U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
/ / 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 LOGO]
PACIFICNET INC.
(Exact name of small business issuer in its charter)
DELAWARE 91-2118007
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
UNIT 2710, HONG KONG PLAZA, N/A
188 CONNAUGHT ROAD WEST, HONG KONG (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER: 011-852-2876-2900
--------------------------------------------------------------------------------
(Former Name and Address)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 / /
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and will not be contained, to the best of the
issuer's knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-KSB or any amendment to this Form
10-KSB. / /
Issuer's revenues for its most recent fiscal year: $29,708,000.The aggregate
market value of the common stock held by non-affiliates of the registrant as of
March 31, 2005 was approximately $53,481,896, based upon the closing sale price
of $8.19 per share as reported by The Nasdaq Small Cap Market on such date.
There were 9,791,583 shares of the Company's common stock outstanding on March
31, 2005.
Transitional Small Business Disclosure Format (check one): YES / / NO /X/
DOCUMENTS INCORPORATED BY REFERENCE - NONE
TABLE OF CONTENTS
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PAGE
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PART I................................................................1
1. Description Of Business..........................................1
2. Description Of Property.........................................19
3. Legal Proceedings...............................................20
4. Submission Of Matters To A Vote Of Security Holders.............20
PART II..............................................................21
5. Market For Common Equity And Related Stockholder Matters........21
6. Management's Discussion And Analysis Or Plan Of Operation.......22
7. Financial Statements............................................27
8. Changes In And Disagreements With Accountants On Accounting
And Financial Disclosure........................................51
8.a. Controls And Procedures.........................................51
8.b. Other Information...............................................51
PART III.............................................................52
9. Directors And Officers..........................................52
10. Executive Compensation..........................................55
11. Security Ownership Of Certain Beneficial Owners And Management..58
12. Certain Relationships And Related Transactions..................60
13. Exhibits And Reports On Form 8-K................................60
14. Principal Accountant Fees And Services..........................61
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.
i
PART I
ITEM 1. DESCRIPTION OF BUSINESS
As used in this report, "we", "us," "our," "Company", "PacificNet" or
"PACT" refers to PacificNet Inc., a Delaware corporation.
OVERVIEW
We were incorporated in the state of Delaware in 1987. Our business
consists of three groups, all of which operate within the outsourcing and
telecommunications industries in Asia, primarily greater China, which includes
the People's Republic of China (PRC), or mainland China, Hong Kong Special
Administrative Region (HKSAR), Macau Special Administrative Region, and Taiwan.
Through our subsidiaries we provide outsourcing services, value-added telecom
services (VAS), and communication products distribution services. Our business
process outsourcing (BPO) services, include call centers, providing customer
relationship management (CRM), and telemarketing services, and our information
technology outsourcing (ITO) includes software programming and development. We
are value-added resellers and providers of telecom VAS, which comprises
interactive voice response (IVR) systems, call center management systems, and
VOIP, as well as mobile phone VAS, such as short messaging services (SMS) and
multimedia messaging services (MMS). Recently, we commenced our communication
products distribution service, through wholesale and, to a lesser extent, retail
sale and distribution of calling cards in China, and we have recently invested
in a company that distributes multimedia interactive self-service kiosks. We
intend to continue to grow our business by acquiring and managing growing
technology and network communications businesses with established products and
customers in Asia.
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 customer'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. 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. Our calling card and related mobile telecom products are sold
cash-on-delivery.
Through our subsidiaries, we invest in and operate companies that
provide outsourcing and value-added services(VAS) and solutions in China, such
as call centers, telemarketing, customerrelationship management (CRM), business
process outsourcing (BPO) and software development outsourcing, interactive
voice response (IVR), mobile applications, and sales and distribution of
telecom products and services. PacificNet's
clients include the leading telecom operators, banks, insurance, travel,
marketing, and service companies, as well as telecom consumers, in Greater
China. Clients include China Telecom, China Netcom, China Mobile, China Unicom,
PCCW, Hutchison Telecom, CSL, SmarTone, Sunday, Swire Travel, Coca-Cola, SONY,
Samsung, TNT Express, Huawei, TCL, Dun & Bradstreet, American Express, Bank of
China, DBS, Hong Kong Government, and Hongkong Post. PacificNet employs over
1000 staff in its various subsidiaries in China with offices in Hong Kong,
Beijing, Shenzhen, Guangzhou, and Shandong.
PacificNet's operations include the following three groups:
(1) Outsourcing Services: including Business Process Outsourcing (BPO),
call center, IT Outsourcing (ITO) and software development services.
(2) Value-Added Telecom Services (VAS): including Interactive Voice
Response (IVR), SMS and related VAS.
(3) Communication Products Distribution Services: including calling
cards, GSM/ CDMA/ XiaoLingTong products, multimedia self-service Kiosks.
1
CORPORATE STRUCTURE
PacificNet conducts its business operations through the following
subsidiaries:
PACIFICNET LIMITED
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.
PACIFICNET COMMUNICATIONS LIMITED
PacificNet Communications Limited (referred to herein as "PacCom"),
incorporated in Hong Kong, is a wholly owned subsidiary of PacificNet that
specializes in telecom related services in Hong Kong and Greater China.
PACIFICNET STRATEGIC INVESTMENT HOLDINGS LIMITED
PacificNet Strategic Investment Holdings Limited (referred to herein as
"PacInvest"), 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.
PACIFICNET SOLUTIONS LIMITED
PacificNet Solutions Ltd. (referred to herein as "PacSo"), incorporated
in Hong Kong, is a subsidiary that specializes in systems integration, software
application, and e-business solutions services in Hong Kong and Greater China.
The scope of PacSo's products and services includes smart card solutions, web
based front-end applications and web based connections to backend enterprise
planning systems.
PACIFICNET POWER LIMITED
PacificNet Power Ltd. (referred to herein as "PacPower"), incorporated
in Hong Kong, is a subsidiary that specializes in information technology (IT)
solutions, systems integration, software application, energy saving and electric
power management systems and solutions in Hong Kong and Greater China.
PacificNet Power was registered in Hong Kong in January 2005 as a subsidiary of
PacificNet Limited with 51% controlling ownership by PacificNet.
2
PACIFICNET TECHNOLOGY (SHENZHEN) LIMITED
PacificNet Technology (Shenzhen) Limited (referred to herein as
"PacSZ") is incorporated in PRC as a wholly owned foreign enterprise (WOFE) that
is a wholly owned subsidiary of PacificNet Limited Hong Kong. Its primary
purpose is to act as a administrative support back-office, IT support and
software development, to support PacificNet's operations in China, and to
conduct the general administrative operations of PacificNet in China.
PACIFICNET EPRO HOLDINGS LIMITED (FORMERLY KNOWN AS: EPRO TELECOM HOLDINGS
LIMITED)
PacificNet Epro Holdings Limited (referred to herein as "Epro",
formerly known as "Epro Telecom Holdings Limited"), a company incorporated in
the Hong Kong Special Administrative Region of the PRC, is engaged in the
business of providing value-added telecom services (VAS), call center and
customer relationship management (CRM) services, mobile marketing and promotion
services, call center training, management and consulting services, call center
software, IVR systems, mobile payment and mobile point of sale (POS) solutions,
internet e-commerce and mobile commerce, mobile applications based on short
messaging services (SMS), multimedia messaging services (MMS), outsourced
telemarketing and customer support services, and other mobile value-added
services (VAS) for Hong Kong and PRC's telecom operators, banks, insurance, and
other financial services companies in the PRC. Epro's clients include major
telecom operators, banks, insurance and financial services companies in Greater
China, such as China Telecom (NYSE: CHA), China Unicom (NYSE: CHU), PCCW (NYSE:
PCW), CSL, SmarTone Telecom, Sunday Communications (Nasdaq: SDAY), Hutchison
Whampoa Limited (HKSE:0013.HK), Swire Coca-Cola, Samsung, Dun & Bradstreet, DBS,
Dao Heng Insurance, Shenzhen Development Bank, Hong Kong Government Housing
Authority and Hongkong Post.
BEIJING LINKHEAD TECHNOLOGIES COMPANY LIMITED
Beijing Linkhead Technologies Company Limited, (referred to herein as
"Linkhead") a PRC limited liability corporation, is engaged in the business of
providing value-added services (VAS), interactive voice response (IVR) system
development and integration, voice internet portals, computer telephony
integration (CTI), VoIP, internet and mobile application development, telecom
customer relationship management (CRM) services for China's telecom operators,
telecom related management and consulting services, mobile consumer analytics,
mobile data-mining, internet e-commerce and mobile commerce, mobile applications
based on WAP, K-Java, BREW, EMS, short messaging services (SMS), multimedia
messaging services (MMS), outsourced software development, and other mobile
value-added services (VAS) in the PRC. Linkhead's major clients and
profit-sharing partners include some of the leading telecom operators such as
China Telecom, China Mobile, China Unicom. Linkhead is also channel partner, or
a master reseller, of NMS Communications (Nasdaq: NMSS), a leading provider of
communications technologies and solutions, which enables new enhanced services
and efficient networks that help customers grow their profits and revenue.
GUANGZHOU YUESHEN TAIYANG TECHNOLOGY CO. LTD.
Guangzhou YueShen TaiYang Technology Co. Ltd. (referred to herein as
"YueShen"), a PRC registered sino-foreign equity joint venture, is a subsidiary
of PacificNet. YueShen is a leading distributor of telecom services including
phone cards, mobile SIM cards, prepaid stored-value cards, re-chargeable phone
cards, VoIP and IDD calling cards, internet access cards, and bundled
cross-selling insurance cards, travel and hotel reservation cards and customer
loyalty membership cards in China. PacificNet YueShen is a leading top-level
distributor for the major telecom operators in China, including China Mobile,
China Unicom, China Telecom, China Netcom, China Railcom, etc.
SMARTIME HOLDINGS LIMITED / SOLUTECK TECHNOLOGY ( SHENZHEN ) CO. LTD.
Smartime Holdings Limited (referred to herein as "Smartime") is an IT
outsourcing company incorporated in Hong Kong that operates through its China
subsidiary Soluteck Technology ( Shenzhen ) Co. Ltd. (aka Soluteck Shenzhen),
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, Bank of East
Asia, etc. In December 2004, Smartime launched a new software development
outsourcing center in Shenzhen, located in a Grade A office building, currently
occupying two floors (total 26,000 square feet) with the capacity to expand to
two additional floors. Each of the two floors will have the capacity to house
about 200 employees. The new outsourcing development center will serve its
existing clients, which includes some of the world's leading telecom and IT
companies.
3
CHEER ERA LIMITED (DBA: VIDEO CLUB INTERNATIONAL)
Cheer Era Limited (doing business as "Video Club International") 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, payment and delivery stations for mobile phones,
and other coin-operated kiosks and kiosk consumables. Cheer Era Limited markets
and distributes its multimedia communication stations around the world including
the USA, Korea, China, India and SE Asia. Cheer Era Limited is headquartered in
Hong Kong with operations in China and the USA.
RECENT DEVELOPMENTS
Recently, we expanded our operations by acquiring entities that operate
as service providers in the wireless VAS & IVR industries, which have grown
rapidly in China in recent years.
PACIFICNET CLICKOM LIMITED
On December 16, 2004, we entered into an agreement to acquire a
controlling interest in Guangzhou Dianxun Digital Network Technology Co., Ltd
("Clickcom-WOFE") through the purchase of a 51% interest of Clickcom-WOFE's
parent company, PacificNet Clickcom Limited, a British Virgin Islands Company
("Clickcom-BVI") from three shareholders, Mr. Jinnan Lai, Mr. Ming Zhang and Mr.
Dong Liu who are majority shareholders of GuangZhou DianXun Company Limited
("Dianxun-DE"), a PRC registered Domestic Enterprise (DE) either. The
acquisition was completed on March 28, 2005 upon receipt of the required
business license and approval from the local government.
GUANGZHOU 3G INFORMATION TECHNOLOGY CO. LTD.
On March 30, 2005 we entered into an agreement to acquire a controlling
interest in Guangzhou 3G Information Technology Co. Ltd. ("Guangzhou3G-WOFE"), a
PRC registered wholly owned foreign enterprise (WOFE), through the purchase of a
51% interest of Guangzhou 3G's parent company, Pacific 3G Information &
Technology Co. Limited, a British Virgin Islands Company ("Guangzhou3G-BVI")
from three shareholders, ASIAFAME INTERNATIONAL LIMITED, STARGAIN INTERNATIONAL
LIMITED, and TRILOGIC INVESTMENTS LIMITED. All of above three shareholders are
incorporated in BVI. Guangzhou3G-WOFE conducts it VAS operations with Guangzhou
Sunroom Information Industrial Co., Ltd.("Sunroom-DE"), a PRC registered
Domestic Enterprise (DE), through a series of contractual agreements.
BUSINESS OPERATIONS OF CLICKCOM-WOFE AND GUANGZHOU3G-WOFE
Clickcom-WOFE and Guangzhou3G-WOFE's operations are conducted through a
series of contractual arrangements with their affiliated PRC incorporated
Domestic Enterprise (DE) value added service (VAS) providers Dianxun-DE and
Sunroom-DE, respectively, and their respective shareholders. We do not have any
ownership interests in Dianxun-DE or Sunroom-DE.
WIRELESS DATA SERVICES
Dianxun-DE and Sunroom-DE have established cooperation arrangements
with mobile telecommunications operators, mobile phone producers and other
wireless data service providers in the wireless value-added services
business. They provide wireless data services through China Mobile's Monternet
and China Unicom's UNI-Info platforms pursuant to revenue sharing agreements
that they have entered into with these mobile telecommunications operators.
These services include color ring back tone (CRBT) services, background music
(BGM) services, VICQ mobile instant messaging services, sports and soccer news,
weather forecasts, stock prices, jokes, short stories, dramas, songs and mobile
karaoke, mobile TV, games, entertainment.
China Mobile and China Unicom control the two mobile telecommunications
networks through which all wireless data services are currently provided to
mobile phone users in China. Close working relationships with China Mobile and
China Unicom are critical to the operation and continued development of wireless
data services business. See "Risk Factors -- Risks Relating to Our Business -- A
substantial portion of Dianxun-DE and Sunroom-DE's business depends on mobile
telecommunications operators in China, and any loss or deterioration of such
relationship may result in severe disruptions to there business operations and
the loss of a significant portion of our revenues." As of the end of 2004,
Dianxun-DE and Sunroom-DE had entered into approximately 25 cooperation and
revenue sharing agreements with various provincial subsidiaries of China Mobile,
as well as China Unicom, to provide wireless data services to mobile phone
users, to research and develop new wireless data technologies and to promote the
use of wireless data services in China.
4
WIRELESS INTERACTIVE VOICE RESPONSE (IVR) SERVICES
In May 2003, China Mobile launched its wireless IVR services
nationwide. Mobile phone users access Sunroom-DE's wireless IVR services through
China Mobile's network. Sunroom-DE's wireless IVR services include weather
forecasts, stock prices, jokes, short stories, dramas, songs and other
entertainment topics, as well as community-oriented services, such as chat and
dating services.
We believe that demand for wireless IVR services in China, like demand
for other wireless value-added services, has been driven by the rapid increase
in mobile phone ownership, the rise in average income and the emergence of a
youth culture that rapidly adopts new modes of affordable entertainment.
VALUE-ADDED SERVICES - FEES AND REVENUE SHARING
Dianxun-DE and Sunroom-DE established the fees for data services in
consultation with telecommunications operators in China. They share the revenue
from these fees with the telecommunications operators, content providers and
mobile phone producers. They also pay a transmission fee to the appropriate
telecommunications operator with respect to messages that they send through its
value-added services platform.
The mobile telecommunications operators establish standards within
which wireless data services providers are able to set the fees for their
services. These standards are filed with the MII by the mobile
telecommunications operators. In accordance with these standards, they charge
the users content fees on either a per message or a monthly subscription basis.
Both per message and monthly subscription content fees vary for the different
wireless data products and services.
REVENUES FROM WIRELESS DATA AND IVR SERVICES
We generate revenues from fees received pursuant to technical and
consulting services agreements entered into between Dianxun-DE and Sunroom-DE
and our PRC WOFE subsidiaries Clickcom-WOFE and Guangzhou3G-WOFE. Under the
agreements, PacificNet's WOFE subsidiaries Clickcom-WOFE and Guangzhou3G-WOFE
are entitled to receive service fees equal to substantially all of the net
income of Dianxun-DE and Sunroom-DE. Payment of the service fees has been
secured through a share pledge agreement with the shareholders of Dianxun-DE and
Sunroom-DE, whereby they pledged all of their shares to Clickcom-WOFE and
Guangzhou3G-WOFE.
In addition, each of the shareholders has granted to PacificNet's
President a power of attorney, which gives him the full power and authority to
exercise all of the shareholder's rights of the shareholders of Dianxun-DE and
Sunroom-DE.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
PRC laws and regulations restrict foreign ownership of companies that
provide value-added telecommunications services and Internet content services in
China. As a result, we conduct substantially all of our operations through
Clickcom-WOFE and Guangzhou3G-WOFE by allowing them to enter into a series of
contractual arrangements with Dianxun-DE and Sunroom-DE and their respective
shareholders, pursuant to which we guarantee any obligations undertaken by these
companies under their contractual arrangements with third parties, and we are
entitled to receive service fees in an amount equal to 51% of the net income of
these companies. Accordingly, we bear the risks of, and enjoy the rewards
associated with, the investments in Clickcom-WOFE and Guangzhou3G-WOFE. As a
result, we have determined that under US GAAP we are the primary beneficiary of
Clickcom-WOFE and Guangzhou3G-WOFE and we consolidate the financial statements
of these companies when preparing our consolidated financial statements.
In the opinion of our internal PRC legal counsel, the ownership
structures of, and contractual agreements among, certain of our wholly-owned
subsidiaries and Dianxun-DE, and Sunroom-DE and their shareholders, and the
businesses and operations of our wholly-owned subsidiaries and Dianxun-DE, and
Sunroom-DE described in this Annual Report, are in compliance with all existing
PRC laws, rules and regulations and are fully enforceable in accordance with
their terms and conditions. In addition, our internal PRC legal counsel is of
the opinion that no consent, approval or license, other than those already
obtained, is required under any of the existing PRC laws, rules and regulations
for the effectiveness and enforceability of the ownership structures,
contractual agreements and businesses and operations of our subsidiaries and
those companies. However, there are substantial uncertainties regarding the
interpretation and implementation of current PRC laws and regulations. See "Risk
Factors -- Risks Relating to Our Business".
