UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________
FORM 10-QSB
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO_____
COMMISSION FILE NUMBER: 000-24985
PACIFICNET INC.
--------------------------------------------------------------------------------
(Exact name of small business issuer in its charter)
DELAWARE 91-2118007
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
601 New Bright Building, 11 Sheung Yuet Road, N/A
Kowloon Bay, Kowloon, Hong Kong (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER: 011-852-2876-2900
UNIT 2710, HONG KONG PLAZA, 188 CONNAUGHT ROAD WEST, HONG KONG
--------------------------------------------------------------
(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 / /
There were 10,728,808 shares of the Company's common stock outstanding on July
23, 2005.
Transitional Small Business Disclosure Format (check one): YES / / NO /X/
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION.................................................2
ITEM 1. FINANCIAL STATEMENTS..............................................2
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION........10
ITEM 3. CONTROLS AND PROCEDURES..........................................19
PART II - OTHER INFORMATION...................................................20
ITEM 1. LEGAL PROCEEDINGS................................................20
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS......20
ITEM 3. DEFAULTS UPON SENIOR SECURITIES..................................20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............20
ITEM 5. OTHER INFORMATION................................................20
ITEM 6. EXHIBITS.........................................................20
SIGNATURES....................................................................22
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited. In thousands of United States dollars,
except par values and share numbers)
JUNE 30, 2005 DECEMBER 31, 2004
(UNAUDITED) (AUDITED)
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 5,364 $ 6,764
Restricted cash - pledged bank deposit 705 3,501
Accounts Receivables (net of allowance for doubtful accounts of $0) 8,175 5,644
Inventories 2,188 1,297
Loans receivable from related parties 1,157 --
Loans receivable from third parties 2,081 --
Other Current Assets 2,769 4,325
----------- -----------
TOTAL CURRENT ASSETS 22,439 21,531
Property and Equipment, net 2,178 1,118
Investments in affiliated companies and subsidiaries 1,271 1,063
Marketable equity securities - available for sale 450 29
Goodwill 12,648 8,912
----------- -----------
TOTAL ASSETS $ 38,986 $ 32,653
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank Line of Credit $ 793 $ 651
Bank Loans-current portion 923 1,327
Capital Lease Obligations - current portion 135 80
Accounts Payable 2,586 3,150
Accrued Expenses and other payables 913 128
Provision for taxation 33 10
Due to related party 390 --
----------- -----------
TOTAL CURRENT LIABILITIES 5,773 5,346
Long-term liabilities: -- --
Bank Loans - non current portion 1,200 69
Capital Lease Obligations - non current portion 136 129
----------- -----------
TOTAL LONG-TERM LIABILITIES 1,336 198
----------- -----------
TOTAL LIABILITIES 7,109 5,544
----------- -----------
Minority Interests in Consolidated Subsidiaries 3,207 2,396
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:
June 30, 2005 - 11,961,687 issued; 10,728,808 outstanding
December 31, 2004 - 10,627,737 shares issued, 9,791,583 outstanding 1 1
Treasury Stock, at cost - 836,154 shares (104) (104)
Additional Paid-In Capital 56,865 53,916
Cumulative Other Comprehensive Loss (24) (24)
Accumulated Deficit (28,068) (29,076)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 28,670 24,713
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 38,986 $ 32,653
=========== ===========
See condensed notes to consolidated financial statements.
2
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited. In thousands of United States dollars, except earnings/(loss) per share and share amounts)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Revenues $ 10,752 $ 8,084 $ 19,885 $ 11,586
------------ ------------ ------------ ------------
Cost of Revenues (8,536) (6,789) (16,020) (9,042)
------------ ------------ ------------ ------------
Gross Profit 2,216 1,295 3,865 2,544
Selling, General and Administrative expenses (1,032) (875) (1,884) (1,652)
Depreciation and amortization (60) (73) (141) (140)
------------ ------------ ------------ ------------
EARNINGS FROM OPERATIONS 1,124 347 1,840 752
Other income (expense), net 239 10 406 74
------------ ------------ ------------ ------------
EARNINGS BEFORE INCOME TAXES AND MINORITY 1,363 357 2,246 826
INTEREST
Provision for income taxes (33) -- (57) --
Share of income of associated companies 12 17 4 17
Minority Interests (745) (323) (1,185) (651)
------------ ------------ ------------ ------------
NET EARNINGS AVAILABLE TO COMMON STOCKHOLDERS $ 597 $ 51 $ 1,008 $ 192
============ ============ ============ ============
BASIC EARNINGS PER COMMON SHARE: $ 0.06 $ 0.01 $ 0.10 $ 0.03
============ ============ ============ ============
DILUTED EARNINGS PER COMMON SHARE: $ 0.06 $ 0.01 $ 0.10 $ 0.03
============ ============ ============ ============
See condensed notes to consolidated financial statements.
