the case of a breach or perceived breach of such policies or guidelines, the
mobile telecommunications operators may require us to reduce or curtail the
content on our Internet portal, which may reduce our portal traffic, and the
mobile telecommunications operators may have the right to impose monetary fines
upon us, or terminate our cooperation with them. In addition, we would be liable
to the mobile telecommunications operators for their economic losses pursuant to
our agreements with these operators if we were found to be in breach of the
policies or guidelines promulgated by them. As a result of the occurrence of any
of the above, our financial condition and results of operations may be
materially adversely affected.
Our
dependence on the substance and timing of the billing systems of the mobile
telecommunications operators may require us to estimate portions of our reported
revenue for wireless value-added services from time to time. As a result,
subsequent adjustments may have to be made to our wireless value-added services
revenue in our financial statements.
As we do
not bill our wireless value-added services users directly, we depend on the
billing systems and records of the mobile telecommunications operators to record
the volume of our wireless value-added services provided, charge our users
through mobile telephone bills and collect payments from our users and pay us.
In addition, we do not generally have the ability to independently verify or
challenge the accuracy of the billing systems of the mobile telecommunications
operators.
Our communication products are
provided cash-on-delivery, which leaves us vulnerable to theft and employee
embezzlement.
The
purchase of calling cards, SIM cards and other mobile phone products are made
with cash. Although there is a low risk that clients will not pay for these
services when delivered, our retail stores maintain large sums of money which
might make them robbery targets. We also face the risk that employees who
collect the cash and others who may be aware that cash is available at these
sites might embezzle the money. Theft or embezzlement could have a material
adverse effect on the revenue generated and the financial condition of our
business operations.
Our customers are concentrated in a
limited number of industries.
Our
clients are concentrated primarily in the telecommunications, telemarketing and
technology industries, and to a lesser extent, the insurance and financial
services industries, where the current trend is to outsource certain CRM and
VAS. Our ability to generate revenue depends on the demand for our services in
these industries. An economic downturn, or a slowdown or reversal of the
tendency in any of these industries to rely on outsourcing could have a material
adverse effect on our business, results of operations or financial
condition.
RISKS
ASSOCIATED WITH DOING BUSINESS IN GREATER CHINA
There are
substantial risks associated with doing business in greater China, as set forth
in the following risk factors.
Our
operations and assets in Greater China are subject to significant political and
economic uncertainties.
Changes
in laws and regulations, or their interpretation, or the imposition of
confiscatory taxation, restrictions on currency conversion, imports and sources
of supply, devaluations of currency or the nationalization or other
expropriation of private enterprises could have a material adverse effect on our
business, results of operations and financial condition. Under its current
leadership, the Chinese government has been pursuing economic reform policies
that encourage private economic activity and greater economic decentralization.
There is no assurance, however, that the Chinese government will continue to
pursue these policies, or that it will not significantly alter these policies
from time to time without notice.
Currency
fluctuations and restrictions on currency exchange may adversely affect our
business, including limiting our ability to convert Chinese Renminbi into
foreign currencies and, if Chinese Renminbi were to decline in value, reducing
our revenue in U.S. dollar terms.
Our
reporting currency is the U.S. dollar and our operations in China and Hong Kong
use their respective local currencies as their functional currencies. The
majority of our revenue derived and expenses incurred are in Chinese Renminbi
with a relatively small amount in Hong Kong dollars and U.S. dollars. We are
subject to the effects of exchange rate fluctuations with respect to any of
these currencies. For example, the value of the Renminbi depends to a large
extent on Chinese government policies and China's domestic and international
economic and political developments, as well as supply and demand in the local
market. Since 1994, the official exchange rate for the conversion of Renminbi to
U.S. dollars has generally been stable and the Renminbi had appreciated slightly
against the U.S. dollar. However, on July 21, 2005, the Chinese government
changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar.
Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed
band against a basket of certain foreign currencies. It is possible that the
Chinese government could adopt a more flexible currency policy, which could
result in more significant fluctuation of Chinese Renminbi against the U.S.
dollar. We can offer no assurance that Chinese Renminbi will be stable against
the U.S. dollar or any other foreign currency.
The
income statements of our international operations are translated into U.S.
dollars at the average exchange rates in each applicable period. To the extent
the U.S. dollar strengthens against foreign currencies, the translation of these
foreign currencies denominated transactions results in reduced revenue,
operating expenses and net income for our international operations. Similarly,
to the extent the U.S. dollar weakens against foreign currencies, the
translation of these foreign currency denominated transactions results in
increased revenue, operating expenses and net income for our international
operations. We are also exposed to foreign exchange rate fluctuations as we
convert the financial statements of our foreign subsidiaries into U.S dollars in
consolidation. If there is a change in foreign currency exchange rates, the
conversion of the foreign subsidiaries' financial statements into U.S dollars
will lead to a translation gain or loss which is recorded as a component of
other comprehensive income. In addition, we have certain assets and liabilities
that are denominated in currencies other than the relevant entity's functional
currency. Changes in the functional currency value of these assets and
liabilities create fluctuations that will lead to a transaction gain or loss. We
have not entered into agreements or purchased instruments to hedge our exchange
rate risks, although we may do so in the future. The availability and
effectiveness of any hedging transaction may be limited and we may not be able
to successfully hedge our exchange rate risks.
Although
Chinese governmental policies were introduced in 1996 to allow the
convertibility of Chinese Renminbi into foreign currency for current account
items, conversion of Chinese Renminbi into foreign exchange for capital items,
such as foreign direct investment, loans or securities, requires the approval of
the State Administration of Foreign Exchange, or SAFE, which is under the
authority of the People's Bank of China. These approvals, however, do not
guarantee the availability of foreign currency. We cannot be sure that we will
be able to obtain all required conversion approvals for our operations or
Chinese regulatory authorities will not impose greater restrictions on the
convertibility of Chinese Renminbi in the future. Because a significant amount
of our future revenue may be in the form of Chinese Renminbi, our inability to
obtain the requisite approvals or any future restrictions on currency exchanges
could limit our ability to utilize revenue generated in Chinese Renminbi to fund
our business activities outside China, or to repay foreign currency obligations,
including our debt obligations, which would have a material adverse effect on
our financial condition and results of operation.
We
are required to obtain licenses to expand our business into mainland
China.
Our
activities must be reviewed and approved by various national and local agencies
of the Chinese government before they will issue business licenses to us. There
can be no assurance that the current Chinese government, or successors, will
continue to approve and renew our licenses. If we are unable to obtain licenses
or renewals we will not be able to continue our business operations in mainland
China, which would have a material adverse effect on our business, financial
condition and results of operations.
We
may have limited legal recourse under PRC law if disputes arise under our
contracts with third parties.
The
Chinese government has enacted some laws and regulations dealing with matters
such as corporate organization and governance, foreign investment, commerce,
taxation and trade. However, their experience in implementing, interpreting and
enforcing these laws and regulations is limited, and our ability to enforce
commercial claims or to resolve commercial disputes is unpredictable. If our new
business ventures are unsuccessful, or other adverse circumstances arise from
these transactions, we face the risk that the parties to these ventures may seek
ways to terminate the transactions, or, may hinder or prevent us from accessing
important information regarding the financial and business operations of these
acquired companies. The resolution of these matters may be subject to the
exercise of considerable discretion by agencies of the Chinese government, and
forces unrelated to the legal merits of a particular matter or dispute may
influence their determination. Any rights we may have to specific performance,
or to seek an injunction under PRC law, in either of these cases, are severely
limited, and without a means of recourse by virtue of the Chinese legal system,
we may be unable to prevent these situations from occurring. The occurrence of
any such events could have a material adverse effect on our business, financial
condition and results of operations.
We
must comply with the Foreign Corrupt Practices Act.
We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits United States companies from engaging in bribery or other prohibited
payments to foreign officials for the purpose of obtaining or retaining
business. Foreign companies, including some of our competitors, are not subject
to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices occur from time-to-time in mainland China. If our
competitors engage in these practices they may receive preferential treatment
from personnel of some companies, giving our competitors an advantage in
securing business or from government officials who might give them priority in
obtaining new licenses, which would put us at a disadvantage. Although we inform
our personnel that such practices are illegal, we cannot assure that our
employees or other agents will not engage in such conduct for which we might be
held responsible. If our employees or other agents are found to have engaged in
such practices, we could suffer severe penalties.
PRC
laws and regulations restrict foreign investment in China’s telecommunications
services industry and substantial uncertainties exist with respect to our
contractual agreements with Wanrong-DE and iMobile-DE to uncertainties regarding
the interpretation and application of current or futures PRC laws and
regulations.
Since we
are deemed to be foreign persons or foreign funded enterprises under PRC laws
and cannot directly invest in telecommunications companies, we operate our IVR,
call center and telecom value-added services business in China through operating
companies or Variable Interest Entities (VIEs) owned by PRC citizens. We control
these companies and operate these businesses through contractual arrangements
with the respective operating companies and their individual shareholders, but
we have no equity control over these companies. Although we believe we are in
compliance with current PRC regulations, we cannot be sure that the PRC
government would view these operating arrangements to be in compliance with PRC
licensing, registration or other regulatory requirements, with existing policies
or with requirements or policies that may be adopted in the future. In the
opinion of our in-house PRC legal counsel, our current ownership structure, the
contractual arrangements among our wholly owned subsidiaries and the operating
company and their shareholders comply with all existing applicable PRC laws,
rules and regulations. Because this structure has not been challenged or
examined by PRC authorities, they have not commented on it and uncertainties
exist as to whether the PRC government may interpret or apply the laws governing
these arrangements in a way that is contrary to the opinion of our in-house PRC
counsel. If we, or the operating companies, were found to be in violation of any
existing PRC laws or regulations, the relevant regulatory authorities would have
broad discretion to deal with such violation, including, but not limited to the
following:
• Levying
fines
• Confiscating
income
• Revoking
licenses
• Shutting
down servers or blocking websites
• Requiring
a restructure of ownership or operations
• Requiring
the discontinuance of wireless VAS and online advertising
businesses
We may
also encounter difficulties in obtaining performance under or enforcement of
related contracts. Any of these or similar actions could cause significant
disruption to our business operations or render us unable to conduct a
substantial portion of our business operations and may materially adversely
affect our business, financial condition and results of operations.
Our
contractual agreements with Wanrong-DE and iMobile-DE may not be as effective in
providing operational control as direct ownership of these
businesses.
We depend
on operating companies in which we have little or no equity ownership interest
and must rely on contractual agreements to control and operate these businesses.
Our contractual agreements with each of the operating companies may not be as
effective in providing and maintaining control over the operating companies and
their business operations as direct ownership of these businesses. For example,
we may not be able to take control of the operating company upon the occurrence
of certain events, such as the imposition of statutory liens, judgments, court
orders, death or capacity. Furthermore, if the operating companies fail to
perform as required under those contractual agreements, we will have to rely on
the PRC legal system to enforce those agreements and there is no guarantee that
we will be successful in an enforcement action. In addition, the PRC government
may propose new laws or amend current laws that may be detrimental to our
current contractual agreements with our operating companies, which may in turn
have a material adverse effect on our business operations.
The
PRC government may prevent us from advertising or distributing content that it
believes is inappropriate.
China has
enacted regulations governing Internet access and the distribution of news and
other information. In the past, the Chinese government has stopped the
distribution of information over the Internet or through VAS that it believes to
violate PRC law, including content that it believes is obscene, incites
violence, endangers national security, is contrary to the national interest or
is defamatory. In addition, we may need the permission of the Chinese government
prior to publishing certain news items, such as news relating to national
security. Furthermore, the Ministry of Public Security has the authority to
cause any local Internet service provider to block any website maintained
outside China at its sole discretion. If the PRC government were to take any
action to limit or prohibit the distribution of information through our network
or via our VAS, or to limit or regulate any current or future content or
services available to users on our network, our business could be significantly
harmed. We are also subject to potential liability for content on our website
that is deemed inappropriate and for any unlawful actions of our subscribers and
other users of our systems. Furthermore, we are required to delete content that
clearly violates the laws of China and report content that we suspect may
violate PRC law. It is difficult to determine the type of content that may
result in liability for us, and if we are wrong, we may be prevented from
operating our website.
RISKS
RELATED TO OUR TECHNOLOGY AND EQUIPMENT
We
must respond quickly and effectively to new technological
developments.
Our
gaming, telecom and VAS businesses are highly dependent on our computer and
telecommunications equipment and software systems. Our failure to maintain the
superiority of our technological capabilities or to respond effectively to
technological changes could adversely affect our business, results of operations
or financial condition. Our future success also depends on our ability to
enhance existing software and systems and to respond to changing technological
developments. If we are unable to successfully develop and bring to market new
software and systems in a timely manner, our competitors’ technologies or
services may render our products or services noncompetitive or
obsolete.
RISKS
RELATED TO OUR COMMON STOCK
Efforts
to comply with recently enacted changes in securities laws and regulations will
increase our costs and require additional management resources. Our failure to
comply could adversely affect our stock price.
Our
business operations grew rapidly by acquisition during 2006 and 2007. We do not
integrate the business operations of our target companies and therefore have
separate administration and accounting personnel at each subsidiary location.
Due to the number of subsidiaries we have acquired, we have faced significant
challenges with the timely reporting of information necessary to complete the
financial statements to be filed with the Securities and Exchange Commission.
These actions have required us to re-evaluate our disclosure controls and
procedures and conclude that they are ineffective. We have sought to improve our
existing disclosure controls and procedures and to that end, have substantially
increased our accounting and administrative resources. Our failure to timely
file our annual and quarterly reports may have an adverse affect on our stock
price and may put our common stock in jeopardy of being delisted.
As
directed by Section 404 of the Sarbanes-Oxley Act of 2002, public companies are
required to include a report of management on the company's internal controls
over financial reporting in their annual reports on Form 10-K. and the public
accounting firm auditing a company's financial statements must attest to and
report on management's assessment of the effectiveness of the company's internal
controls over financial reporting. This requirement will first apply to our
annual report on Form 10-K for our fiscal year ending December 31, 2007. We have
only recently begun to evaluate our internal controls over financial reporting.
Given the status of our efforts, coupled with the fact that guidance from
regulatory authorities in the area of internal controls continues to evolve,
substantial uncertainty exists regarding our ability to comply by applicable
deadlines. If we are unable to conclude that we have effective internal controls
over financial reporting, or if our independent auditors are unable to provide
us with an unqualified report as to the effectiveness of our internal controls
over financial reporting for future year ends, as required by Section 404 of the
Sarbanes-Oxley Act, we could experience delays or inaccuracies in our reporting
of financial information, or non-compliance with SEC reporting and other
regulatory requirements. This could subject us to regulatory scrutiny and result
in a loss of public confidence in our management, which could, among other
things, adversely affect our stock price.
We
issued $8,000,000 in convertible debentures, which we may not be able to repay
in cash and could result in dilution of our basic earnings per
share.
In March
2006, we issued $8 million in convertible debentures which were originally due
in March 2009. The debentures are convertible at any time into shares of our
common stock at an initial fixed conversion price of $10.00 per share, subject
to adjustments for certain events. If any event of default occurs under the
debentures or other related documents, the holders may elect to accelerate the
payment of the outstanding principal amount of the debenture, plus accrued, but
unpaid interest, liquidated damages or other amounts, which shall become
immediately due and payable. In 2007, we began to redeem up to $363,638 every
month, plus accrued, but unpaid interest, liquidated damages and penalties. We
may choose to pay such redemption amount in cash, or, subject to meeting certain
conditions, we may pay all or a part of the redemption amount in shares of
common stock. We may not have enough cash on hand or have the ability to access
cash to pay the redemption amount, or upon acceleration of the debenture in the
case of an event of default, or at maturity. In addition, the redemption of the
debentures with our shares or the conversion of the debentures into shares of
common stock could result in dilution of our basic earnings per
share.
We
have to pay liquidated damages and our debentures are in default and we are
unable to re-instate use of the prospectus contained in our Registration
Statement on Form S-1
On March
27, 2007, we suspended use of the prospectus contained in our Registration
Statement on Form S-1 (File No. 333-134127) that was declared effective on
December 8, 2006, due to the lack of fiscal year end 2005 and 2004 audited
financial statements. As a result 3,152,228 shares of common stock registered
there under, are not freely tradable upon resale. Under the terms of our
registration rights agreement with the holders of the debentures, we are subject
to paying liquidated damages equal to 2% of the debenture amount on a monthly
basis, up to a maximum of 20% per holder, in the event we suspend use of the
prospectus for longer than 15 consecutive calendar days or more than an
aggregate of 30 calendar days during any 12-month period. Our debentures are
currently in default, which resulted in acceleration of the amounts due, we had
an agreement and payment plan with the debenture holder which we were unable to
adhered to and resulted in involuntary petition under Chapter 11 relief in
federal bankruptcy court late Saturday, March 22, 2008 in Wilmington, DE filed
by three debenture holders. We may not have cash on hand, or have the ability to
access cash to pay the debenture in full if such a demand is made. If the
debenture holders refuse to negotiate with us, our failure to pay upon demand
could result in the debenture holders bringing claims against us for payment,
which may include severe penalty payments. If they are successful in such
claims, we may suffer significant losses, which may severely curtail our ability
to continue business operations.
If we are not
successful in defending against a lawsuit by one of our debenture holders our
business operations could be severely curtailed.
One of
our debenture holders has filed a complaint against us in the Supreme Court of
the State of New York claiming that we are in default for failure to timely make
payments under the debentures. The debenture holder is demanding
payment of $3,253,163.80 in the aggregate, together with any accrued but unpaid
interest through the date of judgment and reimbursement of attorney fees and
other costs and expenses incurred together with costs and disbursements of the
action and such other further relief afforded by the
Court. Although we intend to vigorously defend ourselves
against this action, if the debenture holder is successful in its claims or, if
based upon advice from legal counsel we choose to settle this litigation, such
payments could put a severe strain on our available cash and we could suffer
significant losses, which could curtail our ability to continue our
business.
If we are unable to regain compliance
with the NASDAQ rules for continued listing, are securities may be de-listed
from the NASDAQ Global Market.
We are
currently subject to possible delisting procedures by the NASDAQ Stock Market
for failing to have audited financials for the fiscal years ended December 31,
2007. On April 16, 2008, PacificNet received a letter from The NASDAQ Stock
Market indicating that as a result of the Company's failure to file with the
Securities and Exchange Commission the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2007, the Company is not in compliance with
the NASDAQ requirements for continued listing set forth in NASDAQ Marketplace
Rule 4310(c)(14). NASDAQ Marketplace Rule 4310(c)(14) requires the Company to
make on a timely basis all filings with the Securities and Exchange Commission,
as required by the Securities Exchange Act of 1934, as amended. PacificNet has
appealed the NASDAQ Staff's determination and a hearing has been set before the
NASDAQ Listing Qualifications Panel, which automatically stays the delisting of
PacificNet's common stock pending the Panel's review and determination. There
can be no assurance that the Panel will grant the Company's request for
continued listing, once the 10-K is filed.
The
price of our stock has fluctuated in the past and may continue to do
so.
Our stock
price has fluctuated dramatically. There is a significant risk that the market
price of our common stock will decrease in the future in response to any of the
following factors, some of which are beyond our control:
|
●
|
Variations
in our quarterly operating results
|
|
●
|
Announcements
that our revenue or income are below analysts'
expectations
|
|
●
|
General
economic slowdowns
|
|
●
|
Changes
in market valuations of similar
companies
|
|
●
|
Sales
of large blocks of our common stock
|
|
●
|
Announcements
by us or our competitors of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital
commitments
|
|
●
|
Fluctuations
in stock market prices and volumes, which are particularly common among
highly volatile securities of companies with primarily international-based
operations
|
Future
sales of shares could have an adverse effect on the market price of our common
stock
As of
December 31, 2007, we had 11,984,072 shares of common stock outstanding, which
shares will be available to be sold in the public market in the near future,
subject to the volume restrictions and/or manner of sale requirements of Rule
144 under the Securities Act., with respect to shares of common stock held by
affiliates and shares issued between 12 and 24 months ago. Sales by our current
shareholders of a substantial number of shares could significantly reduce the
market price of our common stock.
As of
December 31, 2007, we had warrants outstanding to purchase 1,007,138 shares of
our common stock. To the extent that the warrants are exercised, they may be
exercised at prices below the price of our shares of common stock on the public
market, resulting in a significant number of shares entering the public market
and the dilution of our common stock. In the event that any future financing
should also be in the form of securities convertible into, or exchangeable for,
equity securities, investors may experience additional dilution upon the
conversion or exchange of such securities.
NONE
ITEM
2. PROPERTIES
A
description of our property is as follows:
CHINA -
We maintain our corporate headquarters at 23/F, Building A, TimeCourt, No.6
Shuguang Xili, Chaoyang District, Beijing, China. Postal Code: 100028; and our
Shenzhen finance center located at Room 4203, Jinzhonghuan Business Building,
Futian District, Shenzhen, China; Postal Code: 518040. Both
properties were purchased in 2006.
HONG KONG
- We maintain our Hong Kong office at Room 2702, Richmond Commercial Building,
107-111 Argyle Street, Mongkok, Kowloon, HK.
Locations
|
Area
(Square Feet)
|
PacificNet
Beijing Office: 23/F, Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang
District, Beijing, China, Postal Code:
100028
|
11,324
|
PacificNet
Shenzhen Office: Room 4203, Jinzhonghuan Business Building, Futian
District, Shenzhen, China, Postal Code: 518026
|
4,950
|
Room
2702, Richmond Commercial Building, 107 -111 Argyle Street, Mong Kok,
Kowloon, Hong Kong
|
637
|
416
Production Street North, Aberdeen, SD 57401, USA
|
200
|
We
believe that our offices are adequate for our current operations.
ITEM
3. LEGAL PROCEEDINGS
1.
Johnson Controls Hong Kong Limited (JCHKL) vs. PacificNet Power
Limited
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a civil 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 rain water-cooled chillers,
together with energy saving performance (the "Chiller System"), at the Fortress
Tower in Hong Kong.
In
connection with the claim, PacificNet Power reviewed a letter from its client,
China Weal Property Management Ltd., dated January 22, 2007 stating that the
construction work by JCHKL had not been completed as of the date of the letter,
and that certain violations itemized in a letter issued by the Hong Kong
Environment Protection Department (EPD) (Noise Abatement Notice No. N806030)
addressed to JCHKL with respect to acoustic problems with JCHKL’s equipment had
not been abated.
The board
of directors of PacificNet Power Limited has reviewed the case with its client,
China Weal Property Management Ltd., and our Hong Kong legal counsel and it is
the honest belief of the board that the project work undertaken JCHKL is
defective in numerous aspects. As a result, the board believes that
the construction work has not been completed by JCHKL, and therefore, JCHKL is
not entitled to payment for its services.
On
February 13, 2007, the board instructed the Hong Kong legal counsel to issue a
Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
construction work has not complied with the applicable rules and regulations of
various government authorities in Hong Kong; (ii) the Chiller System provided by
JCHKL was defective and merchantable unfit and JCHKL has failed and/or refused
to rectify such defective works; and (iii) JCHKL shall return the work deposit
in the amount of HK$1,500,000 to PacificNet Power Limited and shall compensate
and keep PacificNet Power Limited indemnified against all the loss and damages
suffered as a result of any claims from the China Weal Property Management
Ltd..
The case
is now in the discovery stage before proceeding to the stage of fixing a date
for trial in the High Court of Hong Kong and the board intends to vigorously
defend against the allegations. We are unable to predict the outcome of these
actions, or a reasonable estimate of the range of possible loss, if
any.
2. PacificNet Power Limited vs
Johnson Controls Hong Kong Limited (JCHKL)
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 Incorpated Owners of Nan Fung Centre,
Tsuen Wan (“the Employer”) for the “construction and replacement works of
existing air-cooled chiller plant by new water-cooled chiller plant for Tsuen
Wan Nan Fung Centre and energy saving performance contract” (“the Contract”).
JCHKL invited and induced PacificNet Power Limited to act as the main contractor
for the Contract and it would then act as a sub-contractor.
PacificNet
Power also expressly made known to JCHKL that the said construction and
replacement works and the guaranteed energy saving should meet all the tender
requirements if PacificNet Power accepted the invitation to act as the main
contractor for the Contract, and PacificNet Power further said that if there
should be any quality defects with the system and/ or the construction work, the
Employer and/ or their prospective tenants would claim against JCHKL and JCHKL
should compensate.
PacificNet
Power however received some correspondences and complaints from the Employer
about the poor and/or sub-standard works done by JCHKL. PacificNet Power, after
separate investigation, discovered the poor workmanship and sub-standard works
done by JCHKL. Accordingly, the Employer and/or their representatives have
delayed the monthly installments payment to PacificNet Power.
On April
23, 2007, PacificNet Power instructed the Hong Kong lawyers to issue a letter to
the Defendant requesting and demanding them, being the sub-contractor of the
Construction and Replacement Works Contract, to take immediate rectification
action within seven days from the date of the said letter to (i) rectify and
complete all outstanding defective works of the Construction and Replacement
Works Contract; (ii) replace the water-cooled chiller plant and/or equipments
which are not conformed with the requirements of the tender documents previously
submitted by the Defendant to the Employer; and (iii) improve the poor
performance of energy saving of the new water-cooled chiller plant.
Despite
the said letter, JCHKL had failed and/or refused to rectify and complete all
outstanding works and/or replace the defective system. And therefore PacificNet
Power claims against JCHKL for: (i) refund HK$6,414,300.00, being the Contract
Price paid by PacificNet Power to JCHKL; (ii) costs and expenses incurred by
PacificNet Power to rectify all defective works of the Contract; (iii) all
damage and loss suffered by PacificNet Power, and further and other
relief.
On July
25, 2007, JCHKL issued a Defense and Counterclaim to PacificNet Power to argue
that: (i) they had carried out the works according to the Contract terms; (ii)
the works had been approved by PKL Consultants Limited, the consultant
representative of the Employer; and (iii) a sum of HK$30,000 is still due and
owing by PacificNet Power to JCHKL.
The case
is now in the discovery stage before proceeding to the stage of fixing a date
for trial in the High Court of Hong Kong. We are unable to predict the outcome
of these actions, or a reasonable estimate of the range of possible loss, if
any.
3.
PacificNet Inc. vs. HLB Hodgson Impey Cheng (HLB or Defendant), a firm of
Chartered Accountants and Certified Public Accountants in Hong Kong
On
September 20, 2007, PacificNet Inc. filed a claim against its former auditors
HLB Hodgson Impey Cheng (HLB), a firm of Chartered Accountants and Certified
Public Accountants, in the High Court of the Hong Kong Special Administrative
Region seeking refund of the professional fees, compensation of professional
fees and expenses for Company to engage and deploy new auditors to take over the
incomplete audit works from the Defendant and returning and/or providing all
relevant accounting records, vouchers, audit program and working papers retained
by the Defendant and losses and damages incurred.
The case
is now in the pleadings stage. We are unable to predict the outcome of these
actions, or a reasonable estimate of the range of possible loss, if
any.
4.
Iroquois Master Fund, Ltd. vs. Pacificnet Inc.
On or
about October 3, 2007 Iroquois Master Fund, Ltd. filed a complaint in the
Supreme Court of the State of New York against PacificNet Inc., claiming that
the Company is in default under the Amended and Restated Convertible Debenture
due March 2009 (the Amended Debenture”) in the principal amount of $3,000,000
and the Convertible Debenture due February 2009 (the New Debenture”) in the
principal amount of $420,000.
Iroquois
Master Fund, Ltd. is seeking damages of $3,253,163.80 in the aggregate, together
with any accrued but unpaid interest through the date of judgment. Iroquois
Master Fund, Ltd. has also demanded reimbursement of its attorney fees and other
costs and expenses incurred together with costs and disbursements of this
action.
On or
about December 5, 2007, PacificNet filed its answer which denies that PacificNet
is in default and asserts an agreement that would enable it to bring the
interest payments up to date by the issuance of stock in the near
future.
On March
27, 2008, three holders of PACT's Convertible Subordinated Debentures filed an
involuntary petition for Chapter 11 relief in federal bankruptcy court late
Saturday, March 22, 2008 in Wilmington, DE. The Company has retained counsel to
oppose the filing because the petition fails to meet the standard for invoking
an involuntary bankruptcy and fails to take into consideration other agreements
between the Company and the petitioning creditors. The Company intends to
vigorously oppose the petition and move for dismissal of the filing, and if
successful will seek damages and attorney fees. Subsequently, PACT also received
default notice from all but one of the debenture holders including Iroquois
Master Fund Ltd., Alpha Capital AG, Whalehaven Capital Fund Limited, DKR
Soundshore Oasis Holding Fund Ltd., Basso Fund Ltd., Basso Multi-Strategy
Holding Fund Ltd., and Basso Private Opportunities Holding Fund Ltd. from the
same Convertible Subordinated Debentures related to the private offering of
$8,000,000 principal amount variable debentures consummated on March 13, 2006,
and due March 2009.