5
PRODUCTS AND SERVICES OFFERED
Our goal is to take a leading role in providing information technology
services and network communications, which are 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
Business Process Outsourcing (BPO). Our call center offers 24 hour
staff-answering and automatic-answering service hotlines in our service areas,
handling customer enquiries regarding services, billing, and technical support,
as well as customer complaints. We offer services targeted at high-value and
corporate customers, including dedicated account executives, on-site visits, and
systems for collecting comments and handling complaints.
o We acquired Epro in December 2003. Epro is a leading provider of
outsourced call-center services with over 13 years of field
experience in greater China. Epro's business consists of the
following three major categories:
(1) OUTSOURCED CALL CENTER SERVICES. Epro's ISO 9001 certified
outsourcing contact center hosts over 1,000 workstations and 500
agents, processing over 100,000 calls daily and provides
multi-lingual inbound and outbound CRM services. The call center
is the largest outsourced call center in Hong Kong. Epro permits
its clients to recruit and hire their own personnel to work in
its call center, for whom Epro provides managerial services, call
center seats, and equipment. Our inbound call center services
include sales inquiry hotline, telephone orders, technical
helpdesk, and customer service. Certain of our clients also
engage us to provide telemarketing and telesales for their
products and for promotions, to conduct market surveys, and to
provide administrative process, such as appointment setting.
(2) TRAINING AND CONSULTING SERVICES. The Epro Call Center Training
Institute (ECCTI) is a leading provider of Contact Center
Management Consulting and Training services, which helps clients
to maximize the return on investment of their CRM operations.
Through ECCTI, we provide on-site training and consulting
services, and we offer courses and seminars for call center
managers and professionals, sales representatives, customer
service representatives and telemarketing service representatives
and in-house trainers.
(3) CALL CENTER MANAGEMENT SOFTWARE PRODUCTS AND SOLUTIONS. WISE-xb
Call Center agent performance management and reporting software
is Epro's proprietary call center management software. Wise-xb
has been installed in over 60 customer sites in the PRC. Epro's
products also include Automatic Call Distribution (ACD) System,
Unified Messaging System (UMS), SMS, and VAS.
INFORMATION TECHNOLOGY OUTSOURCING (ITO). In September 2004, we
acquired Smartime Holdings Limited (Smartime). Through Soluteck Technology
(Shenzhen) Company Limited, its operating subsidiary in Shenzhen, China,
Smartime employs about 285 staff and provides outsourced consulting services and
programming services, including software development, R&D, and project
management to leading telecom, banking and financial services companies
including Huawei, IBM, Bank of East Asia and others.
2. VALUE-ADDED TELECOM SERVICES (VAS)
o In December 2003, we acquired 51% of the shares of a private
mainland China company, Beijing Linkhead Technologies Co., Limited
(Linkhead). Linkhead is a value-added reseller and provider of
VAS, such as IVR system development and integration, SMS, and
voice-portal services. Linkhead is also a channel partner, or a
master reseller, of NMS Communications system hardware, a leading
provider of communications technologies. Linkhead also acts as a
mobile phone systems integrator for service providers in China,
providing the hardware, know-how, and software for mobile phone
VAS, such as mobile chat, mobile karaoke, and color ring back
tone. The service providers ultimately provide the Linkhead
systems to telecom operators, such as China Unicom and China
Netcom.
6
o In December 2004, we entered into an agreement to acquire a
controlling interest in Guangzhou Dianxun Digital Network
Technology Co., Ltd.(Clickcom-WOFE)through the Purchase of a 51%
interest of Clickcom-WOFE's parent company, . PacificNet Clickcom
Limited. The acquisition was completed on March 28, 2005 upon
receipt of the required business license and approval from the
local government. Through Clickcom-WOFE and its affiliated company
Dianxun-DE we can offer, directly to China's telecom operators, a
wide variety of wireless internet services for mobile phones, such
as SMS, Wireless Application Protocol, or WAP, which allows users
to access information instantly via handheld wireless devices, and
Java mobile applications. The acquisition of Clickcom-WOFE is our
first step in entering the VAS service provider market in which we
will be able to design our own mobile phone VAS for distribution
directly to telecom operators.
o PacificNet Solutions Ltd. (PacSo), is a subsidiary that
specializes in systems integration, software application, and
on-line business solution services in greater China. PacSo's
products and services include smart card solutions, web-based user
applications, including kiosks and IVR, and web based connections
to remote or fixed database servers, which are also referred to as
back-end enterprise planning systems.
3. COMMUNICATION PRODUCTS DISTRIBUTION
o In April 2004, we acquired a 51% controlling interest in Guangzhou
Yueshen TaiYang Technology Limited (Yueshen). Yueshen distributes
telecom services for mobile phones, such as calling cards, mobile
SIM cards, prepaid stored-value cards, wireless broadband and
internet services for mobile phones. There are approximately 268.7
million people with mobile phones in China. Because so few people
subscribe to service plans, the mobile calling card business has
become very popular. We sell calling cards wholesale to
distributors who in turn sell to retail shops, such as newsstands.
We have entered the retail calling card market and have
established nine retail stores in the Guangzhou Metro. Yueshen is
the designated distributor of China Netcom's XiaoLingTone/PHS
mobile phone products, prepaid calling cards, wireless broadband
and internet services.
o Also in April 2004, we acquired a 30% interest in Cheer Era
Limited (Cheer Era) with an option to acquire an additional 21%
after one year. Cheer Era is engaged in the business of designing,
developing, and manufacturing interactive multimedia entertainment
and communication kiosk products, including photo and video
entertainment kiosks, digital camera photo development stations,
internet, MMS, ring-tone and mobile content download, payment and
delivery stations for mobile phones, and other coin-operated
kiosks and kiosk consumables. These kiosks have been marketed and
sold to restaurants, gaming facilities and amusement parks in the
USA, Korea, China, India, and Southeast Asia. We sell the kiosks
to channel operators who pay a placement fee or rental fee for the
kiosks.
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.
1. 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:
* Hutchison Telecom
Hutchison Telecom, a subsidiary of Hutchison Whampoa Ltd (HWL,
www.hutchison-whampoa.com) (HKSE:0013.HK), is one of the world's leading owners
and operators of telecommunications, offering a wide range of communication
services in Hong Kong and around the globe including mobile telephony (voice and
multimedia), paging, trunked radio, fixed-line services, Internet services,
fibre optic broadband networks and radio broadcasting.
7
* PCCW
PCCW Limited is a leading telecommunications carrier and service provider in
Hong Kong.
* SUNDAY Communications Limited
SUNDAY Communications Limited is one of the six mobile operators in Hong Kong,
and was granted a mobile carrier license in Hong Kong to construct and operate a
3G network. In addition, SUNDAY offers its mobile subscribers basic airtime
services, value-added services, enhanced services, short messaging services,
wireless data services, roaming services and international long distance calling
services, and sells accessories.
* Bank of China Group Insurance Company (BOCGI)
Bank of China Group Insurance Company Ltd. (http://www.bocgroup.com/bocg-ins/)
was incorporated in Hong Kong in 1992 and has developed its business mainly on
general insurance. BOCGI was awarded 5 years consecutive number 1 rankings in
general insurance in Hong Kong. BOCGI owns 6 branches and one wholly-owned
subsidiary life insurance company (Bank of China Group Life Assurance Company
Ltd.) in Hong Kong and Mainland China.
* American Express Bank (Hong Kong)
American Express Bank (Hong Kong) is a diversified worldwide travel, financial
and network services company founded in 1850. It is a world leader in charge and
credit cards, Travelers Cheques, financial planning, business services,
insurance and international banking.
* ACNielsen (China) Ltd.
ACNielsen is the world's leading provider of market research, information and
analysis to the consumer products and services industries, as well as to
government and social services. More than 9,000 clients in over 100 countries
rely on ACNielsen's dedicated professionals to measure competitive marketplace
dynamics, to understand consumer attitudes and behaviour, and to develop
advanced analytical insights that generate increased sales and profits.
ACNielsen provides four principal market research services: Retail measurement,
Consumer panel research, Customized research and Media measurement. In addition,
ACNielsen markets a broad range of advanced software and modeling and
analytical services. These products help clients integrate large volumes of
information, evaluate it, make judgment about their growth opportunities and
plan future marketing and sales campaigns.
* SWIRE TRAVEL
Swire Travel is a travel management company with over half a century of
experience servicing Hong Kong's most elite companies. Swire Travel's main
expertise is the management of corporate travel in which a wide range of
services is available to meet the needs of its business clients.
* SONY (SO-NET)
So-net, Hong Kong, a wholly-owned subsidiary of Sony Corporation of Hong Kong
Limited. So-net was granted a sub-license from Sony Communication Network
Corporation (SCN) to create a broadband service under the So-net brand. Since
its establishment in 1996, So-net has become the third largest Internet Service
Provider in Japan with a subscriber base of 1.7 million. Sony is a leading
manufacturer of audio, video, game, communications and information technology
products for the consumer and professional markets. Sony is one of the leading
multi-national corporations in Asia, with 38 companies spanning 15 countries and
supported by a family of over 40,000 employees. So-net HK, a wholly owned
subsidiary of Sony Corporation of Hong Kong Limited, was launched in July, 2001
as Sony's first internet venture outside of Japan. Sony's web sites:
www.so-net.com.hk and www.sony.com.hk.
8
* Samsung Electronics
Samsung Electronics has currently positioned into four main business units, Home
Network, Office Network, Mobile Network, and core component Businesses,
producing the world's most innovative 21st century digital components that
everyone will recognize as the best in the world. Samsung Electronics considers
the whole world as a customer base. With 25 worldwide production bases and 59
sales subsidiaries in 46 countries, the company can be contacted globally.
Samsung Electronics is definitely not satisfied with simply producing and
selling products. They are doing our best as an international corporate citizen
by transferring technology and know-how to seven operations overseas, providing
stable employment and increasing the number of parts produced locally.
* TCL
TCL Corporation (www.TCL.com) is the leading consumer electronics brand in China
that runs its business from multimedia to mobile phones, from personal computers
to home appliances, from electric lighting to digital products. TCL is one of
China's fastest growing companies with international presence. TCL has several
companies listed in Shenzhen and Hong Kong Stock Exchange: TCL Corporation
(Shenzhen:000100.SZ) , TCL International (HKSE:1070.HK), and TCL Communication
(HKSE:2618.HK ).
* Hong Kong Government - Hong Kong Housing Authority
The Hong Kong Housing Authority (HA) was established as a statutory body in
April 1973 under Hong Kong's Housing Ordinance. Within the Government's overall
housing policy framework, the HA determines and implements public housing
programs. Apart from planning and building public housing, it manages public
rental housing estates, interim housing estates, transit centers, flatted
factories and ancillary commercial and non-domestic facilities such as shopping
centers, market stalls and car parks. In addition, it acts as the Government's
agent for clearing land, preventing squatting and implementing improvements in
squatter areas.
2. VALUE ADDED TELECOM SERVICES (VAS) CUSTOMERS
* China Telecom
China Telecom is the largest fixed service telecommunications provider in China,
which includes data, Internet, and the XiaoLingTong PAS wireless system.
XiaoLingTong (also known as "Little Smart", PAS "Personal Access System", or PHS
"Personal Handyphone System"), operated by China Telecom, is built into existing
fixed-line networks and lures users with low per minute rates, one-way charges
and cheap monthly fees. It acts like a mobile phone but only good within the
local metropolitan area.
* China Netcom
China Netcom (NYSE:CN) (www.chinanetcom.com.cn), is one of the four major
telecom carriers in China, which includes fixed line, data, Internet, and the
XiaoLingTong wireless system.
* China Mobile
China Mobile (NYSE:CHL) is the largest mobile operator in China.
* China Unicom
China Unicom (www.ChinaUnicom.com.cn) is one of the major mobile operators in
China operating both GSM and CDMA mobile networks, long-distance call, local
call, data communication including Internet service and IP phone, value-added
telecom service, wireless paging and a variety of relevant services.
3. COMMUNICATION PRODUCTS DISTRIBUTION CUSTOMERS
* China Telecom, China Netcom, China Mobile and China Unicom are our primary
customers.
9
SALES AND MARKETING
We do not engage in any significant marketing activities. We advertise
our services by attending various 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.
COMPETITION
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.
EMPLOYEES
As of December 31, 2004, together with our subsidiaries, we had
approximately 1,000 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
------------------------------------------------------------------- ------------
PacificNet Inc. 5
PacificNet Limited 20
PacificNet Solutions Ltd. 2
Epro Telecom Holdings Limited 600
Beijing Linkhead Technologies Company Limited 32
Guangzhou Yueshen TaiYang Technology Limited 33
Smartime / Soluteck Technology (Shenzhen) Company Limited 285
Cheer Era Limited 10
------------
TOTAL 987
============
RESEARCH AND DEVELOPMENT
We place great emphasis on the continued enhancement of our existing
products and solutions, including designing, developing and supporting a
portfolio of converged voice and data enhanced services, products and solutions
to help wireless, wire-line and Internet service providers offer unprecedented
access to communications, information and commerce. We have ongoing research and
development activities with respect to the following products and solutions:
o multi-media information on demand systems, which integrates the
dynamics of the Internet with voice based communication
applications, including text-to-speech and voice recognition
capabilities;
o web-based multimedia call center/ customer relationship management
for service providers and corporations; and
o WISE-xb, which is a Call Center agent performance management and
reporting software. It provides intelligent routing, comprehensive
ACD/ PBX capabilities, Email, IVR, Voice Mail, Messaging,
Conference, Recording, Coaching/ Supervising, Reporting and
Interface.
o voice mail systems; and
o color ringback tone systems; and
o value-added services for mobile users;
10
EXECUTIVE OFFICES
Our executive offices are located in Hong Kong and Minneapolis, USA at
the following addresses:
o PacificNet Limited, 601 New Bright Building, 11 Sheung Yuet Road,
Kowloon Bay, Kowloon, Hong Kong. Tel: 011-852-2876-2900, Fax:
011-852-27930689, E-mail: HKOffice@PAcificNet.com
O PacificNet Inc., 860 Blue Gentian Road, Suite 360, Eagan, MN
55121-1575 USA Tel: 1-651-209-3100, Fax: 1-651-209-3103,
E-mail: IR@PAcificNet.com
We maintain a website at www.PacificNet.com
RISK FACTORS
Investing in our securities involves a great deal of risk. You should
carefully consider the following factors as well as other information included
in this prospectus 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
WE HAVE A LIMITED OPERATING HISTORY. We were founded and commenced operations in
December 1994, and we were incorporated in July 1999. Our operating history may
be insufficient for you to evaluate our business and future prospects. Although,
since inception, our revenues have grown rapidly through acquisition, we cannot
assure you that we will maintain our profitability or that we will not incur net
losses in the future. We expect that our operating expenses will increase as we
expand. Any significant failure to realize anticipated revenue growth could
result in significant operating losses. We will continue to encounter risks and
difficulties frequently experienced by companies at a similar stage of
development, including our potential failure to:
o implement our business model and strategy and adapt and modify
them as needed;
o increase awareness of our brands, protect our reputation and
develop customer loyalty;
o manage our expanding operations and service offerings, including
the integration of any future acquisitions;
o maintain adequate control of our expenses; and
o anticipate and adapt to changing conditions in the markets in
which we operate as well as the impact of any changes in
government regulation, mergers and acquisitions involving our
competitors, technological developments and other significant
competitive and market dynamics.
If we are not successful in addressing any or all of these risks, our business
may be materially and adversely affected.
11
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. We may be
unable to successfully identify or acquire such companies on favorable terms.
Furthermore, any acquisitions we pursue may be subject to approval by the
relevant Chinese government authorities, which approval we may not obtain. Even
if we are able to identify an acquisition or joint venture candidate, the
resources expended may be significant. Any future acquisitions will be subject
to a number of challenges, including:
o the diversion of management time and resources and the potential
disruption of our ongoing business;
o difficulties in maintaining uniform standards, controls,
procedures and policies; and
o potential unknown liabilities associated with acquired businesses.
During the fiscal year ended December 31, 2004, we acquired a
controlling interest in Smartime Holdings Limited (Smartime), and GuangZhou
Dianxun Digital Network Technology Co., Ltd.(Clickcom-WOFE), and entered an
agreement to acquire a controlling interest in Guangzhou 3G Information
Technology Co. Ltd. ( "Guangzhou3G-WOFE"). We expect that acquisitions will
strengthen our position as a provider of outsourced call center, VAS and
communication products in Asia. However, we may not achieve the anticipated
benefits of these acquisitions.
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 revenues
generated and the financial condition of our business operations.
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
AND SEEK EMPLOYMENT WITH COMPETITORS. 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 have been in place for
several years and have 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 hire, motivate and retain 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, which would adversely affect our ability to
provide services, and might cause long-term clients to terminate their
relationship with us, which could have an adverse effect on our business
operations and revenues. Furthermore, non-competition and confidentiality
agreements are hard to enforce in China. Due to the limited enforceability of
these types of agreements, we face the risk that employees of the acquired
subsidiaries might divulge our software and other protected intellectual
property secrets to competitors.
12
OUR CUSTOMERS ARE CONCENTRATED IN A LIMITED NUMBER OF INDUSTRIES. Our clients
are concentrated primarily in the telecommunications, telemarketing and
technology industries, and to a lesser extent, the insurance and financial
services industries, where the current trend is to outsource certain CRM and
VAS. Our ability to generate revenue depends on the demand for our services in
these industries. An economic downturn, or a slowdown or reversal of the
tendency in any of these industries to rely on outsourcing could have a material
adverse effect on our business, results of operations or financial condition.
THE MARKET IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND FRAGMENTED AND WE MAY
NOT BE ABLE TO MAINTAIN MARKET SHARE. We expect competition to persist and
intensify in the future. Our competitors are mainly leaders in the CRM services
market, such as PCCW Teleservices (Hong Kong) Limited, China Motion Telecom
International Limited, and Teletech (Hong Kong) Limited. Our competitors also
include small firms offering specific applications, divisions of large entities
and other large independent firms. We face the risk that new competitors with
greater resources than ours will enter our market. Furthermore, increasing
competition among telecom companies in greater China has led to a reduction in
telecommunication services fees that can be charged by such companies. If a
reduction in telecommunication services fees negatively impacts revenues
generated by our clients, they may require us to reduce the price of our
services, or seek competitors of ours that charge less. If we must significantly
reduce the price of our services, the decrease in revenues could adversely
affect our profitability.