3
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars, except loss per share and share amounts)
SIX MONTHS ENDED JUNE 30,
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 1,008 $ 192
Adjustment to reconcile net earnings to net cash used in operating
activities:
Equity earnings (loss) of associated company (4) (17)
Provision for income taxes 57 --
Minority Interest 811 1,203
Depreciation and amortization 141 140
Decrease in restricted cash 2,796 --
Accounts receivable and other current assets (975) (2,804)
Increase in loan receivables (3,238) --
Inventories (891) (975)
Accounts payable and accrued expenses 221 1,122
----------- -----------
Net cash used in operating activities (74) (1,139)
CASH FLOWS FROM INVESTMENT ACTIVITIES
Increase in purchase of marketable securities (421) --
Acquisition of property and equipment (1,200) (278)
Acquisition of subsidiaries (3,984) (1,160)
Acquisition of investee company -- (385)
----------- -----------
Net cash used in investing activities (5,605) (1,823)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Loans from related parties 390 --
Advances (repayments) under bank line of credit 142 (1,009)
Increase (repayment) of amount borrowed under capital lease obligations 62 (1,919)
Proceeds from sale of common stock -- 2,813
Increase in share consideration post acquisition of subsidiaries 1,977 564
Repurchase of treasury shares -- (96)
Proceeds from exercise of stock options and warrants 981 74
Advances under bank loans 727 1,913
----------- -----------
Net cash provided by financing activities 4,279 2,340
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,400) (622)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,764 3,823
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,364 $ 3,201
=========== ===========
CASH PAID FOR:
Interest (127) 109
Income taxes -- --
NONCASH INVESTING AND FINANCING ACTIVITIES:
Investment in subsidiaries acquired through issuance of common stock $ 1,977 $ 5,250
Common stock issued as a result of exercise of stock options $ -- $ 2
See condensed notes to consolidated financial statements.
4
PACIFICNET INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in United States dollars unless otherwise stated)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-QSB. Accordingly, they do not include all the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. For further information, refer to the
financial statements and footnotes thereto included in the Company's annual
report on Form 10-KSB for the year ended December 31, 2004, as filed with the
SEC.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations and cash flows for all periods presented have been made.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. Examples include provisions for returns and impairment losses,
accounting for income taxes, bad debts, and property, plant and equipment lives
for depreciation purposes. Actual results may differ from these estimates. The
results of operations for the three and six month period ended June 30, 2005 are
not necessarily indicative of the operating results that may be expected for the
entire year ending December 31, 2005. These financial statements should be read
in conjunction with the notes to the financial statements and the Management's
Discussion and Analysis included elsewhere in this report.
STOCK-BASED COMPENSATION
During the quarter ended June 30, 2005, the Company granted stock options to
purchase 200,000 shares of the Company's common stock at $6.80 per share (based
on the market price on May 3, 2005) which will expire on May 3, 2009. During the
quarter ended June 30, 2005, no options were canceled or forfeited, and no
options were exercised. As of June 30, 2005, there were 1,207,100 stock options
outstanding and 490,000 options exercisable. The weighted average exercise price
of the options outstanding and exercisable is $5.80 and $2.07, respectively, and
the weighted average remaining contractual life is 3.50 and 1.50 years,
respectively.
The Company accounts for stock-based compensation using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," under which no compensation cost for stock options
is recognized for stock option awards granted at or above fair market value. Had
compensation expense for the Company's stock-based compensation plans been
determined under FAS 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 June 30:
Three months ended Six Months Ended
2005 2004 2005 2004
-------- -------- -------- -------
Net earnings (loss)
As reported $ 597 $ 51 $ 1,008 $ 192
Less, stock-based employee compensation cost, net of tax (1,196) - (2,740) -
-------- -------- -------- -------
Pro forma $ (599) $ 51 $ (1,732) $ 192
======== ======== ======== =======
Earnings (loss) per share
Basic
As reported $ 0.06 $ 0.01 $ 0.10 $ 0.03
======== ======== ======== =======
Pro forma $ (0.06) $ 0.01 $ (0.18) $ 0.03
======== ======== ======== =======
Diluted
As reported $ 0.06 $ 0.01 $ 0.10 $ 0.03
======== ======== ======== =======
Pro forma $ (0.06) $ 0.01 $ (0.16) $ 0.03
======== ======== ======== =======
5
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based
Payment" ("SFAS No. 123R"). SFAS No. 123R addresses all forms of share-based
payment ("SBP") awards, including shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation rights. SFAS No.