PACT has
retained counsel to oppose the above petition. The amount of the debt in
question is as follows: Iroquois Master Fund Ltd. $2.5 million, Whalehaven
Capital Fund Limited $958,000, Alpha Capital AG $685,000 DKR Soundshore Oasis
Holding Fund Ltd $960,000, and Basso Fund Ltd., Basso Multi- Strategy Holding
Fund Ltd., and Basso Private Opportunities Holding Fund Ltd., a combined amount
of $500,000.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The
Company held its annual meeting on October 17, 2007 at the Company's executive
offices located at 23rd Floor, Building A, TimeCourt, No.6 Shuguang Xili,
Chaoyang District, and Beijing, China for the following purposes:
1.
|
To
elect seven (7) directors to the Board of Directors of the Company to
serve until the next annual meeting of stockholders and until their
successors are duly elected and
qualified.
|
2.
|
To
ratify the appointment of Kabani & Company, Inc. as the Company's
independent auditors.
|
3.
|
To
transact any other business as may properly be presented at the Annual
Meeting or any adjournment or postponement
thereof.
|
At such
meeting the following proposals were voted upon:
1.
|
The
following directors were elected to the Board of Directors of Company,
after each receiving a plurality of the votes cast: 1. Tony Tong
(8,853,833 votes or 61.60% voted for), 2. Victor Tong (8,853,275 votes or
61.60% voted for), 3. ShaoJian (Sean) Wang (8,854,233 votes or 61.60%
voted for), 4. Tao Jin (8,856,177 votes or 61.62% voted for), 5. Jeremy
Goodwin (8,856,535 votes or 61.62% voted for), 6. Michael Chun Ha
(8,856,233 votes or 61.62% voted for), 7. Ho-Man (Mike) Poon (8,854,177
votes or 61.60% voted for).
|
2.
|
Ratification
and approval of the appointment of Kabani & Company, Inc. as the
Company's independent auditors: 8,891,214 shares of the Company's common
stock, constituting a 61.86% majority of the shares of common stock
present in person or by proxy entitled to vote at the meeting voted
in favor of this proposal while 45,392 voted against and 11,858 votes
abstain.
|
ITEM 5. MARKET FOR
REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND PURCHASES OF EQUITY
SECURITIES
Our
common stock is listed on the NASDAQ Global Market, under the symbol “PACT”.
Prior to that time, our common stock was listed on the NASDAQ Capital Market
under the same symbol. The following table sets forth the range of high and low
sales prices of common stock reported by NASDAQ in each fiscal quarter from
January 1, 2006 to December 31, 2007 and for the first quarter of
2008.
|
|
HIGH
|
|
|
LOW
|
|
FISCAL
2006
|
|
|
|
|
|
|
Quarter
Ended March 31, 2006
|
|
$ |
8.88 |
|
|
$ |
6.57 |
|
Quarter
Ended June 30, 2006
|
|
$ |
8.52 |
|
|
$ |
7.05 |
|
Quarter
Ended September 30, 2006
|
|
$ |
7.62 |
|
|
$ |
4.62 |
|
Quarter
Ended December 31, 2006
|
|
$ |
6.28 |
|
|
$ |
5.05 |
|
FISCAL
2007
|
|
|
|
|
|
|
|
|
Quarter
Ended March 31, 2007
|
|
$ |
7.60 |
|
|
$ |
4.80 |
|
Quarter
Ended June 30, 2007
|
|
$ |
5.80 |
|
|
$ |
3.77 |
|
Quarter
Ended September 30, 2007
|
|
$ |
6.10 |
|
|
$ |
3.92 |
|
Quarter
Ended December 31, 2007
|
|
$ |
7.15 |
|
|
$ |
3.91 |
|
FISCAL
2008
|
|
|
|
|
|
|
|
|
Quarter
Ended March 31, 2008
|
|
$ |
4.35 |
|
|
$ |
1.36 |
|
Quarter
Ended June 30, 2008 (through May 12, 2008)
|
|
$ |
1.63 |
|
|
$ |
0.91 |
|
HOLDERS
OF RECORD
As of
March 31, 2008, there were 184 record holders of our common stock. However, the
total number of beneficial holders is unknown as they hold our common stock in
street name.
DIVIDENDS
We have
not paid any cash dividends on our common stock, and we currently intend to
retain any future earnings to fund the development and growth of our
business.
EQUITY
COMPENSATION PLAN INFORMATION
The
following table sets forth aggregate information regarding the Company's equity
compensation plans in effect as of December 31, 2007:
|
Number
of securities
to
be issued upon
exercise
of
outstanding
options, warrants and rights
|
Weighted-average
exercise
price of outstanding options,
warrants
and
rights ($)
|
Remaining
available
for
further issuance
under
equity
compensation
plans
|
Equity
compensation plans approved by security holders (under 2005 Stock Option
Plan) (1)
|
33,000
|
$4.31
|
2,000,000
|
Equity
compensation plans not approved by security holders
|
N/A
|
N/A
|
N/A
|
(1)
Reflects options granted and available for issuance under the 2005 Stock Option
Plan.
STOCK
PRICE PERFORMANCE PRESENTATION
The
following chart compares the cumulative total stockholder return on the
Company’s shares of Common Stock with the cumulative total stockholder return of
(i) the NASDAQ Stock Market Index and (ii) a peer group index consisting of
companies reporting under the Standard Industrial Classification Code 3669
(Communications Equipment):
Since we
have begun a new focus on the gaming industry, we are also providing a chart
comparing the cumulative total stockholder return on the Company’s shares of
Common Stock with the cumulative total stockholder return of (i) the NASDAQ
Stock Market Index and (ii) a peer group index, which includes companies engaged
in the manufacturing of gaming machines, reporting under the Standard Industrial
Classification Code 3990 (Miscellaneous Manufacturing Industries):
|
2002
($)
|
2003
($)
|
2004
($)
|
2005
($)
|
2006
($)
|
2007
($)
|
PACIFICNET,
INC.
|
100.00
|
273.85
|
521.03
|
347.18
|
316.92
|
218.97
|
SIC
CODE INDEX - 3669
|
100.00
|
239.47
|
278.09
|
215.79
|
248.03
|
136.99
|
NASDAQ
MARKET INDEX
|
100.00
|
150.36
|
163.00
|
166.58
|
183.68
|
201.91
|
SIC
CODE INDEX - 399
|
100.00
|
163.14
|
165.69
|
149.34
|
192.26
|
290.00
|
The
material in the charts are not soliciting material, are not deemed filed with
the SEC and are not incorporated by reference in any filing of the Company under
the Securities Act of 1933, as amended or the Exchange Act, whether made before
or after the date of this Form 10-K and irrespective of any general
incorporation language in such filing.
RECENT
SALES OF UNREGISTERED SECURITIES
There
were no sales of unregistered securities during the period covered by the report
that were not previously reported on a Form-8K or Form 10-Q.
REPURCHASES
OF COMPANY COMMON STOCK
There
were no repurchases made during the fourth quarter of the fiscal year covered by
this Annual Report.
The
following selected financial data should be read in conjunction with our
consolidated financial statements and related notes and the following subsection
- Results of Operations as set out in this Annual Report on Form
10-K.
The table
below sets forth a summary of our selected financial data for each of the five
years ended December 31, (amounts in thousands except per share
amounts):
|
For
the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
Audited
|
|
|
restated
|
|
|
restated
|
|
|
restated
|
|
|
restated
|
|
Statement
of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
$ |
18,994 |
|
|
$ |
29,073 |
|
|
$ |
7,081 |
|
|
$ |
10,857 |
|
|
$ |
1,217 |
|
Cost
of revenues
|
|
|
15,292 |
|
|
|
25,529 |
|
|
|
5,722 |
|
|
|
(7,887 |
) |
|
|
698 |
|
Operating
expenses
|
|
|
20,129 |
|
|
|
10,979 |
|
|
|
7,578 |
|
|
|
9,212 |
|
|
|
3,042 |
|
Loss
from operations
|
|
|
(16,427 |
) |
|
|
(7,435 |
) |
|
|
(6,219 |
) |
|
|
(6,242 |
) |
|
|
(2,523 |
) |
Loss
available to common stockholders
|
|
|
(14,195 |
) |
|
|
(12,415 |
) |
|
|
(5,145 |
) |
|
|
(5,446 |
) |
|
|
(1,878 |
) |
Basic
& Diluted Loss Per Share
|
|
$ |
(1.20 |
) |
|
$ |
(1.08 |
) |
|
$ |
(0.21 |
) |
|
$ |
(0.78 |
) |
|
$ |
(0.36 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares-Basic & Diluted
|
|
|
11,850,840 |
|
|
|
11,538,664 |
|
|
|
21,695,473 |
|
|
|
7,015,907 |
|
|
|
5,234,744 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents (excludes restricted cash)
|
|
$ |
3,750 |
|
|
$ |
1,778 |
|
|
$ |
3,331 |
|
|
$ |
9,433 |
|
|
$ |
3,823 |
|
Working
capital
|
|
|
3,205 |
|
|
|
(6,925 |
) |
|
|
7,965 |
|
|
|
12,711 |
|
|
|
1,442 |
|
Total
assets
|
|
|
24,720 |
|
|
|
32,671 |
|
|
|
25,225 |
|
|
|
29,442 |
|
|
|
7,173 |
|
Total
stockholders’ equity
|
|
$ |
2,792 |
|
|
$ |
13,977 |
|
|
$ |
23,205 |
|
|
$ |
24,108 |
|
|
$ |
1,912 |
|
PART
II
ITEM
7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING
STATEMENTS This annual report on Form 10-K, contains forward-looking
statements within the meaning of the federal securities laws. These include
statements about our expectations, beliefs, intentions or strategies for the
future, which we indicate by words or phrases such as "anticipate," "expect,"
"intend," "plan," "will," "we believe," "management believes" and similar
language. The forward-looking statements are based on our current expectations
and are subject to certain risks, uncertainties and assumptions, including those
set forth in the discussion under "Description of Business," including the "Risk
Factors" described in that section, and "Management's Discussion and Analysis or
Plan of Operation." Our actual results may differ materially from results
anticipated in these forward-looking statements.
FACTORS
THAT COULD AFFECT FUTURE RESULTS
Factors
that might cause actual results, performance or achievements to differ
materially from those projected or implied in such forward-looking statements
include, among other things:
• The
impact of competitive products
• Changes
in laws and regulations
• Limitations
on future financing
• Increases
in the cost of borrowings and unavailability of debt or equity
capital
• The
inability of the Company to gain and/or hold market share
• Exposure
to and expense of resolving and defending litigation
• Consumer
acceptance of the Company's products
• Managing
and maintaining growth
• Customer
demands
• Market
and industry conditions
• The
success of product development and new product introductions into the
marketplace
• The
departure of key members of management
• The
effect of the United States War on Terrorism, as well as other risks and
uncertainties that are described from time to time in the Company's filings with
the Securities and Exchange Commission
Our
discussion and analysis or plan of operations is based upon our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities.
On an
on-going basis, we evaluate our estimates, including those related to accounts
receivable reserves, provisions for impairment losses of affiliated companies
and other intangible assets, income taxes and contingencies. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
Management
believes the following critical accounting policies reflect our more significant
estimates and assumptions used in the preparation of our consolidated financial
statements:
Allowance
for Doubtful Accounts
We evaluate the collectibility of our trade receivables based on
a combination of factors. We regularly analyze our significant customer
accounts, and, when we become aware of a specific customer's inability to meet
its financial obligations to us, such as in the case of bankruptcy filings or
deterioration in the customer's operating results or financial position, we
record a specific reserve for bad debt to reduce the related receivable to the
amount we reasonably believe is collectible. We also record reserves for bad
debt for all other customers based on a variety of factors including the length
of time the receivables are past due, the financial health of the customer,
macroeconomic considerations and historical experience. If circumstances related
to specific customers change, our estimates of the recoverability of receivables
could be further adjusted. In the event that our trade receivables become
uncollectible, we would be forced to record additional adjustments to
receivables to reflect the amounts at net realizable value. The accounting
effect of this entry would be a charge to earnings, thereby reducing our net
earnings. Although we consider the likelihood of this occurrence to be remote
based on past history and the current status of our accounts, there is a
possibility of this occurrence.
In the
beginning of the third quarter of 2006, the Chinese government announced that it
would implement several new policies regarding mobile phone value-added service
providers effective from July 10, 2006. These policies include a “double
confirmation” policy and the requirement that value-added service providers
provide one-month trial subscriptions. By requiring that mobile phone customers
“double-confirm” their intention to purchase services, and by requiring free
subscriptions, these policies have negatively affected value-added service
providers.
Inventory
Our
inventory purchases and commitments are made in order to build inventory to meet
forecasted demand for our products. We perform a detailed assessment of
inventory for each period, which includes a review of, among other factors,
demand requirements, product life cycle and development plans, component cost
trends, product pricing and quality issues. Based on this analysis, we record
adjustments to inventory for excess, obsolescence or impairment, when
appropriate, to reflect inventory at net realizable value. Revisions to our
inventory adjustments may be required if actual demand, component costs or
product life cycles differ from our estimates. In the event we were unable to
sell our products, the demand for our products diminished, and/or other
competitors offered similar or better products, we would be forced to record an
adjustment to inventory for impairment or obsolescence to reflect inventory at
net realizable value. The accounting effect of this entry would be a charge to
earnings, thereby reducing our net earnings.
Income
Taxes
We record
a valuation allowance to reduce our deferred tax assets to the amount that is
more likely than not to be realized. We have considered future market growth,
forecasted earnings, future taxable income, and the mix of earnings in the
jurisdictions in which we operate and prudent and feasible tax planning
strategies in determining the need for a valuation allowance. We currently have
recorded a full valuation allowance against net deferred tax assets as we
currently believe it is more likely than not that the deferred tax assets will
not be realized. In the event we determine that we would not be able to realize
all or part of our net deferred tax assets in the future, an adjustment to the
deferred tax assets would be charged to earnings in the period such
determination is made. Likewise, if we later determine that it is more likely
than not that the net deferred tax assets would be realized, the previously
provided valuation allowance would be reversed.
Contingencies
We may be
subject to certain asserted and unasserted claims encountered in the normal
course of business. It is our belief that the resolution of these matters will
not have a material adverse effect on our financial position or results of
operations, however, we cannot provide assurance that damages that result in a
material adverse effect on our financial position or results of operations will
not be imposed in these matters. We account for contingent liabilities when it
is probable that future expenditures will be made and such expenditures can be
reasonably estimated.
Valuation of Long-Lived Assets
Including Goodwill and Purchased Intangible Assets
We review
property, plant and equipment, goodwill and purchased intangible assets for
impairment whenever events or changes in circumstances indicate the carrying
value of an asset may not be recoverable. Our asset impairment review assesses
the fair value of the assets based on the future cash flows the assets are
expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset plus
net proceeds expected from disposition of the asset (if any) are less than the
carrying value of the asset. This approach uses our estimates of future market
growth, forecasted revenue and costs, expected periods the assets will be
utilized and appropriate discount rates. Such evaluations of impairment of
long-lived assets including goodwill arising on a business combination and
purchased intangible assets are an integral part of, but not limited to, our
strategic reviews of our business and operations performed in conjunction with
restructuring actions. When impairment is identified, the carrying amount of the
asset is reduced to its estimated fair value. Deterioration of our business in a
geographic region or within a business segment in the future could also lead to
impairment adjustments as such issues are identified. The accounting effect of
an impairment loss would be a charge to earnings, thereby reducing our net
earnings.
Convertible
debt
In
accordance with recent FASB accounting guidance, due to certain factors,
including a liquidated damages provision in the registration rights agreement
and an indeterminate amount of shares to be issued upon conversion of the
debentures, the Company values and accounts for the embedded conversion feature
related to the Debentures, the Investors’ warrants, and the registration rights
as derivative liabilities. Accordingly, these derivative liabilities are
measured at fair value with changes in fair value reported in earnings as long
as they remain classified as liabilities. The Company reassesses the
classification at each balance sheet date. If the classification required under
EITF No. 00-19 changes as a result of events during the period, the contract
should be reclassified as of the date of the event that caused the
reclassification.
The fair
value of these derivative instruments, as determined by applying the
Black-Scholes valuation model, is adjusted quarterly. The Black-Scholes
valuation model requires the input of highly subjective assumptions, including
the expected stock price volatility. Additionally, although the Black-Scholes
model meets the requirements of SFAS 133, the fair values generated by the model
may not be indicative of the actual fair values as our derivative instruments
have characteristics significantly different from traded options. Accordingly,
the results obtained could be significantly different if other assumptions were
used. The effect of this entry would be a charge to net earnings, thereby either
increasing or reducing our net earnings based upon the assumptions used and the
results obtained.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
March 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on
issue number 06-10, “Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance
Arrangements,” (“EITF 06-10”). EITF 06-10 provides guidance to help companies
determine whether a liability for the postretirement benefit associated with a
collateral assignment split-dollar life insurance arrangement should be recorded
in accordance with either SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” (if, in substance, a postretirement
benefit plan exists), or Accounting Principles Board Opinion No. 12 (if the
arrangement is, in substance, an individual deferred compensation contract).
EITF 06-10 also provides guidance on how a company should recognize and measure
the asset in a collateral assignment split-dollar life insurance contract. EITF
06-10 is effective for fiscal years beginning after December 15, 2007,
though early adoption is permitted. The management is currently evaluating the
effect of this pronouncement on financial statements.
In March
19, 2008, FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities. The new standard is intended to improve financial reporting
about derivative instruments and hedging activities by requiring enhanced
disclosures to enable investors to better understand their effects on an
entity's financial position, financial performance, and cash flows. It is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged. Currently
the Company does not carry any derivative instruments and the adoption of this
statement may not have any effect on the financial statements.
In December 2007, FASB issued FASB Statement No. 160,
Noncontrolling Interests in Consolidated Financial Statements—an amendment of
ARB No. 51. This Statement applies to all entities that prepare consolidated
financial statements, except not-for-profit organizations, but will affect only
those entities that have an outstanding non-controlling interest in one or more
subsidiaries or that deconsolidate a subsidiary. Not-for-profit organizations
should continue to apply the guidance in Accounting Research Bulletin No. 51,
Consolidated Financial Statements, before the amendments made by this Statement,
and any other applicable standards, until the Board issues interpretative
guidance. This Statement is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008 (that is,
January 1, 2009, for entities with calendar year-ends). Earlier adoption is
prohibited. The effective date of this Statement is the same as that of the
related Statement 141(R). This Statement shall be applied prospectively as of
the beginning of the fiscal year in which this Statement is initially applied,
except for the presentation and disclosure requirements. The presentation and
disclosure requirements shall be applied retrospectively for all periods
presented. Management is currently evaluating the effect of this pronouncement
on financial statements.
In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations". This
Statement replaces SFAS No. 141, Business Combinations. This Statement retains
the fundamental requirements in Statement 141 that the acquisition method of
accounting (which Statement 141 called the purchase method) be used for all
business combinations and for an acquirer to be identified for each business
combination. This Statement also establishes principles and requirements for how
the acquirer: a) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree; b) recognizes and measures the goodwill acquired in
the business combination or a gain from a bargain purchase and c) determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. SFAS No.
141(R) will apply prospectively to business combinations for which the
acquisition date is on or after Company's fiscal year beginning October 1, 2009.
While the Company has not yet evaluated this statement for the impact, if any,
that SFAS No. 141(R) will have on its consolidated financial statements, the
Company will be required to expense costs related to any acquisitions after
September 30, 2009.
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 second quarter 2007 financial
statements.
The new
Statement allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item's fair value in subsequent reporting
periods must be recognized in current earnings. FAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. The management is currently evaluating the effect of this
pronouncement on financial statements.
In
September 2006, FASB issued SFAS 158 ‘Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
88, 106, and 132(R)’ This Statement improves financial reporting by requiring an
employer to recognize the over funded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income of a
business entity or changes in unrestricted net assets of a not-for-profit
organization. The requirement to measure plan assets and benefit obligations as
of the date of the employer’s fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. The Company currently
does not have any defined benefit plan and so FAS 158 will not affect the
financial statements.
In
September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial
statements.
RESULTS
OF OPERATIONS
REVENUES
Revenues
for the year ended December 31, 2007 were $18,994,000, representing a
significant year-over-year decline of 35% as compared to $29,073,000 for the
year ended December 31, 2006.
The
decrease in revenues was mainly due to a lower contribution of the low-margin
mobile phone wholesaling and distribution business in Greater China and the
disposal of major legacy CRM and call center unit during 2007. However, the
company has great growth in Gaming Products business revenues that increased to
$2,859,000 (2006: $364,000) due to the emphasis on Gaming technology development
through newly acquired gaming subsidiaries during 2007. Segmented financial
information of the four business operating groups is set out below followed by a
brief discussion of each business group.
For
the year ended December 31, 2007 (in
|
Group
1.
Outsourcing
Services
|
Group
2.
Telecom
Value-Added
Services
|
Group
3.
Products
(Telecom
&
Gaming)
|
Group
4.
Other
Business
|
Total
|
thousands
of US Dollars, except percentages) |
|
|
|
|
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
2,310
|
1,839
|
14,528
|
317
|
18,994
|
(%
of Total Revenues)
|
12%
|
10%
|
76%
|
2%
|
100%
|
Earnings
/ (Loss) from Operations
|
(544)
|
737
|
(6,133)
|
(10,487)
|
(16,427)
|
|
Group
1.
Outsourcing
Services
|
Group
2.
Telecom
Value-Added
Services
|
Group
3.
Products
(Telecom
&
Gaming)
|
Group
4.
Other
Business
|
Total
|
For
the year ended December 31, 2007 (in |
|
|
|
|
|
thousands
of US Dollars, except percentages) |
Restated
|
Restated
|
Restated
|
Restated
|
Restated
|
|
($)
|
($)
|
($)
|
($)
|
($)
|
Revenues
|
1,813
|
2,784
|
23,385
|
1,091
|
29,073
|
(%
of Total Revenues)
|
6%
|
5%
|
77%
|
12%
|
100%
|
Earnings
/ (Loss) from Operations
|
(67)
|
(1,054)
|
(1,345)
|
(4,969)
|
(7,435)
|
(1) OUTSOURCING
SERVICES
Revenues
for the year ended December 31, 2007 were $2,310,000, a significant
year-over-year increase of 28% as compared to $1,813,000 for the year ended
December 31, 2006. Outsourcing services revenues made up 13% of the Company’s
total revenues for the FY 2007 which was mainly derived from software
development, R&D, and project management services.
(2) TELECOM VALUE-ADDED
SERVICES (VAS)
Revenues
for the year ended December 31, 2007 were $1,839,000, a year-over-year increase
of 34% as compared to $2,784,000 for the same period last year. The increase was
mainly due to the sales revenues from WAP-based mobile phone games and
traditional SP businesses, from which revenues accounted for 90% of the
Company’s total VAS revenues for FY2007.
(3) PRODUCTS (TELECOM &
GAMING)
Revenues
for the year ended December 31, 2007 were $14,528,000, a year-over-year decrease
of 38% from $23,385,000 for the year ended December 31, 2006. Decrease in
Products revenues, which accounted for 77% of the Company's total revenues for
FY2007, is largely due to contraction of the Company’s mobile phone wholesaling
and distribution businesses in Greater China.
Gaming
technology revenues derived from selling Multi-player Electronic Gaming Machine
to casino operators amounted to $2,311,000 and accounted for 16% of total
revenues for FY2007.
As
planned, the company continues to scale down its low-margin mobile phone
wholesaling business and distribution business in Greater China. Revenues from
sales and distribution of mobile communication products, accessories, phone
cards and mobile SIM cards, and telecom related services in Hong Kong and
Greater China amounted to $11,669,000, a significant year-over-year decline of
33% as compared to $17,268,000 for the same periods in 2006.
(4) OTHER
BUSINESS
Revenues
for other business for the year ended December 31, 2007 was $317,000, a
significant decrease of 71% as compared to $1,091,000 for the year ended
December 31, 2006 due to the disposal of certain subsidiaries during
2007.
COST
OF REVENUES
Cost of
revenues for the year ended December 31, 2007 were $15,292,000, representing a
year-over-year decrease of 40% as compared to $25,529,000 for the same period of
prior year. Cost of revenues as a percentage of the corresponding revenues was
approximately 81% for FY2007 as compared to 88% for the same period of prior
year.
(1) OUTSOURCING
SERVICES
Cost of
revenues from outsourcing services for FY2007 amounted to $2,199,000, a
year-over-year increase of 55% as compared with 2006. Increase in cost of
revenues was largely due to headcount increase at service staff
level.
(2) TELECOM VALUE-ADDED
SERVICES (VAS)
Cost of
revenues from VAS for FY2007 was $508,000, a decrease of 75% as compared with
2006 due to the sale of a major telecom CRM unit during 2007.
(3) PRODUCTS (TELECOM &
GAMING)
Cost of
revenues derived from Products for FY2007 amounted to $12,538,000, a reduction
of 43% as compared with the same periods in 2006. Approximately 87%
of the cost of revenues related to Products for the third quarter of FY2007 was
derived from the sales of mobile phones and 13% was derived from the sales of
electronic gaming machines.
GROSS
PROFIT
Gross
profit for FY2007 was $3,702,000 (2006: $3,544,000). Gross margin was 20% for
FY2007 as compared to 13% for the same period of prior
year. Improvement in gross margin was attributed to higher margin for
Multiplayer Gaming Machines (39%) and Electronic Slot Machines
(60%).