KEY EMPLOYEES ARE ESSENTIAL TO GROWING OUR BUSINESS. Tony Tong, our Chairman and
Chief Executive Officer, and Victor Tong, our President, are essential to our
ability to continue to grow through acquisitions. Messrs. Tong and Tong have
established relationships within our industry. Their business contacts have been
critical in identifying, and negotiating with, acquisition candidates. If either
of them were to leave our employ, our growth strategy might be hindered, which
could limit our ability to increase revenues.
THE ESTABLISHMENT AND EXPANSION OF INTERNATIONAL OPERATIONS REQUIRES SIGNIFICANT
MANAGEMENT ATTENTION. All of our current, as well as any anticipated future
revenues, are or are expected to be derived from Asia. Our international
operations are subject to risks, including the following, which, if not planned
and managed properly, could materially adversely affect our business, financial
condition and operating results:
o legal uncertainties or unanticipated changes regarding regulatory
requirements, liability, export and import restrictions, tariffs
and other trade barriers;
o longer customer payment cycles and greater difficulties in
collecting accounts receivable;
o uncertainties of laws and enforcement relating to the protection
of intellectual property; and
o potentially uncertain or adverse tax consequences.
OUR OPERATIONS COULD BE CURTAILED IF WE ARE UNABLE TO OBTAIN REQUIRED ADDITIONAL
FINANCING. Since inception our investments and operations primarily have been
financed through sales of our common stock. During the fiscal year ended
December 31, 2004, we completed two private placements of our common stock in
which we received approximately $9,300,000 of gross proceeds. In the future we
may need to raise additional funds through public or private financing, which
may include the sale of equity securities, including securities convertible into
our common stock. The issuance of these equity securities could result in
dilution to our stockholders. If we are unable to raise capital when needed, our
business growth strategy may slow, which could severely limit our ability to
increase revenue.
13
EFFORTS TO COMPLY WITH RECENTLY ENACTED CHANGES IN SECURITIES LAWS AND
REGULATIONS WILL INCREASE OUR COSTS AND REQUIRE ADDITIONAL MANAGEMENT RESOURCES
AND WE STILL MAY FAIL TO COMPLY. As directed by Section 404 of the
Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to
include a report of management on the company's internal controls over financial
reporting in their annual reports on Form 10-KSB. In addition, the public
accounting firm auditing the 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-KSB for our fiscal year ending December 31, 2006. If we
are unable to conclude that we have effective internal controls over financial
reporting or, if our independent auditors are unable to provide us with an
unqualified report as to the effectiveness of our internal controls over
financial reporting as of December 31, 2006 and future year ends as required by
Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose confidence
in the reliability of our financial statements, which could result in a decrease
in the value of our securities. We have only recently begun a formal process 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.
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, among other
things, 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, revenues and financial condition. For example, to the extent that we need
to convert U.S. dollars into Hong Kong dollars or Chinese Renminbi for our
operations, appreciation of either currency against the U.S. dollar could have a
material adverse effect on our business, financial condition and results of
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.
OUR STRATEGY OF ACQUIRING COMPLEMENTARY ASSETS, TECHNOLOGIES AND BUSINESSES MAY
FAIL AND MAY RESULT IN EQUITY OR EARNINGS DILUTION. As a component of our growth
strategy, we have acquired and in the future intend to actively identify and
acquire assets, technologies and businesses that are complementary to our
existing portal business. 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. Moreover, the resources expended in identifying and
consummating acquisitions may be significant. Furthermore, any acquisitions we
decide to pursue may be subject to the approval of the relevant PRC governmental
authorities, as well as any applicable PRC rules and regulations.
There are risks involved in these activities, including but not limited to:
o the possibility that PacificNet pays more than the value it
derives from the acquisition;
o the difficulty of integrating the products, operations and
personnel of the acquired businesses;
o the possibility that all aspects of the integration are not
completed or that all of the anticipated synergies of the
acquisition are not realized;
o difficulties in managing software development activities to define
a combined product roadmap, ensuring timely development of new
products, timely release of new products to market, and the
development of efficient integration and migration processes and
tools;
14
o the difficulty of retaining key alliances on attractive terms with
partners and suppliers;
o the difficulty of retaining and recruiting key personnel and
maintaining employee morale;
o the potential product liability associated with selling the
acquired company's products;
o the potential disruption of PacificNet's ongoing business and the
distraction of management from PacificNet's business; and
o the potential write-down of impaired goodwill and intangible and
other assets. PacificNet recorded approximately $8.88 million of
goodwill as a result of several acquisitions that will not be
amortized in the ordinary course of business. To the extent that
the business acquired in these transactions do not remain
competitive, some or all of the goodwill related to that
acquisition could be charged against future earnings.
These factors could have a material adverse effect on PacificNet's business,
results of operations or financial position, especially in the case of a large
acquisition.
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.
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 CHINESE 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 Chinese 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.
15
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 can not 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.
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 AND THE LOSS OF A
SIGNIFICANT PORTION OF OUR REVENUES.
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, such as the following:
o China Mobile and China Unicom currently 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;
o Our agreements with the mobile telecommunications operators are
subject to negotiation upon renewal. 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; and
o The mobile telecommunications operators may launch and may have
already launched competing services or could discontinue the use
of external content aggregators such as ourselves entirely at any
time.
Due to our reliance on the mobile telecommunications operators for our wireless
value-added services, any loss or deterioration of our relationship with any of
the mobile telecommunications operators may result in severe disruptions to our
business operations and the loss of a significant portion of our revenue.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE MATERIALLY AFFECTED BY
THE CHANGES IN POLICIES OR GUIDELINES OF THE MOBILE TELECOMMUNICATIONS
OPERATORS.
The mobile telecommunications operators in China may, from time to time, issue
certain operating policies or guidelines, requesting or stating its preference
for certain actions to be taken by all wireless value-added service providers
using their platforms. Due to our reliance on the mobile telecommunications
operators, a significant change in their policies or guidelines may have a
material adverse effect on us. For example, some mobile telecommunications
operators recently revised their billing policies to request all wireless
value-added service providers to confirm the subscription status of those users
who have not been active for three months. Such change in policies or guidelines
may result in lower revenues or additional operating costs for us, and we cannot
assure you that our financial condition and results of operation will not be
materially adversely affected by any policy or guideline change by the mobile
telecommunications operators in the future.
16
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 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 you that the mobile telecommunications operators
will not from time to time find certain portions of our content to be
objectionable. In the case of a breach or perceived breach of such policies or
guidelines, the mobile telecommunications operators may require us to reduce or
curtail the content on our Internet portal, which may reduce our portal traffic,
and the mobile telecommunications operators may have the right to impose
monetary fines upon us, or terminate our cooperation with them. In addition, we
would be liable to the mobile telecommunications operators for their economic
losses pursuant to our agreements with these operators if we were found to be in
breach of the policies or guidelines promulgated by them. As a result of the
occurrence of any of the above, our financial condition and results of
operations may be materially adversely affected.
OUR DEPENDENCE ON THE SUBSTANCE AND TIMING OF THE BILLING SYSTEMS OF THE MOBILE
TELECOMMUNICATIONS OPERATORS MAY REQUIRE US TO ESTIMATE PORTIONS OF OUR REPORTED
REVENUE FOR WIRELESS VALUE-ADDED SERVICES FROM TIME TO TIME. AS A RESULT,
SUBSEQUENT ADJUSTMENTS MAY HAVE TO BE MADE TO OUR WIRELESS VALUE-ADDED SERVICES
REVENUE IN OUR FINANCIAL STATEMENTS.
As we do not bill our wireless value-added services users directly, we depend on
the billing systems and records of the mobile telecommunications operators to
record the volume of our wireless value-added services provided, charge our
users through mobile telephone bills and collect payments from our users and pay
us. In addition, we do not generally have the ability to independently verify or
challenge the accuracy of the billing systems of the mobile telecommunications
operators. Generally, within 20 to 60 days after the end of each month, a
statement from each of the mobile telecommunications operators confirming the
value of wireless value-added services they bill to users in that month will be
delivered to us, and generally within 60 days after such delivery, we will be
paid by the mobile telecommunications operators for the wireless value-added
services, net of their revenue share, transmission fees and applicable business
taxes, for that month based on such statements.
PRC LAWS AND REGULATIONS RESTRICT FOREIGN INVESTMENT IN CHINA'S
TELECOMMUNICATIONS SERVICES INDUSTRY, AND SUBSTANTIAL UNCERTAINTIES EXIST WITH
RESPECT TO OUR CONTRACTUAL ARRANGEMENTS WITH DIANXUN-DE, AND SUNROOM-DE DUE TO
UNCERTAINTIES REGARDING THE INTERPRETATION AND APPLICATION OF CURRENT OR FUTURE
PRC LAWS AND REGULATIONS.
In December 2001, in order to comply with China's commitments with respect to
its entry into the World Trade Organization, or WTO, the State Council
promulgated the Administrative Rules for Foreign Investments in
Telecommunications Enterprises, or the Telecom FIE Rules. The Telecom FIE Rules
set forth detailed requirements with respect to capitalization, investor
qualifications and application procedures in connection with the establishment
of a foreign invested telecommunications enterprise. Pursuant to the Telecom FIE
Rules, the ultimate ownership interest of a foreign investor in a foreign-funded
telecommunications enterprise that provides value-added telecommunications
services shall not exceed 50%.
We and our subsidiaries are considered as foreign persons or foreign funded
enterprises under PRC laws. PRC laws and regulations restrict foreign ownership
of companies that provide value-added telecommunications services and Internet
content services in China. As a result, we operate our IVR, call center and
telecom value-added services etc. in China through Dianxun-DE and Sunroom-DE,
which are owned by certain PRC citizens. We do not have any equity interest in
these operating companies and instead enjoy the economic benefit in such
companies through contractual arrangements. Dianxun-DE and Sunroom-DE conduct
substantially all of our operations and generate substantially all of our
revenue and hold the licenses and approvals that are essential to our business.
For a description of our contractual arrangements with Dianxun-DE and
Sunroom-DE, see "Corporate Structure".
17
In the opinion of our internal PRC legal counsel, our current ownership
structure and the ownership structures of Dianxun-DE and Sunroom-DE, the
contractual arrangements among our wholly-owned subsidiaries and Dianxun-DE and
Sunroom-DE and their shareholders, and their business operations as described in
this prospectus are in compliance with all existing PRC laws, rules and
regulations. There are, however, substantial uncertainties regarding the
interpretation and application of current or future PRC laws and regulations,
including but not limited to the laws and regulations governing the enforcement
and performance of our contractual arrangements in the event of imposition of
statutory liens, death, bankruptcy and criminal proceedings. Accordingly, we
cannot assure you that PRC regulatory authorities will not take a view contrary
to the opinion of our internal PRC legal counsel.
If we, Dianxun-DE, or Sunroom-DE, were found to be in violation of any existing
or future PRC laws or regulations, the relevant regulatory authorities would
have broad discretion in dealing with such violation, including, without
limitation, the following:
o levying fines;
o confiscating our, Dianxun-DE or Sunroom-DE's income;
o revoking our, Dianxun-DE or Sunroom-DE's business license;
o shutting down our, Dianxun-DE or Sunroom-DE's servers or blocking
our websites;
o requiring us, Dianxun-DE or Sunroom-DE's to restructure our
ownership structure or operations; and/or
o requiring us, Dianxun-DE or Sunroom-DE's to discontinue our
wireless value-added services and online advertising businesses.
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 ARRANGEMENTS WITH DIANXUN-DE OR SUNROOM-DE MAY NOT BE AS
EFFECTIVE IN PROVIDING OPERATIONAL CONTROL AS DIRECT OWNERSHIP OF THESE
BUSINESSES.
PRC laws and regulations currently restrict foreign ownership of companies that
provide value-added telecommunications services, which includes wireless
value-added services and Internet content services. As a result, we conduct
substantially all of our operations and generate substantially all of our
revenue through Dianxun-DE and Sunroom-DE, each of which is wholly-owned by PRC
citizens, pursuant to a series of contractual arrangements with these entities
and their respective shareholders. For a description of these contractual
arrangements, see "Corporate Structure."
These arrangements, however, may not be as effective in providing control over
our Internet content operations as direct ownership of these businesses as these
arrangements will not preserve our control in the occurrence of certain events
which may be outside the control of the shareholders and us, including the
imposition of statutory liens, judgments, court orders, death or capacity. In
particular, Dianxun-DE and Sunroom-DE could fail to perform or make payments as
required under those contractual agreements, and we will have to rely on the PRC
legal system to enforce those agreements.
The PRC legal system is a civil law system based on written statutes. Unlike
common law systems, it is a system in which decided legal cases have little
precedential value. Although legislation in China over the past 20 years has
significantly improved the protection afforded to various forms of foreign
investment and contractual arrangements in China, these laws, regulations and
legal requirements are relatively new and their interpretation and enforcement
involve uncertainties, which could limit the legal protection available to us.
In addition, the PRC government may propose new laws or amend current laws that
may be detrimental to our current contractual arrangements with Dianxun-DE or
Sunroom-DE, which may in turn have a material adverse effect on our business
operations. Furthermore, as these entities, their shareholders and the assets of
these entities and their shareholders are located in China, it may not be
possible to effect services of processes within the United States or elsewhere
outside of China upon these entities or assets or enforce judgments of courts in
jurisdictions outside of China against these entities or assets. See also
"--Risks Associated with Doing Business in the People's Republic of China - We
may have limited legal recourse under Chinese law if disputes arise under our
contracts with third parties."
18
RISKS RELATED TO OUR TECHNOLOGY AND EQUIPMENT
OUR INSURANCE MAY NOT BE SUFFICIENT TO RESTORE OUR CALL CENTER IF OPERATIONS ARE
INTERRUPTED BY NATURAL DISASTER OR OTHER DESTRUCTION OF OUR FACILITIES OR
EQUIPMENT.
Our operations depend on our ability to protect our call centers, data centers,
CRM information, customer database, data warehouse, computer and
telecommunications equipment and software systems against damage from fire,
power loss, telecommunications interruption or failure, hacker attacks, natural
disaster, epidemic, terrorism, act of war and other similar events. In the event
we experience a temporary or permanent interruption at one or more of our call
centers, through casualty, operating malfunction or otherwise, our business
could be materially adversely affected and we may be required to pay contractual
damages to some clients or allow some clients to terminate or renegotiate their
contracts with us. While we maintain certain property and business interruption
insurance, such insurance may not adequately compensate us for all losses that
we may incur and may not be adequate to cover the costs of rebuilding these
centers. If we are unable to restore our operations, our business activities
would cease.
WE MUST RESPOND QUICKLY AND EFFECTIVELY TO NEW TECHNOLOGICAL DEVELOPMENTS.
Our VAS business is 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 effect 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.
ITEM 2. DESCRIPTION OF PROPERTY
A description of our property is as follows:
HONG KONG - We maintain our corporate headquarters, development center and our
Call Center in Hong Kong located at Units 601-603 New Bright Building, 11 Sheung
Yuet Road, Kowloon Bay, Kowloon where we lease approximately 17,739 square feet
for a monthly fee of $16,365 and our branch office is located at Units 2-3, 17th
Floor, Nan Fung Commercial Centre, 19 Lam Lok Street, Kowloon Bay, Hong Kong
where we lease approximately 2,359 square feet for a monthly rental fee of
$1,815. Also, Cheer Era, an affiliate company of our Company, is located at Unit
C, 19/Floor, Mai Wah Industrial Building, 1-7 Wah Sing Street, Kwai Chung,
Kowloon with an office area of approximately 2,500 square feet.
UNITED STATES - Our current U.S. corporate office is located at 860 Blue Gentian
Road, Suite 360, Eagan, Minnesota 55121, where we sublease space for a monthly
rental fee of $1,000.
CHINA - Our current Chinese corporate office is located at Room 1708, Tower B,
Stars Plaza, Hongli Road, FuTian District, Shenzhen, China where we lease
approximately 1,000 square feet for a monthly rental fee of $449. We lease space
from a shareholder. Our offices are located in Beijing, Shanghai, Guangzhou and
Shenzhen. Details are as follows:-
Locations Area (Square Feet)
------------------------------------------------------------------------------ ------------------
1601, 26 Building, 3 Block, Anzhen Xili, ChaoYang District, Beijing 100029 4,306
1407, 2# Building, Hengji Plaza, 547 Tianmuxilu, Shanghai 2,153
No. 30, ShiBaFu North Road, Liwan District, Guangzhou, 510140 2,250
1-2 floor, Yingyuan Bilding, Yingyuan Road, Yuexiu District, Guangzhou, 510410 2,500
3008,Shum Yip Centre, 5045 Shennan Rd.E., Shenzhen, P.R.C. 1,230
We believe that our offices are adequate for our current operations.
19
ITEM 3. LEGAL PROCEEDINGS
We are not aware of any material pending or threatened legal
proceedings that involve us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual general meeting on December 30, 2004 at the
Company's executive offices located at Room 601 New Bright Building, 11 Sheung
Yuet Road, Kowloon Bay, Kowloon, Hong Kong 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 approve a new stock option plan, the Company's 2005 stock option
plan (the "2005 Plan");
3. To ratify the appointment of Clancy and Co., P.L.L.C. as the Company's
independent auditors; and
4. To transact any other business as may properly be presented at the
Annual Meeting or any adjournment or postponement thereof.
At such meeting the followings proposals were voted and resolved:
1. The following directors were elected to the Board of Directors of
Company: Tony Tong, Victor Tong, Shao Jian Wang, Peter Wang, Michael
Chun Ha and Jeremy Goodwin. Richard C.H. Lo did not receive enough
shareholder votes to remain as a director.
2. Ratification and approval of the new stock option plan for Company's
2005 Plan which include the approval of a new 2 million
option pool for the 2005 Plan for the Company:
3,729,784 shares of the Company's common stock, constituting a 66%
majority of the shares of common stock present in person or by proxy
entitled to vote at this meeting have voted in favor of this proposal
3. Ratification and approval of the appointment of Clancy and Co.,
P.L.L.C. as the Company's independent auditors
5,606,231 shares of the Company's common stock, constituting a 99.91%
majority of the shares of common stock present in person or by proxy
entitled to vote at this meeting have voted in favor of this proposal.
20
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on The Nasdaq SmallCap Market under the
symbol "PACT". The following table sets forth the range of high and low bid
prices of common stock reported by Nasdaq in each fiscal quarter from January 1,
2002 to December 31, 2004. The quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not represent actual
transactions.