123R will require the Company to expense SBP awards with compensation cost for
SBP transactions measured at fair value. On March 29, 2005, the SEC issued Staff
Accounting Bulletin (SAB) 107 which expresses the views of the SEC regarding the
interaction between SFAS No. 123R and certain SEC rules and regulations and
provides the SEC's views regarding the valuation of share-based payment
arrangements for public companies. In April 2005, the SEC issued a release which
amends the compliance dates for SFAS No. 123R. We expect the adoption of SFAS
No. 123R and SAB 107 to have a material impact on the Company's financial
statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections". SFAS No. 154 replaces APB Opinion No. 20 "Accounting Changes" and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS
No. 154 requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. We do not expect the adoption of SFAS No. 154 to have any impact on the
Company's financial statements.
2. EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of shares of
common stock outstanding. Diluted earnings per share is based on the weighted
average number of shares of common stock outstanding and dilutive common stock
equivalents. All earnings per share amounts in these financial statements are
basic earnings per share as defined by SFAS No. 128, "Earnings Per Share."
Diluted EPS is computed using weighted average shares outstanding plus
additional shares issued as if in-the-money options and warrants were exercised
(utilizing the treasury stock method). Dilutive earnings per share for 2005
excludes the potential dilutive effect of 500,000 warrants because their impact
would be antidilutive based on current market prices. All per share and per
share information are adjusted retroactively to reflect stock splits and changes
in par value.
The computation of basic and diluted earnings per share is as follows:
(IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT
WEIGHTED SHARES AND PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Numerator-net earnings $ 597 $ 51 $ 1,008 $ 192
Denominator-weighted average shares to compute
basic EPS 9,887,274 6,880,329 9,840,681 6,757,307
=========== =========== =========== ===========
Basic EPS shares 9,887,274 6,880,329 9,840,681 6,757,307
Potential dilutive from assumed exercise of stock
options and warrants 731,501 969,427 718,383 604,364
----------- ----------- ----------- -----------
Denominator - weighted average number of shares 10,618,775 7,849,756 10,559,064 7,361,671
=========== =========== =========== ===========
Basic earnings per share $ 0.06 $ 0.01 $ 0.10 $ 0.03
Diluted earnings per share $ 0.06 $ 0.01 $ 0.10 $ 0.03
6
3. BUSINESS ACQUISITIONS
In April, 2005, the Company completed the acquisition of 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.
PacificNet Holdings agreed to purchase 23,050 shares (the "Sale Shares") of
3G-BVI from Asiafame International Limited, Stargain International Limited and
Trilogic Investments Limited, with principle place of business located in the
People's Republic of China (the "Sellers"), and directly subscribed to 3G-BVI to
purchase 5,000 shares (the "Subscribed Shares").
The total consideration paid for the Sale Shares was payable as
follows:
(i) USD$1,183,000 payable to the Sellers in cash within 30 days after
the closing of the transaction;
(ii) USD$4,182,000, by delivery of 522,750 shares of common stock, par
value $0.0001 per share (the "Common Stock") of PacificNet (the "PacificNet
Shares") to the Sellers. The PacificNet Shares are to be held in an escrow
account with an Escrow Agent designated by PacificNet Holdings. The first
installment of the PacificNet Shares in the amount of 130,050 will be released
45 days after the closing of the transaction. The remaining installments will be
released in equal installments of 98,175 shares within 30 days after the end of
each quarter, including the quarter ended March 31, 2005, provided that
Guangzhou 3G attains certain net income milestones by the end of each quarter.
The Sellers will be entitled to receive all of the PacificNet Shares if
Guangzhou 3G has achieved cumulative net income for the year ended December 31,
2005 of not less than USD$2,000,000. The Sellers appointed Tony Tong and Victor
Tong, PacificNet's current CEO and President, respectively, as proxy for the
Sellers for a period of 10 years with full power to vote the PacificNet Shares
at all meetings of stockholders of the Registrant.
(iii) issuance of warrants to purchase up to 100,000 shares of the
PacificNet's Common Stock. The exercise price of the warrants is the 5-Day
Volume Weighted Average Price of the PacificNet's Common Stock prior to March
30, 2005. The warrant is exercisable for a period of 3 years.
PacificNet Holdings subscribed to 3G-BVI to purchase an additional 5,000 shares.
The total purchase price for the Subscribed Shares is USD$500,000, payable
within 45 days after the delivery of (i) stock powers transferring the Sale
Shares to PacificNet Holdings; (ii) stock certificates for the Sale Shares and
the Subscribed Shares; (iii) an executed Subscription Agreement for the
Subscribed Shares; and (iv) minutes of the Board of Directors and shareholders
of Guangzhou 3G and 3G-BVI approving the transaction. Net assets acquired
totaled $253,000 representing total assets acquired of $495,000 less liabilities
assumed of $242,000.
PACT included the financial results of the subsidiary in its consolidated 2005
financial results from the date of the purchase April 2005 through June 30,
2005. Guangzhou3G-WOFE was set up as a wholly-owned foreign enterprise ("WOFE")
in the PRC immediately prior to the acquisition and therefore no unaudited pro
forma results are required.