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
Selling,
general and administrative expenses (SG&A) totaled $13,480,000 for FY2007, a
year-over-year increase of 69% as compared to $7,968,000 for the same periods of
prior year. The increased SG&A was mainly due to the provision
for captioned USD5 million against 3G receivables during 2007. SG&A consists
primarily of indirect staff salaries, office rental, insurance, advertising
expenditures and traveling costs.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31,2006
|
|
Percentage
Change
|
|
|
|
Audited
|
|
Restated
|
|
|
|
|
Remuneration
and related expenses
|
|
$ |
4,498 |
|
$ |
2,293 |
|
%
|
96 |
|
Office
(majority is rental and utilities)
|
|
|
821 |
|
|
599 |
|
|
37 |
|
Travel
|
|
|
440 |
|
|
302 |
|
|
46 |
|
Entertainment
|
|
|
158 |
|
|
103 |
|
|
54 |
|
Professional
(legal and consultant)
|
|
|
600 |
|
|
357 |
|
|
68 |
|
Audit
|
|
|
697 |
|
|
156 |
|
|
346 |
|
Selling
|
|
|
470 |
|
|
215 |
|
|
118 |
|
Bad
Debts
|
|
|
5,319 |
|
|
4,537 |
|
|
17 |
|
Other
|
|
|
475 |
|
|
(595 |
) |
% |
(180 |
) |
Total
|
|
$ |
13,480 |
|
$ |
7,968 |
|
|
69 |
|
(1) OUTSOURCING
SERVICES
Selling,
General and Administrative expenses for outsourcing services were $757,000 for
the year ended December 31, 2007, an increase of 67% from $453,000 for the year
ended December 31, 2006.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Group
1. Outsourcing Services
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year ended December 31, 2007
|
|
For
the year ended December 31, 2006
|
|
Percentage
Change
|
|
|
|
Audited
|
|
Restated
|
|
|
|
|
Remuneration
and related expenses
|
|
$ |
463 |
|
$ |
317 |
|
% |
46 |
|
Office
(majority is rental and utilities)
|
|
|
65 |
|
|
35 |
|
|
83 |
|
Travel
|
|
|
87 |
|
|
12 |
|
|
653 |
|
Entertainment
|
|
|
13 |
|
|
5 |
|
|
191 |
|
Professional
(legal and consultant)
|
|
|
7 |
|
|
9 |
|
|
(28 |
) |
Audit
|
|
|
4 |
|
|
3 |
|
|
44 |
|
Selling
|
|
|
11 |
|
|
0 |
|
|
2,225 |
|
Bad
Debts
|
|
|
100 |
|
|
49 |
|
|
103 |
|
Other
|
|
|
7 |
|
|
23 |
|
%
|
(70 |
) |
Total
|
|
$ |
757 |
|
$ |
453 |
|
|
67 |
|
(2) TELECOM VALUE-ADDED
SERVICES (VAS)
Selling,
General and Administrative expenses for VAS were $471,000 for the year ended
December 31, 2007 as compared to $603,000 in 2006.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Group
2. Telecom Value-Added Services
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31, 2006
|
|
Percentage
Change
|
|
|
|
Audited
|
|
Restated
|
|
|
|
|
Remuneration
and related expenses
|
|
$ |
255 |
|
$ |
337 |
|
%
|
(24 |
) |
Office
(majority is rental and utilities)
|
|
|
66 |
|
|
122 |
|
|
(46 |
) |
Travel
|
|
|
42 |
|
|
72 |
|
|
(41 |
) |
Entertainment
|
|
|
26 |
|
|
38 |
|
|
(32 |
) |
Professional
(legal and consultant)
|
|
|
|
|
|
|
|
|
n/a |
|
Audit
|
|
|
3 |
|
|
|
|
|
n/a |
|
Selling
|
|
|
11 |
|
|
10 |
|
|
12 |
|
Bad
Debts
|
|
|
46 |
|
|
3 |
|
|
1,693 |
|
Other
|
|
|
23 |
|
|
23 |
|
|
1 |
|
Total
|
|
$ |
471 |
|
$ |
603 |
|
% |
(22 |
) |
(3) PRODUCTS (TELECOM &
GAMING)
Selling,
General and Administrative expenses for products (telecom & gaming) were
$2,548,000 for the year ended December 31, 2007, a year-over-year increase of 7%
as compared to $2,370,000 for the year ended December 31, 2006.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Group
3. Products (Telecom & Gaming)
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31, 2006
|
|
Percentage
Change
|
|
|
|
Audited
|
|
Restated
|
|
|
|
|
Remuneration
and related expenses
|
|
$ |
1,227 |
|
$ |
315 |
|
% |
289 |
|
Office
(majority is rental and utilities)
|
|
|
455 |
|
|
158 |
|
|
189 |
|
Travel
|
|
|
146 |
|
|
47 |
|
|
208 |
|
Entertainment
|
|
|
99 |
|
|
40 |
|
|
147 |
|
Professional
(legal and consultant)
|
|
|
104 |
|
|
19 |
|
|
437 |
|
Audit
|
|
|
43 |
|
|
0 |
|
|
25,576 |
|
Selling
|
|
|
344 |
|
|
95 |
|
|
264 |
|
Bad
Debts
|
|
|
(126 |
) |
|
1,627 |
|
|
(108 |
) |
Other
|
|
|
256 |
|
|
69 |
|
% |
272 |
|
Total
|
|
$ |
2,548 |
|
$ |
2,370 |
|
|
7 |
|
(4) OTHER
BUSINESS
Selling,
General and Administrative expenses were $9,703,000 for the year ended December
31, 2007, a substantial increase of 114% as compared to $4,542,000 for 2006. The
substantial increase was mainly due to the provision for bad debts for USD$5
million from the sale and disposal of Gz3G during 2007.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
Group
4. Other Business
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31, 2006
|
|
Percentage
Change
|
|
|
|
Audited
|
|
Restated
|
|
|
|
|
Remuneration
and related expenses
|
|
$ |
2,554 |
|
$ |
1,325 |
|
% |
99 |
|
Office
(majority is rental and utilities)
|
|
|
235 |
|
|
284 |
|
|
(17 |
) |
Travel
|
|
|
165 |
|
|
172 |
|
|
(4 |
) |
Entertainment
|
|
|
20 |
|
|
21 |
|
|
(4 |
) |
Professional
(legal and consultant)
|
|
|
489 |
|
|
328 |
|
|
49 |
|
Audit
|
|
|
648 |
|
|
153 |
|
|
322 |
|
Selling
|
|
|
104 |
|
|
110 |
|
|
(6 |
) |
Bad
Debts
|
|
|
5,299 |
|
|
2,858 |
|
|
85 |
|
Other
|
|
|
189 |
|
|
(709 |
) |
% |
(127 |
) |
Total
|
|
$ |
9,703 |
|
$ |
4,542 |
|
|
114 |
|
DEPRECIATION
AND AMORTIZATION EXPENSES
Depreciation
and amortization expenses were $752,000 for the year ended December 31, 2007,
representing a year-over-year decrease of 51% as compared $1,536,000 for the
same periods of the prior year. Decrease in depreciation and amortization was
mainly due to the amortize issuance cost of $835,000 carry forward in the 2006
re-audit.
Depreciation
|
|
|
|
|
|
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31, 2006
|
|
|
Percentage
Change
|
|
Audited
|
|
Restated
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
(2 |
) |
|
$ |
6 |
|
|
% |
(137 |
) |
Group
2. Telecom Value-Added Services
|
|
|
167 |
|
|
|
268 |
|
|
|
(38 |
) |
Group
3. Products (Telecom & Gaming)
|
|
|
116 |
|
|
|
38 |
|
|
|
205 |
|
Group
4. Other Business
|
|
|
159 |
|
|
|
89 |
|
|
|
79 |
|
Total
|
|
$ |
440 |
|
|
$ |
401 |
|
|
% |
10 |
|
Amortization
|
|
|
|
|
|
|
(in
thousands of US Dollars, except percentages)
|
For
the year
ended
December
31, 2007
|
|
For
the year
ended
December
31, 2006
|
|
Percentage
Change
|
|
|
Audited
|
|
|
Restated
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
|
|
|
$ |
- |
|
|
% |
n/a |
|
Group
2. Telecom Value-Added Services
|
|
|
1 |
|
|
|
- |
|
|
|
n/a |
|
Group
3. Products (Telecom & Gaming)
|
|
|
311 |
|
|
|
29 |
|
|
|
972 |
|
Group
4. Other Business
|
|
|
|
|
|
1,106 |
|
|
|
(100 |
) |
Total
|
|
$ |
312 |
|
|
$ |
1,135 |
|
|
% |
(72 |
) |
LOSS
FROM OPERATIONS
On a
year-over-year basis, Loss from operations amounted to $16,427,000 for FY2007,
as compared to $7,434,000 for FY2006. During this year, provision of
$3.5 million against receivable from 3G purchaser and extra goodwill impairment
of approximately $5,461,000 resulted in and reduced the Operating Loss directly
for the fiscal year ended December 31, 2007.
(in
thousands of US Dollars, except percentages)
|
|
Group
1.
Outsourcing
Services
|
|
|
Group
2.
Telecom
Value-Added
Services
|
|
|
Group
3.
Products
(Telecom
& Gaming)
|
|
|
Group
4.
Other
Business
|
|
|
For
the year
ended
December
31, 2007
|
|
|
For
the year
ended
December
31, 2006
|
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
Operating
profits (Loss) before non-cash accounting provisions
|
|
|
3,520 |
|
|
|
783 |
|
|
|
(6,408 |
) |
|
|
(3,491 |
) |
|
|
(5,596 |
) |
|
|
2,945 |
|
Allowance
for doubtful accounts (1)
|
|
|
(100 |
) |
|
|
(46 |
) |
|
|
1,772 |
|
|
|
(6,945 |
) |
|
|
(5,319 |
) |
|
|
(4,537 |
) |
Goodwill
impairment (2)
|
|
|
(3,964 |
) |
|
|
|
|
|
|
(1,497 |
) |
|
|
|
|
|
|
(5,461 |
) |
|
|
(5,601 |
) |
Stock-based
compensation expenses (3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(51 |
) |
|
|
(51 |
) |
|
|
(242 |
) |
Operating
profits (Loss)
|
|
|
(544 |
) |
|
|
737 |
|
|
|
(6,133 |
) |
|
|
(10,487 |
) |
|
|
(16,427 |
) |
|
|
(7,435 |
) |
INTEREST
INCOME / (EXPENSES), NET
(in
thousands of US Dollars, except percentages) |
|
For
the year ended December
31, 2007
|
|
|
For
the year ended
December
31, 2006
|
|
|
Percentage
Change
|
|
|
|
|
Audited
|
|
|
|
Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
$ |
37 |
|
|
$ |
162 |
|
|
% |
(77 |
) |
Interest
expenses
|
|
|
859 |
|
|
|
1,058 |
|
|
|
(19 |
) |
Interest
income / (expenses), net
|
|
$ |
(822 |
) |
|
$ |
(896 |
) |
|
% |
(8 |
) |
Interest
income was $37,000 for the year ended December 31, 2007, a decrease of 77% as
compared to $162,000 for the year ended December 31, 2006. Interest expenses
were $859,000 for the year ended December 31, 2007, a decrease of 19% as
compared to $1,058,000 for the year ended December 31, 2006. The Decrease in
Interest Income (Expenses) was mainly due to the divestiture of telecom CRM
units during 2007, and most of the interest expenses of this year were
attributed to the interest accrual of $499,000 for Five Million Convertible
Note.
Interest
Expenses (in thousands of US
Dollars, except percentages)
|
|
For
the year ended December 31, 2007
|
|
|
For
the year ended December 31, 2006
|
|
|
Percentage
Change
|
|
|
|
Audited
|
|
|
Restated
|
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
6 |
|
|
$ |
22 |
|
|
% |
n/a |
|
Group
2. Telecom Value-Added Services
|
|
|
2 |
|
|
|
|
|
|
|
n/a |
|
Group
3. Products (Telecom & Gaming)
|
|
|
445 |
|
|
|
56 |
|
|
|
695 |
|
Group
4. Other Business
|
|
|
406 |
|
|
|
980 |
|
|
|
(59 |
|
Total
|
|
$ |
859 |
|
|
$ |
1,058 |
|
|
% |
(19 |
|
Interest
Income
(in
thousands of US Dollars, except percentages)
|
|
For
the year ended December 31, 2007
|
|
|
For
the year ended December 31, 2006
|
|
|
Percentage
Change
|
|
|
|
Audited
|
|
|
Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
|
|
|
$ |
- |
|
|
%
|
n/a |
|
Group
2. Telecom Value-Added Services
|
|
|
2 |
|
|
|
- |
|
|
|
n/a |
|
Group
3. Products (Telecom & Gaming)
|
|
|
18 |
|
|
|
140 |
|
|
|
(87 |
) |
Group
4. Other Business
|
|
|
17 |
|
|
|
22 |
|
|
|
(23 |
) |
Total
|
|
$ |
37 |
|
|
$ |
162 |
|
|
%
|
(77 |
) |
SUNDRY
INCOME/EXPENSE
Sundry
income known as non-operating income is defined as the external income
(miscellaneous income) that results from factors outside of our operating
subsidiaries’ control and such income does not relate to each subsidiary’s core
operating business. Income from the sale of various investments is one of the
typical examples. (See Note 11 for details)
For the
year ended December 31, 2007, the non-operating income or sundry income of
$1,238,000 included in Statement of Operations was mainly derived from the
investment income of $561,000, leasehold income $65,000, software service income
$78,000 and various other income totaling $534,000. .
For the
year ended December 31, 2006, the non-operating income or sundry income was
$108,000 mainly derived from leasehold income of $79,000 and various other
incomes totaling $29,000.
(in
thousands of US Dollars, except percentages)
|
|
For
the year ended December 31, 2007
|
|
|
For
the year ended December 31, 2006
|
|
|
Percentage
Change
|
|
|
|
Audited
|
|
|
Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
1 |
|
|
$ |
- |
|
|
%
|
n/a |
|
Group
2. Telecom Value-Added Services
|
|
|
42 |
|
|
|
- |
|
|
|
n/a |
|
Group
3. Products (Telecom & Gaming)
|
|
|
115 |
|
|
|
- |
|
|
|
n/a
|
|
Group
4. Other Business
|
|
|
1,080 |
|
|
|
108 |
|
|
|
900
|
|
Total
|
|
$ |
1,238 |
|
|
$ |
108 |
|
|
%
|
1,046
|
|
SHARE
OF PROFIT OF ASSOCIATED COMPANIES
An
aggregate of $77,000 in loss from investment has been recognized for the year
ended December 31, 2007 as a result of sharing loss of our 40% ownership
interest in Bell-Pact Shanghai, acquired in January 2007.
An
aggregate of $17,000 in earnings from investment has been recognized for the
year ended December 31, 2006 as a result of sharing profits and loss of our 20%
ownership interest in Take1 Technology – ($295,000), acquired in April 2004; 20%
ownership in MOABC – ($19,000), acquired in October 2006; and, 45% ownership
interest in PactGames – $331,000, acquired in September 2006 (ownership has been
increased to 51% interest as of December 31, 2007).
INCOME
TAXES
The
income taxes expenses for the Company’s subsidiaries were $7,000 and $18,000 for
the years ended December 31, 2007 and 2006 respectively. The provision of income
taxes depends on the tax rate and tax exemption. Pursuant to the PRC Income Tax
Laws, the Company’s subsidiaries and VIEs are generally subject to Enterprise
Income Taxes (“EIT”) at a statutory rate of 33%, which comprises 30% national
income tax and 3% local income tax. Certain subsidiaries and VIEs are qualified
for preferred high technology or software enterprise tax status, and they are
subject to preferential tax rate of 15% under PRC Income Tax Rules.
(in
thousands of US Dollars, except percentages)
|
|
For
the year ended December 31, 2007
|
|
|
For
the year ended December 31, 2006
|
|
|
Percentage
Change
|
|
|
|
Audited
|
|
|
Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Group
1. Outsourcing Services
|
|
$ |
|
|
|
$ |
|
|
|
%
|
n/a |
|
Group
2. Telecom Value-Added Services
|
|
|
3 |
|
|
|
|
|
|
|
n/a |
|
Group
3. Products (Telecom & Gaming)
|
|
|
4 |
|
|
|
|
|
|
|
n/a
|
|
Group
4. Other Business
|
|
|
|
|
|
|
18 |
|
|
|
(100
|
) |
Total
|
|
$ |
7 |
|
|
$ |
18 |
|
|
%
|
(61
|
) |
MINORITY
INTERESTS
Minority
interests for the year ended December 31, 2007 and 2006 was $37,000 and $58,000
respectively. Minority interests represented minority ownership interests in
subsidiaries consolidated in the Company’s consolidated financial
statement.
NET
LOSS
On a
year-over-year basis, Net Loss amounted to $14,195,000 for FY2007, a
year-over-year decrease of 15% as compared to $12,415,000 for the same period of
prior year. Net Loss incurred in FY 2007 was mainly due the
substantial provision $3.5 million against receivable from 3G purchaser, $5.5
million of goodwill impairment, and certain write-offs, compensation costs and
provisions for bad debt related to our legacy telecom operation. Segmented
details are set out below:
(in
thousands of US Dollars, except percentages)
|
|
Group
1.
Outsourcing
Services
|
|
|
Group
2. Telecom
Value-Added
Services
|
|
|
Group
3. Products (Telecom & Gaming)
|
|
|
Group
4.
Other
Business
|
|
|
For
the year ended
December
31, 2007
|
|
|
For
the year ended
December
31, 2006
|
|
|
Percentage
Change
|
|
|
|
|
($)
|
|
|
|
($)
|
|
|
|
($)
|
|
|
|
($)
|
|
|
|
($)
|
|
|
|
($)
|
|
|
|
(%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
profits (Loss)
|
|
|
(544 |
) |
|
|
737 |
|
|
|
(6,133 |
) |
|
|
(10,487 |
) |
|
|
(16,427 |
) |
|
|
(7,435 |
) |
|
|
121 |
|
Interest
income / (expenses), net
|
|
|
(6 |
) |
|
|
1 |
|
|
|
(430 |
) |
|
|
(387 |
) |
|
|
(822 |
) |
|
|
(896 |
) |
|
|
(8 |
) |
Loss
in change in fair value of warrants
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(214 |
) |
|
|
(100 |
) |
Liquidated
damages
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(3,817 |
) |
|
|
(100 |
) |
Sundry
income
|
|
|
1 |
|
|
|
42 |
|
|
|
115 |
|
|
|
1,080 |
|
|
|
1,238 |
|
|
|
108 |
|
|
|
1,046 |
|
Shares
of earning from investment on equity method
|
|
|
|
|
|
|
|
|
|
|
(77 |
) |
|
|
|
|
|
|
(77 |
) |
|
|
17 |
|
|
|
(553 |
) |
Earnings
before Income Taxes, Minority Interest and Discontinued
Operations
|
|
|
(549 |
) |
|
|
780 |
|
|
|
(6,525 |
) |
|
|
(9,794 |
) |
|
|
(16,088 |
) |
|
|
(12,237 |
) |
|
|
31 |
|
CONTRACTUAL
OBLIGATIONS
CONTRACTUAL
OBLIGATIONS
Cash
resources required to satisfy short and long term contractual obligations as of
December 31, 2007 are tabulated below:
Payments
Due by Period
Contractual
Obligations (in thousands)
|
|
Total
|
|
Less
than
1
year
|
|
1-5
years
|
|
After
5
years
|
|
Line
of credit
|
|
$ |
100 |
|
|
100 |
|
|
- |
|
|
- |
|
Bank
Loans
|
|
|
1,824 |
|
|
80 |
|
|
370 |
|
|
1,374 |
|
Operating
leases
|
|
|
404 |
|
|
210 |
|
|
194 |
|
|
- |
|
Capital
leases
|
|
|
N/A |
|
|
- |
|
|
- |
|
|
|
Total
cash contractual obligations
|
|
$ |
2,328 |
|
|
390 |
|
|
564 |
|
|
1,374 |
|
OFF-BALANCE
SHEET ARRANGEMENTS
There
were no off-balance sheet guarantees, interest rate swap transactions, foreign
currency forward contracts or long term purchase commitments outstanding as of
December 31, 2007. Further, the Company had not engaged in any non-exchange
trading activities during 2007.
LIQUIDITY
AND CAPITAL RESOURCES
OVERVIEW
Net cash
and cash equivalents at December 31, 2007 were approximately $3.75million,
an increase of approximately $1.97 million compared to December 31, 2006.
This change resulted from cash used in operations of $1.08 million, cash
provided by investing activities of $0.52 million and cash provided by financing
activities of $2.29 million.
Significant
components of cash flows from operations are as follows:
(Amounts
in millions of US Dollars)
|
|
|
|
Net
loss
|
|
$ |
(14,195 |
) |
Non-cash
and/or nonrecurring items
|
|
|
12,008 |
|
Other
changes in assets and liabilities
|
|
|
1,108 |
|
Net
cash used in operations
|
|
$ |
(1,079 |
) |
Other
significant sources (uses) of cash during 2007 were mainly attribute to $3.5
million of provision against receivables from 3G purchaser, $2.95 million
proceeds from issuance of convertible debenture, $5.5 million of Goodwill
impairment and $1.5 million of accounts receivable and other current assets,
..
WORKING
CAPITAL
The
Company’s working capital decreased to $3,205,000 at December 31, 2007, as
compared to $6,925,000 at December 31, 2006. The decreased working capital
primarily resulted from the decreased $6,865,000 in net assets held for
dispositions, and the decreased $2,311,000 in other current assets.
ISSUANCE
OF COMMON STOCK
During
the year ended December 31, 2007, the Company had the following equity
transactions (i) 199,444 shares of common stock were issued as the monthly
principal redemption shares for 8 million convertible debentures from January to
March, such shares are valued at $1,090,914; (ii) 41,426 treasury shares were
sold to the open market with total consideration $127,000; (iii) 202,000 shares
as a results of exercise of stock options with cash consideration of $406,000.
As of December 31, 2007, the Company received $196,000 from exercise of stock
options.
CAPITAL
RESOURCES
As of
December 31, 2007, we had approximately $3,750,000 in cash. We regularly review
our cash funding requirements and attempt to meet those requirements through a
combination of cash on hand; cash provided by operations, available borrowings
under bank lines of credit and possible future public or private equity
offerings. We evaluate possible acquisitions of, or investments in, businesses
that are complementary to ours, which transactions may require the use of cash.
We believe that our cash, other liquid assets, operating cash flows, credit
arrangements, access to equity capital markets, taken together, provide adequate
resources to fund ongoing operating expenditures. In the event that they do not,
we may require additional funds in the future to support our working capital
requirements or for other purposes and may seek to raise such additional funds
through the sale of public or private equity as well as from other
sources.
On
February 6, 2007, our subsidiary, PacificNet Games Limited (PactGames) entered
into a definitive agreement for a $5 million financing in the form of secured
convertible debt with Pope Asset Management, LLC (Pope), an institutional
investor. Proceeds from the financing was be used to provide PactGames with
additional working capital in expanding its gaming technology operations,
funding for strategic acquisitions in China and funding for general corporate
purposes.
The $5
million convertible debt issued by PactGames to Pope, matures on February 6,
2010, and may be converted into 26% to 32% ownership interest in PactGames based
on reaching certain net income milestones during fiscal year 2007 The interest
rate on the convertible debt will initially be set at 8%, and shall increase to
15% if the note is not converted prior to maturity.
ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are
exposed to various market risks arising from adverse changes in market rates and
prices, such as foreign exchange fluctuations and interest rates, which could
impact our results of operations and financial position. We do not currently
engage in any hedging or other market risk management tools, and we do not enter
into derivatives or other financial instruments for trading or speculative
purposes.
Foreign Currency Exchange Rate Risk
All of
the Company's revenues are denominated either in U.S. dollars or Hong Kong
dollars, while its expenses are denominated primarily in Hong Kong dollars and
Chinese Renminbi ("RMB"). The value of the RMB-to-U.S. dollar or Hong Kong
dollar-to-United States dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Since 1994, the conversion of Renminbi into foreign currencies, including U.S.
dollars, has been based on rates set by the People's Bank of China, which are
set daily based on the previous day's inter-bank foreign exchange market rates
and current exchange rates on the world financial markets. Since 1994, the
official exchange rate for the conversion of Renminbi to U.S. dollars had
generally been stable and the Renminbi had appreciated slightly against the U.S.
dollar. However, on July 21, 2005, the Chinese government changed its policy of
pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy,
Chinese Renminbi may fluctuate within a narrow and managed band against a basket
of certain foreign currencies. Recently there has been increased political
pressure on the Chinese government to decouple the Renminbi from the United
States dollar. At the recent quarterly regular meeting of People's Bank of
China, its Currency Policy Committee affirmed the effects of the reform on
Chinese Renminbi exchange rate. Since February 2006, the new currency rate
system has been operated; the currency rate of Renminbi has become more flexible
while basically maintaining stable and the expectation for a larger appreciation
range is shrinking. Although a devaluation of the Hong Kong dollar or Renminbi
relative to the United States dollar would likely reduce the Company's expenses
(as expressed in United States dollars), any material increase in the value of
the Hong Kong dollar or Renminbi relative to the United States dollar would
increase the Company's expenses, and could have a material adverse effect on the
Company's business, financial condition and results of operations. For
fluctuations in period to period exchange rates, the translation adjustment is
required to translate from local functional currency to the USD reporting
currency (not RMB to HKD to USD). The Company has never engaged in currency
hedging operations and has no present intention to do so.
Interest Rate Risk
Changes
in interest rates may affect the interest paid (or earned) and therefore affect
our cash flows and results of operations. We are exposed to interest rate change
risk with respect to one of our subsidiaries credit facility with a commercial
lender. However, we do not believe that this interest rate change risk is
significant.
Inflation
Inflation
has not had a material impact on the Company's business in recent
years.
Concentration
of Credit Risk
Credit
risk represents the accounting loss that would be recognized at the reporting
date if counterparties failed completely to perform as contracted.
Concentrations of credit risk (whether on or off balance sheet) that arise from
financial instruments exist for groups of customers or counterparties when they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other
conditions as described below:
|
●
|
The
Company's business is characterized by rapid technological change, new
product and service development, and evolving industry standards and
regulations. Inherent in the Company's business are various risks and
uncertainties, including the impact from the volatility of the stock
market, limited operating history, uncertain profitability and the ability
to raise additional capital.
|
|
●
|
All
of the Company's revenue is derived from Asia and Greater China. Changes
in laws and regulations, or their interpretation, or the imposition of
confiscatory taxation, restrictions on currency conversion, devaluations
of currency or the nationalization or other expropriation of private
enterprises could have a material adverse effect on our business, results
of operations and financial condition.
|
|
●
|
If
the Company is unable to derive any revenues from Greater China, it would
have a significant, financially disruptive effect on the normal operations
of the Company.
|
A
substantial portion of the operations of business operations depend on mobile
telecommunications operators (operators) in China and any loss or deterioration
of such relationship may result in severe disruptions to their business
operations and the loss of a significant portion of the Company's revenue. The
VIEs rely entirely on the networks and gateways of these operators to provide
its wireless value-added services. Specifically these operators are the only
entities in China that have platforms for wireless value-added services. The
Company's agreements with these operators are generally for a period of less
than one year and generally do not have automatic renewal provisions. If neither
of them is willing to continue to cooperate with the Company, it would severely
affect the Company's ability to conduct its existing wireless value-added
services business.
The
consolidated financial statements and the report and notes, are attached hereto
following the signature page beginning on Page F-1.
INDEX
TO FINANCIAL STATEMENTS
Report
of Independent Registered Public Accounting
Firm
|
F-2
|
Consolidated
Balance Sheets - As of December 31, 2007 and December 31, 2006
(restated)
|
F-3
|
Consolidated
Statements of Operations - For the Years Ended December 31, 2007, December
31, 2006 (restated) and December 31, 2005
(restated)
|
F-4
|
Consolidated
Statements of Changes in Stockholders' Equity - For the Years Ended
December 31, 2007, December 31, 2006 (restated) and December 31, 2005
(restated)
|
F-5
|
Consolidated
Statements of Cash Flows - For the Years Ended December 31, 2007, December
31, 2006 (restated) and December 31, 2005
(restated)
|
F-6
|
Notes
to Consolidated Financial Statements
|
F-7
|
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
NONE
ITEM
9A. CONTROLS AND PROCEDURES
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting of the Company. Internal control over financial
reporting is a process designed by, or under the supervision of, our chief
executive and chief financial officers and effected by our board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principals.
Management,
with the participation of our principal executive officer and principal
financial officer, has evaluated the effectiveness of our internal control over
financial reporting as of December 31, 2007 based on criteria established under
the COSO framework, an integrated framework for evaluation of internal controls
issued to identify the risks and control objectives related to the evaluation of
the control environment by the Committee of Sponsoring Organizations of the
Treadway Commission.
Based on
our evaluation described above, management has concluded that our internal
control over financial reporting was not effective as of December 31,
2007. Management has determined that (i) our inadequate staffing and
supervision and (ii) the significant amount of manual intervention required in
our accounting and financial reporting process are material weaknesses in our
internal control over financial reporting.
This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation
requirements by our registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit the Company to
provide only management’s report in this annual report.
ITEM
9B. OTHER INFORMATION
None
PART
III
COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
Set forth
below are the names of the directors, executive officers and significant
employees of the Company as of June 11, 2008:
Name
|
Age
|
Title
|
Tony
Tong
|
40
|
Chairman
and Chief Executive Officer
|
Victor
Tong
|
37
|
President,
Secretary, and Director
|
Phillip
Wong
|
57
|
Chief
Financial Officer(Appointed on April 10, 2008)
|
Daniel
Lui
|
43
|
Former
Chief Financial Officer
|
ShaoJian
(Sean) Wang
|
41
|
Director
|
Guo-Jing
Su
|
37
|
Independent
Director (1)(2)(3)
|
Jeremy
Goodwin
|
33
|
Independent
Director (1)
|
Tao
Jin
|
38
|
Independent
Director (1)(2)
|
Stephen
Crystal
|
43
|
Independent
Director
|
Mike
Fei
|
38
|
Company
Secretary and General Counsel
|
(1)
Member of Audit Committee
(2)
Member of Nominating Committee
(3)
Member of Compensation Committee
Our
executive officers are appointed at the discretion of our board of
directors with no fixed term. There are no
family relationships between or among any of our
executive officers or our directors other than the relationship between Mr.
Tony Tong and Mr. Victor Tong.