HIGH LOW
-------- -------
FISCAL 2003
Quarter Ended March 31, 2003 $3.65 $0.85
Quarter Ended June 30, 2003 $3.90 $2.30
Quarter Ended September 30, 2003 $10.29 $2.18
Quarter Ended December 31, 2003 $6.41 $4.10
FISCAL 2004
Quarter Ended March 31, 2004 $7.11 $4.98
Quarter Ended June 30, 2004 $5.65 $2.71
Quarter Ended September 30, 2004 $3.85 $1.91
Quarter Ended December 31, 2004 $14.08 $2.43
FISCAL 2005
January 1, 2005 - March 31, 2005 $10.55 $6.57
As of March 31, 2005, there were 108 record holders of our common
stock. However, the total number of beneficial holders is unknown as they hold
our common stock in street name, and such number is not provided to us by our
Transfer Agent and Registrar. 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.
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.
REPURCHASES OF COMPANY COMMON STOCK
There were no repurchases of our common stock made during the fourth
quarter ended December 31, 2004.
21
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
FORWARD-LOOKING STATEMENTS. This annual report on Form 10-KSB 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:
o the impact of competitive products;
o changes in laws and regulations;
o adequacy and availability of insurance coverage;
o limitations on future financing;
o increases in the cost of borrowings and unavailability of debt or
equity capital;
o the inability of the Company to gain and/or hold market share;
o exposure to and expense of resolving and defending liability claims and
other litigation;
o consumer acceptance of the Company's products;
o managing and maintaining growth;
o customer demands;
o market and industry conditions,
o the success of product development and new product introductions into
the marketplace;
o the departure of key members of management, and
o 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.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis 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
amount 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 bad debts, inventories, intangible assets,
income taxes and contingencies. We base our estimates on historical experience
and on various other assumptions that we believe 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
the most significant estimates and assumptions used in the preparation of its
consolidated financial statements.
RESEARCH AND DEVELOPMENT
We evaluate research and development costs to identify any research and
development activities that could be objectively measured and recognized as an
asset for accounting purposes at the time they are acquired or at the time they
have developed future economic benefits. Some costs and expenses are recognized
as costs and expenses incurred during the period, provided that (a) there are no
discernible future benefits, (b) costs recorded as assets in prior periods no
longer provide discernible benefits, and (c) allocating costs either on the
basis of association with revenue or among several accounting periods is
considered to serve no useful purposes.
22
VALUATION OF LONG-LIVED ASSETS INCLUDING GOODWILL AND PURCHASED INTANGIBLE
ASSETS
We review property, plant and equipment, goodwill and purchased intangible
assets for impairment whenever events or changes in circumstances indicate the
carrying value of an asset may not be recoverable. Our asset impairment review
assesses the fair value of the assets based on the future cash flows the assets
are expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset plus
net proceeds expected from disposition of the asset (if any) are less than the
carrying value of the asset. This approach uses our estimates of future market
growth, forecasted revenue and costs, expected periods the assets will be
utilized and appropriate discount rates. Such evaluations of impairment of
long-lived assets including goodwill arising on a business combination and
purchased intangible assets are an integral part of, but not limited to, our
strategic reviews of our business and operations performed in conjunction with
restructuring actions. When an impairment is identified, the carrying amount of
the asset is reduced to its estimated fair value. Deterioration of our business
in a geographic region or within a business segment in the future could also
lead to impairment adjustments as such issues are identified. The accounting
effect of an impairment loss would be a charge to income, thereby reducing our
net profit.
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 income, thereby reducing our net profit. 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.
TAXES ON EARNINGS
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, 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. 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.
23
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations data as
a percentage of revenues for the periods indicated.
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2004 2003
------------ ------------
Revenues 100.0% 100.0%
Cost of Revenues (81.0) (57.4)
Gross Margin 19.0 42.6
Selling, general and administrative expense (12.2) (226.6)
Depreciation and amortization (0.3) (6.2)
Provision of written off of fixed assets -- (17.1)
OPERATING PROFIT (LOSS) 6.5 (207.3)
Interest (expenses) income, net 0.3 2.2
Sundry income 1.4 4.4
Provision for income taxes (0.1) (2.6)
Share of profit of associated companies 0.1
Minority interest (5.5) 49.0
Discontinued operations (0.1)
NET PROFIT (LOSS) 2.6% (154.3)%
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
REVENUES. Revenues for the year ended December 31, 2004 were $29,708,000, a
increase of $28,491,000 from $1,217,000 for the year ended December 31, 2003.
Increase in revenue was mainly due to revenues derived from the call center and
value-added telecom services rendered by the Company's newly acquired
subsidiaries of YueShen, Epro, Linkhead and Smartime. In the aggregate, the four
newly acquired subsidiaries contributed to 91% of total revenues. Summarized
financial information concerning each of these subsidiaries was set forth in the
following table. The "Admin & Other" column included our other insignificant
subsidiaries and corporate related items.
For the year ended 1. 2. 3. Communications
December 31, 2004 Outsourcing Business VAS Business Distribution Business Admin & Other Total
($) ($) ($) ($) ($)
Revenues 9,385,000 5,724,000 11,790,000 2,810,000 29,709,000
Profit / (Loss) from
Operations 1,000,000 1,859,000 85,000 (1,007,000) 1,937,000
COST OF REVENUES AND GROSS MARGIN. Cost of revenues for the year ended December
31, 2004 were $24,074,000, an increase of $23,376,000 from $698,000 for the year
ended December 31, 2003. The significant increase in cost of revenues was
directly associated with the increase in revenues. Cost of revenues, as a
percentage of revenues, was 81% for the year ended December 31, 2004 compared
with 57% for the year ended December 31, 2003. The increase in percentage cost
of revenues was attributable to the changes in operations, from supplying
systems integration and software application in 2003 to becoming value-added
telecom services and product providers in 2004. Gross margin for the year ended
December 31, 2004 was $5,634,000, an increase of $5,115,000 from $519,000 for
the year ended December 31, 2003, resulting from gross margin contributions from
our newly acquired subsidiaries in 2004. We believe that our gross margin
overall approximates the industry standards. The decrease in gross margin came
primarily from Yueshen, our calling card business, which, typically for that
industry, has lower gross margins. However, we expect our gross margin
percentage to increase gradually as a result of cost reduction and efficient
utilization of assets.
24
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, General and
Administrative expenses totaled $3,620,000 for the year ended December 31, 2004,
an increase of $862,000 from $2,758,000 for the year ended December 31, 2003.
The increase in selling, general and administrative expenses reflected the
expansion of our operations of which expenses were incurred by our newly
acquired subsidiaries.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses
amounted to $78,000 for the year ended December 31, 2004, which was
approximately the same as the year ended December 31, 2003 of which depreciation
and amortization expenses was $76,000.
INTEREST EXPENSES / INCOME. Interest income was $79,000 for the year ended
December 31, 2004, as compared to an interest income of $27,000 for the year
ended December 31, 2003. The increase in income was due to increase in cash and
bank balance during 2004 as a result of cash flow from funding activities.
SHARE OF PROFIT OF ASSOCIATED COMPANIES. For the year ended 2004 we recorded
income of $32,000 with respect to our 30% ownership interest in Cheer Era
Limited, acquired in April 2004.
INCOME TAXES. The income taxes expenses for the Company's subsidiaries were
$30,000 for the year ended December 31, 2004 The provision of income taxes was
the result of the operating profit generated by YueShen and Smartime, the
subsidiaries we acquired in 2004. During the year ended December 31, 2004,
YueShen, Smartime and Epro provided income taxes expenses of $8,000, $12,000 and
$10,000, respectively.
MINORITY INTERESTS. Minority interests for the year ended December 31, 2004
totaled $1,622,000. Minority interest represented the interests of third parties
in our subsidiaries' results.
CONTRACTUAL OBLIGATIONS
CONTRACTUAL OBLIGATIONS. We have significant cash resources to meet our
contractual obligations as of December 31, 2004, as detailed below:
Payments Due by Period
Less than
Contractual Obligations Total 1 year 1-3 years 4-5 years After 5 years
Line of credit $ 651,000 $ 651,000 -- -- --
Bank Loans $ 1,396,000 $ 1,327,000 $ 69,000 -- --
Operating leases $ 104,000 $ 104,000 -- -- --
Capital leases $ 209,000 $ 80,000 $ 129,000 -- --
------------ ------------ ----------
Total cash contractual obligations $ 2,360,000 $ 2,162,000 $ 198,000
============ ============ ==========
OFF-BALANCE SHEET ARRANGEMENTS. We had no outstanding derivative financial
instruments, off-balance sheet guarantees, interest rate swap transactions or
foreign currency forward contracts. We did not engage in trading activities
involving non-exchange traded contracts during 2004.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL The Company's working capital increased by $14,046,000 to
$15,488,000 at December 31, 2004, as compared to $1,442,000 at December 31,
2003. The increase in working capital primarily represents $11.773 million
proceeds (shown net of offering costs) from our private placement activities
that resulted in $6,230,000 increase in cash balance and time deposit, net of
cash expenditure for operations and acquisitions.
ISSUANCE OF COMMON STOCK For the year ended December 31, 2004, the Company
issued (i) 1,756,240 shares with a market value of $8,866,000 to acquire various
subsidiaries; (ii) 352,364 shares as a result of exercise of stock options and
warrants with cash consideration of $716,000; (iii) 2,205,697 shares for cash
proceeds of $11,773,000 (net of offering costs); (iv) 149,459 shares with a
market value of $771,000 for acquisition of affiliated company; and (v)
repurchase of 36,154 as treasury shares for $99,000.
25
FUTURE LIQUIDITY NEEDS
As of December 31, 2004, we had approximately $6,764,000 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.
INFLATION. Inflation has not had a material impact on the Company's business in
recent years.
CURRENCY EXCHANGE FLUCTUATIONS. All of the Company's revenues are denominated
either in U.S. dollars or Hong Kong dollars, while its expenses are denominated
primarily in Hong Kong dollars and Renminbi ("RMB"), the currency of the
People's Republic of China. The value of the RMB-to-U.S. dollar or Hong Kong
dollar-to-United States dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Since 1994, the conversion of Renminbi into foreign currencies, including U.S.
dollars, has been based on rates set by the People's Bank of China, which are
set daily based on the previous day's interbank foreign exchange market rates
and current exchange rates on the world financial markets. Since 1994, the
official exchange rate generally has been stable. Recently there has been
increased political pressure on the Chinese government to decouple the RMB from
the United States dollar. Although a devaluation of the Hong Kong dollar or RMB
relative to the United States dollar would likely reduce the Company's expenses
(as expressed in United States dollars), any material increase in the value of
the Hong Kong dollar or RMB relative to the United States dollar would increase
the Company's expenses, and could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
has never engaged in currency hedging operations and has no present intention to
do so.
CONCENTRATION OF CREDIT RISK. All of the Company's revenues are derived in Asia
and Greater China. The Company does not have any single customer that accounts
for more than 10% of its revenues or 10% of its purchases. 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. Based on the current economic environment in China, the Company does
not expect any material adverse impact to its business, financial condition and
results of operations.
SEASONALITY AND QUARTERLY FLUCTUATIONS. Several of our businesses experience
fluctuations in quarterly performance. Traditionally, the first quarter from
January to March is a low season for our call center business due to the long
Lunar New Year holidays in China. Revenue and income from operations for the
call center and VAS tend to be higher in the fourth quarter due to special
holiday promotions. Internet/Direct Commerce revenues also tend to be higher in
the fourth quarter due to increased consumer spending during that period.
Revenues from the VAS and IVR segment can vary from quarter to quarter due to
new product launches and the seasonality of certain product lines.
26
ITEM 7. FINANCIAL STATEMENTS.
The consolidated financial statements and the reports and notes, which are
attached hereto are incorporated herein by reference.
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm 28
Consolidated Balance Sheets - As of December 31, 2004 and 2003 29
Consolidated Statements of Operations - For the Years Ended
December 31, 2004 and December 31, 2003 30
Consolidated Statements of Changes in Stockholders' Equity -
For the Years Ended December 31, 2004 and December 31, 2003 31
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 2004 and December 31, 2003 32
Notes to Consolidated Financial Statements 33
27
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of PacificNet Inc.:
We have audited the accompanying consolidated balance sheets of PacificNet Inc.
(a Delaware Corporation) and Subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the years then ended. 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, 2004 and 2003, and the results of their
consolidated operations and cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/S/ CLANCY AND CO, P.L.L.C.
Phoenix, Arizona
April 15, 2005
28
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except par values and share numbers)
DECEMBER 31, DECEMBER 31,
2004 2003
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 6,764 $ 3,823
Restricted cash - pledged bank deposit 3,501 212
Accounts receivables 5,644 1,890
Inventories 1,297 76
Other current assets 4,325 286
----------- -----------
Total Current Assets 21,531 6,287
Property and equipment, net 1,118 466
Investments in affiliated companies and subsidiaries 1,063 --
Marketable equity securities - available for sale 29 --
Goodwill 8,912 420
----------- -----------
TOTAL ASSETS $ 32,653 $ 7,173
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank overdraft $ 651 $ 1,199
Bank loans-current portion 1,327 1,405
Capital lease obligations - current portion 80 152
Accounts payable 3,150 1,007
Accrued expenses 128 360
Income tax payable 10 --
Subscription payable -- 722
----------- -----------
Total Current Liabilities 5,346 4,845
----------- -----------
Long-term liabilities:
Bank loans - non current portion 69 377
Capital lease obligations - non current portion 129 149
----------- -----------
Total long-term liabilities 198 526
----------- -----------
Total liabilities 5,544 5,371
Minority interest in consolidated subsidiary 2,396 (110)
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, 2004 - 10,627,737 shares, 9,791,583 outstanding
December 31, 2003 - 6,163,977 shares, 5,363,977 outstanding 1 1
Treasury stock, at cost (2004: 836,154 shares; 2003: 800,000) (104) (5)
Additional paid-in capital 53,916 31,790
Cumulative other comprehensive loss (24) (24)
Accumulated deficit (29,076) (29,850)
----------- -----------
Total Stockholders' Equity 24,713 1,912
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 32,653 $ 7,173
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
29
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands of United States dollars, except loss per share and share amounts)
YEAR ENDED DECEMBER 31: 2004 2003
----------- -----------
Revenues $ 29,709 $ 1,217
Cost of Revenues (24,074) (698)
----------- -----------
Gross Margin 5,635 519
Selling, General and Administrative expenses (3,620) (2,758)
Depreciation and amortization (78) (76)
Provision for written off of fixed assets -- (208)
----------- -----------
EARNINGS / (LOSS) FROM OPERATIONS 1,937 (2,523)
Interest Income 79 27
Sundry income 422 54
----------- -----------
EARNINGS / (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND DISCONTINUED 2,438 (2,442)
OPERATIONS
Provision for income taxes (30) (32)
Share of profit of associated companies 32 --
Minority Interests (1,623) 596
----------- -----------
EARNINGS / (LOSS) BEFORE DISCONTINUED OPERATIONS 817 (1,878)
----------- -----------
LOSS FROM DISCONTINUED OPERATIONS (43) --
NET EARNINGS / (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 774 ($ 1,878)
=========== ===========
BASIC EARNINGS / (LOSS) PER COMMON SHARE:
Earnings / (Loss) from continuing operations $ 0.11 ($ 0.36)
Earnings / (Loss) from discontinued operations -- --
----------- -----------
Net earnings / (loss) $ 0.11 ($ 0.36)
=========== ===========
DILUTED EARNINGS / (LOSS) PER COMMON SHARE:
Earnings / (Loss) from continuing operations $ 0.09 ($ 0.36)
Earnings / (Loss) from discontinued operations 0.00 0.00
----------- -----------
Net earnings / (loss) $ 0.09 ($ 0.36)
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
30
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
CUMULATIVE
OTHER TOTAL
ADDITIONAL COMPREHENSIVE STOCK-
PREFERRED COMMON PAID-IN INCOME/ ACCUMULATED TREASURY HOLDERS'
STOCK STOCK CAPITAL (LOSS) DEFICIT STOCK EQUITY
-------- -------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 2002 (4,907,252 SHARES) $ -- $ 1 $ 31,253 $ (24) $(27,972) (5) 3,253
COMPREHENSIVE LOSS:
Net loss -- -- -- -- (1,878) (1,878)
--------
TOTAL COMPREHENSIVE LOSS (1,878)
--------
Issuance of treasury shares (800,000 shares) -- -- -- -- -- --
Issuance of common stock to satisfy services
(16,725 shares) -- -- 27 -- -- 27
Issuance of common stock to satisfy officer's
employment compensation (200,000 shares) -- -- 100 -- -- 100
Issuance of common stock for cash (240,000 shares) -- -- 410 -- -- 410
-------- -------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 2003 (5,363,977 SHARES) -- 1 31,790 (24) (29,850) (5) 1,912
COMPREHENSIVE EARNINGS:
Net earnings -- -- -- -- 774 774
--------
TOTAL COMPREHENSIVE EARNINGS: 774
--------
Issuance of common stock for acquisition of
subsidiaries (1,756,240 shares) -- -- 8,866 -- -- 8,866
Proceeds from the sale of common stock , net of
related costs (2,205,697, shares) -- -- 11,773 -- -- 11,773
Issuance of common stock for acquisition of Cheer
Era (149,459 shares) -- -- 771 -- -- 771
Repurchase of common shares [(36,154 shares)] (99) (99)
Exercise of stock options and warrants for cash
(352,364 shares) 716 716
-------- -------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 2004 (9,791,583 SHARES) $ -- $ 1 $ 53,916 $ (24) $(29,076) $ (104) $ 24,713
======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
31
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars, except loss per share and share amounts)
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ 774 ($ 1,878)
Adjustment to reconcile net loss to net cash used in operating activities:
Expenses settled by issuance of common shares -- 127
Minority Interest 2,506 (596)
Loss on disposal of fixed assets -- 208
Provision for write-off of intangible assets -- 761
Unrealized losses on marketable equity securities 17
Provision for write-off of goodwill -- 19
Depreciation 78 72
Amortization -- 4
Changes in current assets and liabilities:
Accounts receivable and other current assets (7,793) 272
Inventories (1,221) --
Accounts payable and other accrued expenses 1,921 106
-------- --------
Net cash provided by (used in) operating activities (3,718) (905)
-------- --------
CASH FLOWS FROM INVESTMENT ACTIVITIES
Increase in restricted cash-pledged bank deposits (3,289) (52)
Acquisition of property and equipment (730) (29)
Acquisition of intangible assets -- (19)
Acquisition of subsidiaries and affiliated companies (640) (211)
Acquisition of marketable securities (46) --
-------- --------
Net cash used in investing activities (4,705) (311)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Advances under bank line of credit -- 634
Proceeds from sale of common stock 11,773 --
Proceeds from exercise of stock options 496 235
Proceeds from exercise of warrants 220 175
Repurchase of common stock (99) --
Repayment of bank overdraft (548) (465)
Repayments on bank loans (386) 717
Repayments on capital lease obligations (92) 49
-------- --------
Net cash provided by financing activities 11,364 1,345
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENT 2,941 129
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,823 3,694
-------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,764 $ 3,823
======== ========
CASH PAID FOR:
Interest 20 54
Income taxes -- --
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Investment in subsidiary acquired through issuance of subscriptions payable $ -- $ 722
Common stock issued to satisfy certain liabilities and to settle expenses $ -- $ 127
Investments in subsidiaries acquired through the issuance of common stock $ 9,637
The accompanying notes are an integral part of these consolidated financial statements.