4. STOCKHOLDERS' EQUITY
For the six months period ended June 30, 2005, the Company issued (i)
280,225shares of restricted common stock in connection with acquisitions of
certain subsidiaries and (ii) 57,000 shares of common stock as a result of
exercise of options and 600,000 shares of common stock from the exercise of
warrants for cash consideration totaling $981,400.
Warrant Exercise:
For the three months ended June 30, 2005, the Company received $870,000 from
Sino Mart Management Limited ("Sino Mart") as a result of Sino Mart's exercise
of a warrant to purchase 600,000 shares of common stock at a price of $1.45 per
share. Background of the warrant: On March 28 2002, the Company completed a
$3,480,000 private placement by issuing 2,400,000 shares of common stock at a
price of $1.45 per share to Sino Mart Management Limited ("Sino Mart"), whose
executive director Mr. TONG Cho-Sam 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 common stock at $1.45 per share. The warrant is
fully exercisable beginning on April 1, 2002. The $3,480,000 private placement
transaction (including the 600,000 warrants) was approved at a special
stockholder meeting held on March 25, 2002. (See Note 6)
7
Total warrants outstanding as of June 30, 2005 are 1,121,138. The weighted
average remaining life is 2.92 years and the weighted average price per share is
$6.99 per share.
Common Stock Repurchase Program.
--------------------------------
The Company's Board of Directors has approved a Corporate Stock Repurchase
Program to purchase up to US$800,000 worth of outstanding shares of its common
stock in open market transactions, from time to time, in compliance with Rule
10b-18 of the Securities Exchange Act of 1934 and all other applicable
securities regulations. The purpose of the repurchase program is to enhance
shareholder value. During the three months ended June 30, 2005, the Company did
not repurchase any shares.
5. SEGMENT INFORMATION
The Company's reportable segments are operating units, which represent the
operations of the Company's significant business operations.
Our operations include the following three groups:
(1) Outsourcing Services: including Business Process Outsourcing (BPO),
call center, IT Outsourcing (ITO) and software development services.
(2) Value-Added Telecom Services (VAS): including Interactive Voice
Response (IVR), SMS and related VAS.
(3) Communication Distribution Services: including calling cards, GSM/
CDMA/ XiaoLingTong products, multimedia self-service Kiosks.
Summarized financial information concerning the Company's reportable segments is
shown in the following table. The "Other" column includes the Company's other
insignificant services and corporate related items, and, as it relates to
segment profit (loss), income and expense not allocated to reportable segments:
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
FOR THE THREE MONTHS 1. 2. 3. Communications
ENDED Outsourcing VAS Business Distribution Admin & Other Total
JUNE 30, 2005 Business ($) Business ($) ($)
($) ($)
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 3,402,000 3,216,000 4,054,000 80,000 10,752,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 341,000 939,000 118,000 (35,000) 1,363,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Total Assets 5,468,000 7,827,000 13,661,000 12,030,000 38,986,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
FOR THE THREE MONTHS 1. 2. 3. Communications
ENDED Outsourcing VAS Business Distribution Admin & Other Total
JUNE 30, 2004 Business ($) Business ($) ($)
($) ($)
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 2,250,000 1,624,000 3,805,000 405,000 8,084,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 241,000 381,000 52,000 (300,000) 374,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Total Assets 3,733,000 3,364,000 271,000 9,308,000 16,676,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
8
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
FOR THE SIX MONTHS 1. 2. 3. Communications
ENDED Outsourcing VAS Business Distribution Admin & Other Total
JUNE 30, 2005 Business ($) Business ($) ($)
($) ($)
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 6,466,000 4,546,000 8,730,000 143,000 19,885,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 570,000 1,545,000 322,000 (208,000) 2,246,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Total Assets 5,468,000 7,827,000 13,661,000 12,030,000 38,986,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
FOR THE SIX MONTHS 1. 2. 3. Communications
ENDED Outsourcing VAS Business Distribution Admin & Other Total
JUNE 30, 2004 Business ($) Business ($) ($)
($) ($)
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 4,302,000 2,781,000 3,805,000 698,000 11,586,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 451,000 736,000 52,000 (413,000) 826,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Total Assets 3,733,000 3,364,000 271,000 9,308,000 16,676,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
6. RELATED PARTY TRANSACTIONS
Loan receivable from related parties
As at June 30, 2005, there was a total loan receivable of US$1,157,000 due from
related parties including US$603,000 due from Cheer Era (30% owned by PACT),
US$192,000 due from a director of PACT's subsidiary, Solutek, and US$362,000 due
from the shareholder of Yueshen, a subsidiary of PACT. The terms of these three
related parties loan receivables are below:
Loan to Cheer Era
As at June 30, 2005, there was a total loan receivable of US$603,000 outstanding
from Cheer Era, a 30% owned investee of PACT. The purpose of the loan was a
working capital loan to finance the expansion of Cheer Era's business in Europe
and North America. The repayment of this loan will be due around end of 2005
with 8% interest per annum, plus 8% penalty interest in case of overdue. The
loan is collateralized with 149,459 PACT shares owned by the two equity owners
of Cheer Era having 70% majority stake in Cheer Era, and the remaining assets
and equity ownership of Cheer Era.