The
following is a brief description of each board of director, key positions and
brief biography:
MR. TONY TONG, age 40, is the
Chairman, CEO, Executive Director, and co-founder of PacificNet. Prior to
founding PACT, Mr. Tong worked at Andersen Consulting (now Accenture, NYSE:ACN)
and ADC Telecommunications (NASDAQ:ADCT), a global supplier of telecom
equipment. Mr. Tong's R&D achievements include being the inventor and patent
holder of US Patent Number 6,012,066 (granted by US Patent and Trademark Office)
titled "Computerized Work Flow System." Tony is a frequent speaker on Asian
gaming technology and was invited to present at the G2E (Las Vegas), G2E Asia
(Macau), European iGaming Congress - Barcelona (EiGexpo.com), Casino Affiliate
Convention - Macau (CAC2007.com), Asia GEM Gaming Expo – Philippines, and China
3G Summit. Tony is also a frequent speaker on technology investment
in China, and was invited to present at the APEC International Finance &
Technology Summit, China Venture Capital Forum, and China Hi-Tech Fair, and a
Fellow of Hong Kong Institute of Directors. Tony graduated with Bachelor of
Mechanical/Industrial Engineering Degree from the University of Minnesota and
served on the Computer Engineering Department Advisory Board and was an Adjunct
Professor at the University of Minnesota, USA. Mr. Tony Tong was
named to the 2008 "25 People to Watch" List compiled by Global Gaming Business
Magazine, the leading global gaming magazine which annually honors 25 top
individuals with major impact on the gaming industry. At the 3rd
Annual Euro-Asian Summit of Leaders at the Asia GEM 2008 in Manila, Philippines,
Mr. Tony Tong was elected member of the Euro-Asian Cooperation on Gaming
Association Limited (ECG, http://www.ecglimited.com ), a leading gaming
association for gaming operators, suppliers, and regulators which promotes the
development and growth of the legitimate gaming industry.
MR. VICTOR TONG, age 37, is
the President of PacificNet, and has served on our board as an Executive
Director since 2002. Mr. Victor Tong gained his consulting, systems integration,
and technical expertise through his experience at Andersen Consulting (now
Accenture, NYSE:ACN), American Express Financial Advisors (IDS), 3M, and the
Superconductivity Center at the University of Minnesota. In 1994, Mr. Victor
co-founded Talent Information Management ("TIM"), a leading internet application
development and consulting company in Minnesota. PacificNet.com was originally
founded as an operating division of TIM. In 1997, Mr. Tong successfully sold
GoWeb, an internet consulting division of TIM to Key Investment, a leading
technology and media investment company owned by Vance Opperman, a billionaire
in Minnesota who founded West Publishing. Mr. Tong became the President of
KeyTech, a leading information technology consulting company based in Minnesota.
In 1999, he was recognized in "City Business 40 Under 40" as one of the future
business and community leaders in Minnesota. Mr. Tong won the Student
Commencement Speaker Award and graduated with honors with a Bachelor of Science
in Physics from the University of Minnesota. Mr. Victor Tong was named to the
2008 "25 People to Watch" List compiled by Global Gaming Business Magazine, the
leading global gaming magazine which annually honors 25 top individuals with
major impact on the gaming industry. Victor Tong is the brother of
Tony Tong.
MR. PHILLIP WONG, age 57, has
served as Chief Financial Officer since April 10, 2008. Mr. Phillip
Wong, age 57, has over 20 years of hands-on China business experience, including
financial and lottery gaming experience. Mr. Wong has served as president of
Shenzhen G-Lot Technology Limited, a leading provider of lottery technology and
systems in China serving the Welfare and Sports Lottery markets. Mr. Wong was
formerly the General Manager of a listed company in Hong Kong (Culturecom: HK
Stock Code 0343.HK, formerly known as Jademan Holdings). Mr. Wong has
a Post Graduate Diploma in General Management from Macquarie University of
Australia. He is also a Fellow of the Chartered Institute of Management
Accountants of the UK since 1986 as well as a Fellow of the Hong Kong Institute
of Certified Public Accountants. Mr. Wong was awarded the Ten Outstanding Young
Persons' Award in Hong Kong and was elected Vice-Chairman of the Ten Outstanding
Young Persons Association in the late 1980's. Before the transfer of sovereignty
of Hong Kong back to China in 1997, Mr. Wong was the Convener of the Economic
Sub-group of the Basic Law Drafting Committee of the Hong Kong Management
Association. From 1992 to 2002, Mr. Wong was a Committee Member of the Chinese
Political Party's Consultative Committee of Zengcheng City, Guangdong. Mr. Wong
discontinued with his voluntary services based Hong Kong after he moved to
Shanghai in 2002.
MR. DANIEL LUI, age 43, has
served as Chief Financial Officer from March 1, 2007, to April 2008. Mr. Lui
joined PacificNet with over 17 years of professional and commercial accounting
experience, 7 years of which was in Mainland China. He carries the credentials
of Chartered Accountant (Alberta, Canada) and CPA-inactive (Washington, USA).
Mr. Lui was Vice President of Finance and Company Secretary of Fiberxon Inc., a
leading communications subsystem maker, where he was in charge of Fiberxon’s
Finance, Company Secretarial, and Information Technology departments from 2002
to 2007. Prior to joining Fiberxon, Mr. Lui was Chief Financial Officer of China
Motion NetCom Ltd., a wholly owned subsidiary of China Motion Telecom
International Limited, a Hong Kong Exchange listed company, engaged in long
distance call resale business from 2000 to 2001. Prior to that, Mr. Lui was
Financial Advisory Services Manager of PricewaterhouseCoopers and Auditor at
KPMG. Mr. Lui received his Bachelors of Business Administration degree from the
University of Hawaii at Manoa in 1987 and Master of Business Administration from
University of Alberta in Canada in 1994.
MR. SHAOJIAN (SEAN) WANG, age
41, has served on
our board as a Director since 2002. From 2002 to May 2006, Mr. Wang also served
as Chief Financial Officer of PacificNet. Mr. Wang is now President and Chief
Operating Officer of Hurray! Holding Co., Ltd. (NASDAQ:HRAY), a NASDAQ-listed
Chinese VAS company. Previously, Mr. Wang was COO and acting Chief Financial
Officer (CFO) at GoVideo and Opta Corporation, a public listed consumer
Electronics Company in the US controlled by TCL, a leading consumer electronics
maker in China. From 1987 to 2002, he served as a country manager at Ecolab,
Inc. and as the managing director at Thian Bing Investments PTE, Ltd. From 1993
to 2002, Mr. Wang served as managing director of Thian Bing Investments PTE,
Ltd. where he managed the Singapore-based company's multi-million dollar
investment operations and identified strategic and investment opportunities. Mr.
Wang attended Peking University and received a BS in Economics from Hamline
University and an MBA from Carlson School of Management, University of
Minnesota.
MR. GUO-JING SU, age 37, has
served on our board as an independent director since February 5, 2008. Mr. Su is
currently the Chief Executive Officer of Beijing Lottery International
Information Technology Development Ltd., Chairman of the Board of Directors of
Vindaway Trading Co., Ltd. and a member of the China IT Channel Committee as
well as a member of the 9th Beijing Enterprise Committee of the China National
Democratic Construction Association. In 2005, Mr. Su became a shareholder of
Beijing Lottery International Information Technology Development Ltd. In the
same year, the company cooperated with the China Center for Lottery Studies of
Peking University to found the magazine “Gaming Industry and Public Welfare”
where Mr. Su served as a Special Advisor. Mr. Su became the second largest
shareholder of Hubei Bothwin Investment Ltd. the following year. From 2004 to
2005, Mr. Su was the General Manager of the Paperless Lottery Department
at the Beijing Welfare Lottery Center, taking charge of the operations of
Happy 8 (a gaming method) and paperless lottery. In 2001, Mr. Su established
Vindaway Trading Co., Ltd, which acquired related technology and facilities from
Silicon Valley-based Filanet and launched the Interjak hardware series between
2002 and 2004. Prior to that, Mr. Su served as a Project Director at China
National Electronics Import and Export Corporation. He is also referred to by
industry reporters as “China’s Gaming Expert” because of his insights on gaming
in China. Mr. Su graduated from the University of Shanghai where he studied
Science and Technology from 1989 to 1992 and studied law at the Party School of
the Central Committee of C.P.C. from 1998 to 2000.
MR. JEREMY GOODWIN, age 33,
has served on our board as an Independent Director since December 24, 2004.
Jeremy Goodwin is the founder of China Diligizer and a Managing Partner with 3G
Capital Partners. He began his career in 1995 at Mees Pierson Investment Finance
S.A. in Geneva, Switzerland where he supported the fund private
placement/private equity finance team. Noteworthy transactions executed by the
group included assistance on the placements of the $1.2 Billion Carlyle Partners
II Limited Partnership. In 1997 he went to work for the then parent institution,
ABN Amro, in Beijing, China where he established the Global Clients desk
representing the bank's multinational clients to sovereign regulatory agencies
and local financial institutions while monitoring their working capital needs.
During his time there, the office was approved by the Central Bank of China to
operate as a fully licensed branch. Noteworthy transactions executed by the
group included assistance in the business development and project management for
the Royal Dutch Shell Oil project and the Beijing Capital International Airport
listing on the Hong Kong Stock Exchange arranged by the Hong Kong office of ABN
Amro Rothschild. He also assisted the Singapore Debt Capital Markets team in the
business development origination of Sovereign Euro Debt Issuances for the
Ministry of Finance and the State Development Bank in Beijing for the People's
Republic of China. In 1999, He went to work for ING Barings in London as an
International Associate working directly for the business manager to the CEO.
One of his primary assignments was in Hong Kong with the ING Beijing Investment
arm of Baring Private Equity Partners, a joint venture with the Beijing
Municipal Government established in 1994 at the decree of then Chinese Premier
Zhu Rong Ji and widely considered the first domestic Chinese Private Equity
fund. Mr. Goodwin received his BS from Cornell University in 1996 in conjunction
with the Institute of Higher International Studies in Geneva, Switzerland. He
later pursued his advanced degree with Princeton University with a concentration
in Chinese affairs which he completed at the prestigious Nanjing Chinese Studies
Center of the Johns Hopkins School of Advanced International Studies. Jeremy is
fluent in written and spoken Mandarin Chinese, French and has working knowledge
of Vietnamese.
MR. TAO JIN, age 38, has
served on our board as an Independent Director since January 6, 2005. Mr. Jin is
a resident partner at Jun He Law Offices (www.JunHe.com), a leading Chinese law
firm specializing in commercial legal practice with over 160 lawyers and offices
in Beijing, Shanghai, Shenzhen, Dalian, Haikou and New York. Founded in April
1989, Jun He was one of the first private law firms formed in China, and has
been a pioneer in the re-established Chinese legal profession with a focus in
representing foreign clients in business activities throughout China. Over the
past few years, Jun He has been honored a number of times as one of the best law
firms in China by the Ministry of Justice of China. With a team of more than 160
well-trained lawyers, Jun He is one of the largest and most established law
firms in China. Prior to joining Jun He, Mr. Jin served as Vice President and
Assistant General Counsel of J.P. Morgan Chase Bank, as the head legal counsel
for capital markets transactions in Asia, and for JPMorgan's M&A
transactions in China. Mr. Jin joined Jun He as a partner in 2005. From 1999 to
2002, Mr. Jin served as a Senior New York Qualified Lawyer for Sullivan &
Cromwell, which represented China Unicom, PetroChina and China Telecom in their
IPO's and dual listings in New York and Hong Kong. From 1996 to 1999, Mr. Jin
served as Associate Lawyer for Cleary, Gottlieb Steen & Hamilton, which
represented various Fortune 500 companies and investment banks in public and
private securities offerings and M&A activities. Mr. Jin received his Juris
Doctor in 1996 with high honors from Columbia University, and received B.S. in
Psychology in 1990 from Beijing University.
MR. STEPHEN CRYSTAL, age 43,
has served on the Board of Directors of PacificNet as an Independent Director
since March 3, 2008. Mr. Crystal is currently Chief Executive Officer
and President of TableMAX Holdings, LLC, a leading provider of electronic table
games. Mr. Crystal is also a former board member of Las Vegas Gaming, Inc., a
game management system operator as well as founder and managing member of JMC
Investments, LLC, an investment company whose portfolio includes gaming real
estate and operations, gaming technology, hospitality and entertainment, and
franchise assets. Prior to that, Mr. Crystal co-founded Barrick Gaming
Corporation, which owned and operated six hotel casinos in Las Vegas. Prior to
entering the gaming world, Mr. Crystal practiced law at Armstrong Teasdale, LLP,
Gage & Tucker L.C, and Wirken & King, P.C. Mr. Crystal also served as an
Equal Opportunity Specialist for the United States Department of Labor from May
1990 to May 1992 and served in the New Hampshire House of Representatives from
December 1988 to August 1989. Mr. Crystal received his law degree from the
American University, Washington College of Law in 1992 and his Bachelor degree
from Dartmouth College in Political Science in 1986.
MR. MIKE FEI, age 38, is the
Company Secretary and General Counsel for PacificNet. Mr. Fei joined PacificNet
in 2004 as in-house PRC Chief Legal Counsel for PacificNet’s China Operations.
Mr. Fei is a Member of the All-China Bar Association and holds a Master of Law
degree from the University of New South Wales of Australia. Mr. Fei has 8 years
of experience in the legal profession and dealt with more than 200 cases of
litigation and arbitration which related to the issues of foreign investment,
bankruptcy, merging, commercial contract and debt disputes.
CORPORATE
GOVERNANCE
We have
seven members serving on our Board of Directors. Three of our current members
were appointed by the board of directors in 2008. Each board member is nominated
for re-election at our annual meeting to serve until the next annual meeting of
stockholders and until their successors are duly elected and qualified. There
have been no material changes to the procedures by which security holders may
recommend nominees to the company’s board of directors.
AUDIT
COMMITTEE OF THE BOARD OF DIRECTORS
The board
of directors has established a separately-designated audit committee in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as
amended. As of March 31, 2008 our Audit Committee consisted of
Messrs. Tao Jin (Chairman), Jeremy Goodwin, Mike Poon and Guo-Jing Su, each of
whom are considered “independent” under the NASDAQ Stock Market listing
standards currently in effect. The board of directors has determined that each
of the members of the audit committee qualify as an “audit committee financial
expert”.
The Audit
Committee is responsible for nominating the Company’s independent auditors and
reviewing any matters that might impact the auditors’ independence from the
Company; reviewing plans for audits and related services; reviewing audit
results and financial statements; reviewing with management the adequacy of the
Company’s system of internal accounting controls, including obtaining from
independent auditors management letters or summaries on such internal accounting
controls; determining the necessity and overseeing the effectiveness of the
internal audit function; reviewing compliance with the U.S. Foreign Corrupt
Practices Act and the Company’s internal policy prohibiting insider trading in
its Common Stock; reviewing compliance with the SEC requirements for financial
reporting and disclosure of auditors’ services and audit committee members and
activities; reviewing related-party transactions for potential conflicts of
interest; and reviewing with corporate management and internal and independent
auditors the policies and procedures with respect to corporate officers’ expense
accounts and perquisites, including their use of corporate assets.
CODE OF
ETHICS
On May
14, 2003, we adopted a code of ethics that applies to our Chief Executive
Officer and Chief Financial Officer, and other persons who perform similar
functions. A copy of our Code of Ethics was filed as an exhibit to our Annual
Report on Form 10-KSB filed on April 2, 2004. Our Code of Ethics is intended to
be a codification of the business and ethical principles which guide us, to
deter wrongdoing, to promote honest and ethical conduct, to avoid conflicts of
interest, and to foster full, fair, accurate, timely and understandable
disclosures, compliance with applicable governmental laws, rules and
regulations, the prompt internal reporting of violations and accountability for
adherence to this Code.
COMPLIANCE
WITH SECTION 16(A) OF EXCHANGE ACT
Section
16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
requires our executive officers, directors and persons who beneficially own more
than 10% of a registered class of our equity securities to file with the
Securities and Exchange Commission initial reports of ownership and reports of
changes in ownership of our common stock and other equity securities. Such
executive officers, directors, and greater than 10% beneficial owners are
required by SEC regulation to furnish us with copies of all Section 16(a) forms
filed by such reporting persons.
Based
solely on our review of such forms furnished to us and written representations
from certain reporting persons, we believe that the following executive officers
and directors failed to timely file Form 4’s: Tony Tong failed to timely file
Form 4’s, one Form 4 reporting the exercise of a stock option and three Form 4’s
each reporting the grant of stock options; Victor Tong failed to timely file
Form 4’s, one Form 4 reporting the exercise of a stock option and four Form 4’s
each reporting the grant of stock options; Shaojian Wang failed to timely file
Form 4’s, two Form 4’s each reporting the exercise of stock options and three
Form 4’s each reporting the grant of stock options; Michael Chun Ha failed to
timely file Form 4’s, one Form 4 reporting the exercise of an option and three
Form 4’s each reporting the grant of stock options; Peter Wang failed to timely
file three Form 4’s each reporting the grant of stock options; Jeremy Goodwin
failed to timely file three Form 4’s each reporting the grant of stock options
and Tao Jin failed to timely file three Form 4’s each reporting the grant of
stock options.
ITEM
11. EXECUTIVE COMPENSATION
Overview
This
compensation discussion describes the material elements of compensation awarded
to, earned by, and paid to each of our executive officers listed in the Summary
Compensation Table below (the "named executive officers") during the last
completed fiscal year. This compensation discussion focuses on the information
contained in the following tables and related footnotes and narrative primarily
for the last completed fiscal year, but we have also described compensation
actions taken before or after the last completed fiscal year to the extent it
enhances the understanding of our executive compensation
disclosure.
The
compensation committee currently oversees the design and administration of our
executive compensation program.
Objectives
and Philosophy
In
General. The objectives of our compensation programs are to:
|
●
|
Provide
our executive officers with both cash and equity incentives to motivate
them to further the interests of the company and our
stockholders
|
|
●
|
Provide
employees with long-term incentives to assist in creating a culture of
corporate ownership, which we believe will assist in retaining these
employees
|
|
●
|
Provide
stability during our growth stage
|
Generally,
the compensation of our executive officers is composed of an annual base salary
annual incentive compensation and equity awards in the form of stock options,
other benefits and perquisites, post-termination severance and acceleration of
stock option vesting for certain named executive officers upon termination
and/or a change in control. Our other benefits and perquisites consist of life
and health insurance benefits. In setting base salaries, the compensation
committee generally reviews the individual contributions of the particular
executive. In addition, stock options are granted to provide the opportunity for
long-term compensation based upon the performance of our common stock over time.
Our philosophy is to aggregate these elements so that they reach at a level that
is commensurate with our size and sustained performance.
Elements
of Compensation
Compensation
consists of following elements:
Base Salary. Base salaries
for our executive officers are established based on the scope of their
responsibilities, taking into account competitive market compensation paid by
other companies in our industry for similar positions, and the other elements of
the executive officer’s compensation, including stock-based compensation. Our
intent is to target executive base salaries near the median of the range of
salaries for executives in similar positions with similar responsibilities at
comparable companies, in line with our compensation philosophy. Base salaries
are reviewed annually, and may be increased annually to realign salaries with
market levels after taking into account individual responsibilities, performance
and experience. Based on publicly available information, we believe that the
base salaries established for our executive officers are comparable to those
paid by similar companies in our industry.
Annual Bonuses. Our executive
officers and certain other employees are eligible for annual cash bonuses, which
are paid at the discretion of our compensation committee. The employment
agreement with our executive officers do not provide for minimum bonuses. The
determination of the amount of annual bonuses paid to our executive officers
generally reflects a number of subjective considerations, including the
performance of our company overall and the contributions of the executive
officer during the relevant period.
Incentive Compensation. We
believe that long-term performance is achieved through an ownership culture that
encourages long-term performance by our executive officers through the use of
stock-based awards. Our 2006 Stock Option Plan permits the grant of stock
options, restricted stock, stock appreciation rights, and performance-based
stock awards. Under power delegated by our Board, the Compensation Committee of
the Board has the authority to award incentive compensation to our executive
officers, employees, consultants and directors in such amounts and on such terms
as the committee determines in its sole discretion.
Currently,
we do not maintain any incentive compensation plans based on pre-defined
performance criteria. Incentive compensation is intended to compensate executive
officers, employees, consultants and directors for achieving financial and
operational goals and for achieving individual annual performance objectives.
These objectives are expected to vary depending on the individual executive, but
are expected to relate generally to strategic factors such as expansion of our
services and to financial factors such as improving our results of operations.
The actual amount of incentive compensation for the prior year will be
determined following a review of each executive’s individual performance and
contribution to our strategic goals conducted during the first quarter of each
year. Specific performance targets used to determine incentive compensation for
each of our executive officers for 2007 have not yet been
determined.
Other Compensation. Each
employment agreement provides the executive with certain other benefits,
including reimbursement of business and entertainment expenses and housing
allowance. Each executive is eligible to participate in all benefit plans and
programs that are or in the future may be available to other executive employees
of our company, including any profit-sharing plan, thrift plan, health insurance
or health care plan, disability insurance, pension plan, supplemental retirement
plan, vacation and sick leave plan, and other similar plans. The compensation
committee in its discretion may revise, amend or add to the officer’s executive
benefits and perquisites as it deems advisable. We believe that these benefits
and perquisites are typically provided to senior executives of similar
companies.
Compensation
Committee Interlocks and Insider Participation
As of
March 31, 2008 our Compensation Committee consisted of Messrs. Guo-Jing Su
(Chairman), Tao Jin, Mike Poon. No member of our Compensation Committee was, or
has been, an officer or employee of the Company or any of our subsidiaries. No
member of the Compensation Committee has a relationship that would constitute an
interlocking relationship with executive officers or directors of the Company or
another entity.
Compensation
Committee Report on Executive Compensation
The
compensation committee has reviewed and discussed with management the
disclosures contained in the Compensation Discussion and Analysis of this Annual
Report on Form 10-K. Based upon this review and discussion, the compensation
committee recommended to our Board of Directors that the Compensation Discussion
and Analysis be included in our Annual Report on Form 10-K to be filed with the
SEC.
Compensation Committee of
the Board of Directors: Guo-Jing Su (Chairman), Tao Jin, Mike
Poon.
This
report shall not constitute soliciting material or otherwise be considered filed
under the Securities Act or the Securities Exchange Act.
Summary
Compensation Table
Name
and Principal Position
|
|
Year
|
|
Salary
($)
|
|
|
Option
Awards
($)(1)
|
|
|
All
Other Compensation
|
|
|
Total
($)
|
|
Tony
Tong, Chairman, Chief Executive Officer
and
Director
|
|
2007
|
|
$ |
100,000 |
|
|
$ |
27,453 |
|
|
$ |
200,000 |
|
|
$ |
327,543 |
|
|
|
2006
|
|
$ |
100,000 |
|
|
$ |
21,552 |
|
|
|
|
|
|
$ |
121,552 |
|
Daniel
Lui, Chief Financial Officer(2)
|
|
2007
|
|
$ |
100,000 |
|
|
|
|
|
|
|
|
|
|
$ |
40,000 |
|
|
|
2006
|
|
$ |
40,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Victor
Tong, President and Director
|
|
2007
|
|
$ |
100,000 |
|
|
$ |
27,453 |
|
|
$ |
200,000 |
|
|
$ |
327,543 |
|
|
|
2006
|
|
$ |
48,000 |
|
|
$ |
21,552 |
|
|
|
|
|
|
$ |
121,552 |
|
1)
|
Valuation
based on the dollar amount of option grants recognized for financial
statement reporting purposes pursuant to FAS 123R with respect to 2006. On
December 15, 2006, the board of directors cancelled all options granted in
2005 and 2006.
|
2)
|
Mr.
Daniel Lui resigned as our Chief Financial Officer in April,
2008.
|
Employment
Agreements
On March
17, 2008, the Company renewed an Executive Employment Contract with Tony Tong
for a period of three years. Mr. Tong currently serves as our Chairman and Chief
Executive Officer. The employment agreement provides for Mr. Tong to earn an
annual base salary of $50,000 in cash and $300,000 in stock compensation
annually until March 17, 2011. Mr. Tong is also eligible for an annual bonus for
each fiscal year during the term of his contract based on performance standards
as the compensation committee may deem appropriate. Mr. Tong is entitled to
receive a monthly housing allowance of $5,000 and a monthly automobile allowance
of $500.
On March
17, 2008, the Company renewed an Executive Employment Contract with Victor Tong
for a period of three years. Mr. Tong currently serves as our President. The
employment agreement provides for Mr. Tong to earn an annual base salary of
$50,000 in cash and $250,000 stock compensation annually until March 17, 2011.
Mr. Tong is also eligible for an annual bonus for each fiscal year during the
term of his contract based on performance standards as the compensation
committee may deem appropriate. Mr. Tong is entitled to receive a monthly
housing allowance of $5,000 and a monthly automobile allowance of $500. Mr.
Tong’s employment contract was renewed for a period of three years through March
17, 2011, starting from March 17, 2008.
Grants
of Plan-Based Awards
During
the fiscal year ended December 31, 2007, options were issued to the named
executive officers to purchase 10,000 shares of common stock in the
aggregate.
2005
Equity Incentive Plan
Awards
The 2005
Equity Incentive Plan (the "2005 Plan") provides for the grant of options and
stock appreciation rights (“SARs”) of up to an aggregate of 2,000,000 shares of
Common Stock to directors, officers, employees and independent contractors of
the Company or its affiliates. If any award expires, is cancelled, or terminates
unexercised or is forfeited, the number of shares subject thereto is again
available for grant under the 2005 Plan.
Administration
of the 2005 Plan
The 2005
Plan is administered by the Board of Directors or a committee of the Board of
Directors consisting of not less than two members of the Board, each of whom is
a “non-employee
director” within the meaning of Rule 16b-3 promulgated under the Exchange
Act and an “outside director”
within the meaning of Code Section 162(m) (in either case, the “Committee”). Among other
things, the Committee has complete discretion, subject to the express limits of
the 2005 Plan, to determine the persons to be granted an award, the type of
award to be granted, the number of shares of Common Stock subject to each award,
the exercise price of each option, the term of each award, the vesting schedule
for an award, whether to accelerate vesting, the value of the stock, and the
required withholding. The Committee may amend, modify or terminate any
outstanding award, provided that the participant’s consent to such action is
required if the action would materially and adversely affect the participant.
The Committee is also authorized to construe the award agreements, and may
prescribe rules relating to the 2005 Plan. Notwithstanding the foregoing, the
Committee does not have any authority to grant or modify an award under the 2005
Plan with terms or conditions that would cause the grant, vesting or exercise to
be considered nonqualified “deferred compensation”
subject to Code Section 409A.
Limitation
on number of Awards
Among
other things, in order for the grant of stock options and SARs to qualify as
performance-based compensation and be excluded from the Company’s corporate
income tax deduction cap of $1,000,000 per year for its Named Executive
Officers, as set forth in Section 162(m) of the Code, the stockholders must
approve the maximum number of shares of common stock that can be issued to any
one person under the Plan in any calendar year. The number of shares of Common
Stock for which stock options or SARs may be granted to a participant under the
2005 Plan in any calendar year cannot exceed 500,000.
Options
Options
granted under the 2005 Plan may be either “incentive stock options”
(“ISOs”), which are
intended to meet the requirements for special federal income tax treatment under
the Code, or “nonqualified
stock options” (“NQSOs”). Options may be
granted on such terms and conditions as the Committee may determine; provided,
however, that the exercise price of an option may not be less than the fair
market value of the underlying stock on the date of grant and the term of the
option my not exceed 10 years (110% of such value and 5 years in the case of an
ISO granted to an employee who owns (or is deemed to own) more than 10% of the
total combined voting power of all classes of capital stock of the Company or a
parent or subsidiary of the Company). ISOs may only be granted to employees. In
addition, the aggregate fair market value of Common Stock covered by ISOs
(determined at the time of grant) which are exercisable for the first time by an
employee during any calendar year may not exceed $100,000. Any excess is treated
as a NQSO.
Stock Appreciation
Rights
Stock
appreciation rights may be granted under our 2005 Plan. Stock appreciation
rights allow the recipient to receive the appreciation in the fair market value
of our common stock between the exercise date and the date of grant. The
Committee determines the terms of stock appreciation rights, including when such
rights become exercisable and whether to pay the increased appreciation in cash
or with shares of our common stock, or a combination thereof. Stock appreciation
rights expire under the same terms that apply to stock options.
Additional
Terms
Except as
provided in the 2005 Plan, awards granted under the 2005 Plan are not
transferable and may be exercised only by the respective grantees during their
lifetime or by their guardian or legal representative. Each award agreement
will specify, among other things, the effect on an award of the disability,
death, retirement, authorized leave of absence or other termination of
employment. The Company may require a participant to pay the Company the amount
of any required withholding in connection with the grant, vesting, exercise or
disposition of an award. A participant is not considered a stockholder with
respect to the shares underlying an award until the shares are issued to the
participant.
Term;
Amendments
The 2005
Plan is effective for 10 years, unless it is sooner terminated or suspended. The
Committee may at any time amend, alter, suspend or terminate the 2005 Plan;
provided that no amendment requiring stockholder approval will be effective
unless such approval has been obtained. No termination or suspension of the 2005
Plan will affect an award which is outstanding at the time of the termination or
suspension.