32
PACIFICNET INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in United States dollars unless otherwise stated)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
PacificNet Inc. (referred to herein as "PacificNet" or the "Company") was
originally incorporated in the State of Delaware on April 8, 1987. Through our
subsidiaries we provide outsourcing services, value-added telecom services
(VAS), and communication products distribution services. Our business process
outsourcing (BPO) services, include call centers, providing customer
relationship management (CRM), and telemarketing services, and our information
technology outsourcing (ITO) includes software programming and development. We
are value-added resellers and providers of telecom VAS, which comprises
interactive voice response (IVR) systems, call center management systems, and
VOIP, as well as mobile phone VAS, such as short messaging services (SMS) and
multimedia messaging services (MMS). The Company's operations are primarily
targeted in the China and Hong Kong market.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and 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. All significant intercompany transactions and balances have been
eliminated. The Company fully consolidates the financial results of entities
acquired when it obtains a controlling financial interest and the normal
attributes of ownership expected with an acquisition, such as effective control
and ownership of the assets acquired, liabilities assumed, and the operating and
financing decisions of the acquired companies transfer on that date, and the
benefits derived and/or detriments incurred with respect to the acquired
entities.
Investments in Affiliated Companies
-----------------------------------
The Company's investments in affiliated companies for which its ownership
exceeds 20%, but are 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.
Revenue Recognition
-------------------
Revenue is recognized from the provision of telecommunication and related
services when the services are rendered. Revenues from the sale of products and
systems is recognized when the product and system is completed, shipped, and the
risks and rewards of ownership have transferred. Revenues from services rendered
consist primarily of license and support revenue from consulting, implementation
and training services. Revenue from license agreements is recognized when: i) a
signed non-cancelable software license exists, ii) delivery has occurred, iii)
the Company's fee is fixed or determinable, and iv) collectibility is probable
at the date of sale. Revenue from support services is recognized when (i) the
services are performed, (ii) collectibility is probable and (iii) such revenues
are contractually nonrefundable.
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
reviews a customer's credit history before extending credit. 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 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,
the Company's estimates of the recoverability of receivables could be further
adjusted.
33
Estimates and Assumptions
-------------------------
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
Property and Equipment
----------------------
Property and equipment is stated at cost and depreciated using the straight-line
method over the shorter of the estimated useful life of the asset or the lease
term, ranging from three to five years. Significant improvements and betterments
are capitalized. Routine repairs and maintenance are expensed when incurred.
When property and equipment is sold or otherwise disposed of, the asset account
and related accumulated depreciation account are relieved, and any gain or loss
is included in operations.
Inventories
-----------
Inventories consist of finished goods and are stated at the lower of cost or
market value. Cost is computed using the first-in, first-out method and includes
all costs of purchase and other costs incurred in bringing the inventories to
their present location and condition. Market value is determined by reference to
the sales proceeds of items sold in the ordinary course of business after the
balance sheet date or management estimates based on prevailing market
conditions. The inventories consist of finished goods and represent
telecommunication products such as mobile phone, rechargeable phone cards, smart
chip and interactive voice response cards.
Foreign Currency Translation
----------------------------
The functional currency of the Company is United States dollars (US$) and the
financial records are maintained and the financial statements prepared in US$.
The functional currency of the Company's subsidiaries is Hong Kong dollars (HK$)
and the financial records of the subsidiaries are maintained and the financial
statements are prepared in HK$.
The translation of the financial statements into US$ is performed for balance
sheet accounts using the closing exchange rate in effect at the balance sheet
date and for revenue and expense accounts using an average exchange rate during
each reporting period. The resulting foreign currency translation gain or loss
is included in Cumulative Other Comprehensive Loss, which is shown separately
from retained earnings in the equity section of the balance sheet.
Income taxes
------------
The Company and its subsidiaries account for income taxes using the liability
method, which requires an entity to recognize deferred tax liabilities and
assets. Deferred income taxes are recognized based on the differences between
the tax bases of assets and liabilities and their reported amounts in the
financial statements, which will result in taxable or deductible amounts in
future years. Further, the effects of enacted tax laws or rate changes are
included as part of deferred tax expenses or benefits in the year that covers
the enactment in the near-future date. A valuation allowance will be provided
when there is an uncertainty that a deferred tax benefit will be realized.
Goodwill and Purchased Intangible Assets
----------------------------------------
Goodwill and purchased intangible assets determined to have indefinite useful
lives related to acquisitions after June 30, 2001 are not amortized, in
accordance with the provisions of Statement of Financial Accounting Standards
(SFAS) SFAS No. 142, "Goodwill and Other Intangible Assets."
34
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, goodwill 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 an 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 will be 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.
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, 2004 and
2003, the Company did not capitalize any costs related to the purchase of
software and related technologies and content, which provide new functionality
for the Company's existing software products and the Company wrote off all the
costs and expenses incurred of $761,000 during the year ended December 31, 2003.
Earnings per share
------------------
Basic and diluted earnings or loss per share amounts in the financial statements
are computed in accordance with SFAS No. 128, "Earnings Per Share." Basic
earnings or loss per share is based on the weighted average number of common
shares outstanding. Diluted earnings or loss per share is based on the weighted
average number of common shares outstanding and dilutive common stock
equivalents. Basic earnings/loss per share 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. Dilutive
earnings per share for 2004 excludes the potential dilutive effect of 400,000
warrants because their impact would be antidilutive based on current market
prices. Dilutive loss per share does not include the potential dilutive effect
of options and warrants outstanding at December 31, 2003 because to do so would
be antidilutive based on the Company's loss position. All per share and per
share information are adjusted retroactively to reflect stock splits and changes
in par value.
35
The reconciliation of the numerators and denominators of the basic and diluted
EPS calculations was as follows for the years ended December 31:
2004 2003
----------- -----------
Numerator: earnings / (loss) $ 774 $ (1,878)
=========== ===========
Denominator:
Weighted-average shares used to compute basic EPS 7,268,374 5,234,744
Dilutive potential from assumed exercise of stock options 157,585 --
Dilutive potential from assumed exercise of stock warrants 816,037 --
----------- ----------
Weighted-average shares used to compute diluted EPS 8,241,996 5,234,744
=========== ===========
Basic earnings / (loss) per common share: $ 0.11 $ (0.36)
=========== ===========
Diluted earnings / (loss) per common share: $ 0.09 $ (0.36)
=========== ===========
Stock-Based Compensation Plans
------------------------------
The Company has adopted SFAS No. 123, "Accounting for Stock Based Compensation".
As permitted by SFAS No. 123, the Company measures compensation cost in
accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting
for Stock Issued to Employees" and related interpretations. Compensation cost
for stock options, if any, is measured as the excess of the quoted market price
of the Company's stock at the date of grant over the amount an employee must pay
to acquire the stock. Accordingly, no accounting recognition is given to stock
option granted at fair market value until they are exercised. Upon exercise, net
proceeds including tax benefits realized, are credited to equity. Details
regarding a description and status of the Company's stock option plans can be
found in Note 10.
Had compensation expense for the Company's stock-based compensation plans been
determined under SFAS No. 123, based on the fair market value at the grant
dates, the Company's pro forma net earnings (loss) and pro forma net earnings
(loss) per share would have been reflected as follows at December 31:
The Company's net earnings (loss) and net earnings (loss) per common share would
have increased to the pro forma amounts indicated below if compensation cost for
the Company's stock option had been determined based on fair value at the grant
date for awards in accordance with SFAS No. 123, (in thousands, except per share
amounts):
2004 2003
--------- ---------
Net earnings (loss):
As reported $ 774 $ (1,878)
Stock-based compensation cost, net of tax (1,188) (2,090)
--------- ---------
Pro forma (414) (3,968)
========= =========
Basic earnings/(loss) per share:
As reported $ 0.11 $ (0.36)
Pro forma (0.06) (0.76)
Diluted profit/(loss) per share:
As reported $ 0.09 $ (0.36)
Pro forma $ (0.05) $ (0.76)
The fair value of options granted during 2004 and 2003, respectively was
approximately $1.88 and $2.17 per option respectively based on the Black-Scholes
option pricing model using valuation assumptions of: a) average remaining
contractual life of two and three years; b) expected volatility of 3824% and
129.8%, c) dividend yield of 0% for both years; and d) a risk free interest
rate of 3% and 2.5%.
36
Other Comprehensive Income
--------------------------
Comprehensive income includes net earnings as well as additional other
comprehensive income, such as translation adjustments, in the financial
statements and displays the accumulated balance of other comprehensive income
separately from retained earnings in the equity section of the balance sheet.
Advertising Costs
-----------------
Advertising costs are expensed as incurred and amounted to $9,908 in 2004 and
$9,114 in 2003.
Cash Equivalents
----------------
Highly liquid investments with maturity of three months or less at the time of
acquisition 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 12).
Reclassification
----------------
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
-----------------------------------
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities, and
current portions of debt, the carrying amounts approximate fair value due to
their short maturities.
Business Operating Risks
------------------------
o The Company's business is characterized by rapid technological change, new
product and service development and evolving industry standards. Inherent
in the Company's business are various risks and uncertainties, including
limited operating history, uncertain profitability, history of losses and
risks associated with the Internet, e-commerce and the ability to raise
additional capital.
o For those financial institutions that the Company maintains cash balances
in the United States, the amounts are insured by the Federal Deposit
Insurance Corporation up to $100,000.
o All of the Company's revenues are derived in Asia and Greater China. 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.
o The Company does not have any single customer that accounts for more than
10% of its revenues or 10% of its purchases.
37
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, wit the change in
fair value during the period excluded from earnings and recorded net of tax as a
component of other comprehensive income. Investments in securities
available-for-sale based primarily on quoted market prices at December 31, 2004,
are summarized as follows: cost $46,000, gross unrealized losses $17,000 and
estimated fair value of $29,000.
Recent Accounting Pronouncements
--------------------------------
The Financial Accounting Standards Board issued the following pronouncements
during 2004, of which SFAS 123R is the only one that may have a significant
effect on the financial statements:
In March 2004, the EITF reached consensus on EITF Issue No. 03-6, "Participating
Securities and the Two Class Method under FASB Statement No. 128" ("EITF 03-6").
EITF 03-6 addresses a number of questions regarding the computation of earnings
per share by companies that have issued securities other than common stock that
contractually entitle the holder to participate in the dividends and earnings of
the company when, and if, it declares dividends on its common stock. EITF 03-6
also provides further guidance in applying the two-class method of calculating
earnings per share, clarifying what constitutes a participating security and how
to apply the two-class method of computing earnings per share once it is
determined that a security is participating, including how to allocate
undistributed earnings to such a security. EITF 03-6 is effective for fiscal
periods beginning after March 31, 2004 and requires retroactive restatement of
prior earning per share amounts. This statement does not affect the Company.
In June 2004, the FASB issued EITF Issue No. 02-14, "Whether an Investor Should
Apply the Equity Method of Accounting to Investments Other Than Common Stock."
EITF Issue No. 02-14 addresses whether the equity method of accounting applies
when an investor does not have an investment in voting common stock of an
investee but exercises significant influence through other means. EITF Issue No.
02-14 states that an investor should only apply the equity method of accounting
when it has investments in either common stock or in-substance common stock of a
corporation, provided that the investor has the ability to exercise significant
influence over the operating and financial policies of the investee. The
accounting provisions of EITF Issue No. 02-14 are effective for the reporting
period beginning after September 15, 2004. This statement does not affect the
Company.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of ARB No. 43, Chapter 4." The amendments made by SFAS No. 151 clarify that
abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage) should be recognized as current-period charges and require
the allocation of fixed production overheads to inventory based on the normal
capacity of the production facilities. The guidance is effective for inventory
costs incurred during fiscal years beginning after November 23, 2004. The
Company does not believe the adoption of SFAS No. 151 will have a material
impact on our financial position, results of operations or cash flows.
In December 2004, the FASB issued a revision of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123R). SFAS 123R supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and its related implementation guidance. SFAS 123R establishes
standards for the accounting for transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value
of the entity's equity instruments or that may be settled by the issuance of
those equity instruments. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for interim
reporting period that begins after June 15, 2005. The Company is evaluating the
requirements of SFAS 123R and expects that the adoption of SFAS 123R may have a
material impact on the Company's consolidated results of operations and earnings
per share. The Company has not yet determined the method of adoption or the
effect of adopting SFAS 123R, and it has not determined whether the adoption
will result in amounts that are similar to the current pro forma disclosures
under SFAS 123.
38
In December 2004, the FASB issued SFAS No. 152, "Accounting for Real Estate
Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67,"
which discusses the accounting and reporting of real estate time-sharing
transactions. This Statement is effective for financial statements for fiscal
years beginning after June 15, 2005, and restatement of previously issued
financial statements is not permitted. This statement does not affect the
Company.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- an amendment of APB Opinion No. 29." The guidance in APB Opinion No. 29,
"Accounting for Nonmonetary Transactions," is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged and provided an exception to the basic measurement
principle (fair value) for exchanges of similar productive assets. That
exception required that some nonmonetary exchanges, although commercially
substantive, be recorded on a carryover basis. This Statement eliminates the
exception to fair value for exchanges of similar productive assets and replaces
it with a general exception for exchange transactions that do not have
commercial substance--that is, transactions that are not expected to result in
significant changes in the cash flows of the reporting entity. The provisions of
this Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005, applied prospectively. This statement
does not affect the Company.
2. BUSINESS ACQUISITIONS
During 2004 and 2003, PACT acquired various entities in accordance with the
Company's strategy to grow via mergers and acquisitions. The entities acquired
met various PACT acquisition criteria, which include reasonable expectations for
positive earnings and cash flow within two years of acquisition and reputation
for high quality and performance in customer relationship management, brand
name recognition, and well-established relationships with clients. Several
factors contributed to the determination of the negotiated purchase price and
deal structure. Among them were the value of assets acquired and liabilities
assumed, historical EBITDA and projected EBITDA. The assets acquired and
liabilities assumed were recorded at estimated fair values as determined by the
Company's management based on information currently available and on current
assumptions as to future operations.
A summary of business acquisitions for the periods presented:
EPRO TELECOM HOLDINGS LIMITED ("EPRO")
--------------------------------------
On December 1 2003, the Company acquired 50% of the stock of EPRO Telecom
Holdings Limited, which specializes in customer relationship management located
in Hong Kong.
The details of the acquisition are as follows:
On December 1, 2003, the Company completed an agreement to acquire a 50%
ownership interest for total consideration of $3,500,000 payable in cash
($500,000) and the issuance of common stock $3,000,000 (600,000 shares valued at
$5.00 per share). Within 90 days of signing the agreement, the Company is
required to pay $500,000 and within 30 days the Company is required to deliver
100,000 shares ("deposit shares") of common stock to EPRO as a refundable
deposit. As of the date of issuance of these financial statements, the Company
has paid the $500,000 and issued the 100,000 deposit shares and 500,000 earnout
shares of common stock to EPRO. Additionally, the Company has agreed to issue a
maximum of 300,000 bonus shares of common stock per year for achieving net
income in excess of $1,000,000 in 2004 and 2005. EPRO is also required to return
a portion of the shares equivalent to the dollar amount of the shortfall of net
income in years 2004 and 2005. There was no shortfall in 2004.
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 2,549,883
Property Plant and equipment 344,428
Intangible Assets 362,208
Goodwill 3,310,000
-------------
Total Assets Acquired 6,566,519
Current Liabilities assumed 2,810,269
Long Term Liabilities assumed 256,250
-------------
Net assets acquired $ 3,500,000
=============
39
The following unaudited pro forma results were developed assuming the
acquisition of Epro occurred January 1, 2003.
2004 2003
Revenue $ 6,825,000
Net loss Fully consolidated (1,793,000)
Basic and diluted loss per share $ In 2004 (0.32)
PACT has included the financial results of Epro Telecom Holding Limited in its
consolidated 2004 financial results from the date of the purchase, December 1,
2003 through December 31, 2004.
BEIJING LINKHEAD TECHNOLOGIES COMPANY LIMITED ("LINKHEAD")
On December 15, 2003, the Company acquired 51% of the stock of Beijing Linkhead
Technologies Company Limited, which specializes in interactive voice response
located in PRC.
The details of the acquisition are as follows:
On December 15, 2003, the Company completed an agreement to acquire a 51%
ownership interest for total consideration of $4,972,500 payable in cash
($222,500) and the issuance of common stock $4,750,000 (950,000 shares valued at
$5.00 per share). Within 30 days of signing the agreement, the Company is
required to pay $222,500 and to deliver 350,000 shares ("deposit shares") of
common stock as a refundable deposit. As of the date of issuance of these
financial statements, the Company has paid the $222,500 and issued the 350,000
deposit shares and 600,000 earnout shares of common stock to Linkhead.
Additionally, the Company has agreed to issue a maximum of 600,000 bonus shares
of common stock for achieving net income in excess of $1,500,000.
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 244,018
Property Plant and equipment 80,135
Intangible Assets 379,347
Goodwill 4,269,000
------------
Total Assets Acquired 4,972,500
Liabilities assumed --
------------
Net assets acquired $ 4,972,500
============
The following unaudited pro forma results were developed assuming the
acquisition of Linkhead occurred January 1, 2003.
2004 2003
Revenue $ 6,825,000
Net profit /(loss) Fully consolidated (1,793,000)
Basic and diluted loss per share $ In 2004 (0.32)
PACT has included the financial results of Linkhead in its consolidated 2004
financial results from the date of the purchase, December 15, 2003 through
December 31, 2004.
Note: Goodwill at December 31, 2003, represented the partial acquisition of EPRO
and Linkhead above.
GUANGZHOU YUESHEN TAI YANG TECHNOLOGY LTD. ("YUESHEN")
------------------------------------------------------
On April 12, 2004, the Company acquired 51% of the stock of Guangzhou YueShen
Tai Yang Technology Ltd., a telecommunication company located in PRC Guangzhou.