Loan to Solutek's Director
As at June 30, 2005, there was a loan outstanding of US$192,000 receivable from
a director of Solutek, payable in three equal installments
of US$72,314 each, being principal plus interest, due on 14th of December for
three consecutive years ending 2007. The interest rate for the loan is 8% per
annum plus 5% penalty interest in case of overdue. The loan is collateralized
with 100,000 PACT shares owned by the borrowing director and Ms Iris Lo, and the
remaining assets of Smartime Holding Ltd.
Loan to Yueshen's Shareholder
As at June 30, 2005, a US$362,000 loan receivable was outstanding from the
shareholder of a PACT's subsidiary, Yueshen for the purpose of repaying the
working capital loan by the predecessor of Yueshen advanced prior to PACT's
acquisition. This loan is collateralized with PACT shares owned by the
shareholder of Yueshen.
Due to related party
As at June 30, 2005, a US$390,000 loan was outstanding from Linkhead to a
shareholder and director of Linkhead. On March 8 and April 5, 2005, US$100,000
and US$460,000 were advanced to Linkhead for a period of 6 months at zero
interest for working capital purposes. Prior to June 30, US$170,000 was repaid
to the shareholder resulting in a balance of US$390,000.
Apart from the above loan receivables, related parties transactions occurred
during the three months ended June 30, 2005 included a $870,000 proceed from
Sino Mart Management Limited ("Sino Mart") resulted from its exercise of a
warrant to purchase 600,000 shares of common stock at a price of $1.45 per
share. For details, please see Note 4.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information, the matters discussed in this Form 10-QSB
contain forward-looking statements that involve risks or uncertainties.
Generally, the words "believes," "anticipates," "may," "will," "should,"
"expect," "intend," "estimate," "continue," and similar expressions or the
negative thereof or comparable terminology are intended to identify
forward-looking statements. Such statements are subject to certain risks and
uncertainties, including the matters set forth in this report or other reports
or documents we filed with the Securities and Exchange Commission from time to
time, which could cause actual results or outcomes to differ materially from
those projected. Undue reliance should not be placed on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation
to update these forward-looking statements. Readers should carefully review the
risks described in other documents we filed from time to time with the
Securities and Exchange Commission, including the Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2004, the Quarterly Reports on Form
10-QSB filed by the Company and Current Reports on Form 8-K (including any
amendments to such reports). References in this filing to the "Company",
"Group", "we", "us", and "our" refer to PacificNet Inc. and its subsidiaries.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based
Payment" ("SFAS No. 123R"). SFAS No. 123R addresses all forms of share-based
payment ("SBP") awards, including shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation rights. SFAS No.
123R will require the Company to expense SBP awards with compensation cost for
SBP transactions measured at fair value. On March 29, 2005, the SEC issued Staff
Accounting Bulletin (SAB) 107 which expresses the views of the SEC regarding the
interaction between SFAS No. 123R and certain SEC rules and regulations and
provides the SEC's views regarding the valuation of share-based payment
arrangements for public companies. In April 2005, the SEC issued a release which
amends the compliance dates for SFAS No. 123R. We expect the adoption of SFAS
No. 123R and SAB 107 to have a material impact on the Company's financial
statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections". SFAS No. 154 replaces APB Opinion No. 20 "Accounting Changes" and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS
No. 154 requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. We do not expect the adoption of SFAS No. 154 to have any impact on the
Company's financial statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis or plan of operations is based upon our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to accounts receivable reserves,
provisions for impairment losses of affiliated companies and other intangible
assets, income taxes and contingencies. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
10
We believe the following critical accounting policies reflect our more
significant estimates and assumptions used in the preparation of our
consolidated financial statements:
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We evaluate the collectibility of our trade receivables based on a combination
of factors. We regularly analyze our significant customer accounts, and, when we
become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration in
the customer's operating results or financial position, we record a specific
reserve for bad debt to reduce the related receivable to the amount we
reasonably believe is collectible. We also record reserves for bad debt for all
other customers based on a variety of factors including the length of time the
receivables are past due, the financial health of the customer, macroeconomic
considerations and historical experience. If circumstances related to specific
customers change, our estimates of the recoverability of receivables could be
further adjusted. In the event that our trade receivables become uncollectible,
we would be forced to record additional adjustments to receivables to reflect
the amounts at net realizable value. The accounting effect of this entry would
be a charge to 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.
INCOME TAXES - We record a valuation allowance to reduce our deferred tax assets
to the amount that is more likely than not to be realized. We have considered
future market growth, forecasted earnings, future taxable income, and prudent
and feasible tax planning strategies in determining the need for a valuation
allowance. We currently have recorded a full valuation allowance against net
deferred tax assets as we currently believe it is more likely than not that the
deferred tax assets will not be realized.