Certain
Federal Income Tax Consequences
The following is a general summary of
the federal income tax consequences under current tax law of options and stock
appreciation rights. It does not purport to cover all of the special rules,
including special rules relating to participants subject to Section 16(b)
of the Exchange Act and the exercise of an option with previously-acquired
shares, or the state or local income or other tax consequences inherent in the
ownership and exercise of stock options and the ownership and disposition of the
underlying shares or the ownership and disposition of restricted
stock.
Options. A participant does
not recognize taxable income upon the grant of NQSO or an ISO. Upon the exercise
of a NQSO, the participant recognizes ordinary income in an amount equal to the
excess, if any, of the fair market value of the shares acquired on the date of
exercise over the exercise price thereof, and the Company will generally be
entitled to a deduction for such amount at that time. If the participant later
sells shares acquired pursuant to the exercise of a NQSO, the participant
recognizes long-term or short-term capital gain or loss, depending on the period
for which the shares were held. Long-term capital gain is generally subject to
more favorable tax treatment than ordinary income or short-term capital
gain.
Upon the
exercise of an ISO, the participant does not recognize taxable income If the
participant disposes of the shares acquired pursuant to the exercise of an ISO
more than two years after the date of grant and more than one year after the
transfer of the shares to the participant, the participant recognizes long-term
capital gain or loss and the Company is not be entitled to a deduction. However,
if the participant disposes of such shares within the required holding period,
all or a portion of the gain is treated as ordinary income and the Company is
generally entitled to deduct such amount.
Stock Appreciation Rights.
Generally, no taxable income is realized upon the grant of an SAR. Upon
exercise, the holder of the SAR is taxed at ordinary income tax rates on the
amount of any cash and the fair market value of any stock received.
In
addition to the tax consequences described above, a participant may be subject
to the alternative minimum tax, which is payable to the extent it exceeds the
participant’s regular tax. For this purpose, upon the exercise of an ISO, the
excess of the fair market value of the shares over the exercise price therefore
is an adjustment which increases alternative minimum taxable income. In
addition, the participant’s basis in such shares is increased by such excess for
purposes of computing the gain or loss on the disposition of the shares for
alternative minimum tax purposes. If a participant is required to pay an
alternative minimum tax, the amount of such tax which is attributable to
deferral preferences (including the incentive option adjustment) is allowed as a
credit against the participant’s regular tax liability in subsequent years. To
the extent the credit is not used, it is carried forward.
Outstanding
Equity Awards at Fiscal Year End
The
following table summarizes the unexercised options and equity incentive plan
awards for each name executive officer outstanding as of December 31,
2007. There were no stock awards outstanding as of December 31,
2007.
Name
|
|
Number
of
Securities
Underlying
Unexercised
Options
(#) Exercisable
|
|
Number
of
Securities
Underlying
Unexercised
Options
(#) Unexercisable
|
|
Equity
Incentive
Plan
Awards:
Number
of
Securities
Underlying
Unexercised
Unearned
Options
(#)
|
|
Option
Exercise
Price
($)
|
|
Option
Expiration
Date
|
|
Tony
Tong, CEO
|
|
|
0 |
|
|
10,000 |
|
|
|
$ |
4.31 |
|
|
2013-8-8 |
|
Option
Exercises and Stock Vested
The
following table summarizes stock option exercises by our named executive
officers in 2007. There were no stock awards granted or vested during
2007.
|
|
Option
Awards
|
|
Name/
Principal
Position
|
|
Number
of
Shares
Acquired
on Exercise (#)
|
|
|
Value
Realized
on
Exercise ($)
|
|
Tony
Tong, CEO
|
|
|
90,000 |
|
|
$ |
193,500 |
|
Victor
Tong, President
|
|
|
90,000 |
|
|
$ |
198,000 |
|
Pension
Benefits
We do not
sponsor any qualified or non-qualified defined benefit plans.
Nonqualified
Deferred Compensation
We do not
maintain any non-qualified defined contribution or deferred compensation plans.
The compensation committee may elect to provide our officers and other employees
with non-qualified defined contribution or deferred compensation benefits if the
compensation committee determines that doing so is in our best
interests.
Name
of Director
|
|
Fees
Earned
or
Paid in
Cash
|
|
|
Option
Awards ($) (1)
|
|
|
All
other compensation
($)
|
|
|
Total($)
|
|
WANG
SHAO JIAN
|
|
|
-
|
|
|
|
|
|
|
40,000
|
|
|
|
40,000
|
|
TONY
I TONY
|
|
|
|
|
|
|
27,543-
|
|
|
|
40,000
|
|
|
|
67,543
|
|
VICTOR
TONG
|
|
|
-
|
|
|
|
|
|
|
|
40,000
|
|
|
|
40,000
|
|
JIN
TAO
|
|
|
-
|
|
|
|
|
|
|
|
40,000
|
|
|
|
40,000
|
|
JEREMY
GOODWIN
|
|
|
|
|
|
|
-
|
|
|
|
40,000
|
|
|
|
40,000
|
|
POO
HO-MAN
|
|
|
|
|
|
|
|
|
|
|
40,000
|
|
|
|
40,000
|
|
SU
GUO JING
|
|
|
|
|
|
|
|
|
|
|
20,000
|
|
|
|
20,000
|
|
STEPHEN
CRYSTAL
|
|
|
|
|
|
|
|
|
|
|
40,000
|
|
|
|
40,000
|
|
(1) The
aggregate number of option awards outstanding at fiscal year end is
10,000.
DIRECTORS'
FEES
All of
the Company's directors are reimbursed for out-of-pocket expenses relating to
attendance at meetings. Each director is paid a sign-on bonus of 10,000 stock
options of common stock of the Company. Each director is also entitled to US$500
for each board meeting that such director attends in person, by conference call,
or by committee action and US$200 for each committee meeting, payable by cash,
common stock or stock options of the Company, at the option of the
Company.
ANNUAL
RETAINER FEE
Each
director is paid an annual retainer fee of US$10,000 in the form of common stock
or stock options of the Company. Such retainer fee is paid semi-annually in
arrears. The number of shares of common stock issued is based on the average
closing market price over the ten trading days prior to the end of the six month
period that the retainer fee is due.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The
following table sets forth as of December 31, 2007, the number of shares of our
Common Stock beneficially owned by (i) each person who is known by us to be the
beneficial owner of more than five percent of the Company's Common Stock; (ii)
each director; (iii) each of the named executive officers in the Summary
Compensation Table; and (iv) all directors and executive officers as a group.
Unless otherwise indicated, the stockholders listed in the table have sole
voting and investment power with respect to the shares indicated.
NAME
AND ADDRESS OF BENEFICIAL OWNER
|
|
NUMBER
OF SHARES STOCK BENEFICIALLY OWNED (1)
|
|
|
%
OF
COMMON
STOCK
BENEFICIALLY
OWNED
|
|
Sino
Mart Management Ltd. (2)
c/o
ChoSam Tong
16E,
Mei On Industrial Bldg.17 Kung Yip Street, Kwai Chung, NT, Hong
Kong
|
|
|
1,851,160 |
|
|
|
15.45 |
% |
ChoSam
Tong (3)
16E,
Mei On Industrial Bldg. 17 Kung Yip Street, Kwai Chung, NT, Hong
Kong
|
|
|
1,861,160 |
|
|
|
15.45 |
% |
Kin
Shing Li (4)
Rm.
3813, Hong Kong Plaza 188 Connaught Road West, Hong Kong
|
|
|
1,150,000 |
|
|
|
9.60 |
% |
Tony
Tong
|
|
|
296,000 |
|
|
|
2.47 |
% |
Victor
Tong
|
|
|
96,000 |
|
|
|
* |
|
ShaoJian
(Sean) Wang
|
|
|
16,000 |
|
|
|
* |
|
Tao
Jin
|
|
|
10,000 |
|
|
|
* |
|
Jeremy
Goodwin
|
|
|
- |
|
|
|
* |
|
Ho-Man
(Mike) Poon
|
|
|
- |
|
|
|
* |
|
All
directors and officers as a group (8 persons)
|
|
|
418,000 |
|
|
|
3.49 |
% |
* Less
than one percent.
** The
address for each beneficial owner not otherwise specified is: c/o PacificNet
Inc., 23/F, Building A, TimeCourt, No.6 Shuguang Xili, Chaoyang District,
Beijing, China,100028
(1)
|
Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission and generally includes voting or investment power with
respect to the shares shown. Except as indicated by footnote and subject
to community property laws where applicable, to our knowledge, the
stockholders named in the table have sole voting and investment power with
respect to all common stock shares shown as beneficially owned by them. A
person is deemed to be the beneficial owner of securities that can
be acquired by such person within 60 days upon the exercise of
options, warrants or convertible securities (in any case, the "Currently
Exercisable Options"). Each beneficial owner's percentage ownership is
determined by assuming that the Currently Exercisable Options that are
held by such person (but not those held by any other person) have been
exercised and converted.
|
(2)
|
Sino
Mart Management Ltd. is owned by Mr. ChoSam Tong, the father of Messrs.
Tony Tong and Victor Tong.
|
(3)
|
Includes
shares of common stock of Sino Mart Management Ltd., which is owned by Mr.
ChoSam Tong.
|
(4)
|
Information
obtained from the Schedule 13D/A filed by Mr. Kin Shing Li on October 14,
2003.
|
The
following table sets forth aggregate information regarding the Company's equity
compensation plans in effect as of December 31, 2007:
|
Number
of securities
to
be issued
upon
exercise
of
outstanding
options,
warrants
and
rights
|
Weighted-average
exercise
price of
outstanding options,
warrants
and rights ($)
|
Remaining
available
for
further issuance
under
equity
compensation
plans
|
Equity
compensation plans approved by security holders (under 2005 Stock Option
Plan) (1)
|
33,000
|
$4.31
|
2,000,000
|
Equity
compensation plans not approved by security holders
|
N/A
|
N/A
|
N/A
|
(1)
Reflects options granted and available for issuance under the 2005 Stock Option
Plan.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
There
were no transactions, or currently proposed transactions in an amount exceeding
$120,000, since the beginning of the Company’s last fiscal year in which the
Company was or is to be a participant and in which any related person had or
will have a direct or indirect material interest.
We will
reimburse our officers and directors for any reasonable out-of-pocket business
expenses incurred by them in connection with certain activities on our behalf
such as identifying and investigating possible target businesses and business
combinations. There is no limit on the amount of accountable out-of-pocket
expenses reimbursable by us, which will be reviewed only by our board or a court
of competent jurisdiction if such reimbursement is challenged.
All
ongoing and future transactions between us and any of our officers and directors
or their respective affiliates, including loans by our officers and directors,
will be on terms believed by us to be no less favorable than are available from
unaffiliated third parties and such transactions or loans, including any
forgiveness of loans, will require prior approval in each instance by a majority
of our uninterested “independent” directors (to the extent we have any) or the
members of our board who do not have an interest in the transaction, in either
case, who had access, at our expense, to our attorneys or independent legal
counsel.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During
fiscal year ended December 31, 2007, our principal independent auditors were
Kabani & Company, Inc. (“Kabani”). Our former independent auditors, Clancy
and Co., P.L.L.C., resigned as our independent auditor on January 19, 2007. The
following is a summary of the services provided and fees billed to us by Kabani
during 2007 and by Clancy during 2006.
AUDIT
FEES
An
aggregate of $365,000 and $160,000 has been paid for professional services
rendered by Kabani for the audit of the financial statements for the years ended
December 31, 2007 and 2006, respectively. Further, an aggregate of
$500,000 has been accrued in 2007 for professional services rendered by Kabani
& Company, Inc for the restatement of the Company's financial statements for
the fiscal years ended December 31, 2006 and 2005.
AUDIT
RELATED FEES
NONE
TAX
FEES
NONE
ALL
OTHER FEES
NONE
PRE-APPROVAL
OF SERVICES
The Audit
Committee pre-approves all services, including both audit and non-audit
services, provided by our independent accountants. For audit services, each year
the independent auditor provides the Audit Committee with an engagement letter
outlining the scope of the audit services proposed to be performed during the
year, which must be formally accepted by the audit commences. The independent
auditor also submits an audit services fee proposal, which also must be approved
by the audit commences.
PART
IV
ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBITS
The
following exhibits are filed as part of this report:
EXHIBIT
NUMBER
|
DESCRIPTION
|
3.1
|
Certificate
of Incorporation, as amended. (1)
|
3.2
|
Form
of Amended By Laws of the Company.(1)
|
4.0
|
Specimen
Stock Certificate of the Company (3)
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet Inc.
and the purchasers identified therein (2)
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(2)
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated December
9, 2004 (3)
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated November
17, 2004 (3)
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc. and the
Holders identified therein (4)
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to each of
the Holders (4)
|
4.6(a)
|
Form
of Amended and Restated Variable Rate Convertible Debenture due March 2009
issued to each of the Holders
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(4)
|
4.8
|
Form
of Registration Rights Agreement, dated February 28,
2006(5)
|
4.9
|
Form
of Variable Rate Convertible Debenture due February
2009
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(6)
|
10.2
|
Amendment
to 1998 Stock Option Plan. (7)
|
10.3
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription of
Shares in Epro Telecom Holdings Limited (8)
|
10.4
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares in Beijing
Linkhead Technologies Co., Ltd. (8)
|
10.5
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet Inc.
and the purchasers identified therein (3)
|
10.6
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet Inc.
and the purchasers identified therein (3)
|
10.7
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
10.8
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(9)
|
10.9
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
10.10
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science and Technology Ltd. (11)
|
10.11
|
PacificNet
Inc. Amended and Restated 2005 Stock Option Plan (10)
|
10.12
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information Technology
Co., Ltd. (11)
|
10.13
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(11
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(12)
|
10.15
|
Form
of Lock-Up Agreement, dated March 13, 2006(5)
|
10.16
|
Form
of Voting Agreement, dated March 13, 2006(5)
|
10.17
|
Agreement
among PacificNet Strategic Investment Holdings LimiteD, Shenzhen
GuHaiGuanChao Investment Consultant Co., Ltd., Lion Zone Holdings Limited
and Mr. Wang Wenming for the termination of “the Agreement for the Sale
and Purchase 51% Shares of Lion Zone Holdings Limited”
(13)
|
10.18+
|
Tony
Tong Employment Agreement
|
10.19+
|
Victor
Tong Employment Agreement
|
10.20
|
Consulting
Service Agreement with Daniel Howing Lui (14)
|
14
|
Code
of Ethics (8)
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
|
Corporate
structure chart of our corporate and share ownership
structure
|
+ Filed
herewith.
(1)
|
Incorporated
by reference to the Amendment to Registration Statement on Form S-3 on
Form SB-2/A (Registration No. 333-113209) filed on April 21,
2004.
|
(2)
|
Incorporated
by reference to the Registration Statement on Form S-3 filed on March 2,
2004
|
(3)
|
Incorporated
by reference to the Form SB-2 Registration Statement filed on December 31,
2004.
|
(4)
|
Incorporated
by reference to the Company's Form 8-K filed on March 6,
2006
|
(5)
|
Incorporated
by reference to the Company’s Form 10-KSB/A filed on November 3,
2006.
|
(6)
|
Incorporated
by reference to the Company's Form SB-2 filed on October 21,
1998.
|
(7)
|
Incorporated
by reference to the Company's 10-KSB filed on March 31,
2003.
|
(8)
|
Incorporated
by referenced to the Company's Form 10-KSB filed on April 2,
2004.
|
(9)
|
Incorporated
by reference to the Company's Form 8-K filed on April 19,
2004.
|
(10)
|
Incorporated
by reference to the Company’s Definitive Proxy Statement filed on October
26, 2006.
|
(11)
|
Incorporated
by reference to the Company’s Form 10-KSB filed on April 19,
2005.
|
(12)
|
Incorporated
by reference to the Company's Form 8-K filed on December 20,
2005.
|
(13)
|
Incorporated
by reference to the Company’s Form 8-K filed on November 27,
2006.
|
(14)
|
Incorporated
by reference to the Company’s Form 8-K filed on February 23,
2007.
|
SIGNATURES
In
accordance with the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
|
|
PACIFICNET
INC.
|
|
|
|
|
|
|
Date:
June 12, 2008
|
BY:
/S/ TONY TONG
|
|
|
|
Tony
Tong
Chief
Executive Officer (Principal Executive Officer)
|
|
|
|
|
|
|
Date:
June 12, 2008
|
BY:
/S/ PHILLIP WONG
|
|
|
|
Phillip
Wong
Chief
Financial Officer (Principal Financial Officer)
|
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
NAME
|
|
TITLE
|
|
DATE
|
|
|
|
|
|
/s/
TONY TONG
|
|
Director,
Chairman and CEO
|
|
June 12,
2008
|
Tony
Tong
|
|
|
|
|
|
|
|
|
|
/s/
VICTOR TONG
|
|
Director,
President
|
|
June 12,
2008
|
Victor
Tong
|
|
|
|
|
|
|
|
|
|
/s/
PHILLIP WONG
|
|
Chief
Financial Officer
|
|
June 12,
2008
|
Phillip
Wong
|
|
|
|
|
EXHIBITS
EXHIBIT
NUMBER
|
DESCRIPTION
|
3.1
|
Certificate
of Incorporation, as amended. (1)
|
3.2
|
Form
of Amended By Laws of the Company.(1)
|
4.0
|
Specimen
Stock Certificate of the Company (3)
|
4.1
|
Securities
Purchase Agreement, dated as of January 15, 2004, among PacificNet Inc.
and the purchasers identified therein (2)
|
4.2
|
Form
of Common Stock Warrant issued to each of the purchasers
(2)
|
4.3
|
Form
of Common Stock Warrant issued to each of the purchasers, dated December
9, 2004 (3)
|
4.4
|
Form
of Common Stock Warrant issued to each of the purchasers, dated November
17, 2004 (3)
|
4.5
|
Securities
Purchase Agreement, dated February 28, 2006, among PacificNet Inc. and the
Holders identified therein (4)
|
4.6
|
Form
of Variable Rate Convertible Debenture due March 2009 issued to each of
the Holders (4)
|
4.6(a)+
|
Form
of Amended and Restated Variable Rate Convertible Debenture due March 2009
issued to each of the Holders
|
4.7
|
Form
of Common Stock Purchase Warrant issued to each of the holders
(4)
|
4.8
|
Form
of Registration Rights Agreement, dated February 28,
2006(5)
|
4.9+
|
Form
of Variable Rate Convertible Debenture due February
2009
|
10.1
|
Form
of Indemnification Agreement with officers and directors.
(6)
|
10.2
|
Amendment
to 1998 Stock Option Plan. (7)
|
10.3
|
Agreement
dated on December 1, 2003 for the Sale and Purchase and Subscription of
Shares in Epro Telecom Holdings Limited (8)
|
10.4
|
Agreement
dated on December 15, 2003 for the Sale and Purchase of Shares in Beijing
Linkhead Technologies Co., Ltd. (8)
|
10.5
|
Securities
Purchase Agreement, dated as of December 9, 2004, among PacificNet Inc.
and the purchasers identified therein (3)
|
10.6
|
Securities
Purchase Agreement, dated as of November 17, 2004, among PacificNet Inc.
and the purchasers identified therein (3)
|
10.7
|
Agreement
for the Sale and Purchase of Shares in Shanghai Classic Group Limited
(4)
|
10.8
|
Agreement
for the Sale and Purchase of Shares of Cheer Era Limited
(9)
|
10.9
|
Agreement
for the Sale and Purchase of Shares in Pacific Smartime Solutions
Limited
|
10.10
|
Agreement
for the Sale and Purchase of Shares in Guangzhou Clickcom Digit-net
Science and Technology Ltd. (11)
|
10.11
|
PacificNet
Inc. Amended and Restated 2005 Stock Option Plan (10)
|
10.12
|
Agreement
for the Sale and Purchase of Shares in GuangZhou 3G Information Technology
Co., Ltd. (11)
|
10.13
|
Agreements
of Consulting, Pledge, and Power of Attorney of Clickcom and Sunroom
(11
|
10.14
|
Agreement
for the Sale and Purchase of Shares in Lion Zone Holdings
(12)
|
10.15
|
Form
of Lock-Up Agreement, dated March 13, 2006(5)
|
10.16
|
Form
of Voting Agreement, dated March 13, 2006(5)
|
10.17
|
Agreement
among PacificNet Strategic Investment Holdings Limited, Shenzhen
GuHaiGuanChao Investment Consultant Co., Ltd., Lion Zone Holdings Limited
and Mr. Wang Wenming for the termination of “the Agreement for the Sale
and Purchase 51% Shares of Lion Zone Holdings Limited”
(13)
|
10.18+
|
Tony
Tong Employment Agreement
|
10.19+
|
Victor
Tong Employment Agreement
|
10.20
|
Consulting
Service Agreement with Daniel Howing Lui (14)
|
14
|
Code
of Ethics (8)
|
21
|
List
of Subsidiaries (Included in Exhibit 99.1)
|
99.1+
|
Corporate
structure chart of our corporate and share ownership
structure
|
(1)
|
Incorporated
by reference to the Amendment to Registration Statement on Form S-3 on
Form SB-2/A (Registration No. 333-113209) filed on April 21,
2004.
|
(2)
|
Incorporated
by reference to the Registration Statement on Form S-3 filed on March 2,
2004
|
(3)
|
Incorporated
by reference to the Form SB-2 Registration Statement filed on December 31,
2004.
|
(4)
|
Incorporated
by reference to the Company's Form 8-K filed on March 6,
2006
|
(5)
|
Incorporated
by reference to the Company’s Form 10-KSB/A filed on November 3,
2006.
|
(6)
|
Incorporated
by reference to the Company's Form SB-2 filed on October 21,
1998.
|
(7)
|
Incorporated
by reference to the Company's 10-KSB filed on March 31,
2003.
|
(8)
|
Incorporated
by referenced to the Company's Form 10-KSB filed on April 2,
2004.
|
(9)
|
Incorporated
by reference to the Company's Form 8-K filed on April 19,
2004.
|
(10)
|
Incorporated
by reference to the Company’s Definitive Proxy Statement filed on October
26, 2006.
|
(11)
|
Incorporated
by reference to the Company’s Form 10-KSB filed on April 19,
2005.
|
(12)
|
Incorporated
by reference to the Company's Form 8-K filed on December 20,
2005.
|
(13)
|
Incorporated
by reference to the Company’s Form 8-K filed on November 27,
2006.
|
(14)
|
Incorporated
by reference to the Company’s Form 8-K filed on February 23,
2007.
|
INDEX
TO FINANCIAL STATEMENTS
Report
of Independent Registered Public Accounting
Firm
|
F-2
|
Consolidated
Balance Sheets - As of December 31, 2007 and 2006
(restated)
|
F-3
|
Consolidated
Statements of Operations - For the Years Ended December 31,
2007, December 31, 2006 (restated) and December 31, 2005
(restated)
|
F-4
|
Consolidated
Statements of Changes in Stockholders' Equity - For the Years Ended
December 31, 2007, December 31, 2006 (restated) and December 31, 2005
(restated)
|
F-5
|
Consolidated
Statements of Cash Flows - For the Years Ended December 31,
2007, December 31, 2006 (restated) and December 31, 2005
(restated)
|
F-6
|
Notes
to Consolidated Financial Statements
|
F-7
|
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,
2007. 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, 2007 and 2006, and the results of their
consolidated operations and cash flows for each of the three years in the period
ended December 31, 2007 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, 2007, the Company incurred net losses of $14,195,000. In
addition, the Company had a negative cash flow in operating activities amounting
to negative $1,079,000 in the year ended December 31, 2007, and the Company’s
accumulated deficit was $65,070,000 as of December 31, 2007. In addition, the
Company is in default on its convertible debenture obligation and three holders
of Convertible Subordinated Debentures filed an involuntary petition for Chapter
11 relief in federal bankruptcy court on Saturday, March 22, 2008 in Wilmington,
DE. 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.
/s/
KABANI & COMPANY, INC.
LOS
ANGELES, CA
April 28,
2007
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
AS
AT DECEMBER 31, 2007 AND 2006
(In
thousands of United States dollars, except par values and share
numbers)
|
As
at December 31,
|
|
|
2007
|
|
2006
|
|
ASSETS
|
|
|
(Restated)
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
3,750 |
|
|
$ |
1,778 |
|
Accounts
receivables, net
|
|
|
5,241 |
|
|
|
4,774 |
|
Inventories,
net
|
|
|
693 |
|
|
|
188 |
|
Loan
receivable from related parties
|
|
|
2,273 |
|
|
|
2,991 |
|
Loan
receivable from third parties
|
|
|
815 |
|
|
|
128 |
|
Marketable
equity securities - available for sale
|
|
|
547 |
|
|
|
18 |
|
Net
assets held for disposition
|
|
|
2,692 |
|
|
|
9,557 |
|
Other
current assets
|
|
|
408 |
|
|
|
2,719 |
|
Total
Current Assets
|
|
|
16,419 |
|
|
|
22,153 |
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
5,285 |
|
|
|
4,008 |
|
Intangible
assets, net
|
|
|
343 |
|
|
|
323 |
|
Investments
- cost basis
|
|
|
120 |
|
|
|
15 |
|
Investment
- equity method
|
|
|
13 |
|
|
|
100 |
|
Goodwill
|
|
|
870 |
|
|
|
5,601 |
|
Other
receivables
|
|
|
1,670 |
|
|
|
471 |
|
TOTAL
ASSETS
|
|
$ |
24,720 |
|
|
$ |
32,671 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
Bank
line of Credit
|
|
$ |
100 |
|
|
$ |
111 |
|
Bank
loans-current portion
|
|
|
80 |
|
|
|
411 |
|
Accounts
payable
|
|
|
414 |
|
|
|
225 |
|
Accrued
expenses
|
|
|
3,500 |
|
|
|
1,270 |
|
Customer
deposits
|
|
|
514 |
|
|
|
243 |
|
Convertible
debenture
|
|
|
5,809 |
|
|
|
8,945 |
|
Warrant
liability
|
|
|
|
|
|
|
904 |
|
Liquidated
damages liability
|
|
|
2,697 |
|
|
|
2,837 |
|
Loan
payable to related party
|
|
|
- |
|
|
|
282 |
|
Shares
to be issued
|
|
|
127 |
|
|
|
- |
|
Total
Current Liabilities
|
|
|
13,241 |
|
|
|
15,228 |
|
|
|
|
|
|
|
|
|
|
Bank
loans - non current portion
|
|
|
1,743 |
|
|
|
637 |
|
Convertible
debenture-non current portion
|
|
|
5,224 |
|
|
|
- |
|
Total
long-term liabilities
|
|
|
6,967 |
|
|
|
637 |
|
Total
liabilities
|
|
|
20,208 |
|
|
|
15,865 |
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
1,720 |
|
|
|
2,829 |
|
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, 2007: 16,887,041 issued, 14,314,072 outstanding
|
|
|
|
|
|
|
|
|
December
31, 2006: 14,155,597 issued, 11,541,202 outstanding
|
|
|
1 |
|
|
|
1 |
|
Treasury
stock, at cost (2007: 2,572,969 shares ;2006: 2,614,395
shares)
|
|
|
(145 |
) |
|
|
(272 |
) |
Additional
paid-in capital
|
|
|
79,125 |
|
|
|
65,757 |
|
Shares
issued as deposit
|
|
|
(10,974 |
) |
|
|
- |
|
Cumulative
other comprehensive income
|
|
|
200 |
|
|
|
(42 |
) |
Accumulated
deficit
|
|
|
(65,070 |
) |
|
|
(51,090 |
) |
Stock
subscription receivable
|
|
|
(345 |
) |
|
|
(377 |
) |
Total
Stockholders' Equity
|
|
|
2,792 |
|
|
|
13,977 |
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
24,720 |
|
|
$ |
32,671 |
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
FOR
THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(In
thousands of United States dollars, except loss per share and share
amounts)
|
For
The Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
Restated
|
|
Restated
|
|
Net
Revenues
|
|
|
|
|
|
|
|
|
|
Services
|
|
$ |
4,466 |
|
|
$ |
5,720 |
|
|
$ |
4,242 |
|
Product
sales
|
|
|
14,528 |
|
|
|
23,353 |
|
|
|
2,839 |
|
Total
net revenue
|
|
|
18,994 |
|
|
|
29,073 |
|
|
|
7,081 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
2,754 |
|
|
|
3,562 |
|
|
|
3,160 |
|
Product
sales
|
|
|
12,538 |
|
|
|
21,967 |
|
|
|
2,562 |
|
Total
cost of revenue
|
|
|
15,292 |
|
|
|
25,529 |
|
|
|
5,722 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
3,702 |
|
|
|
3,544 |
|
|
|
1,359 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
General and Administrative expenses
|
|
|
13,480 |
|
|
|
7,968 |
|
|
|
3,576 |
|
Stock-based
compensation expenses
|
|
|
51 |
|
|
|
242 |
|
|
|
282 |
|
Depreciation
and amortization
|
|
|
752 |
|
|
|
1,536 |
|
|
|
31 |
|
Impairment
of Goodwill
|
|
|
5,461 |
|
|
|
- |
|
|
|
3,689 |
|
Impairment
of Investment
|
|
|
385 |
|
|
|
1,233 |
|
|
|
- |
|
Total
Operating expenses
|
|
|
20,129 |
|
|
|
10,979 |
|
|
|
7,578 |
|
|
|
|
|
|
|
|
|
|
|
Loss
from continued operations
|
|
|
(16,427 |
) |
|
|
(7,435 |
) |
|
|
(6,219 |
) |
Other
income (expenses):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income /(expense), net
|
|
|
(822 |
) |
|
|
(896 |
) |
|
|
194 |
|
Gain
/ (Loss) in change in fair value of derivatives
|
|
|
- |
|
|
|
(214 |
) |
|
|
- |
|
Liquidated
damages expense
|
|
|
- |
|
|
|
(3,817 |
) |
|
|
- |
|
Share
of earnings from investment on equity method
|
|
|
(77 |
) |
|
|
17 |
|
|
|
855 |
|
Sundry
income, net
|
|
|
1,238 |
|
|
|
108 |
|
|
|
266 |
|
Total
other income (expense)
|
|
|
339 |
|
|
|
(4,803 |
) |
|
|
1,315 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continued operations before Income Taxes and Minority
Interests
|
|
|
(16,058 |
) |
|
|
(12,238 |
) |
|
|
(4,904 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
(7 |
) |
|
|
(18 |
) |
|
|
(28 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
Interests
|
|
|
37 |
|
|
|
(58 |
) |
|
|
(1,203 |
) |
Loss
from continued operations
|
|
|
(16,058 |
) |
|
|
(12,314 |
) |
|
|
(6,135 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
/ (Loss) from discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
gain on disposal
|
|
|
2,181 |
|
|
|
- |
|
|
|
- |
|
Net
loss on disposal
|
|
|
- |
|
|
|
26 |
|
|
|
- |
|
Income
/ (Loss) from discontinued operations
|
|
|
(318 |
) |
|
|
(127 |
) |
|
|
989 |
|
Total
income / (Loss) from discontinued operations
|
|
|
1,863 |
|
|
|
(101 |
) |
|
|
989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
LOSS
|
|
|
(14,195 |
) |
|
|
(12,415 |
) |
|
|
(5,145 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
exchange gain (loss)
|
|
|
242 |
|
|
|
(27 |
) |
|
|
7 |
|
Net
comprehensive loss
|
|
$ |
(13,953 |
) |
|
$ |
(12,442 |
) |
|
$ |
(5,138 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC
& DILUTED LOSS PER COMMON SHARE:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
per share-Continued Operations
|
|
$ |
(1.35 |
) |
|
$ |
(1.07 |
) |
|
$ |
(0.28 |
) |
Loss
per share-Discontinued Operations
|
|
$ |
0.16 |
|
|
$ |
(0.01 |
) |
|
$ |
0.07 |
|
Basic
& Diluted Loss Per Share
|
|
$ |
(1.19 |
) |
|
$ |
(1.08 |
) |
|
$ |
(0.21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
*
Weighted average number of shares-Basic & Diluted
|
|
|
11,895,525 |
|
|
|
11,538,664 |
|
|
|
21,695,473 |
|
* Basic
and diluted weighted average number of shares are considered equivalent as the
effect of dilutive securities is anti-dilution.