The details of the acquisition are as follows:
On April 12, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of a 51% controlling
interest (the "Acquisition") in Guangzhou YueShen TaiYang Technology Limited, a
newly formed company incorporated in the People's Republic of China ("Yueshen").
The Company acquired the controlling interest in Yueshen through the purchase of
85 shares (representing 100% of the issued and outstanding shares, the "Shanghai
Shares") of Shanghai Classic Group Limited, the beneficial owner of the 51%
controlling interest in Yueshen. The consideration for the Acquisition was an
aggregate value of approximately USD$1,196,143, which was paid in cash and
shares of common stock of the Company (the "Common Stock"), and a warrant to
purchase up to 50,000 shares of Common Stock. The consideration was paid as
follows:
40
(i) approximately USD$616,195 by delivery of 106,240 shares of Common
Stock as consideration for the purchase of 51 of the Shanghai Shares from Yan
Kuan Li ("Ms. Li") within thirty (30) days of the signing of the agreement for
the Acquisition. All of the Common Stock deliverable to Ms. Li is being held in
escrow pursuant to the terms of an escrow agreement, which provides that the
Common Stock will be released in installments over the twelve month period
following the consummation of the Acquisition, provided, that Yueshen attains
certain net income milestones during such period. In the event there is a
shortfall in the net income during the period Ms. Li shall return to the Company
shares of Common Stock equivalent to the dollar amount of such shortfall divided
by $5.80; and
(ii) approximately USD$338,303 in cash as consideration for the
purchase of 34 of the Shanghai Shares from Avatar Trading, Ltd. ("Avatar")
within thirty (30) days of the closing of the Acquisition; and
(iii) approximately USD$241,645 in cash directly to Yueshen within
thirty (30) days of the closing of the Acquisition, as consideration for the
purchase of the Yueshen shares by Shanghai.
(iii) A common stock purchase warrant to purchase 50,000 shares of PACT
common stock, par value $0.0001 per share. The exercise price under this warrant
shall be the 5-Day volume weighted average price of the common stock of PACT
before the signing date of this Agreement, exercisable within 3 years from the
date of issuance.
The cash portion of the purchase price for the Acquisition was from working
capital of the Company.
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 211,886
Property Plant and equipment 38,917
Goodwill 1,100,585
---------------
Total Assets Acquired 1,351,388
Liabilities assumed (155,245)
---------------
Net assets acquired $ 1,196,143
===============
The following unaudited pro forma results were developed assuming the
acquisition of subsidiary occurred January 1, 2003.
2004 2003
Revenue $ 12,546,857 N/A
Net profit 182,228 Newly
Basic and diluted profit per share $ 0.02 acquired
PACT included the financial results of the subsidiary in its consolidated 2004
financial results from the date of the purchase, April 12, 2004 through December
31, 2004.
SMARTIME HOLDINGS LIMITED ("SMARTIME")
--------------------------------------
On September 15, 2004, the Company acquired 51% of the stock of Smartime
Holdings Limited , its subsidiary, Soluteck Technology (Shenzhen) Company
Limited, specializes in outsourcing IT services located in PRC Shenzhen.
The details of the acquisition are as follows:
On September 15, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of a 51% controlling
interest (the "Acquisition") in Soluteck Technology (Shenzhen) Company Limited,
a corporation incorporated in Shenzhen, China ("Soluteck"). The Company acquired
the controlling interest in Soluteck through the purchase of 630 shares (the
"Shares") of Smartime Holdings Limited("Smartime"), the beneficial owner of a
81% controlling interest in Soluteck, from the shareholders of Smartime. The
consideration for the Acquisition was payable as follows:
41
(i) USD$500,000, payable in shares of common stock of the Company (the
"Common Stock"), equivalent to 100,000 restricted shares (the "Shares") of
Common Stock, based on a fair market value of $5.00, deliverable within 30 days
of signing the Agreement. All of the Shares deliverable to the Shareholders are
being held in escrow pursuant to the terms of an escrow agreement, which
provides that the Common Stock will be released in installments over the twelve
month period ending on September 30, 2005; provided, that Soluteck meets certain
net income milestones during such period. If at the end of the second twelve
month period ending on September 30, 2006, there is a shortfall in Soluteck's
net income, the Shareholders shall return to the Company Shares equivalent to
the dollar amount of such shortfall divided by $5.00; and
(ii) warrants to purchase up to 50,000 shares of common stock at an
exercise price equal to the 5 day volume weighted average price of the Company's
common stock before the signing of the Agreement. The warrants are exercisable
for a period of 3 years from the date of issuance.
In connection with the Acquisition, the Company's subsidiary has agreed to
provide Soluteck with an operating loan of RMB 3,000,000; provided, that
Soluteck secures certain contracts with Huawei. The loan would mature within 3
years with interest at a rate of 4% per year.
The Shares are restricted shares issued under an exemption from registration of
the Securities Act of 1933, as amended. If at the time the Shareholders are
eligible to sell the Shares under Rule 144, the fair market value of the Common
Stock is less than USD$3.50, the Company shall issue additional shares of Common
Stock for an aggregate amount of USD$100,000, up to a maximum of 60,000 shares
of Common Stock. If at such time the fair market value of the Common Stock is
more than USD$8.00 per share, the Shareholders and the Company will share on an
equal basis any excess over USD$8.00 per share.
A summary of the assets acquired and liabilities assumed in the acquisition
follows:
Estimated fair values:
Current Assets $ 460,957
Property Plant and equipment 60,505
Intangible Assets 562
Goodwill 233,000
------------
Total Assets Acquired 755,024
Current Liabilities assumed (255,024)
------------
Net assets acquired $ 500,000
============
The following unaudited pro forma results were developed assuming the
acquisition occurred on January 1, 2003.
2004 2003
Revenue $ 1,829,998 N/A
Net profit 268,689
Basic and diluted profit per share $ 0.037
PACT included the financial results of Smartime in its consolidated 2004
financial results from the date of the purchase, September 15, 2004 through
December 31, 2004.
42
3. BUSINESS DISPOSITIONS
BUSINESS DISPOSITION - In October 2004, the Board of Directors of the Company
approved a plan to dedicate the company's resources to pursue the Greater China
market and to cease all operations related to the South East Asian market. As a
result, the Board of Directors decided not to further invest in PacificNet.com
(SE Asia) Limited ("PacificNet.com (SE Asia)"), a wholly owned subsidiary of
PacificNet registered in Hong Kong with a mission to provide internet and IT
solutions to the South East Asian market. As of October 27, 2004 all activities
related to PacificNet.com (SE Asia) had significantly reduced and the Company
planned to liquidate PacificNet.com (SE Asia). Revenue and net loss information
related to PacificNet.com (SE Asia) operations is as follows (in thousands):
YEAR ENDED DECEMBER 31,
2004 2003
---------------------------------
REVENUES $ - $ -
NET LOSS $ (43) $ -
Net liabilities of PacificNet.com (SE Asia) Limited's operations included in
continuing operations in the accompanying financial statements were $43,832 at
December 31, 2004. Total assets were comprised primarily of investments in
associate operations. Total liabilities were comprised primarily of trade
payables, accrued expenses and amount due to holding company and a fellow
subsidiary. There was no income tax effect due as a result of the transaction
due to the Company's loss position.
4. INVESTMENT IN AFFILIATED COMPANIES
Investments in affiliated companies and goodwill consist of the following as of
December 31, 2004 (in thousands):
COLLATERAL/OWNERSHIP % AND BUSINESS
DESCRIPTION AMOUNT DESCRIPTION
INVESTMENTS IN AFFILIATED COMPANIES:
Cheer Era Limited [1] $ 1,063 30% ownership interest; trader of vending machine located in Hong Kong.
Xmedia Holdings Inc 95 25% ownership; provides new media business development and marketing
to advertisers.
Less: Provision for Impairment (95)
------
Total $1,063
======
[1] CHEER ERA LIMITED ("CHEER ERA")
-----------------------------------
On April 7, 2004, the Company acquired 30% of the stock of Cheer Era Limited. a
trader of vending machine located in Hong Kong.
The details of the acquisition are as follows:
On April 7, 2004, the Company, through its subsidiary PacificNet Strategic
Investment Holdings Limited, consummated the acquisition of 300 shares (the
"Shares"), representing 30% of the issued and outstanding shares of Cheer Era
Limited, a newly formed company incorporated in Hong Kong SAR ("Cheer Era"). The
consideration for the Shares was an aggregate value of approximately
USD$1,156,812, which was paid in cash and shares of Common Stock, and a warrant
to purchase up to 80,000 shares of Common Stock. The consideration was paid as
follows:
43
(i) approximately USD$771,208 by delivery of 149,459 shares of Common
Stock as consideration for the purchase of 100 of the Shares from Apex Legend
Limited, a company incorporated in the British Virgin Islands ("Apex") within
thirty (30) days of the signing of the agreement for the purchase of the Shares.
All of the Common Stock deliverable to Apex is being held in escrow pursuant to
the terms of an escrow agreement, which provides that the Common Stock will be
released in installments over the twelve month period following the consummation
of the purchase and sale of the Shares, provided, that Cheer Era attains certain
net income milestones during such period. In the event there is a shortfall in
the net income during the period, Apex shall return to the Company shares of the
Common Stock equivalent to the dollar amount of such shortfall divided by $6.00;
and
(ii) approximately USD$385,604 in cash directly to Cheer Era within
thirty (30) days of the closing of the purchase and sale of the Shares for the
Company's subscription to purchase 200 of the Shares. The cash used to pay for
the Shares was from working capital of the Company.
(iii) A common stock purchase warrant to purchase 80,000 shares of PACT
common stock, par value $0.0001 per share. The exercise price under this warrant
shall be the 5-Day volume weighted average price of the common stock of PACT
before the signing date of this Agreement, exercisable within 3 years from the
date of issuance.
5. PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following as of December 31 (in
thousands):
2004 2003
---- ----
Office furniture, fixtures and leasehold improvements $1,411 $4
Computers and office equipment 4,261 4,938
Motor Vehicles -- 16
Less: Accumulated depreciation (4,554) (4,476)
-------------------
Net Property and Equipment $1,118 $466
===================
Depreciation charged to expense during the years ended December 31, 2004 and
2003 was $78,000 and $72,000, respectively.
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company leases warehouse and office space under operating
leases for two years with fixed monthly rentals that expire through 2005. None
of the leases included contingent rentals. Lease expense charged to operations
for 2004 amounted to $397,854 (2003: $109,000). Future minimum lease payments
under non-cancelable operating leases are as follows: 2005: $104.
RESTRICTED CASH - The Company has other restricted cash in the aggregate amount
of $3,289,000 representing overdraft protections with certain financial
institutions.
BANK LINE OF CREDIT (2004): The Company has an overdraft banking facility with
certain major financial institutions in the aggregate amount of $1,309,000,
which is secured by a pledge of the Company's fixed deposits of $212,000,
pursuant to the following terms: interest will be charged at the Hong Kong Prime
Rate per annum and payable at the end of each calendar month or the date of
settlement, whichever is earlier. As of December 31, 2004, the Company utilized
$651,000 of the above-mentioned banking facility.
BANK LINE OF CREDIT (2003): The Company has an overdraft banking facility with
certain major bankers in the aggregate amount of $1,309,000 which is secured by
a pledge of the Company's fixed deposits in the amount of $212,000, pursuant to
the following terms: interest will be charged at the Hong Kong Prime Rate per
annum and payable at the end of each calendar month or the date of settlement,
which ever is earlier. As of December 31, 2003, the Company utilized
US$1,199,000 of the above-mentioned banking facility.
44
7. BANK LOANS
Bank loans represent the following at December 31 (in thousands):
2004 2003
-------------------------
Secured [1] $860 $1,776
Unsecured $536 $6
Less: current portion (1,327) (1,405)
-------------------------
Non current portion $69 $377
=========================
[1] The loans were secured by the following: joint and several personal
guarantees executed by certain directors of the subsidiary of the Company;
corporate guarantee executed by a subsidiary of the Company; second legal charge
over a property owned by a subsidiary of the Company; and pledged bank deposits
of $212,000 of a subsidiary of the Company.
Aggregate future maturities of borrowing for the next five years are as follows:
(2005: $1,327,000 and 2006: $69,000).
8. CAPITAL LEASE OBLIGATIONS
The Company leases various equipment under capital leases expiring in various
years through 2005. The assets and liabilities under capital leases are recorded
at the lower of the present value of the minimum lease payments or the fair
value of the asset. The assets are depreciated over the lesser of their related
lease terms or their estimated productive lives and are secured by the assets
themselves. Depreciation of assets under capital leases is included in
depreciation expense for 2003 and 2002.
Aggregate minimum future lease payments under capital leases as of December 31,
2004 for each of the next five years are as follows: (2005: $80,000; 2006:
$66,000; and 2007: $63,000)
Capital lease obligations represent the following at December 31 (in thousands):
2004 2003
-------------------------
Total minimum lease payments $225 $328
Interest expense relating to future periods (16) (27)
-------------------------
Present value of the minimum lease payments 209 301
Less: current portion (80) (152)
-------------------------
Non current portion $129 $149
=========================
Following is a summary of fixed assets held under capital leases at December 31
(in thousands):
2004 2003
-------------------------
Computers and office equipment $268 $268
Less: accumulated depreciation (246) (205)
-------------------------
$22 $63
=========================
45
9. SUBSCRIPTION PAYABLE
In December 2003, the Company executed agreements and acquired controlling
interests in two subsidiaries. The purchase price was payable in cash and shares
of common stock and resulted in a subscription payable as follows:
Epro Telecom Holdings Limited $ 500,000
Beijing Linkhead Technologies Co., Limited $ 222,500
---------
$ 722,500
See note 2 for details regarding the acquisitions.
10. STOCKHOLDERS' EQUITY
a) ALLOTMENT AND REPURCHASE OF COMMON AND RESTRICTED STOCK
COMMON STOCK
For the year ended 31 December, 2004, the Company issued (i) 1,756,240 shares
with a market value of $8,866,000 to acquire various subsidiaries (see Note 2
for details); (ii) 352,364 shares as a result of exercise of stock options and
warrants with cash consideration of $716,000; (iii) 2,205,697 shares for cash
proceeds of $11,773,000 (net of offering costs); (iv) 149,459 shares with a
market value of $771,000 for acquisition of affiliated company (see Note 4 for
details); and (v) repurchase of 36,154 as treasury shares for $99,000.
For the year ended December 31, 2003, the Company issued (i) 16,725 shares for
cash consideration of $27,000 to settle expenses;, (ii) 200,000 shares as a
result of providing compensation for officer according to the employment
contract of $100,000; (iii) 240,000 shares as a result of the exercise of stock
options and warrants for cash consideration of $410,000; and (iv) the Company
returned to treasury 800,000 shares issued as a deposit for a business
acquisition that was terminated.
b) STOCK OPTION PLAN
On December 23, 2003, stockholders of the Company adopted an amendment to the
Stock Option Plan (the "Plan") to increase the number of shares reserved under
the Plan from 1,666,667 to 2,000,000. On December 30, 2004, stockholders of the
Company approved the new 2005 Stock Option Plan (the "2005 Option Plan"). The
2005 Option Plan would provide for the grant to directors, officers, employees
and consultants of the Company (including its subsidiaries) of options to
purchase up to an aggregate of 2,000,000 shares of Common Stock. The 2005 Plan
may be administered by the Board of Directors or a committee of the Board of
Directors (in either case, the "Committee"), which has complete discretion to
select the optionees and to establish the terms and conditions of each option,
subject to the provisions of the 2005 Option Plan. Options granted under the
2005 Plan may be "incentive stock options" as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), or nonqualified options.
The purpose of the Plan is to attract and retain the best available personnel
for positions of responsibility and to provide incentives to such personnel to
promote the success of the business. The Plan provides for the grant to
directors, officers, employees and consultants of the Company (including its
subsidiaries) of options to purchase shares of common stock. Options granted
under the Plan may be "incentive stock options" as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified
options. To date, all options granted have been nonqualified options. The
exercise price of incentive stock options may not be less than 100% of the fair
market value of the common stock as of the date of grant. The number of options
outstanding and the exercise price thereof are subject to adjustment in the case
of certain transactions such as mergers, recapitalizations, stock splits or
stock dividends. Options granted under the Plan fully vest through June 2005.
46
The status of the Stock Option Plan as of December 31, 2004, is as follows:
WEIGHTED
AVERAGE
OPTIONS EXERCISE PRICE
--------------- --------------
OUTSTANDING, DECEMBER 31, 2002 312,600 $1.13
Granted 963,000 $2.97
Exercised (350,000) $1.13
--------------
OUTSTANDING, DECEMBER 31, 2003 925,600 $2.87
Granted 600,000 $2.00
Cancelled (400,000) $4.25
Exercised (321,500) $2.11
--------------
OUTSTANDING, DECEMBER 31, 2004 804,100 $1.90
==============
Additional information on options outstanding as of December 31, 2004 is as
follows:
WEIGHTED
AVERAGE AVERAGE REMAINING
EXERCISE PRICE OPTIONS CONTRACTUAL LIFE
----------------- --------- -----------------
Options outstanding $ 2.90 804,100 2.17 years
Options exercisable $ 2.07 547,000 1.50 years
c) WARRANTS
Total warrants outstanding as of December 31, 2004 are 1,752,002. The weighted
average remaining life is 2.08 years and the weighted average price per share is
$4.93 per share.
A SUMMARY OF WARRANTS OUTSTANDING IS AS FOLLOWS:
o On January 15, 2004, as part of a private placement fund raising, the
Company issued warrants to purchase up to 154,320 shares of common stock of
the Company at an exercise price of $7.15 per share. The warrants are
exercisable through January 15, 2009.
o On April 12, 2004, the Company issued warrants to YueShen to purchase up to
50,000 shares of the common stock at an exercise price equal to the 5 day
volume weighted average price ($5.27) of the of the Company's common stock
prior to April 12, 2004. 16, 2004. The warrant is exercisable for a period
of three years from the date of issuance.
o On April 16, 2004, the Company issued warrants to Cheer Era to purchase up
to 80,000 shares of the common stock at an exercise price equal to the 5
day volume weighted average price ($6.00) of the of the Company's common
stock prior to April 16, 2004. The warrant is exercisable for a period of
three years from the date of issuance.
o On September 15, 2004, the Company issued warrants to purchase up to 50,000
shares of common stock at an exercise price equal to the 5 day volume
weighted average price ($2.82) of the Company's common stock before the
signing of the agreement with Smartime. The warrants are exercisable for a
period of 3 years from the date of issuance.
o On December 16, 2004, the Company issued warrants to Clickcom to purchase
up to 50,000 shares of the common stock at an exercise price equal to the 5
day volume weighted average price ($10.45) of the of the Company's common
stock prior to December 16, 2004. The warrant is exercisable for a period
of three years from the date of issuance.
o On November 15, 2004, as part of a private placement fund raising, the
Company issued warrants to purchase up to 117,682 shares of common stock of
the Company at an exercise price of $3.89 per share. The warrants are
exercisable through November 15, 2009.
o On December 19, 2004, as part of a private placement fund raising, the
Company issued warrants to purchase up to 350,000 shares of common stock of
the Company at an exercise price of $12.21 per share. The warrants are
exercisable through January 15, 2009.