CONTINGENCIES - We may be subject to certain asserted and unasserted claims
encountered in the normal course of business. It is our belief that the
resolution of these matters will not have a material adverse effect on our
financial position or results of operations, however, we cannot provide
assurance that damages that result in a material adverse effect on our financial
position or results of operations will not be imposed in these matters. We
account for contingent liabilities when it is probable that future expenditures
will be made and such expenditures can be reasonably estimated.
VALUATION OF LONG-LIVED ASSETS INCLUDING GOODWILL AND PURCHASED INTANGIBLE
ASSETS
We review property, plant and equipment, goodwill and purchased intangible
assets for impairment at least annually or 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.
11
NATURE OF THE OPERATIONS OF THE COMPANY
NATURE OF BUSINESS.
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 China, which includes the People's Republic of China (PRC), or
mainland China, Hong Kong Special Administrative Region (HKSAR), and Macau
Special Administrative Region. We intend to continue to grow our business by
acquiring and managing growing technology and network communications businesses
with established products and customers in China. Our current subsidiaries are
grouped into the following three divisions providing various voice focused
telecom services:
(1) Outsourcing Services [Human Voice Service]: including Business Process
Outsourcing (BPO), CRM, call center, IT Outsourcing (ITO) and software
development services. PacificNet's Outsourcing Services Group includes the
following subsidiaries: PacificNet Epro, Smartime (aka Soluteck Shenzhen), and
PacificNet Solutions. 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.
(2) Value-Added Telecom Services (VAS) [Machine Voice Service]: including
Interactive Voice Response (IVR), SMS and related VAS. PacificNet's VAS Group
includes the following subsidiaries: Linkhead, Clickcom, and Guangzhou 3G (aka
Sunroom). Our telecom VAS often includes a post-sale service contract for
systems integration and consulting services for which we bill separately.
(3) Communication Products Distribution Services Group [Voice Product
Distribution Service]: including calling cards, GSM/CDMA/XiaoLingTong products,
and multimedia self-service entertainment kiosks. This group includes the
following subsidiaries: PacificNet Communications, Yueshen, and Cheer Era. Our
calling card and related mobile telecom products are mostly sold
cash-on-delivery.
Our 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. Headquartered in Hong Kong
and Minneapolis USA, PacificNet employs over, 1400 staff in its various
subsidiaries in China with offices Beijing, Shenzhen, Guangzhou, Shandong, and
27 provinces in China.
For the three months ended June 30, 2005, we continue to win business from
high-profile Chinese and multinational companies conducting business in China
such as China Mobile, China Unicom, China Telecom, Bank of China, Ping An
Insurance, TCL, TNT Express, Watsons, Hutchison, etc. All of our business units
remain strong, and we continue to focus on penetrating the CRM and VAS/IVR
markets through organic growth and via acquisition. With the launch of the
'iPACT' IVR-Alliance program, we hope to sign up new local IVR service providers
to join our unified brand and strong IVR content and service offerings, under a
chain of unified service standard under the iPACT brand. We look forward to
revenue growth, market share improvement, and stronger partnerships with all the
major telecom operators and local IVR service providers in China. With business
activity increasing across all of our units, we are excited about the prospects
for the Company in the coming quarters. We believe that our fundamentals are
stronger than ever and that market opportunities for sustainable growth and
profitability in China's CRM and VAS sector are vast. The following are some of
the highlights in the second quarter:
o We have formed an alliance with the largest Call Center in Japan, under
which we will be the designated agent for Bellsystem24, Inc. in China and
Hong Kong. Bellsystem24 is Japan's largest telemarketing, call center, and
CRM services company with over 4,300 clients, 22,135 communication service
representatives, 9,500 workstations, 160 system engineers, and 31 offices
in Japan.
o We have successfully deployed its WISE-xb Interactive Voice Response System
(IVRS) Contact Center Solution for TNT Hong Kong, a division of TPG NV and
the world's leading business to business express delivery company, as TNT's
key customer relationship management (CRM) initiative to enhance its
customer services.
o Watsons Water selected PacificNet Epro's WISE-xb Multimedia Contact Center
System as its customer services initiative for its customer services
center.
o We also continue to win high-profile government and private sector
projects. We won a project tender by the City of Guangzhou, one of the
largest and most affluent cities in China, to develop an internet and
intranet based e-business platform for Guangzhou Metro.
o We expanded our operations by acquiring entities that operate as service
providers in the VAS & IVR industries, which have grown rapidly in China in
recent years and to further develop products and services organically. On
the acquisition front, the purchase of Guangzhou 3G Information Technology
Co. Ltd. in April was a significant event. We purchased a 51% controlling
interest, which is expected to help expand PacificNet's value-added service
coverage to all of China through Guangzhou 3G's experienced operation team
of 285 staff and sales offices in 26 provinces in China. Guangzhou 3G is
one of the largest value-added telecom and information services providers
in China with both voice and data connections to the four major telecom
operators including China Mobile, China Unicom, China Telecom, and China
Netcom, covering both mobile and fixed-line networks.