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS
OF CHANGES IN STOCKHOLDERS’ EQUITY
(In
thousands of United States dollars, except number of shares)
|
|
Common
Stock
|
|
|
Additional
Paid-in |
|
|
Issuance of shares as |
|
|
Stock
Subscription
|
|
|
Cumulative Other Comprehensive
|
|
|
Accumulated
Deficit |
|
|
Treasury
Stock
|
|
|
Total
Stockholders’ Equity |
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deposit
|
|
|
Receivable |
|
|
Income/(loss) |
|
|
(Restated) |
|
|
Shares
|
|
|
Amount
|
|
|
(Restated) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE
AT DECEMBER 31, 2004 - Restated
|
|
|
9,794,121 |
|
|
|
1 |
|
|
$ |
57,729 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
(22 |
) |
|
$ |
(33,482 |
) |
|
|
833,616 |
|
|
|
(119 |
) |
|
$ |
24,107 |
|
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 shares for acquisition of Cheer Era
|
|
|
(149,459 |
) |
|
|
- |
|
|
|
(1,547 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
149,459 |
|
|
|
- |
|
|
|
(1,547 |
) |
Cancellation
of common shares
|
|
|
(45,000 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
45,000 |
|
|
|
- |
|
|
|
- |
|
Repurchase
of common shares
|
|
|
(2,000 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
2,000 |
|
|
|
(15 |
) |
|
|
(15 |
) |
Options
granted
|
|
|
- |
|
|
|
- |
|
|
|
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 ChinaGoHi deemed issued under
S&P
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(137,500 |
) |
|
|
- |
|
|
|
- |
|
To
record the correction for the excess finders fee adjusted to
Apic
|
|
|
- |
|
|
|
- |
|
|
|
455 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
455 |
|
To
correctly record the option exercise price
|
|
|
- |
|
|
|
- |
|
|
|
60 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
60 |
|
Foreign
currency translation gain/(loss)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
7 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
7 |
|
Net
loss
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(5,145 |
) |
|
|
- |
|
|
|
- |
|
|
|
(5,145 |
) |
BALANCE
AT DECEMBER 31, 2005 - Restated
|
|
|
10,809,562 |
|
|
|
1 |
|
|
|
61,980 |
|
|
|
- |
|
|
|
- |
|
|
|
(15 |
) |
|
|
(38,627 |
) |
|
|
1,191,125 |
|
|
|
(134 |
) |
|
$ |
23,205 |
|
Exercise
of stock options for cash and receivable
|
|
|
418,000 |
|
|
|
- |
|
|
|
834 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
834 |
|
Issuance
of common stock for acquisition of subsidiaries
|
|
|
618,112 |
|
|
|
- |
|
|
|
4,346 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,142,798 |
|
|
|
- |
|
|
|
4,346 |
|
Cancellation
of common stock for acquisition of subsidiaries
|
|
|
(275,000 |
) |
|
$ |
- |
|
|
$ |
(1,672 |
) |
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
|
275,000 |
|
|
$ |
- |
|
|
$ |
(1,672 |
) |
Repurchase
of common shares - Treasury shares
|
|
|
(29,472 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
29,472 |
|
|
|
(138 |
) |
|
|
(138 |
) |
Foreign
currency translation gain/(loss)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(27 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(27 |
) |
Issuance
of stock options
|
|
|
- |
|
|
|
- |
|
|
|
242 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
242 |
|
Issuance
of warrants for issuing fee of convertible debts
|
|
|
- |
|
|
|
- |
|
|
|
28 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
28 |
|
Stock
subscription receivable
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(377 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(377 |
) |
Goodwill
opening balance adjust
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(48 |
) |
|
|
- |
|
|
|
- |
|
|
|
(48 |
) |
Net
income/(loss)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(12,415 |
) |
|
|
- |
|
|
|
- |
|
|
|
(12,415 |
) |
BALANCE
AT DECEMBER 31, 2006 - Restated
|
|
|
11,541,202 |
|
|
|
1 |
|
|
|
65,758 |
|
|
|
- |
|
|
|
(377 |
) |
|
|
(42 |
) |
|
|
(51,090 |
) |
|
|
2,614,395 |
|
|
|
(272 |
) |
|
|
13,978 |
|
Reclassification
of warrant liability to equity
|
|
|
- |
|
|
|
- |
|
|
|
690 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
213 |
|
|
|
- |
|
|
|
- |
|
|
|
903 |
|
Issuance
of common stock for repayment of convertible debenture
(199,444)
|
|
|
199,444 |
|
|
|
- |
|
|
|
1,091 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,091 |
|
Sale
of treasury shares
|
|
|
41,426 |
|
|
|
- |
|
|
|
155 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(41,426 |
) |
|
|
127 |
|
|
|
282 |
|
Issuance
of common stock in escrow - restricted
|
|
|
2,330,000 |
|
|
|
|
|
|
|
10,974 |
|
|
|
(10,974 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
- |
|
|
|
- |
|
Exercise
of stock options for cash (202,000 shares)
|
|
|
202,000 |
|
|
|
- |
|
|
|
406 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
406 |
|
Stock
option expense
|
|
|
- |
|
|
|
- |
|
|
|
51 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
51 |
|
Foreign
currency translation gain/(loss)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
242 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
242 |
|
Stock
subscription receivable
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
32 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
32 |
|
Net
loss
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(14,195 |
) |
|
|
- |
|
|
|
- |
|
|
|
(14,195 |
) |
BALANCE
AT December 31, 2007
|
|
|
14,314,072 |
|
|
$ |
1 |
|
|
$ |
79,125 |
|
|
$ |
(10,974 |
) |
|
|
(345 |
) |
|
$ |
200 |
|
|
$ |
(65,070 |
) |
|
|
2,572,969 |
|
|
$ |
(145 |
) |
|
$ |
2,792 |
|
The
accompanying notes form an integral part of these consolidated financial
statements
PACIFICNET
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands of United States dollars)
|
For
The Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
Restated
|
|
Restated
|
|
Cash
Flows from operating activities
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$ |
(14,195 |
) |
|
$ |
(12,415 |
) |
|
$ |
(5,145 |
) |
Adjustment
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for allowance for doubtful accounts
|
|
|
5,319 |
|
|
|
4,537 |
|
|
|
2,739 |
|
Minority
Interest
|
|
|
(37 |
) |
|
|
58 |
|
|
|
1,203 |
|
Depreciation
and amortization
|
|
|
752 |
|
|
|
1,536 |
|
|
|
31 |
|
Share
of earnings from investment on equity method
|
|
|
77 |
|
|
|
(17 |
) |
|
|
(855 |
) |
Goodwill
impairment
|
|
|
5,461 |
|
|
|
- |
|
|
|
3,689 |
|
Investment
impairment
|
|
|
385 |
|
|
|
1,233 |
|
|
|
- |
|
Stock-based
compensation
|
|
|
51 |
|
|
|
242 |
|
|
|
282 |
|
Issuance
of shares for services
|
|
|
- |
|
|
|
- |
|
|
|
63 |
|
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
|
|
|
1,544 |
|
|
|
(7,098 |
) |
|
|
(297 |
) |
Inventories
|
|
|
(505 |
) |
|
|
2 |
|
|
|
(55 |
) |
Accounts
payable and other accrued expenses
|
|
|
1,244 |
|
|
|
(2,202 |
) |
|
|
3,526 |
|
Net
cash provided by (used in) operating activities of continued
operations
|
|
|
96 |
|
|
|
(9,403 |
) |
|
|
5,182 |
|
Net
cash provided by (used in) operating activities of discontinued
operations
|
|
|
(1,175 |
) |
|
|
28 |
|
|
|
(988 |
) |
Net
cash provided by (used in) operating activities
|
|
|
(1,079 |
) |
|
|
(9,375 |
) |
|
|
4,193 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in restricted cash
|
|
|
- |
|
|
|
(71 |
) |
|
|
- |
|
Increase
in purchase of marketable securities
|
|
|
(529 |
) |
|
|
(19 |
) |
|
|
11 |
|
Acquisition
of property and equipment
|
|
|
(1,033 |
) |
|
|
(2,608 |
) |
|
|
(2,966 |
) |
Acquisition
of subsidiaries and affiliated companies
|
|
|
- |
|
|
|
(667 |
) |
|
|
(3,958 |
) |
Repurchase
of treasury shares
|
|
|
282 |
|
|
|
(138 |
) |
|
|
(15 |
) |
Net
cash used in investing activities of continued operations
|
|
|
(1,280 |
) |
|
|
(3,503 |
) |
|
|
(6,928 |
) |
Net
cash provided by (used in) investing activities of discontinued
operations
|
|
$ |
1,801 |
|
|
$ |
1,408 |
|
|
$ |
(2,678 |
) |
Net
cash provided by (used in) investing activities
|
|
$ |
521 |
|
|
$ |
(2,095 |
) |
|
$ |
(9,606 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
receivable from third parties
|
|
|
(237 |
) |
|
|
934 |
|
|
|
(1,024 |
) |
Loans
receivable from related parties
|
|
|
(564 |
) |
|
|
622 |
|
|
|
(868 |
) |
Loan
payable to related party
|
|
|
(282 |
) |
|
|
(121 |
) |
|
|
575 |
|
Advances
(repayments) under bank line of credit
|
|
|
(11 |
) |
|
|
(204 |
) |
|
|
1,113 |
|
Repayments
of amount borrowed under capital lease obligations
|
|
|
- |
|
|
|
41 |
|
|
|
(5 |
) |
Proceeds
from exercise of stock options and subscription
|
|
|
438 |
|
|
|
237 |
|
|
|
966 |
|
Advances
under bank loans
|
|
|
(10 |
) |
|
|
935 |
|
|
|
(1,453 |
) |
Net
proceeds from issuance of convertible debenture
|
|
|
2,954 |
|
|
|
7,500 |
|
|
|
- |
|
Net
cash provided by (used in) financing activities of continued
operations
|
|
|
2,288 |
|
|
|
9,944 |
|
|
|
(696 |
) |
Net
cash provided by (used in) financing activities of discontinued
operations
|
|
-
|
|
|
-
|
|
|
-
|
|
Net
cash provided by (used in)financing activities
|
|
|
2,288 |
|
|
|
9,944 |
|
|
|
(696 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate change on cash and cash equivalents
|
|
|
242 |
|
|
|
(27 |
) |
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
1,972 |
|
|
|
(1,553 |
) |
|
|
(6,102 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
1,778 |
|
|
|
3,331 |
|
|
|
9,433 |
|
CASH
AND CASH EQUIVALENTS, END OF PERIOD
|
|
$ |
3,750 |
|
|
$ |
1,778 |
|
|
$ |
3,331 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$ |
(822 |
) |
|
$ |
664 |
|
|
$ |
229 |
|
Income
taxes paid
|
|
$ |
(7 |
) |
|
$ |
5 |
|
|
$ |
(53 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
NON-CASH
INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
& Equipment acquired under bank loans
|
|
$ |
785 |
|
|
$ |
1,082 |
|
|
$ |
- |
|
Investments
in subsidiaries and affiliate through issuance of common
stock
|
|
$ |
- |
|
|
$ |
4,346 |
|
|
$ |
3,971 |
|
Issuance
of common stock for payment of convertible debenture
|
|
$ |
1,091 |
|
|
$ |
- |
|
|
$ |
- |
|
Cumulative
effect of change in accounting principle (note 10)
|
|
$ |
213 |
|
|
$ |
- |
|
|
$ |
- |
|
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. PacificNet (PACT) is a
leading provider of gaming and mobile game technology worldwide with a focus on
emerging markets in Asia. PacificNet's gaming products are localized to their
specific markets creating an enhanced user experience for players and larger
profits for operators. PacificNet's gaming clients include the leading hotels,
casinos, and gaming operators in Macau, Europe and elsewhere around the world.
PacificNet also maintains legacy subsidiaries in the call center and ecommerce
business in China. PacificNet employs about 500 staff in its various
subsidiaries with offices in the US, Hong Kong, Macau, China. 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. 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) 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). We own 51% of the shares in each
of the WOFEs and each WOFE signed Consulting and Services Agreements with
IMOBILE-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 based on
the contractual arrangements from these companies. Accordingly, we bear the
risks of and enjoy the rewards associated with the investments in the
WOFEs.
The
operations of DE 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 DE and WOFE. 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 based on the contractual
arrangements and on management’s decision 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 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 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”), is a China company controlled through
business agreement. ThroughiMobile -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 ,however, it does have the power to change the management, if needed,
because PacificNet is directly or indirectly controlling the board of this
VIE.
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 of 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 the 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 the 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 six reporting units: EPRO (assets held for
disposition), Smartime/Soluteck, iMobile-WOFE, Wanrong, PacificNet Games, and
Take 1, 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, 2007
is $870,000 and the changes in the carrying amount of goodwill for the following
reporting periods are summarized below:
|
|
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, 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
|
|
|
- |
|
|
|
461 |
|
|
|
1,176 |
|
|
|
1,637 |
|
Balance
as of December 31, 2006-Restated
|
|
|
3,964 |
|
|
|
461 |
|
|
|
1,176 |
|
|
|
5,601 |
|
Goodwill
acquired during the year
|
|
|
- |
|
|
|
- |
|
|
|
730 |
|
|
|
730 |
|
Goodwill
impaired during the year
|
|
|
(3,964 |
) |
|
|
- |
|
|
|
(1,497 |
) |
|
|
(5,461 |
) |
Balance
as of December 31, 2007
|
|
-
|
|
|
$ |
461 |
|
|
$ |
409 |
|
|
$ |
870 |
|
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 2007
and 2006:
|
|
For
the Years ended December 31,
|
|
(US$'000s)
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
Restated
|
|
Epro
|
|
$ |
- |
|
|
$ |
3,949 |
|
Smartime
(Soluteck)
|
|
|
- |
|
|
|
15 |
|
iMobile
|
|
|
- |
|
|
|
430 |
|
Wanrong
|
|
|
461 |
|
|
|
461 |
|
Take
1
|
|
|
141 |
|
|
|
- |
|
PacificNet
Games
|
|
|
268 |
|
|
|
746 |
|
Total
|
|
$ |
870 |
|
|
$ |
5,601 |
|
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.
There was
$5,461,000 impairment of goodwill in the year ended December 31,
2007.
(US$'000s)
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
Restated
|
|
Epro
|
|
$ |
3,949 |
|
|
$ |
- |
|
Smartime
(Soluteck PactSo)
|
|
|
15 |
|
|
|
- |
|
iMobile
|
|
|
430 |
|
|
|
- |
|
PacificNet
Games
|
|
|
478 |
|
|
|
- |
|
Take
1
|
|
|
589 |
|
|
|
- |
|
Total
|
|
$ |
5,461 |
|
|
$ |
N/A- |
|
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.
Following
is the summary of the entities accounted under the equity method:
|
|
2007
|
|
2006
|
|
Total
assets
|
|
|
$131,210 |
|
|
$1,987,498 |
|
Total
liabilities
|
|
|
14,393 |
|
|
1,312,445 |
|
Net
assets
|
|
|
116,817 |
|
|
675,053 |
|
Income
(loss) from operation
|
|
|
(180,083 |
) |
|
292,598 |
|
Net
income (loss)
|
|
|
$(191,558 |
) |
|
$292,463 |
|
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 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 Gross Revenues 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, 2007 was approximately $5,365,000
(2006: $4,536,000).
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 gaming and telecommunication
products such as electronic gaming machines, gaming systems, AWP, VLT, slot and
bingo machines, mobile phone, rechargeable phone cards, smart chip, and
interactive voice response cards.
Income
taxes are accounted for using an asset and liability approach, which requires
the recognition of income taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in the Company's consolidated financial statements or
tax returns. The measurement of current and deferred tax liabilities and assets
is based on provisions of the enacted tax laws; the effects of future changes in
tax laws or rates are not anticipated. The measurement of deferred tax assets is
reduced, if necessary, by the amount of any tax benefits that, based on
available evidence assessed using the criteria in SFAS No. 109, "Accounting for
Income Taxes," will not more-likely-than-not be realized.
The
Company records a valuation allowance for deferred tax assets, if any, based on
estimates of its future taxable income as well as its tax planning strategies
when it is more likely than not that a portion or all of its deferred tax assets
will not be realized. If the Company is able to utilize more of its deferred tax
assets than the net amount previously recorded when unanticipated events occur,
an adjustment to deferred tax assets would be reflected in income when those
events occur.
RESEARCH AND DEVELOPMENT
COSTS AND CAPITALIZED SOFTWARE COSTS
Expenditures
related to the research and development of new products and processes, including
significant improvements and refinements to existing products are expensed as
incurred, unless they are required to be capitalized.
Software
development costs are required to be capitalized when a product's technological
feasibility has been established by completion of a detailed program design or
working model of the product, and ending when a product is available for release
to customers. For the years ended December 31, 2007 and 2006, the Company did
not capitalize any costs related to the purchase of software and related
technologies and content.
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.
On July
3, 2007 the board extended the grant of previously expired options. Total
options for which the grant was extended were 15,000 and 3,000 on two different
grants. The Company recorded $51,400 as stock based compensation expense
utilizing Black Scholes Options Pricing Model by using the following
assumptions: exercise price of $2.20 and $1.75, risk free interest rate of
4.76%, volatility of 70.88% and dividend yield of 0%.
As of
December 31, 2007 we had no stock options exercisable, 202,000 options were
exercised during FY2007.
Additional
information on options outstanding as of December 31, 2007 is as
follows:
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
|
OPTIONS
|
|
|
WEIGHTED
AVERAGE
REMAINING
CONTRACTUAL
LIFE
|
|
Options
outstanding
|
|
$ |
4.31 |
|
|
|
33,000 |
|
|
5.62years
|
|
Options
exercisable
|
|
|
N/A |
|
|
|
N/A |
|
|
|
N/A |
|
On April
28, 2008 the Company’s Board of Directors approved the grant of up to 2,000,000
in bonus shares to the directors, employees and consultants of the Company as
compensation. The Company issued 1,086,000 shares against 2007 compensation and
accrued $1,086,000 in expenses at the fair market value at the approval
date.
ADVERTISING
EXPENSES
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 $23,341 in 2007 (2006:
$31,052).
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 $3,750,000 in 2007.
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 Variable Interest Entities (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, 2007.
|
Cost
|
Market
Value
|
UnrealizedGain/(Loss)
|
December
31, 2007
|
$369,000
|
$547,000
|
$178,000
|
December
31, 2006
|
$19,000
|
$18,000
|
$(1,000)
|
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. During the year ended December 31, 2007,
the foreign currency translation adjustments to the Company's comprehensive
income was $242,000 and the currency translation gain was approximately
$118,000, 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 $65.million and $51 million as of December 31, 2007 and
2006 respectively. Negative cash flows from the operations was $1.1 million for
the year ended December 31, 2007. These matters raise substantial doubt about
the Company’s ability to continue as a going concern.
In view
of the matters described in the preceding paragraph, recoverability of a major
portion of the recorded asset amounts shown in the accompanying balance sheet is
dependent upon continued operations of the Company, which in turn is dependent
upon the Company’s ability to raise additional capital, obtain financing and to
succeed in its future operations. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The
Company has taken certain restructuring steps to provide the necessary capital
to continue its operations. These steps included, but not limited to: 1)
accelerate disposal and spin-off of unprofitable or unfavorable
return-on-investment non-gaming operations; 2) focus on execution of the new
high potential gaming business initiatives; 3) acquisition of profitable and/or
strategic operations through issuance of equity instruments; 4) formation of
strategic relationship with key gaming operators in Asia; 5) issuance and/or
restructure of new long-term convertible debentures.
On April
30, 2007, the Company entered into a sale and purchase agreement to dispose of
its interest in Guangzhou3G for a consideration of US$6 million. The deal was
subsequently reopened for renegotiation in November 2007 (See note
14).
On May 15
& 20, 2007, the Company entered into various definitive agreements to divest
and reduce its equity interests in certain unprofitable subsidiaries to below
20% equity interest, namely: Linkhead, Clickcom, PacTelso, PacSo and PacPower
(See note 14).
On March
27, 2008, three holders of PACT's Convertible Subordinated Debentures filed an
involuntary petition for Chapter 11 relief in federal bankruptcy court late
Saturday, March 22, 2008 in Wilmington, DE. The Company has retained counsel to
oppose the filing because the petition fails to meet the standard for invoking
an involuntary bankruptcy and fails to take into consideration other agreements
between the Company and the petitioning creditors. The Company intends to
vigorously oppose the petition and move for dismissal of the filing, and if
successful will seek damages and attorney fees. Subsequently, PACT also received
default notice from all but one of the debenture holders including Iroquois
Master Fund Ltd., Alpha Capital AG, Whalehaven Capital Fund Limited, DKR
Soundshore Oasis Holding Fund Ltd., Basso Fund Ltd., Basso Multi-Strategy
Holding Fund Ltd., and Basso Private Opportunities Holding Fund Ltd. from the
same Convertible Subordinated Debentures related to the private offering of
$8,000,000 principal amount variable debentures consummated on March 13, 2006,
and due March 2009.
PACT has
retained counsel to oppose the above petition. The amount of the debt
in question is as follows: Iroquois Master Fund Ltd. $2.5 million,
Whalehaven Capital Fund Limited $958,000, Alpha Capital AG $685,000 DKR
Soundshore Oasis Holding Fund Ltd $960,000, and Basso Fund Ltd., Basso Multi-
Strategy Holding Fund Ltd., and Basso Private Opportunities Holding Fund Ltd., a
combined amount of $500,000.
RECENT
PRONOUNCEMENTS
In March
19, 2008, FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities. The new standard is intended to improve financial reporting
about derivative instruments and hedging activities by requiring enhanced
disclosures to enable investors to better understand their effects on an
entity's financial position, financial performance, and cash flows. It is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged. Currently
the Company does not carry any derivative instruments and the adoption of this
statement may not have any effect on the financial statements.
In
December 2007, FASB issued FASB Statement No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51. This Statement
applies to all entities that prepare consolidated financial statements, except
not-for-profit organizations, but will affect only those entities that have an
outstanding non-controlling interest in one or more subsidiaries or that
deconsolidate a subsidiary. Not-for-profit organizations should continue to
apply the guidance in Accounting Research Bulletin No. 51, Consolidated
Financial Statements, before the amendments made by this Statement, and any
other applicable standards, until the Board issues interpretative guidance. This
Statement is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008 (that is, January 1, 2009, for
entities with calendar year-ends). Earlier adoption is prohibited. The effective
date of this Statement is the same as that of the related Statement 141(R). This
Statement shall be applied prospectively as of the beginning of the fiscal year
in which this Statement is initially applied, except for the presentation and
disclosure requirements. The presentation and disclosure requirements shall be
applied retrospectively for all periods presented. Management is currently
evaluating the effect of this pronouncement on financial
statements.
In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations". This
Statement replaces SFAS No. 141, Business Combinations. This Statement retains
the fundamental requirements in Statement 141 that the acquisition method of
accounting (which Statement 141 called the purchase method) be used for all
business combinations and for an acquirer to be identified for each business
combination. This Statement also establishes principles and requirements for how
the acquirer: a) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree; b) recognizes and measures the goodwill acquired in
the business combination or a gain from a bargain purchase and c) determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. SFAS No.
141(R) will apply prospectively to business combinations for which the
acquisition date is on or after Company's fiscal year beginning October 1, 2009.
While the Company has not yet evaluated this statement for the impact, if any,
that SFAS No. 141(R) will have on its consolidated financial statements, the
Company will be required to expense costs related to any acquisitions after
September 30, 2009.
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.
2.
BUSINESS ACQUISITIONS
TAKE 1 TECHNOLOGIES GROUP
LIMITED
On
January 05, 2007, we entered into an agreement for PacificNet to exercise the
option to acquire an additional 31% interest in Take 1. The completion date for
the new Securities Subscription Agreement was January 05, 2007, with a
contingent consideration to be paid entirely with shares of PacificNet: 149,459
PACT Shares. As a result, PacificNet has become the majority and controlling
shareholder of Take1 with our ownership percentage increasing from 20% to
51%.
An
initial equity investment of 30% in Take 1 was made in April 2004 by the
Company, through its subsidiary PacificNet Strategic Investment Holdings
Limited, for a consideration of 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.
Summarized
below were the assets acquired and liabilities assumed for Take 1 in the
acquisition: (In
thousands of US Dollars)
Estimated
fair values:
|
|
Current
assets
|
106,422
|
Current
liabilities
|
(728,156)
|
Net
assets (liabilities) acquired
|
(621,734)
|
Total
Consideration Paid
|
217,247
|
Goodwill
and Identified Intangibles
|
838,981
|
Allocation:
|
|
Customer
Relations
|
88,805
|
Product
Design
|
7,990
|
Proprietary
Technology
|
11,325
|
Goodwill
|
730,860
|
In accordance with SFAS 142, goodwill
is not amortized but is tested for impairment at least annually. The purchase
price allocation for Take 1 acquisition is based on a management's estimates and
overall industry experience. During the year ended December 31, 2007
the Company impaired goodwill amounting to $590,000.
UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE YEAR ENDED
December 31, 2007 AND 2006
The
following is an un-audited pro forma consolidated financial information for the
year ended December
31, 2006 and 2007, as presented below, reflects the results of operations
of the Company assuming the acquisition occurred on January 1, 2006 and
2007, respectively, and after giving effect to the purchase accounting
adjustments. These pro forma results have been prepared for information purposes
only and do not purport to be indicative of what operating results would have
been had the acquisitions actually taken place on January 1, 2006 and 2007,
respectively, and may not be indicative of future operating
results.
Take
1
|
Years
ended December 31.
|
(In
thousands of U.S Dollars, except for loss per share)
|
2007
|
2006
|
Revenue
|
$
|
18,994
|
$
|
30,412
|
Operating
income
|
|
(16,427)
|
|
(7,144)
|
Net
Loss
|
$
|
(14,195)
|
$
|
(12,325)
|
Basic
& Diluted Loss Per Share
|
$
|
(1.19)
|
$
|
(1.07)
|
Accordingly,
PacificNet included the financial results of Take 1 in its consolidated 2007
financial results from January 5, 2007 to December 31, 2007.
3.
EARNINGS PER SHARE (EPS)
Basic and
diluted earnings or loss per share (EPS) amounts in the financial statements are
computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS is
based on the weighted average number of common shares outstanding. Diluted EPS
is based on the weighted average number of common shares outstanding plus
dilutive common stock equivalents. Basic EPS is computed by dividing net
income/loss available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Diluted EPS
is calculated by dividing net earnings by the weighted average number of common
shares outstanding and other dilutive securities. Dilutive earnings
per share for the period ended December 31, 2007 exclude the potential dilutive
effect of 889,456 warrants because their impact would be anti-dilutive based on
current market prices. 445,455 convertible debentures are tested by using
if-converted method. The result shows when convertible debentures are included
in the computation, diluted EPS increases. According to SFAS No.128, those
convertible debentures are ignored in the computation of diluted EPS. All per
share and per share information are adjusted retroactively to reflect stock
splits and changes in par value.
The
reconciliation of the numerators and denominators of the basic and diluted EPS
calculations was as follows:
|
|
FY
2007
|
|
|
FY
2006
|
|
(In
thousands of US Dollars, except weighted shares and per share
amounts.)
|
|
|
|
|
Restated
|
|
Numerator:
Net Loss
|
|
$ |
(14,195 |
) |
|
$ |
(12,415 |
) |
Denominator:
|
|
|
|
|
|
|
|
|
Weighted
average number of shares-Basic & Diluted
|
|
|
11,895,525 |
|
|
|
11,538,664 |
|
Basic
& Diluted Loss Per Share
|
|
$ |
(1.19 |
) |
|
$ |
(1.08 |
) |
4.
INVESTMENT IN AFFILIATED COMPANIES
Investments
Investments
that are recorded at cost are evaluated for any impairments that are not
temporary in nature and adjusted for the impairment.
Investments
in affiliated companies consist of the following as of December 31, 2007
and 2006:
Under
Cost Method:
(USD
' 000s)
|
|
2007
|
|
2006
(Restated)
|
|
DESCRIPTION
|
Glad
Smart
|
|
$ |
30 |
|
$ |
30 |
|
15%
ownership interest
|
Linkhead
|
|
$ |
65 |
|
|
- |
|
15%
ownership interest
|
Clickcom
|
|
$ |
25 |
|
|
- |
|
15%
ownership interest
|
Community
Media
|
|
|
- |
|
$ |
4 |
|
5%
ownership interest
|
MOABC
|
|
|
- |
|
$ |
(19 |
) |
15%
ownership interest
|
Total
|
|
$ |
120 |
|
$ |
15 |
|
|
Under
Equity Method:
Investments
accounted for under the equity method are carried at cost and adjusted for the
Company’s proportionate share of undistributed earnings and losses.
(USD
' 000s)
|
|
2007
|
|
2006
(Restated)
|
|
DESCRIPTION
|
Take
1
|
|
|
|
$ |
100 |
|
20%
ownership interest
|
Bell-Pact
Shanghai JV
|
|
$ |
13 |
|
|
- |
|
40%
ownership interest
|
Total
|
|
$ |
13 |
|
$ |
100 |
|
|
5.
PROPERTY AND EQUIPMENT, NET
Property
and equipment consists of the following as of December 31 (in thousands of US
Dollars):
|
|
FY2007
|
|
|
FY2006
|
|
(In
thousands of US Dollars)
|
|
|
|
|
Restated
|
|
Office
furniture, fixtures and leasehold improvements
|
|
$ |
548 |
|
|
$ |
505 |
|
Computers
and office equipment
|
|
|
1,875 |
|
|
|
1,212 |
|
Motor
Vehicles
|
|
|
132 |
|
|
|
56 |
|
Software
|
|
|
21 |
|
|
|
27 |
|
Electronic
Equipment
|
|
|
854 |
|
|
|
19 |
|
Land
and buildings
|
|
|
2,896 |
|
|
|
2,805 |
|
Less:
Accumulated depreciation
|
|
|
1,040 |
|
|
|
615 |
|
Net
Property and Equipment, Net
|
|
$ |
5,285 |
|
|
$ |
4,008 |
|
For the
years ended December 31, 2007 and 2006, the total depreciation and amortization
expenses were $752,000 and $1,536,000 respectively.
The
significant increase of the office furniture, fixtures and leasehold
improvements was mainly due to the computers, office, software and electronic
equipment in 2007 as the expansion of our business including Games ($820,000)
and Wanrong ($532,000). Additionally, Shenzhen office purchased through Inc
($1,301,000) during 2007.
OPERATING
LEASES - The Company leases warehouse and office space under operating leases
with fixed monthly rentals. None of the leases included contingent rentals.
Lease expense charged to operations for 2007 amounted to $466,000 (2006:
$571,000). Future minimum lease payments under non-cancelable operating leases
are $210,000 for 2008, $194,000 for 2009 to 2012.
BANK LINE
OF CREDIT (2007): As of December 31, 2007, Smartime has an overdraft banking
facility with a large Hong Kong bank in the aggregate amount of $100,000. This
overdraft facility is personally pledged by the deposit account of a director of
Smartime.
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):
|
|
2007
|
|
|
2006
|
|
(USD
' 000s)
|
|
|
|
|
Restated
|
|
Prepayment
to suppliers
|
|
$ |
346 |
|
|
$ |
886 |
|
Deposit
|
|
|
237 |
|
|
|
- |
|
Receivable
from Lion Zone Holdings Ltd
|
|
|
- |
|
|
|
485 |
|
Loans
to employees
|
|
|
273 |
|
|
|
412 |
|
Prepaid
expenses
|
|
|
129 |
|
|
|
347 |
|
loan
to Golden Charpel
|
|
|
517 |
|
|
|
- |
|
Others
receivable
|
|
|
525 |
|
|
|
404 |
|
WeiDa
for disposal Linkhead
|
|
|
150 |
|
|
|
- |
|
Loan
to Webplus
|
|
|
237 |
|
|
|
- |
|
loan
to Mou Yi Liang
|
|
|
244 |
|
|
|
- |
|
loan
to Bell-Pact Shanghai JV
|
|
|
102 |
|
|
|
- |
|
loan
to UASIT
|
|
|
96 |
|
|
|
- |
|
Advances
to sales reps
|
|
|
- |
|
|
|
228 |
|
Provision
for doubtful account
|
|
|
(2,448 |
) |
|
|
- |
|
Total
|
|
$ |
408 |
|
|
$ |
2,762 |
|
Bank
loans represent the following at December 31 (in thousands):
|
|
2007
|
|
|
2006
|
|
Unsecured
|
|
|
1,823 |
|
|
|
1,048 |
|
Less:
current portion
|
|
|
80 |
|
|
|
411 |
|
Non
current portion
|
|
$ |
1,743 |
|
|
$ |
637 |
|
Aggregate
future maturities of borrowing for the next five years are as
follows:
(As at
December 31, 2007, the aggregate future maturities of borrowing for the next
five years were as follows: 2008: $80,000, 2009: $85,000, 2010: $88,000, 2011:
$95,000, 2012: $101,000 thereafter: $1,374,000)
(US$000s)
|
|
January
2008
to
December
2008
|
|
|
January
2009
to
December
2009
|
|
|
January
2010
to
December
2010
|
|
|
January
2011to
December
2011
|
|
|
January
2012
to
December
2012
|
|
|
Thereafter
|
|
|
TOTAL
|
|
Beijing
PACT office mortgage (1)
|
|
|
56 |
|
|
|
59 |
|
|
|
61 |
|
|
|
66 |
|
|
|
70 |
|
|
|
755 |
|
|
|
1,067 |
|
Shenzhen
PACT office mortgage (2)
|
|
|
24 |
|
|
|
26 |
|
|
|
27 |
|
|
|
29 |
|
|
|
31 |
|
|
|
619 |
|
|
|
756 |
|
TOTAL
|
|
|
80 |
|
|
|
85 |
|
|
|
88 |
|
|
|
95 |
|
|
|
101 |
|
|
|
1,374 |
|
|
|
1,823 |
|
|
(1)
|
Fixed
mortgages expiring in 2012 at interest rate of 5.5% per
annum.
|
|
(2)
|
Fixed
mortgage expiring in 2012 at interest rate of 6.2% per
annum.
|
Accrued
expenses consist of the following at December 31 (in thousands of US
Dollars):
|
|
2007
|
|
|
2006
(Restated)
|
|
Professional
fee
|
|
$ |
480 |
|
|
$ |
221 |
|
Director
fee
|
|
|
111 |
|
|
|
100 |
|
Salaries
and benefit payable
|
|
|
1,042 |
|
|
|
535 |
|
Marketing
expense
|
|
|
973 |
|
|
|
341 |
|
Income
tax payable
|
|
|
7 |
|
|
|
(53 |
) |
Others
|
|
|
887 |
|
|
|
126 |
|
Total
|
|
$ |
3,500 |
|
|
$ |
1,270 |
|
9.
STOCKHOLDERS' EQUITY
a) COMMON
STOCK
During
the year ended December 31, 2007, the Company had the following equity
transactions (i) 199,444 shares of common stock were issued as the monthly
principal redemption shares for 8 million convertible debentures from January to
March, such shares are valued at $1,090,914; (ii) 41,426 treasury shares were
sold to the open market with total consideration $127,000; (iii) 202,000 shares
as a results of exercise of stock options with cash consideration of $406,000;
(iv) 2,330,000 shares issued for the purpose of acquisition of Octavian
International Ltd recorded as a deposit amounting to $10,974,300 (note 17). As
of December 31, 2007, the Company received $196,000 from exercise of stock
options.
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.
b) STOCK
OPTION PLAN
Prior to
January 1, 2006, PacificNet accounted for awards granted under stock-based
compensation plans following the recognition and measurement principles of APB
25, Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, compensation expense was recognized for awards granted at an
exercise price less than fair market value of the underlying common stock on the
date of grant. Effective January 1, 2006, PacificNet adopted the fair value
recognition provisions of SFAS 123(R). See Note 2 for a description of the
Company’s adoption of SFAS 123R. The fair value of stock options is determined
using the Black-Scholes option pricing model, which is consistent with the
valuation techniques previously utilized for options in footnote disclosures
required under SFAS 123, as amended by FASB Statement No.148, “Accounting for
Stock-Based Compensation - Transition and Disclosure.” The determination of the
fair value of stock-based compensation awards on the date of grant using an
option-pricing model is affected by the Company’s stock prices as well as
assumptions regarding a number of complex and subjective variables, including
the expected volatility of the Company’s stock price over the term of the
awards, actual and projected employee stock option exercise behaviors, risk-free
interest rate and expected dividends. The valuation provisions of SFAS 123(R)
apply to new grants and unvested grants that were outstanding as of the
effective date. For the year ended December 31, 2007, 33,000 new options were
granted and no options were vested, thus the option-related compensation cost is
zero. PacificNet elected the modified prospective method and therefore has not
restated results for prior periods due to 123R.
The
status of the Stock Option Plan as of December 31, 2007, is as
follows:
|
|
|
|
|
WEIGHTED
|
|
|
|
|
|
|
AVERAGE
|
|
|
|
Options
|
|
|
EXERCISE
|
|
|
|
outstanding
|
|
|
PRICE
|
|
OUTSTANDING,
DECEMBER 31, 2005
|
|
|
756,100 |
|
|
$ |
3.99 |
|
Granted
|
|
|
500,000 |
|
|
$ |
4.75 |
|
Cancelled
|
|
|
(491,600 |
) |
|
$ |
4.75 |
|
Exercised
|
|
|
(394,000 |
) |
|
$ |
2.12 |
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
370,500 |
|
|
$ |
2.00 |
|
*Granted
|
|
|
806,000 |
|
|
|
4.26 |
|
Cancelled
|
|
|
(941,500 |
) |
|
|
2.00 |
|
Exercised
|
|
|
(202,000 |
) |
|
|
2.00 |
|
OUTSTANDING,
DECEMBER 31, 2007
|
|
|
33,000 |
|
|
|
4.31 |
|
*This
includes 18,000 options expired in 2006 and extended in 2007.
Following
is a summary of the status of options outstanding at December 31,
2007:
Grant
Date
|
Total
Options
Outstanding
|
Aggregate
Intrinsic
Value
|
Weighted
Average Remaining
Life
(Years)
|
Total
Weighted
Average
Exercise
Price
|
Option
Exercisable
|
Weighted
Average
Exercise
Price
|
2007-8-13
|
33,000
|
$0
|
5.62
|
$4.31
|
-
|
$4.31
|
PacificNet
originally granted 788,000 options on August 11, 2007; however, as the optionees
did not sign the option agreements before December 31, 2007, most of the options
have been forfeited except for 33,000 options. These options will be vested
commencing August 8, 2008 with a 5% per quarter vesting schedule, and the
corresponding compensation costs will be recorded within the vesting period. The
weighted-average fair value of such options was $2.75.The assumptions used in
calculating the fair value of options granted using the Black-Scholes
option-pricing model are as follows:
|
|
Risk-free
interest rate
|
4.51%
|
Expected
life of the options
|
5.86
years
|
Expected
volatility
|
67.44%
|
Expected
dividend yield
|
0%
|
33,000
options were granted and 202,000 were exercised during the fiscal year ended
December 31, 2007.
Among the
202,000 options exercised, 184,000 were included in the ending balance of
370,500 options per the 2006 annual report; these 184,000 options were exercised
on July 26, 2007. The other 18,000 were exercised on July 5, 2007.
On July
3, 2007 the board extended the grant of previously expired options to a former
director as a result of legal settlement. Total options for which the grant was
extended were 15,000 and 3,000 on two different grants. The Company recorded
$51,400 as stock based compensation expense utilizing Black Scholes Options
Pricing Model by using the following assumptions: exercise price of $2.20 and
$1.75, risk free interest rate of 4.76%, volatility of 70.88% and dividend yield
of 0%.
The
information is as below:
Option
Certificate
Number
|
Grant
Date
according
to (d)
|
Options
Approved
|
Option
Price(A)
|
Option
Shares
Exercised(B)
|
Date
Exercised
|
2104
|
12-30-2002
|
3,000
|
$1.75
|
3,000
|
7-5-2007
|
2300
|
6-23-2003
|
15,000
|
$2.20
|
15,000
|
7-5-2007
|
No other
options were vested during the fiscal year ended December 31, 2007.
c)
WARRANTS
At December 31, 2007, the Company had
outstanding and exercisable warrants to purchase an aggregate of 1,007,138
shares of common stock. The weighted average remaining life is 2.34 years and
the weighted average price per share is $10.61 per
share.
Following
is a summary of the warrant activity:
|
|
|
Warrants
outstanding
|
|
|
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|
|
|
Aggregate
Intrinsic
Value
|
|
OUTSTANDING,
DECEMBER 31, 2005 |
|
|
591,138 |
|
|
$ |
9.50 |
|
|
$ |
|
|
Granted
|
|
|
416,000 |
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
|
|
|
|
|
|
OUTSTANDING,
DECEMBER 31, 2006
|
|
|
1,007,138 |
|
|
$ |
10.61 |
|
|
$ |
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
OUTSTANDING,
DECEMBER 31, 2007
|
|
|
1,007,138 |
|
|
$ |
10.61 |
|
|
$ |
|
|
Following
is a summary of the status of warrants outstanding at December 31,
2007:
|
Total
warrants
Outstanding
|
Weighted
Average
Remaining
Life
(Years)
|
Total
Weighted
Average
Exercise
Price
|
Warrants
Exercisable
|
Weighted
Average
Exercise
Price
|
2004-1-15
|
123,456
|
1.04
|
$7.15
|
123,456
|
$7.15
|
2004-11-15
|
117,682
|
1.88
|
$3.89
|
117,682
|
$3.89
|
2004-12-9
|
350,000
|
1.94
|
$12.21
|
350,000
|
$12.21
|
2006-3-13
|
416,000
|
3.20
|
$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. Those warrants have a term of 5 years and immediately vesting. The
assumptions used in calculating the fair value of such warrants granted using
the Black-Scholes option- pricing model are as follows:
Risk-free
interest rate
|
4.78%
|
Expected
life of the options
|
5.00
years
|
Expected
volatility
|
37.08%
|
Expected
dividend yield
|
0%
|
No
warrants were granted, cancelled and exercised during the years ended December
31, 2007.
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, 2007.
|
|
Number
of shares
|
|
|
Note
|
|
Escrow
shares returned to treasury on
|
|
|
800,000 |
|
|
|
|
Repurchase
in the open market
|
|
|
40,888 |
|
|
|
|
Repurchase
of shares from Take1
|
|
|
149,459 |
|
|
|
|
Cancellation
of former employee shares
|
|
|
45,000 |
|
|
|
|
Holdback
shares as contingent consideration due to performance targets not yet
met
|
|
|
529,848 |
|
|
|
(1 |
) |
Termination
with ChinaGoHi
|
|
|
825,000 |
|
|
|
|
|
Incomplete
acquisition of Allink
|
|
|
200,000 |
|
|
|
|
|
Repurchase
of shares from Yueshen
|
|
|
24,200 |
|
|
|
|
|
Shares
sold to the open market
|
|
|
(41,426 |
) |
|
|
|
|
Balance,
December 31, 2007
|
|
|
2,572,969 |
|
|
|
|
|
Shares
outstanding at December 31, 2007
|
|
|
14,314,072 |
|
|
|
|
|
Shares
issued at December 31, 2007
|
|
|
16,887,041 |
|
|
|
|
|
(1) Includes
shares related to Clickcom acquisition: 78,000 PACT shares; Guangzhou Wanrong
acquisition: 138,348 PACT shares; iMobile acquisition: 153,500 PACT Shares; and
Pacificnet Games: 160,000 PACT shares.
10.
CONVERTIBLE DEBENTURES
10.1
Eight Million Convertible Debentures
On March
13, 2006, we completed a private placement in which we sold $8,000,000 in
convertible debentures and issued warrants to purchase up to an aggregate of
400,000 shares of common stock. The debentures are convertible at any time into
shares of our common stock at an initial fixed conversion price of $10.00 per
share, subject to adjustments for certain dilutive events. The debentures are
due March 13, 2009. The warrants are exercisable for a period of five years at
an exercise price of $12.20 per share. At the closing of the private placement,
we prepaid the first year's interest on debentures equal to 5% of the aggregate
principal amount of debentures. We will pay interest in cash or shares, provided
that certain conditions are met, at the rate of 6% for the second year the
debentures are outstanding and then 7% for the third. Beginning January 1, 2007,
we are obligated to redeem up to $320,000 every month, plus accrued, but unpaid
interest, liquidated damages and penalties. We also have the option to prepay
the debentures at any time, provided that certain conditions have been met,
after the 12 month anniversary of the effective date of the registration
statement that has been filed with the Securities and Exchange Commission with
respect to the common stock issuable upon conversion of the debentures, some or
all of the outstanding debentures for cash in an amount equal to 120% of the
principal amount outstanding, plus accrued, but unpaid interest, liquidated
damages and penalties outstanding. At any time after the nine months anniversary
of the effective date of the registration statement, we may force the holders to
convert up to 50% of the then outstanding principal amount of the debentures,
subject to certain trading conditions being met. If any event of default occurs
under the debentures or other related documents, the holders may elect to
accelerate the payment of the outstanding principal amount of the debenture,
plus accrued, but unpaid interest, liquidated damages and penalties, which shall
become immediately due and payable.
Under the
terms of a registration rights agreement entered into at the time of the private
placement, the Company was obligated to file a registration statement with
respect to the shares issuable under the debenture and the warrants by April 30,
2006, and have the registration statement declared effective by the SEC no later
than June 28, 2006. Due to various factors, the Company did not file the
registration statement until May 15, 2006, and it was not declared effective
until December 8, 2006. Therefore, under the terms of the registration rights
agreement, the Company was obligated to pay liquidated damages to the investors
at the rate of 2% of the principal amount of the debenture each month beginning
on June 28, 2006 until the effectiveness of the registration statement, which
was equal to $1,120,000, in the aggregate.
In
February 2007, upon reaching an agreement on the amount and payment of accrued
liquidated damages, the Company signed a Settlement and Release Agreement with
each of the investors. Under the terms of the Settlement and Release Agreements,
the Company paid an aggregate $140,000 in cash as satisfaction in full of
liquidated damages owed to Basso Fund Ltd., Basso Multi-Strategy Holding Fund
Ltd., and Basso Private Opportunities Holding Fund Ltd. Partial liquidated
damages owed to Whalehaven Capital Fund Ltd. were paid in the amount of $35,000
in cash, with the remaining liquidated damages in the amount of $105,000 paid in
the form of a new convertible debenture due February 2009, on substantially the
same terms as the original debentures, except that interest only is paid on the
new debentures until October 2008 and beginning in November 2008 until February
2009, when the new debentures are due, the monthly redemption amount under the
new debentures shall be equal to $315,000. The remaining investors also agreed
to accept the aggregate $840,000 in liquidated damages owed to them in the form
of the new convertible debentures for the amount of their respective portion of
the liquidated damages. The Company also agreed to amend the original debentures
to shorten the term for payment of the original principal amount to a 22 month
term. As a result the monthly redemption amount for the original debenture
increased from $320,000 to $ 363,638. All other terms and conditions of the
original debenture remain in full force and effect.
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.
CHANGE IN
ACCOUNTING PRINCIPLE: On January 1, 2007, the Company adopted FSP EITF 00-19-2
and reclassified warranty liability to equity thru cumulative – effect
adjustment to the opening balance of retained earnings/loss by
$213,000.
The FSP
states that for registration payment arrangements and financial instruments
subject to those arrangements that were entered into prior to the issuance of
the FSP and that continue to be outstanding at the beginning of the period of
adoption, transition shall be achieved by reporting a change in accounting
principle through a cumulative effect adjustment to the opening balance of
retained earnings, or other appropriate component of equity or net assets in the
statement of financial position, in the first interim period of the fiscal year
in which this FSP is initially applied. No prior period information is
retrospectively adjusted following the transition provisions of
FSP.
EVENT OF
DEFAULT
On March
16, 2007 our predecessor auditor withdrew their opinion on our previously filed
financial statements for the years ended December 31, 2005, December 31, 2004
and December 31, 2003. As a result, on March 27, 2007, we notified the holders
of the outstanding convertible debenture that we suspended use of the prospectus
contained in our Registration Statement on Form S-1 (File No. 333-134127) that
was declared effective on December 8, 2006, due to the lack of fiscal year end
2005 and 2004 audited financial statements and that they must cease selling
under the prospectus. The suspension of the use of the prospectus after April
17, 2007, triggered an event of default under the registration rights agreement
and the convertible debentures, and if any of the holders so elect, they could
accelerate and demand payment under the debentures, in accordance with the
registration rights agreement based on the following provisions.
a)
|
"If,
during the Effectiveness Period, either the effectiveness of the
Registration Statement lapses for any reason or the Holder shall not be
permitted to resell Registerable Securities under the Registration
Statement for a period of more than 20 consecutive Trading Days or 60
non-consecutive Trading Days during any 12 month period, the Company has
to pay ‘Mandatory Default Amount’ as the sum of (i) the greater of (A)
130% of the outstanding principal amount of this Debenture, plus all
accrued and unpaid interest hereon, or (B) the outstanding principal
amount of this Debenture, plus all accrued and unpaid interest hereon,
divided by the Conversion Price on the date the Mandatory Default Amount
is either (a) demanded (if demand or notice is required to create an Event
of Default) or otherwise due or (b) paid in full, whichever has a lower
Conversion Price, multiplied by the VWAP on the date the Mandatory Default
Amount is either (x) demanded or otherwise due or (y) paid in full,
whichever has a higher VWAP, and (ii) all other amounts, costs, expenses
and liquidated damages due in respect of this
Debenture."
|
b)
|
"If
any Event of Default occurs, the outstanding principal amount of this
Debenture plus accrued but unpaid interest, liquidated damages and other
amounts owing in respect thereof through the date of acceleration, shall
become, at the Holder’s selection, immediately due and payable in cash at
the Mandatory Default Amount. Commencing 5 days after the occurrence of
any Event of Default that results in the eventual acceleration of this
Debenture, the interest rate on this Debenture shall accrue at an interest
rate equal to the lesser of 18% per annum or the maximum rate permitted
under applicable law."
|
Due to
the provisions mentioned above and as per the terms of the Debenture, the
Company has reclassified the principal amount of the Debenture of $8,000,000
(remaining balance: $4,864,000) and the principal amount of the new Debenture of
$945,000 and the interest accrued thereon to current liabilities.
The
Company accrued 2% as liquidated damages and 30% as mandatory default amount
from the date of ineffectiveness of registration statement as
follows:
($,000) |
|
|
December
31, 2007
|
|
Liquidated
damages
|
|
|
2 |
% |
|
$ |
450 |
|
Mandatory
default
|
|
|
30 |
% |
|
|
2,247 |
|
Total
|
|
|
|
|
|
$ |
2,697 |
|
Such
amounts have been recorded as liquidated damages liability as of December 31,
2007.
Following
is the summary of convertible debenture:
($,000) |
|
|
$8
Million convertible debenture
|
|
|
|
$945,000
convertible debenture
|
|
|
|
Total
|
|
Balance
December 31, 2006
|
|
$ |
8,000 |
|
|
$ |
945 |
|
|
$ |
8,945 |
|
Principal
payment:
|
|
|
|
|
|
|
|
|
|
|
|
|
Redemption
through shares
|
|
|
(1,091 |
) |
|
|
- |
|
|
|
(1,091 |
) |
Cash
payment
|
|
|
(2,045 |
) |
|
|
|
|
|
|
(2,045 |
) |
Balance
December 31, 2007
|
|
$ |
4,864 |
|
|
$ |
945 |
|
|
$ |
5,809 |
|
The
Company issued 199,444 shares to redeem $1,090,909 of convertible note as of
December 31, 2007.
10.2
Five Million Convertible Note
On
February 7, 2007, PacificNet Games Limited (PactGames), a 51% owned subsidiary
of the Company, entered into a definitive $5 million convertible secured note
financing agreement with Pope Asset Management, LLC (Pope), an institutional
investor. Proceeds of the financing are to provide PactGames with additional
working capital to expand its gaming technology operations, to make further
synergistic acquisitions in China and for general corporate
purposes.
The $5
million convertible secured note issued to Pope matures on February 6, 2010.
Subject to reaching certain net income milestones during fiscal year 2007, the
note is convertible into an equity interest of PactGames ranging between 26% and
32%. The interest rate of the convertible note has initially been set at 8%, and
shall increase to 15% if the note is not converted prior to
maturity.
In
connection with the issuance of the note, PactGames incurred issuance costs of
$274,667, which primarily consisted of investment banker fees, legal and other
professional fees. These costs have been capitalized and will be amortized over
three years, the life of the note. Interest accrual as of December 31, 2007
amounted to $498,288.
Following
is the summary of convertible debenture:
($,000) |
|
December
31, 2007 |
|
Convertible
debenture
|
|
$ |
5,000 |
|
Accrued
interest
|
|
|
499 |
|
Unamortized
financing cost
|
|
|
(275 |
) |
Balance
December 31, 2007
|
|
$ |
5,224 |
|
11.