47
o On March 25, 2002, the Company issued warrants to purchase up to 600,000
shares of common stock of the Company at an exercise price of $1.45 per
share. The warrants are exercisable through April 5, 2005.
o On December 30, 2002, the Company issued warrants to purchase up to 300,000
shares of common stock of the Company at an exercise price of $1.74 per
share. The warrants are exercisable through December 30, 2005.
THE FOLLOWING WARRANTS WERE EXERCISED DURING 2004 AND 2003:
For the year ended December 31, 2004, 30,864 warrants were exercised at an
exercise price of $7.15 per share for total proceeds of $220,678. For the year
ended December 31, 2003, 100,000 warrants were exercised at an exercise price of
$1.75 per share for total proceeds of $175,000.
11. INCOME TAXES
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,
2004 and 2003. Provision for Hong Kong profits tax for 2004 was $10,000 (2003:
$32,000). Provision for PRC business tax for 2004 was $20,000 (2003: Nil). There
is no provision for U.S. federal income tax due to the Company's loss position.
Deferred tax asset represents the tax benefit of U.S. net operating loss carry
forwards as follows:
2004 2003
---------- ----------
Non current deferred tax asset $ 1,434 $ 1,146
Valuation allowance (1,434) (1,146)
---------- ----------
Net deferred tax asset $ -- $ --
========== ==========
The Company and its subsidiaries are subject to income taxes on an equity basis
on income arising in or derived from the tax jurisdictions in which they
operate. The Company is subject to United States federal income tax at a rate of
34%. The Hong Kong subsidiaries are subject to Hong Kong profits tax at a rate
of 17.5%. The PRC subsidiaries are subject to Business Tax at a rate of 5%. No
tax benefits have been recorded related to the loss generated by the Company or
any or it subsidiaries. The reconciliation of the United States federal income
tax rate to the effective income tax rate based on the loss before income taxes
in the consolidated statements of operations is as follows (in thousands):
Entity 2004 2003
------ ---------- ----------
Company, including discontinued operations $ (915) $ (771)
PRC subsidiaries 1,344 --
Hong Kong subsidiaries 345 (1,107)
---------- ----------
Total $ 774 $ (1,878)
========== ==========
No tax benefits have been recorded related to the loss generated by the Company
or any of its subsidiaries.
The valuation allowance increased by $296 and $456 at December 31, 2004 and
2003, respectively. The Company has U.S. net operating loss carryforwards of
approximately $4,172,000 available to offset future income, which expire through
2024. Pursuant to the Tax Reform Act of 1986, annual utilization of the
Company's net operating loss carry forwards may be limited if a cumulative
change in ownership of more than 50% is deemed to occur within any three-year
period.
48
12. RELATED PARTY TRANSACTIONS
Employment Agreement - The Company has an employment agreement with its Chief
Executive Officer (CEO) and President. The employment agreement with the CEO
provides for $100,000 cash compensation plus $60,000 annual share compensation
until April 1, 2005. The CEO is also eligible for an annual bonus for each
fiscal year of the Company during the term based on performance standards as the
Board or compensation committee designates. The CEO is entitled to receive a
monthly housing allowance of $2,500, monthly automobile allowance of $500, Tax
Preparation expenses of $2,000 per year, and Cash Bonus based on net profit of
the Company. During 2004, under the Company's stock option plan, the CEO was
granted an option to acquire 65,000 shares at an exercise price per share of
$2.00 (at market price) which has not been exercised. During 2004, under the
Company's stock option plan, the President was granted an option to acquire
73,000 shares at an exercise price per share of $2.00 (at market price) which
has not been exercised.
Lease Agreement - In November 2004, the Company entered a lease agreement with
EPRO for rental space in the amount of $1,923 per month. The term of the lease
was one year and renewable by either party.
13. SEGMENT INFORMATION
The Company's reportable segments are operating units, which represent the
operations of the Company's significant business operations. Summarized
financial information concerning the Company's reportable segments is shown in
the following table. The "Other" column includes the Company's other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable segments
----------------------- ----------------------- ---------------------- ----------------------- ------------------- -----------------
FOR THE YEAR ENDED 1. 2. 3. Communications
DECEMBER 31, 2004 Outsourcing Business VAS Business Distribution Business Admin & Other Total
($) ($) ($) ($) ($)
----------------------- ----------------------- ---------------------- ----------------------- ------------------- -----------------
Revenues 9,385,000 5,724,000 11,790,000 2,810,000 29,709,000
----------------------- ----------------------- ---------------------- ----------------------- ------------------- -----------------
Profit / (Loss) from
Operations 1,000,000 1,859,000 85,000 (1,007,000) 1,937,000
----------------------- ----------------------- ---------------------- ----------------------- ------------------- -----------------
Total assets 6,017,000 2,600,000 5,018,000 19,018,000 32,653,000
----------------------- ----------------------- ---------------------- ----------------------- ------------------- -----------------
For the year ended December 31, 2003, the Company's operations did not meet the
description of any of the Company's 2004 operating units and accordingly, no
information has been provided.
14. EVENTS SUBSEQUENT TO DECEMBER 31, 2004 (UNAUDITED)
In January 2005, the Company set up a 51% interests subsidiary PacificNet Power
Ltd ("PacificNet Power") which specializes in IT solutions, systems integration,
software application, energy saving and electric power management systems and
solutions in Hong Kong and Greater China.
On December 16, 2004, the Company entered into an agreement to acquire a
controlling interest in GuangZhou Dianxun Digital Network Technology Co., Ltd
("Clickcom-WOFE") through the purchase of a 51% interest of Clickcom-WOFE's
parent company, Clickcom-BVI. The acquisition was completed on 28 March 2005.
49
On March 30, 2005, the Company entered into an agreement to acquire a
controlling interest in Guangzhou 3G Information Technology Co. Ltd.
("Guangzhou3G-WOFE"), through the purchase of a 51% interest of
Guangzhou3G-WOFE's parent company, Pacific 3G Information & Technology Co.
Limited (Guangzhou3G-BVI), a British Virgin Islands company.
[END OF AUDITED FINANCIAL STATEMENTS]
50
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 8A CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including our chief executive officer and the chief financial
officer, the Company conducted an evaluation of the effectiveness of the design
and operation of its disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end
of the period covered by this report (the "Evaluation Date"). Based on this
evaluation, the Company's chief executive officer and chief financial officer
concluded as of the Evaluation Date that the Company's disclosure controls and
procedures were effective such that the material information required to be
included in our Securities and Exchange Commission ("SEC") reports is recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms relating to the Company, including our consolidating
subsidiaries, and was made known to them by others within those entities,
particularly during the period when this report was being prepared.
Additionally, there were no significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the Evaluation Date. We have not identified any
significant deficiencies or material weaknesses in our internal controls, and
therefore there were no corrective actions taken.
ITEM 8B. OTHER INFORMATION
None
51
PART III
ITEM 9. DIRECTORS AND OFFICERS
Set forth below are the names of the directors, executive officers and
key employees of the Company as of April 15, 2005:
Name Age Title
-------------------- --- -----------------------------------------------------
Tony Tong 36 Chairman and Chief Executive Officer
Victor Tong 34 President, Secretary, and Director
ShaoJian (Sean) Wang 41 Chief Financial Officer, Vice President, and Director
Peter Wang 50 Director
Michael Ha 35 Director
Jeremy Goodwin 31 Director
Tao Jin 37 Director
Brian Lin 40 Vice President of PacificNet China Operations
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 director and executive
officer's business experience:
Mr. Tony Tong, age 36, is the Chairman, CEO, Executive Director, and
founder of PacificNet. From 1995 to 1997, Mr. Tong served as the Chief
Information Officer of DDS Inc., a leading SAP-ERP consulting company in the
USA, which was later acquired by CIBER, Inc. (NYSE: CBR). From 1993 to 1994, Mr.
Tong worked for Information Advantage, Inc. (Nasdaq:IACO), a leading business
intelligence, Data-Mining and CRM technology provider serving Fortune 500
clients. IACO consummated an IPO on Nasdaq in 1997 and was later acquired by
Sterling Software and Computer Associates (NYSE: CA). From 1992 to 1993, Mr.
Tong worked as a Business Process Re-engineering Consultant at Andersen
Consulting (now Accenture, NYSE:ACN). From 1990 to 1991, Mr. Tong worked for 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 the US Patent and Trademark Office) titled
"Computerized Work Flow System, an Internet-based workflow management system for
automated web creation and process management." Mr. Tong also serves on the
board of advisors of Fortune Telecom (listed on Hong Kong Stock Exchange:
0110.HK), a leading distributor of mobile phones, PDAs, telecom services, and
accessories in China and Hong Kong. Mr. Tong is a frequent speaker on technology
investment in China, and was invited to present at the Fourth APEC International
Finance & Technology Summit in 2001. Mr. Tong is the Vice Chairman (PRC) of Hong
Kong Call Centre Association, a Fellow of Hong Kong Institute of Directors, a
consultant on privatization and securitization for China's State-Owned Assets
Supervision and Administration Commission (SASAC), and a frequent speaker for
LexisNexis, a licensed Continued Professional Development (CPD) trainer, on
China investment. Mr. Tong 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. Tony Tong is the brother of Victor Tong.
Mr. Victor Tong, age 34, currently is the President, Secretary and an
Executive Director of the Company. Mr. Victor Tong gained his consulting,
systems integration, and technical expertise in client/server systems through
his experience at Andersen Consulting (now Accenture), American Express
Financial Advisors (IDS), 3M, and the Superconductivity Center at the University
52
of Minnesota. In 1994, Victor co-founded Talent Information Management ("TIM").
The Company was originally founded as an operating division of TIM. As the
managing partner, Mr. Tong sold GoWeb consulting division of TIM to a
billionaire in Minnesota USA in late 1997 and became the President of KeyTech, a
leading information technology consulting company based in Minnesota. In 1999,
he was recognized in "CityBusiness 40 Under 40" as one of the future business
and community leaders in Minnesota. Mr. Tong won the Student Commencement
Speaker Award while graduated with honors with a Bachelor of Science in Physics
from the University of Minnesota. Mr. Tong is a guest professor at College of
Software of Beihang University, one of the top software colleges in China.
Victor Tong is the brother of Tony Tong.
Mr. ShaoJian (Sean) Wang, age 41, is the Chief Financial Officer, Vice
President of International Business and is one of our Directors. Mr. Wang has
served on our board of directors since 2002. Sean Wang also serves as the
chairman of GoVideo since January 2005. GoVideo is subsidiary Opta which is a
majority owned subsidiary of PRC-based consumer electronics company TCL
Corporation. TCL entered into joint ventures with Alcatel and Thomson/RCA in
2004, becoming a worldwide leader in television and mobile phones. Before that,
Mr. Wang served as managing director of Thian Bing Investments PTE, Ltd from
1993 to 2002, where he managed the Singapore-based company's multi-million
dollar investment operations and identified strategic and investment
opportunities. From 1987 to 1993, Mr. Wang held a number of increasingly
important positions with St. Paul, Minnesota-based Ecolab Inc., culminating in
his serving as general manager for the company's Indonesia operations. Mr. Wang
led the strategic marketing initiatives, built high-profile business
partnerships, negotiated joint venture agreements, and positioned Ecolab as a
market leader. Mr. Wang received a Bachelor of Science Degree in Economics from
Hamline University in St. Paul, Minnesota, and a Masters of Business
Administration from The Carlson School of Management at the University of
Minnesota. Mr. Wang also attended Peking University in Beijing, China, and
originally came to the United States as an exchange student.
Mr. Bin "Brian" Lin, age 40, was promoted to the Vice President for
PacificNet China Operations in March 2005. Mr. Lin is currently President of
Beijing Linkhead Technologies Co., Ltd (BLT), a company that is 51% owned by
PacificNet Strategic Investment Holding Limited, which is a wholly owned
subsidiary of PacificNet Inc. Mr. Lin began his career 1989 as a Member of
Scientific Staff with BNR, a research and development division of Nortel in
Canada. Mr. Lin has gained strong professional management skills and technical
expertise in telecommunications industry in the US and Canada through working at
BNR, Tandem Telecom (the telecom division of Tandem Computer), Motorola. In
1998, Mr. Lin joined UTStarcom in the US and relocated to China to manage the
Telecom Value Added Services division of UTStarcom. In 1999, Mr. Lin served as
President of Beijing Linkhead Information Technologies (BLIT). Under his
leadership, BLIT has rolled out large call center systems and VoIP gateways, and
has more than doubled company sales revenue to over US$4M in 2000. At the end of
2000, iSoftel Ltd, a Singapore company bought over BLIT and Mr. Lin has served
as President of BLIT and iSoftel (Beijing) from 2001 to 2002. In 2003, Mr. Lin,
along with other management team and investors, bought the business of BLIT and
formed BLT to focus on telecom value added services platforms and solutions such
as QQ chat, Color Ring Back Tone and Background Music. Mr. Lin received the
Master of Applied Science degree in Electrical Engineering from University of
Toronto in 1989.
Mr. Peter Wang, age 50, is a Director. Mr. Wang has served on our board
of directors since 2003. Mr. Wang serves as Chief Executive Officer of China
Quatum Communications Ltd., a privately-held company. Mr. Wang was a founder of
Unitech Telecom (now named UTStarcom, NASDAQ: UTSI). Under his management,
UTStarcom created the first digital loop carrier system and installed the first
PHS (Personal Handyphone System) system in China. As an entrepreneur, he has
successfully co-founded and built other ventures in the US, including World
Communication Group and World PCS, Inc. Before forming his own companies, he
worked at AT&T Bell Labs and Racal-Milgo Information System. With AT&T Bell
Labs, he worked on Network Evolution Planning and representing AT&T Network
System Division served on Network Management Protocol Forum. With Racal-Milgo,
he worked on network management system architecture as a senior engineer. As
part of the technologically trained community in China, he was elected Deputy
Chairman of the Association of Privately Owned High-tech Enterprises in China.
He has been elected president of the first Chinese PACS User and Providers Forum
that promotes the international PCS standard worldwide. He also served on the
boards of directors of many U.S. and Chinese companies, specifically Joray
Enterprises Inc., Phoenix Tech Ltd. and World Communication Group. Mr. Wang has
a BS in Computer Science and a MS in Electrical Engineering from University of
Illinois, as well as an MBA in Marketing from Southeast-Nova University.
53
Mr. Michael Chun Ha, age 35, is a Director. Mr. Ha has served on our
board of directors since 2003. Mr. Ha graduated from the Faculty of Law,
University of Hong Kong in 1994 with a bachelor degree in law and was admitted
as a solicitor of the High Court of the Hong Kong Special Administrative Region
in 1997 and a solicitor of the Supreme Court of England and Wales in 1998. From
1995 to 2002, Mr. Ha worked as a lawyer in a number of prestigious international
and Hong Kong law firms, specializing in the areas of corporate finance,
securities offerings, takeovers, cross-border mergers and acquisitions, venture
capital, corporate restructuring, regulatory and compliance issues, project
finance, and general commercial transactions and services in Hong Kong and the
People's Republic of Hong Kong. In 2002, Mr. Ha commenced his own practice in
the trade name of "Ha and Ho Solicitors". Mr. Ha specializes in the areas of
general commercial transactions, corporate finance and civil and criminal
litigation. Mr. Ha has been the company secretary of Shanxi Central
Pharmaceutical International Company Limited, a Hong Kong main board listed
company, and since 2003 Mr. Ha has been a director of a private investment
company, Metro Concord Investment Limited.
Mr. Jeremy Goodwin, age 31, is a Director. Mr. Goodwin has served as a
Vice President with Global Capital Group since 2002. From 1999 to 2001, Mr.
Goodwin worked 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 Dutch.
Mr. Tao Jin, age 37, is a Director. Mr. Jin is a Vice President and
Assistant General Counsel of J.P. Morgan Chase Bank. 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.
COMPLIANCE WITH SECTION 16(a) OF EXCHANGE ACT
Based on the Company's review of copies of Forms 3, 4 and 5 filed with
the Securities and Exchange Commission (the "SEC") or written representations
from certain reporting persons, we believe that during fiscal year 2004, all
officers, directors, and greater than ten-percent beneficial owners timely
complied with the applicable filing requirements of Section 16(a) of the
Securities Exchange Act of 1934, except that Sino Mart Management Limited failed
to timely file Form 4's reflecting four open market stock purchase transactions,
Mr. Shao Jian Wang failed to timely File Form 4's reflecting three transactions,
and Messrs. Jeremy Goodwin and Jin failed to timely file Form 3's.
54
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all cash compensation paid or to be paid
by the Company, as well as certain other compensation paid or accrued, during
each of the Company's last three fiscal years to each named executive officer.
------------------------- ------------- ----------------------------------- -------------------------------------------
Annual Compensation Long Term Compensation Awards
------------------------- ------------- ----------------------------------- -------------------------------------------
Name / Restricted Stock All Other
Principal Position Fiscal Year Salary ($) Bonus ($) Other ($) Stock Award ($) Options Comp. ($)
------------------------- ------------- ----------- ----------- ----------- --------------- ------------ --------------
Tony Tong, CEO 2004 $70,000 - - - 65,000 -
------------------------- ------------- ----------- ----------- ----------- --------------- ------------ --------------
2003 $100,000 - - 120,000 -
------------------------- ------------- ----------- ----------- ----------- --------------- ------------ --------------
2002 $110,000 - - $57,900 206,000 -
------------------------- ------------- ----------- ----------- ----------- --------------- ------------ --------------
OPTION GRANTS
The following table sets forth certain information with respect to stock option
grants to our executive officers during the fiscal year ended December 31, 2004.