o In July, we announced the launch of a new IVR-Alliance program called
"iPACT" at the 2005 Voice Value-added Service (VAS) Conference. Under this
iPACT program, PacificNet plans to sign up qualified Voice-VAS and IVR
service providers as profit sharing members in China under a unified brand
"iPACT". PacificNet will provide to qualified VAS-Alliance partners, on a
profit sharing basis, all of the hardware, software, application, and
content for VAS, including a variety of IVR and other wireless and
fixed-line VAS content. Mobile and fixed-line phone users can access
PacificNet's VAS-Alliance services through Guangzhou 3G presence in 26
provinces in China.
o PacificNet Clickcom, reached an agreement with China Unicom's Guangdong
Branch to launch a new Mobile Mailbox Service called "UMAIL" for Unicom's
CDMA users on its WAP Portal website. Guangdong is one of the largest and
most affluent provinces in China and represents a significant opportunity
for PacificNet to offer value added telecom services. As of June, 2005,
China Unicom has 30.47 million CDMA users and 8.5 million WAP users
nationwide. China Unicom's CDMA users in Guangdong may go to its WAP
Portal, enter UMAIL service, and be able to send and receive e-mail by
mobile phone.
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations data as a
percentage of revenues for the periods indicated.
QUARTER ENDED QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30,
--------------------------------------------------------- ---------------- ----------------- ----------------------
2005 2004 2005 2004
--------------------------------------------------------- ---------------- ----------------- ----------------------
Revenues 100% 100.0% 100% 100%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Cost of Revenues (79.4%) (84.0%) (80.6%) (78.0%)
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Gross Margin 20.6% 16.0% 19.4% 22.0%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Selling, general and administrative expense (9.60%) (10.8%) (9.5%) (14.3%)
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Depreciation and amortization (0.6%) (0.9%) (0.7%) (1.2%)
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Earnings from operations 10.5% 4.3% 9.3% 6.5%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Other income, net 2.2% 0.1% 2.1% 0.6%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Earnings before income taxes and minority interests 12.7% 4.4% 11.3% 7.1%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Provision for income taxes (0.3%) 0.0% (0.3%) 0.0%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Share of income of associated companies 0.1% 0.2% 0.0% 0.2%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Minority interest (6.9%) (4.0%) (5.9%) (5.6%)
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
Net earnings 5.5% .6% 5.1% 1.6%
--------------------------------------------------------- ---------------- ----------------- ----------- ----------
12
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
REVENUES. Revenues for the three months ended June 30, 2005 were $10,752,000, an
increase of $2,668,000 from $8,084,000 for the three months ended June 30, 2004.
For the three months ended June 30, 2005, revenues of $3,402,000 (2004:
$2,250,000), $3,216,000 (2004: $1,624,000), and $4,054,000 (2004: $3,805,000)
were derived from the services rendered by the Company's three operating units:
Outsourcing Services, Value-Added Services, and Communications Distribution
Services, respectively. The increase in revenues is primarily due to the new
revenues as a result of the acquisition of Guangzhou 3G completed in April 2005.
Several of our businesses experience fluctuations in quarterly performance.
Traditionally, the first quarter from January to March is a low season for our
call center business due to the long Lunar New Year holidays in China. Revenues
from the VAS and IVR segment can vary from quarter to quarter due to new product
launches and the seasonality of certain product lines.
Our operations include the following three groups:
(1) Outsourcing Services: including Business Process Outsourcing (BPO),
call center, IT Outsourcing (ITO) and software development services.
(2) Value-Added Telecom Services (VAS): including Interactive Voice
Response (IVR), SMS and related VAS.
(3) Communication Distribution Services: including calling cards, GSM/
CDMA/ XiaoLingTong products, multimedia self-service Kiosks.
Summarized financial information concerning each of our main operating units is
set forth in the following table. The "Admin & Other" column included our other
insignificant subsidiaries and corporate related items.
FOR THE PERIOD ENDED 1. 2. 3. Communications
JUNE 30, 2005 Outsourcing VAS Business Distribution Admin & Other Total
Business ($) Business ($) ($)
($) ($)
----------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 3,402,000 3,216,000 4,054,000 80,000 10,752,000
----------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 341,000 939,000 118,000 (35,000) 1,363,000
----------------------- -------------------- ------------------ --------------------- ----------------- --------------
FOR THE THREE MONTHS 1. 2. 3. Communications
ENDED Outsourcing VAS Business Distribution Admin & Other Total
JUNE 30, 2004 Business ($) Business ($) ($)
($) ($)
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Revenues 2,250,000 1,624,000 3,805,000 405,000 8,084,000
---------------------- -------------------- ------------------ --------------------- ----------------- --------------
Profit / (Loss) from
Operations 241,000 381,000 52,000 (300,000) 374,000
COST OF REVENUES. Cost of revenues for the three months ended June 30 was
$8,536,000, an increase of $1,747,000 from $6,789,000 for the three months ended
June 30, 2004. The increase is directly associated with the corresponding
increase in revenues.