INCOME TAXES
The
components of income before income taxes are as follows:
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Income
subject to PRC
|
|
$ |
(353 |
) |
|
$ |
1,620 |
|
|
$ |
1,308 |
|
Income
(Loss) subject to Hong Kong
|
|
|
(8,743 |
) |
|
|
(8,098 |
) |
|
|
(4,451 |
) |
Income
(Loss) subject to United States
|
|
|
(5,092 |
) |
|
|
(5,961 |
) |
|
|
(1,947 |
) |
Income
(Loss) before taxesx
|
|
|
(14,188 |
) |
|
|
(12,439 |
) |
|
|
(5,090 |
) |
Less:
income taxes
|
|
|
(7 |
) |
|
|
(18 |
) |
|
|
(55 |
) |
Net
Income (Loss) available to common stockholders
|
|
$ |
(14,195 |
) |
|
$ |
(12,457 |
) |
|
$ |
(5,145 |
) |
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 2007, 2006 and 2005 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, 2007, 2006 and 2005.
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, 2007, 2006
and 2005.
|
2007
|
|
2007
|
|
2005
|
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, 2007, 2006
and 2005. Provision for Hong Kong profits tax for 2007, 2006 and 2005 was
approximately $4,000, $18,000 and $0 respectively.
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 2007 was $3,000,
2006 was zero (reclassified to discontinued operations) and 2005 was
$28,000.
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
LOAN DUE TO AND FROM RELATED
PARTIES
As at the
years ended December 31, 2007 and 2006, there was a total loan receivable of
approximately $2,273,000 and $2,991,000 respectively due from related parties
while the loan due to related party was $0 and $282,000.
As of
December 31, 2006, the related party loan receivables included $1,026,000 due
from Take 1, $196,000 due from MOABC, $1,101,000 due fro m PACT Power, $159,000
due from PactSo-HK, $25,000 due from PACT AD, and $484,000 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 $356,000 due from a shareholder
of Yueshen and $128,000 due from a director of Soluteck.
As of
December 31, 2007 the related party loans receivable included $781,000 due from
PACT Power, $523,000 due from MOABC, $625,000 due from PACT Linkhead, $15,000
due form PACT AD, $150,000 due from PACT Solution, and $179,000 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 are comprised of $115,000 due
from a shareholder of Victor Choi and $64,000 due from a director of
Soluteck.
The terms
of these related parties loan receivables and payables are summarized
below:
LOAN TO
POWER
PactPower is an affiliated company, 15%
owned by PacificNet, as of December 31, 2007. A convertible loan of $781,000 is
outstanding from PactPower. The maturity date of loan was September 9, 2007.
Within ninety (90) days overdue, an additional interest charge of 5% per annum
will be levied as a penalty. The loan is received approximately $128,000 on
January 2008.
LOAN TO
MOABC
MOABC is
an affiliated company and is 15% owned by PacificNet as of December 31, 2007. A
convertible loan of $523,000 is outstanding from MOABC as of December 31, 2007.
The maturity date of loan is January 1, 2009.
LOAN TO
LINKHEAD
Linkhead
is an affiliated company, 15% owned by PacificNet, as of December 31, 2007. A
convertible loan of $625,000 is outstanding from Linkhead. The maturity date of
loan is January 1, 2008.
LOAN TO PACIFICNET
AD
PACIFICNET
AD is an affiliated company, 19% owned by PacificNet as of December 31, 2007. A
convertible loan of $15,000 is outstanding from AD and is received on March
2008.
LOAN TO PACIFICNET SOLUTION
LIMITED (PacSo-HK)
PacSo-HK
is an affiliated company, 15% owned by PacificNet, as of December 31, 2007. A
convertible loan of $150,000 is outstanding from PactSo-HK. The maturity date of
loan was January 6,2007. The loan is
currently due on demand, non-interest bearing and unsecured.
LOAN TO VICTOR CHOI
SHAREHOLDER
As of
December 31, 2007, there was a loan outstanding of $115,000 receivable from the
shareholder of Victor Choi. This loan is secured by 30,000 PacificNet shares.
The maturity date of loan was August 31, 2007. The loan is currently due on
demand and non-interest bearing.
LOAN TO SOLUTECK’S
DIRECTOR
As of
December 31, 2007, there was a loan outstanding of $64,000 receivable from a
director of Soluteck, due on January 17 for three consecutive years ending 2008.
The interest rate for the loan is 8% per annum plus 5% penalty interest in case
it has not been timely paid. The loan is collateralized with 100,000
PacificNet’s shares owned by the borrowing director and Ms Iris Lo, and the
remaining assets of Smartime Holding Ltd.
LOAN PAYABLE TO RELATED
PARTY
As of
December 31, 2007, there was no outstanding loan payable to related
parties.
As of
December 31, 2006, a loan of $282,000 was payable to a shareholder of Smartime.
The loan was advanced to Smartime for working capital purposes.
13.
SEGMENT INFORMATION
SFAS No.
131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION ("SFAS
131"), establishes standards for reporting information about operating segments
and for related disclosures about products, services and geographic areas.
Operating segments are identified as components of an enterprise about which
separate discrete financial information is available for evaluation by the chief
operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance. PacificNet’s chief
decision-makers, as defined under SFAS 131, are the Chief Executive Officer and
Chairman. During 2007 and 2006, PacificNet had four operating
segments.
The
Company’s reportable segments are operating units, which represent the
operations of the Company’s significant business operations. Summarized
financial information concerning the Company’s reportable segments is shown in
the following table. The “Other” column includes the Company’s other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable
segments.
For
the year ended December 31, 2007
|
|
Group
1.
Outsourcing
Services
|
|
|
Group
2.
Telecom
Value-Added
Services
|
|
|
Group
3.
Products
(Telecom
&
Gaming)
|
|
|
Group
4.
Other
Business
|
|
|
Total
|
|
(in
thousands of US Dollars, except percentages)
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
Revenues
|
|
|
2,310 |
|
|
|
1,839 |
|
|
|
14,528 |
|
|
|
317 |
|
|
|
18,994 |
|
(%
of Total Revenues)
|
|
|
12 |
% |
|
|
10 |
% |
|
|
76 |
% |
|
|
2 |
% |
|
|
100 |
% |
Earnings
/ (Loss) from Operations
|
|
|
(544 |
) |
|
|
737 |
|
|
|
(6,133 |
) |
|
|
(10,487 |
) |
|
|
(16,427 |
) |
(%
of Total Profit)
|
|
|
3 |
% |
|
|
(4 |
)% |
|
|
37 |
% |
|
|
64 |
% |
|
|
100 |
% |
Total
Assets
|
|
|
1,490 |
|
|
|
2,516 |
|
|
|
16,512 |
|
|
|
4,202 |
|
|
|
24,720 |
|
(%
of Total Assets)
|
|
|
6 |
% |
|
|
10 |
% |
|
|
67 |
% |
|
|
17 |
% |
|
|
100 |
% |
Goodwill
|
|
|
- |
|
|
|
461 |
|
|
|
409 |
|
|
|
- |
|
|
|
870 |
|
Geographic
Area
|
|
HK,PRC
|
|
|
HK,
PRC
|
|
|
HK,PRC,Macau
|
|
|
HK,PRC
|
|
|
|
|
|
For
the year ended December 31, 2006
|
|
Group
1.
Outsourcing
Services
|
|
|
Group
2.
Telecom
Value-Added
Services
|
|
|
Group
3.
Products
(Telecom
&
Gaming)
|
|
|
Group
4.
Other
Business
|
|
|
Total
|
|
(in
thousands of US Dollars, except percentages)
|
|
Restated
|
|
|
Restated
|
|
|
Restated
|
|
|
Restated
|
|
|
Restated
|
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
Revenues
|
|
|
1,813 |
|
|
|
2,784 |
|
|
|
23,385 |
|
|
|
1,091 |
|
|
|
29,073 |
|
(%
of Total Revenues)
|
|
|
6 |
% |
|
|
10 |
% |
|
|
80 |
% |
|
|
4 |
% |
|
|
100 |
% |
Earnings
/ (Loss) from Operations
|
|
|
(67 |
) |
|
|
(1,054 |
) |
|
|
(1,345 |
) |
|
|
(4,969 |
) |
|
|
(7,435 |
) |
(%
of Total Profit)
|
|
|
1 |
% |
|
|
14 |
% |
|
|
18 |
% |
|
|
67 |
% |
|
|
100 |
% |
Total
Assets
|
|
|
3,413 |
|
|
|
12,673 |
|
|
|
(1,570 |
) |
|
|
18,155 |
|
|
|
32,671 |
|
(%
of Total Assets)
|
|
|
10 |
% |
|
|
39 |
% |
|
|
(5 |
)% |
|
|
56 |
% |
|
|
100 |
% |
Goodwill
|
|
|
3,964 |
|
|
|
461 |
|
|
|
1,176 |
|
|
|
- |
|
|
|
5,601 |
|
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
Smartime/Soluteck-PactSo.
(2)
Telecom Value-Added Services (VAS) - Our subsidiary, Guangzhou Wanrong
Information Technology Co., Ltd. ("Guangzhou Wanrong"), is one of the leading
value-added telecom service providers in China. Since its inception in 2003,
Guangzhou Wanrong has achieved strong growth in its VAS including SMS, WAP,
JAVA, MMS, IVR, multimedia entertainment download services, media interactive
products, mobile email services, life, sports, entertainment, and business
information services.
(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, Take1 and PacificNet Games. PacificNet Games Limited (PactGames) 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. Take1 Technologies (Take 1), is in the business of
designing and manufacturing electronic multimedia entertainment kiosks, coin-op
kiosks and machines, Electronic Gaming Machines (EGM), bingo and slot machines,
AWP (Amusements With Prizes) games, server-based downloadable games systems, and
Video Lottery Terminals (VLT) such as Keno and Bingo machines, including
hardware, software, and cabinets.
(4) Other
Business - other administrative, financial and investment services and non-core
businesses.
Product
and service revenues classified by major geographic areas are as follows (in
thousands of US Dollars):
For
the year ended December 31, 2007
|
|
Hong
Kong
|
|
|
PRC
|
|
|
Macau
|
|
|
United
States
|
|
|
Total
|
|
Product
revenues
|
|
$ |
5,447 |
|
|
$ |
6,770 |
|
|
$ |
2,311 |
|
|
$ |
- |
|
|
$ |
14,528 |
|
Service
revenues
|
|
$ |
261 |
|
|
$ |
4,205 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
4,466 |
|
For
the year ended December 31, 2006
|
|
Hong
Kong
|
|
|
PRC
|
|
|
Macau
|
|
|
United
States
|
|
|
Total
|
|
Product
revenues
|
|
$ |
17,071 |
|
|
$ |
7,147 |
|
|
$ |
364 |
|
|
$ |
- |
|
|
$ |
24,582 |
|
Service
revenues
|
|
$ |
1,228 |
|
|
$ |
3,263 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
4,491 |
|
14.
NET ASSETS HELD FOR DISPOSITION
Sale
of Interest in Linkhead Technology Bejing Limited. ("Linkhead") and
PacificNet Telecom Solutions Inc. (“PactTelso”)
On May
20, 2007, the Company entered into a definitive agreement to sell its 36% equity
interest in Linkhead, a PRC limited liability corporation engaged in the
business of resale of VAS, IVR, NMS hardware and software platforms in China, to
Mr. Mu Yingliang, a resident of People’s Republic of China.
On May
20, 2007, the Company entered into a definitive agreement to sell its 36% equity
interest in PactTelso, 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 Linkhead and PactTelso was US$500,000, to be paid in
three installments. The Company’s interest in Linkhead and PactTelso was
decreased from 51% to 15% after the transaction. Absent any explicit closing
conditions contained in the said agreement, the disposal was completed upon
title transfer during the third quarter of 2007.
Sale of Interest in
PacificNet Solutions Limited ("PacSo-HK")
On May
18, 2007, the Company entered into a definitive agreement to sell its 45% equity
interest in PacSo-HK, 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-HK was HK$4,500 (or US$577), to be
paid within 90 days after signing of the agreement. The Company’s interest in
PacSo-HK decreased from 60% to 15% after the transaction. Absent any explicit
closing conditions contained in the said agreement, the disposal was completed
upon title transfer during the third quarter of 2007.
Sale
of Interest in PacificNet Power Limited ("PactPower")
On May
18, 2007, the Company entered into a definitive agreement to sell its 36% equity
interest in PactPower, a company registered under the laws of Hong Kong SAR,
China and engaged in power and energy saving contracting and consulting
businesses, to Mr. Alex Au, a resident of Hong Kong SAR, China. Consideration
for the 36% interest of PactPower was HK$3,600 (or US$462), to be paid within 90
days after signing of the agreement. The Company’s interest in PactPower
decreased from 51% to 15% after the transaction. Absent any explicit closing
conditions contained in the said agreement, the disposal was completed upon
title transfer during the third quarter of 2007.
Sale
of Interest in MOABC.com ("MOABC")
On May
20, 2007, the Company entered into a definitive agreement to sell its 5% equity
interest in MOABC, a PRC limited liability corporation engaged in the business
of value-added services platform providing, to Mr. Jack Ou, a resident of
People’s Republic of China. Consideration for the 5% interest of MOABC was
RMB5,000 (or US$647), to be paid within 90 days after signing of the agreement.
The Company’s interest in MOABC decreased from 20% to 15% after the
transaction.
Sale of Interest in
PacificNet Clickcom Limited ("Clickcom")
On
December 18, 2007, the Company entered into a definitive agreement to sell its
36% entire interest in PacificNet Clickcom Limited. ("Clickcom"), a leading
Value-Added Services (VAS) company in China, to Mr. Ou Zhenbin, a Chinese
resident. Consideration for the 36% interest of Clickcom was RMB10,000 (or
US$1,314), to be paid in cash within 90 days after the agreement signing.
The Company’s interest in Clickcom decreased from 51% to 15% after the
transaction.
Sale
of Interest in Guangzhou 3G Information Technology Co., Ltd. ("Guangzhou
3G")
On April
30, 2007, through our wholly-owned subsidiary, PacificNet Strategic Investment
Holdings Limited (“PSI Holdings”), we entered into a stock purchase and sale
agreement with Heyspace International Limited to sell PSI Holdings’ 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. Heyspace paid an initial purchase price of $1,000,000 and
the remaining balance to be paid by October 2007. Due to non payment of the
remaining balance by Heyspace as per the agreement, the Company on November 25,
2007 entered into a memorandum of understanding (“MOU”) with Heyspace. Pursuant
to the MOU, we agreed with Heyspace that for a period commencing on November 25,
2007 through March 31, 2008, we are free to seek new buyers to purchase PSI
Holdings’ share ownership in Guangzhou 3G at a consideration and term which at a
minimum will not cause any disposal loss to us. As at December 31, 2007,
Heyspace owns Pacific 3G.
Sale
of Interest in PacificNet Epro Holdings Limited ("Epro")
On April
18, 2008, PacificNet, consummated the sale of the Company's subsidiary,
PacificNet Epro Holdings Limited, a company incorporated in the Hong Kong
Special Administrative Region of the PRC ("Epro"), which is primarily engaged in
the business of providing call center telecom and customer relationship
management services as well as other business outsourcing services in China.
Pursuant to the terms of the Sales and Purchase Agreement (the "Agreement")
entered into between the Company and Epro Group International Limited (the "Epro
Group International"), PacificNet sold its entire share ownership of 7,766,993
shares in Epro for HK$21 million. Upon execution of the Agreement, the Company
received a payment of HK$3 million. PacificNet shall receive the remaining
purchase price in installments over the next twenty-four months. Pursuant to the
terms of the Agreement, within sixty days of the closing, Epro shall repay
PacificNet HK$2 million for an interest bearing loan granted from PacificNet to
Epro. As at December 31, 2007, PacificNet Epro Holdings is classified under ‘Net
Assets Held for Disposal’ in the accompanying financial statements.
Information
relating to the operations of the subsidiaries up to the periods of
disposal/held for disposal during the year ended December 31, 2007 is as follows
(in thousands of US Dollars):
2007
(In US$ thousands)
|
|
Linkhead
+PacTelso
|
|
|
Clickcom
|
|
|
Power
|
|
|
Solutions
|
|
|
3G
|
|
|
EPRO
|
|
|
AD
|
|
|
Total
|
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
Income
(loss) from discontinued operations
|
|
|
(84 |
) |
|
|
41 |
|
|
|
(478 |
) |
|
|
(10 |
) |
|
|
(228 |
) |
|
|
491 |
|
|
|
(50 |
) |
|
|
(318 |
) |
Gain
on disposal
|
|
|
244 |
|
|
|
60 |
|
|
|
1,274 |
|
|
|
218 |
|
|
|
333 |
|
|
|
- |
|
|
|
53 |
|
|
|
2,181 |
|
Net
assets held for disposition (remaining interest)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
2,692 |
|
|
|
- |
|
|
|
2,692 |
|
15.
LEGAL PROCEEDINGS
1.
Johnson Controls Hong Kong Limited (JCHKL) vs. PacificNet Power
Limited
On
January 19, 2007, Johnson Controls Hong Kong Limited filed a civil 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 rain water-cooled chillers,
together with energy saving performance (the "Chiller System"), at the Fortress
Tower in Hong Kong.
In
connection with the claim, PacificNet Power reviewed a letter from its client,
China Weal Property Management Ltd., dated January 22, 2007 stating that the
construction work by JCHKL had not been completed as of the date of the letter,
and that certain violations itemized in a letter issued by the Hong Kong
Environment Protection Department (EPD) (Noise Abatement Notice No. N806030)
addressed to JCHKL with respect to acoustic problems with JCHKL’s equipment had
not been abated.
The board
of directors of PacificNet Power Limited has reviewed the case with its client,
China Weal Property Management Ltd., and our Hong Kong legal counsel and it is
the honest belief of the board that the project work undertaken JCHKL is
defective in numerous aspects. As a result, the board believes that
the construction work has not been completed by JCHKL, and therefore, JCHKL is
not entitled to payment for its services.
On
February 13, 2007, the board instructed the Hong Kong legal counsel to issue a
Defense and Counterclaim to JCHKL to counter-claim that ( i) JCHKL's
construction work has not complied with the applicable rules and regulations of
various government authorities in Hong Kong; (ii) the Chiller System provided by
JCHKL was defective and merchantable unfit and JCHKL has failed and/or refused
to rectify such defective works; and (iii) JCHKL shall return the work deposit
in the amount of HK$1,500,000 to PacificNet Power Limited and shall compensate
and keep PacificNet Power Limited indemnified against all the loss and damages
suffered as a result of any claims from the China Weal Property Management
Ltd..
The case
is now in the discovery stage before proceeding to the stage of fixing a date
for trial in the High Court of Hong Kong and the board intends to vigorously
defend against the allegations. We are unable to predict the outcome of these
actions, or a reasonable estimate of the range of possible loss, if
any.
2. PacificNet Power Limited vs
Johnson Controls Hong Kong Limited (JCHKL)
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 Incorpated Owners of Nan Fung Centre,
Tsuen Wan (“the Employer”) for the “construction and replacement works of
existing air-cooled chiller plant by new water-cooled chiller plant for Tsuen
Wan Nan Fung Centre and energy saving performance contract” (“the Contract”).
JCHKL invited and induced PacificNet Power Limited to act as the main contractor
for the Contract and it would then act as a sub-contractor.
PacificNet
Power also expressly made known to JCHKL that the said construction and
replacement works and the guaranteed energy saving should meet all the tender
requirements if PacificNet Power accepted the invitation to act as the main
contractor for the Contract, and PacificNet Power further said that if there
should be any quality defects with the system and/ or the construction work, the
Employer and/ or their prospective tenants would claim against JCHKL and JCHKL
should compensate.
PacificNet
Power however received some correspondences and complaints from the Employer
about the poor and/ or sub-standard works done by JCHKL. PacificNet Power, after
separate investigation, discovered the poor workmanship and sub-standard works
done by JCHKL. Accordingly, the Employer and/ or their representatives have
delayed the monthly installments payment to PacificNet Power.
On April
23, 2007, PacificNet Power instructed the Hong Kong lawyers to issue a letter to
the Defendant requesting and demanding them, being the sub-contractor of the
Construction and Replacement Works Contract, to take immediate rectification
action within seven days from the date of the said letter to (i) rectify and
complete all outstanding defective works of the Construction and Replacement
Works Contract; (ii) replace the water-cooled chiller plant and/or equipments
which are not conformed with the requirements of the tender documents previously
submitted by the Defendant to the Employer; and (iii) improve the poor
performance of energy saving of the new water-cooled chiller plant.
Despite
the said letter, JCHKL had failed and/ or refused to rectify and complete all
outstanding works and/ or replace the defective system. And therefore PacificNet
Power claims against JCHKL for: (i) refund HK$6,414,300.00, being the Contract
Price paid by PacificNet Power to JCHKL; (ii) costs and expenses incurred by
PacificNet Power to rectify all defective works of the Contract; (iii) all
damage and loss suffered by PacificNet Power, and further and other
relief.
On July
25, 2007, JCHKL issued a Defense and Counterclaim to PacificNet Power to argue
that: (i) they had carried out the works according to the Contract terms; (ii)
the works had been approved by PKL Consultants Limited, the consultant
representative of the Employer; and (iii) a sum of HK$30,000 is still due and
owing by PacificNet Power to JCHKL.
The case
is now in the discovery stage before proceeding to the stage of fixing a date
for trial in the High Court of Hong Kong. We are unable to predict the outcome
of these actions, or a reasonable estimate of the range of possible loss, if
any.
3.
PacificNet Inc. vs. HLB Hodgson Impey Cheng (HLB or Defendant), a firm of
Chartered Accountants and Certified Public Accountants in Hong Kong
On
September 20, 2007, PacificNet Inc. filed a claim against its former auditors
HLB Hodgson Impey Cheng (HLB), a firm of Chartered Accountants and Certified
Public Accountants, in the High Court of the Hong Kong Special Administrative
Region seeking refund of the professional fees, compensation of professional
fees and expenses for Company to engage and deploy new auditors to take over the
incomplete audit works from the Defendant and returning and/or providing all
relevant accounting records, vouchers, audit program and working papers retained
by the Defendant and losses and damages incurred.
The case
is now in the pleadings stage. We are unable to predict the outcome of these
actions, or a reasonable estimate of the range of possible loss, if
any.
4.
Iroquois Master Fund, Ltd. vs. Pacificnet Inc.
On or
about October 3, 2007 Iroquois Master Fund, Ltd. filed a complaint in the
Supreme Court of the State of New York against PacificNet Inc., claiming that
the Company is in default under the Amended and Restated Convertible Debenture
due March 2009 (the Amended Debenture”) in the principal amount of $3,000,000
and the Convertible Debenture due February 2009 (the New Debenture”) in the
principal amount of $420,000.
Iroquois
Master Fund, Ltd. is seeking damages of $3,253,163.80 in the aggregate, together
with any accrued but unpaid interest through the date of
judgment. Iroquois Master Fund, Ltd. has also demanded reimbursement
of its attorney fees and other costs and expenses incurred together with costs
and disbursements of this action.
On or
about December 5, 2007, PacificNet filed its answer denies that PacificNet is in
default and assert an agreement that would enable it to bring the interest
payments up to date by the issuance of stock in the near future.
On March
27, 2008, three holders of PACT's Convertible Subordinated Debentures filed an
involuntary petition for Chapter 11 relief in federal bankruptcy court late
Saturday, March 22, 2008 in Wilmington, DE. The Company has retained counsel to
oppose the filing because the petition fails to meet the standard for invoking
an involuntary bankruptcy and fails to take into consideration other agreements
between the Company and the petitioning creditors. The Company intends to
vigorously oppose the petition and move for dismissal of the filing, and if
successful will seek damages and attorney fees. Subsequently, PACT also received
default notice from all but one of the debentureholder including Iroquois Master
Fund Ltd., Alpha Capital AG, Whalehaven Capital Fund Limited, DKR Soundshore
Oasis Holding Fund Ltd., Basso Fund Ltd., Basso Multi-Strategy Holding Fund
Ltd., and Basso Private Opportunities Holding Fund Ltd. from the same
Convertible Subordinated Debentures related to the private offering of
$8,000,000 principal amount variable debentures consummated on March 13, 2006,
and due March 2009.
PACT has
retained counsel to oppose the above petition. The amount of the debt in
question is as follows: Iroquois Master Fund Ltd. $2.5 million, Whalehaven
Capital Fund Limited $958,000, Alpha Capital AG $685,000 DKR Soundshore Oasis
Holding Fund Ltd $960,000, and Basso Fund Ltd., Basso Multi- Strategy Holding
Fund Ltd., and Basso Private Opportunities Holding Fund Ltd., a combined amount
of $500,000.
16.
CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environments in the PRC, by the general state of
the PRC's economy. The Company's business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation, among other things.
17.
EVENTS SUBSEQUENT TO DECEMBER 31, 2007
1) STATUS OF ACQUISITION OF
OCTAVIAN INTERNATIONAL LIMITED ("OCTAVIAN")
On
January 22 2008, PacificNet Inc. (NASDAQ:PACT) (the “Company” or “PacificNet”),
announced the acquisition of Octavian International Limited (“Octavian”), a
worldwide supplier of gaming technology, solutions and
systems. The Company had previously reported on a Form 8-K
filed with the Securities and Exchange Commission on December 13, 2007, the
execution of definitive agreements, including that certain Agreement among,
PacificNet Games International Corporation, Octavian, Emperor Holdings Limited,
Ziria Enterprises Limited and the Company on December 7, 2007, for the
acquisition of 100% of Octavian (the “Agreement”). PacificNet,
through its wholly-owned subsidiary, Pacificnet Games International Corporation,
signed an agreement to acquire from Ziria Enterprises Limited, a company
incorporated in Cyprus (the “Seller”), 100% of the issued and outstanding shares
(the “Shares”) of Emperor Holdings Limited, a company incorporated in Cyprus
(the “Holding Company”), which is the parent company of Octavian.
Up to
April 14, 2008, Ziria Enterprises Limited did not deliver to PacificNet the
share certificates of Emperor Holdings Limited, the legal owner of Octavian
International Limited. As a result of Ziria’s failure to deliver the
share certificates, which was a condition to closing the acquisition of
Octavian, on May 21, 2008, the Company, Ziria, PacificNet Games International
Corporation, Octavian and Emperor Holdings Limited terminated the agreement to
acquire Octavian. Under the acquisition agreement, if the transaction
had been consummated, PacificNet was obligated to issue, in the aggregate,
2,330,000 restricted shares of PACT representing approximately 19.5% of
PacificNet's outstanding shares and cash of up to $18,900,000, which would have
been paid upon the completion of certain net profit performance
targets.
All
parties involved have agreed not to complete the merger but will remain
distribution partners of complimentary products in each others respective
markets.
As a
result of the failure of the Octavian acquisition to be consummated and the
termination of the acquisition agreement, on May 21, 2008, Mr. Harmen
Brenninkmeijer, Chief Executive Officer of Octavian, resigned as a member of the
Board of Directors of PacificNet. It was a condition to the closing
of the acquisition of Octavian that Mr. Brenninkmeijer was appointed to the
Board of Directors. There was no disagreement between Mr.
Brenninkmeijer and PacificNet on any matter relating to PacificNet’s operations,
policies or practices.
2) SALE OF INTEREST IN EPRO.
("EPRO")
On April
18, 2008, PacificNet, consummated the sale of the Company's subsidiary,
PacificNet Epro Holdings Limited, a company incorporated in the Hong Kong
Special Administrative Region of the PRC ("Epro"), which is primarily engaged in
the business of providing call center telecom and customer relationship
management services as well as other business outsourcing services in China.
Pursuant to the terms of the Sales and Purchase Agreement (the "Agreement")
entered into between the Company and Epro Group International Limited (the "Epro
Group International"), PacificNet sold its entire share ownership of 7,766,993
shares in Epro for HK$21 million.
Upon
execution of the Agreement, the Company received a payment of HK$3 million.
PacificNet shall receive the remaining purchase price in installments over the
next twenty-four months.
Pursuant
to the terms of the Agreement, within sixty days of the closing, Epro shall
repay PacificNet HK$2 million for an interest bearing loan granted from
PacificNet to Epro.
3) SALE OF GUANGZHOU
3G
PacificNet
and Heyspace entered into a Supplement Agreement for 3G’s deal on 20th March,
2008. According to this supplement agreement, PacificNet will apply $500,000
received as of December 31, 2007 against the 5% ownership interest and the
remaining $500,000 will be served as a collateral along with the transfer of the
share certificates of 46% shares to PacificNet from Heyspace. If Heyspace fails
to pay the remaining USD$5,000,000 on or before 31 March, 2009, PacificNet has
right to reclaim for the unpaid 46% shares of Pacific 3G Information &
Technology Co., Limited, and demand for an annual interest rate of 12% (See note
14 for details). As at December 31, 2007, Company has made a provision of $3.5
million against receivable from Heyspace and the net amount is included under
other receivables in the accompanied financial statements.
F-35