OPTION GRANTS DURING FISCAL YEAR 2004 (INDIVIDUAL GRANTS)
Potential Realizable Value at
Assumed Rates of Stock Price
Appreciation for Option Term(3)
---------------------- ----------- -------------------- ----------- ------------- --------------- ----------------
% of Total Options Exercise
Options Granted to Employees or Expiration
Name Granted (1) in 2004 (2) Base Price Date 5% 10%
---------------------- ----------- -------------------- ----------- ------------- --------------- ----------------
Tony Tong, CEO 65,000 16% $2.00 July 26, 2007 $ 150,491 $ 173,030
---------------------- ----------- -------------------- ----------- ------------- --------------- ----------------
(1) All options were granted pursuant to our 1999 Stock Plan and as amended in
2002 and 2003. The options have a ten-year term and vest and become exercisable
over three years. In the event of a change in control of the Company, the
options will be substituted by the successor corporation or will fully vest and
become exercisable for a period of fifteen days.
(2) Based on an aggregate of 2,000,000 shares subject to options granted to our
employees in 2004.
(3) Potential realizable values are computed by (a) multiplying the number of
shares of Common Stock subject to a given option by the exercise price, (b)
assuming that the aggregate stock value from that calculation compounds at the
annual 5% or 10% rate shown in the table for the entire three-year term of the
option and (c) subtracting from that result the aggregate option exercise price.
The 5% and 10% assumed annual rates of stock price appreciation are mandated by
the rules of the SEC and do not represent our estimate or projection of future
Common Stock prices.
55
OPTION EXERCISE AND VALUES
Aggregated Option Exercises During Fiscal Year 2004 and Fiscal Year-End Option
Values.
The following table sets forth information for our executive officers relating
to the number and value of securities underlying exercisable and unexercisable
options they held at December 31, 2004 and sets forth the number of shares of
Common Stock acquired and the value realized upon exercise of stock options held
as of December 31, 2004 by our executive officers.
-------------------------- --------------- ------------- ---------------------------------- ------------------------------------
SHARES VALUE ($) OF UNEXERCISED
ACQUIRED ON VALUE NO. OF SECURITIES UNDERLYING IN-THE-MONEY OPTIONS AT 12/31/04 (2)
NAME EXERCISE REALIZED (1) UNEXERCISED OPTIONS AT 12/31/04
-------------------------- --------------- ------------- ---------------------------------- ------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
-------------------------- --------------- ------------- ----------------- ---------------- ------------------ -----------------
Tony Tong, CEO 0 $0 36,000 65,000 $293,760 $528,450
-------------------------- --------------- ------------- ----------------- ---------------- ------------------ -----------------
(1) The "Value Realized" is based on the closing price of our Common Stock as
quoted on Nasdaq on the date of exercise, minus the per share exercise price,
multiplied by the number of shares issued upon exercise of the option.
(2) The value of unexercised in-the-money options is calculated based on the
difference between the closing price of $10.16 per share as quoted on Nasdaq on
December 31, 2004, and the exercise price for the shares, multiplied by the
number of shares underlying the option. The actual value of unexercised options
fluctuate depending on the price of our Common Stock.
AUDIT COMMITTEE OF THE BOARD OF DIRECTORS
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.
The board of directors has established an audit committee in accordance
with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The
members of the Audit Committee are Messrs. Peter Wang, Michael Chun Ha, Jeremy
Goodwin and Tao Jin, each of whom are considered "independent" under the Nasdaq
SmallCap 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" under the
Securities and Exchange Commission's definition.
56
COMPENSATION OF DIRECTORS
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 option 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.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL
On December 30, 2002, we entered into an Executive Employment Contract
with Tony Tong. Mr. Tong currently serves as our Chief Executive Officer. The
employment agreement provides for Mr. Tong to earn an annual base salary of
$100,000 in cash, plus $60,000 in stock compensation annually until April 1,
2005. 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 Board or
compensation committee designates. Mr. Tong is entitled to receive a monthly
housing allowance of $2,500, monthly automobile allowance of $500, tax
preparation expenses of $2,000 per year, and cash bonus based on our net profit.
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. Our Code of Ethics is intended to be a codification
of the business and ethical principles which guide us, and 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.
57
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth as of March 31, 2004 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.
NUMBER OF % OF COMMON
SHARES STOCK STOCK
BENEFICIALLY BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OWNED
------------------------------------ ------------ ------------
Sino Mart Management Ltd. (2)
c/o ChoSam Tong
16E, Mei On Industrial Bldg.
17 Kung Yip Street, Kwai Chung, NT, Hong Kong 1,850,000 15.4%
ChoSam Tong (3)
16E, Mei On Industrial Bldg.
17 Kung Yip Street, Kwai Chung, NT, Hong Kong 1,903,000 15.8%
Kin Shing Li (4)
Rm. 3813, Hong Kong Plaza
188 Connaught Road West, Hong Kong 1,150,000 9.6%
Tony Tong (5) 300,000 2.5%
Victor Tong (6) 145,000 1.2%
ShaoJian (Sean) Wang (7) 25,000 *
Peter Wang(8) 25,000 *
Michael Chun Ha(9) 25,000 *
Tao Jin (10) 5,000 *
Jeremy Goodwin (11) 5,000 *
All directors and officers as a group (6 persons) 530,000 4.4%
* Less than one percent.
** The address for each beneficial owner not otherwise specified is:
c/o PacificNet Inc., 860 Blue Gentian Rd., Suite 360, Eagan, MN 55121.
USA.
(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. Includes 600,000 warrants issued to
Sino Mart which was approved at a special stockholder meeting held on
March 25, 2002.
(3) Includes shares of common stock of Sino Mart Management Ltd., which is
owned by Mr. ChoSamTong.
(4) Information obtained from the Schedule 13D/A filed by Mr. Kin Shing Li
on October 14, 2003.
58
(5) Includes Currently Exercisable Options to acquire 101,000 shares of
common stock. Excludes 1,850,000 shares owned by Sino Mart Management
Ltd., as to which shares Mr. Tony Tong disclaims beneficial ownership.
(6) Includes Currently Exercisable Options to acquire 109,000 shares of
common stock. Excludes 1,850,000 shares owned by Sino Mart Management
Ltd., as to which shares Mr. Victor Tong disclaims beneficial
ownership.
(7) Represents shares issuable upon exercise of Currently Exercisable
Options.
(8) Represents shares issuable upon exercise of Currently Exercisable
Options.
(9) Represents shares issuable upon exercise of Currently Exercisable
Options.
(10) Represents shares issuable upon exercise of Currently Exercisable
Options.
(11) Represents shares issuable upon exercise of Currently Exercisable
Options.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth aggregate information regarding the
Company's equity compensation plans in effect as of December 31, 2004:
Weighted-average
Number of securities to exercise price of Remaining available
be issued upon exercise outstanding options, for further issuance
of outstanding options, warrants and rights under equity
warrants and rights ($) compensation plans
Equity compensation plans approved by
security holders (under 1998 Stock Option
Plan)(1) 804,100 2.90 522,000
Equity compensation plans approved by
security holders (under 2005 Stock Option
Plan)(2) 0 N/A 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 1998 Stock
Option Plan.
(2) Reflects options granted and available for issuance under the 2005 Stock
Option Plan.
59
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On March 28 2002, the Company completed a $3,480,000 private placement
by issuing 2,400,000 shares of restricted common stock at a price of $1.45 per
share to Sino Mart Management Limited ("Sino Mart"), whose executive director is
the father of the chairman and CEO of the Company. In addition, the Company
issued Sino Mart a warrant to purchase up to an additional 600,000 shares of
restricted common stock at $1.45 per share. The warrant is fully exercisable
beginning on April 1, 2002. The $3,480,000 private placement transaction was
approved at a special stockholder meeting held on March 25, 2002. The Company's
issuance of the restricted shares and warrant to Sino Mart represented
approximately 62% of the number of shares of the Company's common stock
outstanding after the private placement, based on beneficial ownership on a
fully-diluted basis, making Sino Mart the largest shareholder of the Company and
resulting in a change of control of the registrant.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
EXHIBITS
The following exhibits are filed as part of this report:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Share Exchange Agreement by and among Davin Enterprises, Inc.,
Carl Tong, Leo Kwok and Acma Strategic Holdings Limited dated
December 15, 1997. (1)
2.2 Share Exchange Agreement dated February 17, 2000, between
Registrant and holders of membership interests in PacificNet.com
LLC.(2)
2.3 Supplement to Share Exchange Agreement dated April 29, 2000,
between Registrant and holders of membership interests in
PacificNet.com LLC. (2)
2.4 Agreement dated September 30, 2000, among the Company and the
"Purchasers" named therein. (3)
2.5 Supplemental Agreement dated October 3, 2000, among the Company
and the "Purchasers" named therein. (3)
2.6 Deed of Waiver, dated October 3, 2000, by Creative Master
Limited in favor of the Company. (3)
3.1 Certificate of Incorporation, as amended. (4)
3.2 Form of Amended By Laws of the Company. (4) Specimen Stock
Certificate of the Company.
4.1 Securities Purchase Agreement, dated as of January 15, 2004,
among PacificNet Inc. and the purchasers identified therein (5)
4.2 Form of Common Stock Warrant issued to each of the purchasers
(5)
4.3 Form of Common Stock Warrant issued to each of the purchasers,
dated December 9, 2004 (10)
4.4 Form of Common Stock Warrant issued to each of the purchasers,
dated November 17, 2004 (10)
10.1 Form of Indemnification Agreement with officers and directors.
(1)
10.2 Amendment to 1998 Stock Option Plan. (8)
10.3 Form of Notice of Stock Option Grant and Stock Option Agreement
under the 1998 Stock Option Plan. (2)
10.4 Amendment dated January 31, 2002 to the Subscription Agreement
by and between the Company and Sino Mart Management Ltd., dated
as of December 9, 2001 (6)
10.6 Sub-Lease Agreement dated August 30, 2002.(8)
10.7 Agreement dated on December 1, 2003 for the Sale and Purchase
and Subscription of Shares in Epro Telecom Holdings Limited (9)
10.8 Agreement dated on December 15, 2003 for the Sale and Purchase
of Shares in Beijing Linkhead Technologies Co., Ltd. (9)
10.9 Securities Purchase Agreement, dated as of December 9, 2004,
among PacificNetInc. and the purchasers identified therein (10)
10.10 Securities Purchase Agreement, dated as of November 17, 2004,
among PacificNet Inc. and the purchasers identified therein (10)
10.11 Agreement for the Sale and Purchase of Shares in Shanghai
Classic Group Limited (4)
10.12 Agreement for the Sale and Purchase of Shares of Cheer Era
Limited (11)
10.13 Agreement for the Sale and Purchase of Shares in Smartime
Holdings Limited
10.14+ Agreement for the Sale and Purchase of Shares in GuangZhou
Dianxun Digital Network Technology Co., Ltd.
10.15+ PacificNet Inc. 2005 Stock Option Plan
60
10.16+ Agreement for the Sale and Purchase of Shares in GuangZhou 3G
Information Technology Co., Ltd.
14 Code of Ethics (9)
21 List of Subsidiaries
31.1 CEO Certification Pursuant to Section 302 The Sarbanes-Oxley Act
of 2002
31.2 CFO Certification Pursuant to Section 302 The Sarbanes-Oxley Act
of 2002
32 CEO and CFO Certification Pursuant to Section 906 of The
Sarbanes-Oxley Act of 2002
99.2 Subscription Agreement by and between the Company and Sino Mart
Management Ltd., dated as of December 9, 2001 (6)
99.3 19.9% Private Placement Agreement and Amendments between Ho
Shu-Jen and PacificNet.com Inc. (7)
----------------
+ Filed herewith.
(1) Incorporated by reference to the Company's Form SB-2 filed on October 21,
1998.
(2) Incorporated by reference to the Company's Form 8-K filed on August 11,
2000.
(3) Incorporated by reference to the Company's Form 8-K filed on October 17,
2000.
(4) 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.
(5) Incorporated by reference to the Registration Statement on Form S-3 filed on
March 2, 2004
(6) Incorporated by reference to the Company's Form 8-K filed on March 20, 2002.
(7) Incorporated by reference to the Company's Form 10-KSB filed on April 16,
2002.
(8) Incorporated by reference to the Company's 10-KSB filed on March 31, 2003.
(9) Incorporated by referenced to the Company's Form 10-KSB filed on April
2, 2004.
(10) Previously filed as an exhibit to the Form SB-2 Registration Statement
filed on December 30, 2004.
(11) Incorporated by reference to the Company's Form 8-K filed on April 19,
2004.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During fiscal years ended December 31, 2004 and 2003, our principal
independent auditor was Clancy and Co., P.L.L.C. and its Hong Kong affiliate HLB
Hodgson Impey Cheng (collectively, "Clancy".) The following is a summary of the
Services provided and fees billed to us by Clancy:
AUDIT FEES
The aggregate fees billed by Clancy for professional services rendered
for the audit of the Company's annual financial statements for the fiscal years
ended December31, 2004 and 2003, and for the review of the financial statements
included in the Company's Quarterly Reports on Form 10-QSB for fiscal years 2004
and 2003 were $75,100 and $50,650, respectively.
AUDIT RELATED FEES
The aggregate fees billed by Clancy for professional services rendered
for audit related services, primarily related to the Company's registration
statements on Form SB-2 for fiscal years 2004 and 2003 were $7,860 and $3,200,
respectively.
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 Committee
before the audit commences. The independent auditor also submits an audit
services fee proposal, which also must be approved by the Committee before the
audit commences.
61
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: April 15, 2005 BY: /S/ TONY TONG
----------------------------
Tony Tong
Chief Executive Officer
Principal Executive Officer)
Date: April 15, 2005 BY: /S/ SHAO JIAN WANG
-----------------------------
Shao Jian Wang
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 April 15, 2005
------------------------
Tony Tong
/s/ VICTOR TONG Director, President and Secretary April 15, 2005
------------------------
Victor Tong
/s/ SHAO JIAN WANG Director and CFO April 15, 2005
------------------------
Shao Jian Wang
/s/ PETER WANG Director April 15, 2005
------------------------
Peter Wang
/s/ MICHAEL CHUN HA Director April 15, 2005
------------------------
Michael Chun Ha
/s/ TAO JIN Director April 15, 2005
------------------------
Tao Jin
/s/ JEREMY GOODWIN Director April 15, 2005
------------------------
Jeremy Goodwin
62
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Share Exchange Agreement by and among Davin Enterprises, Inc.,
Carl Tong, Leo Kwok and Acma Strategic Holdings Limited dated
December 15, 1997. (1)
2.2 Share Exchange Agreement dated February 17, 2000, between
Registrant and holders of membership interests in PacificNet.com
LLC.(2)
2.3 Supplement to Share Exchange Agreement dated April 29, 2000,
between Registrant and holders of membership interests in
PacificNet.com LLC. (2)
2.4 Agreement dated September 30, 2000, among the Company and the
"Purchasers" named therein. (3)
2.5 Supplemental Agreement dated October 3, 2000, among the Company
and the "Purchasers" named therein. (3)
2.6 Deed of Waiver, dated October 3, 2000, by Creative Master
Limited in favor of the Company. (3)
3.1 Certificate of Incorporation, as amended. (4)
3.2 Form of Amended By Laws of the Company. (4) Specimen Stock
Certificate of the Company.
4.1 Securities Purchase Agreement, dated as of January 15, 2004,
among PacificNet Inc. and the purchasers identified therein (5)
4.2 Form of Common Stock Warrant issued to each of the purchasers
(5)
4.3 Form of Common Stock Warrant issued to each of the purchasers,
dated December 9, 2004 (10)
4.4 Form of Common Stock Warrant issued to each of the purchasers,
dated November 17, 2004 (10)
10.1 Form of Indemnification Agreement with officers and directors.
(1)
10.2 Amendment to 1998 Stock Option Plan. (8)
10.3 Form of Notice of Stock Option Grant and Stock Option Agreement
under the 1998 Stock Option Plan. (2)
10.4 Amendment dated January 31, 2002 to the Subscription Agreement
by and between the Company and Sino Mart Management Ltd., dated
as of December 9, 2001 (6)
10.6 Sub-Lease Agreement dated August 30, 2002.(8)
10.7 Agreement dated on December 1, 2003 for the Sale and Purchase
and Subscription of Shares in Epro Telecom Holdings Limited (9)
10.8 Agreement dated on December 15, 2003 for the Sale and Purchase
of Shares in Beijing Linkhead Technologies Co., Ltd. (9)
10.9 Securities Purchase Agreement, dated as of December 9, 2004,
among PacificNetInc. and the purchasers identified therein (10)
10.10 Securities Purchase Agreement, dated as of November 17, 2004,
among PacificNet Inc. and the purchasers identified therein (10)
10.11 Agreement for the Sale and Purchase of Shares in Shanghai
Classic Group Limited (4)
10.12 Agreement for the Sale and Purchase of Shares of Cheer Era
Limited (11)
10.13 Agreement for the Sale and Purchase of Shares in Smartime
Holdings Limited
10.14+ Agreement for the Sale and Purchase of Shares in GuangZhou
Dianxun Digital Network Technology Co., Ltd.
10.15+ PacificNet Inc. 2005 Stock Option Plan
10.16+ Agreement for the Sale and Purchase of Shares in GuangZhou 3G
Information Technology Co., Ltd.
14 Code of Ethics (9)
21 List of Subsidiaries
31.1 CEO Certification Pursuant to Section 302 The Sarbanes-Oxley Act
of 2002
31.2 CFO Certification Pursuant to Section 302 The Sarbanes-Oxley Act
of 2002
32 CEO and CFO Certification Pursuant to Section 906 of The
Sarbanes-Oxley Act of 2002
99.2 Subscription Agreement by and between the Company and Sino Mart
Management Ltd., dated as of December 9, 2001 (6)
99.3 19.9% Private Placement Agreement and Amendments between Ho
Shu-Jen and PacificNet.com Inc. (7)
63
----------------
+ Filed herewith.
(1) Incorporated by reference to the Company's Form SB-2 filed on October 21,
1998.
(2) Incorporated by reference to the Company's Form 8-K filed on August 11,
2000.
(3) Incorporated by reference to the Company's Form 8-K filed on October 17,
2000.
(4) 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.
(5) Incorporated by reference to the Registration Statement on Form S-3 filed on
March 2, 2004
(6) Incorporated by reference to the Company's Form 8-K filed on March 20, 2002.
(7) Incorporated by reference to the Company's Form 10-KSB filed on April 16,
2002.
(8) Incorporated by reference to the Company's 10-KSB filed on March 31, 2003.
(9) Incorporated by referenced to the Company's Form 10-KSB filed on April
2, 2004.
(10) Previously filed as an exhibit to the Form SB-2 Registration Statement
filed on December 30, 2004.
(11) Incorporated by reference to the Company's Form 8-K filed on April 19,
2004.
64