GROSS PROFIT. Gross profit for the three months ended June 30 was $2,216,000, an
increase of $921,000 from $1,295,000 for the three months ended June 30, 2004.
Gross margin for the three months ended June 30, 2005, was 21% of total revenues
compared to 16% for the same period in 2004. We believe that our gross margin
overall approximates the industry standards. The improvement on gross margins
for both 3 months and 6 months from the prior periods were primarily due to
higher margin acquisitions added to PACT in 1Q and 2Q in 2005, such as PACT 3G
and Clickcom, both WOFEs are set up with revenues net of operating costs from
the PRC operating entities. In addition, the proportionate increase of
high-margin investees in groups (1) outsourcing services and group (2) VAS
services have outgrown the 2-5% of low-margin investees under group 3
Communication Distribution Services for both quarters.
14
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $1,032,000 for the three months ended June 30,
2005, an increase of $157,000, from $875,000 for the three months ended June 30,
2004. This increase resulted from increasing the size of our operations, which
included increased premises costs and staff costs.
INCOME TAXES. Income tax provision was $33,000 for the three months ended June
30, 2005, as compared to $0 for the three months ended June 30, 2004. Interim
income tax provisions are based upon management's estimate of taxable income and
the resulting consolidated effective income tax rate for the full year. As a
result, such interim estimates are subject to change as the year progresses and
more information becomes available.
MINORITY INTERESTS. Minority interests for the three months ended June 30, 2005
totaled $(745,000), compared with $(323,000) for the same period in the prior
year, which represents increased number of our subsidiaries resulted in
increased outside ownership interests consolidated with the parent for financial
reporting purposes.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
REVENUES. Revenues for the six months ended June 30, 2005 were $19,885,000, an
increase of $8,299,000 from $11,586,000 for the six months ended June 30, 2004.
As contrast to prior period revenue, contributors by Epro and Linkhead, in the
aggregate, 94% of total revenues, revenues for the six months ended June 30,
2005 were mainly derived from the following 3 sources:
(a) Newly acquired subsidiaries in Group (1) Outsourcing Services such as
Smartime has added approx. US$1.9m to 6 months ended June 30, 2005 as
compared to the same period prior year;
(b) Newly acquired subsidiary in Group (2) Value-added Telecom Services,
such as PACT 3G and Clickcom have together added approx. US$1.1m
revenues in the six months ended June 30, 2005 as compared to the same
period prior year.
(c) The remaining incremental revenues for six months ended June 30, 2004
as compared to prior period were derived from growth from existing
subsidiaries such as Yue Shen (Group 3), Linkhead (Group 2), EPRO
(Group 1), for US$5.1m, US$0.6m and US$0.3m respectively.
COST OF REVENUES. Cost of revenues for the six months ended June 30, 2005 was
$16,020,000, an increase of $6,978,000 from $9,042,000 for the six months ended
June 30, 2004. This significant increase is directly associated with the
proportionate increase in significant revenues growth.
GROSS MARGIN AND GROSS MARGIN RATIO. Gross margin for the six months ended June
30, 2005 was $3,865,000, an increase of $1,321,000 from $2,544,000 for the six
months ended June 30, 2004. As explained above, the improvement on gross margins
for both 3 months and 6 months from the prior periods were primarily due to
higher margin acquisitions added to PACT in 1Q and 2Q in 2005, such as PACT 3G
and Clickcom, both WOFEs are set up with revenues net of operating costs from
the PRC operating entities. In addition, the proportionate increase of
high-margin investees in groups (1) outsourcing services and group (2) VAS
services have outgrown the 2-5% of low-margin investees under group 3
Communication Distribution Services for both quarters. Group (3) as contributor
to the overall gross margin contributor has been decreasing for the six months
ended June 30, 2005 as compared to the prior period.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $1,884,000 for the six months ended June 30,
2005, an increase of $232,000, from $1,652,000 for the six months ended June 30,
2004. This increase resulted from increasing the size of our operations, which
included increased premises costs and staff costs, mainly attributable to the
operations of Epro, Linkhead, Yueshen and Smartime.
OTHER INCOME. Other income was $406,000 for the six months ended June 30, 2005,
as compared to $74,000 for the six months ended June 30, 2004, primarily due to
non-operating gains from sale of properties and interest income during the first
half of 2005.
15
EQUITY EARNINGS IN UNDISTRIBUTED EARNINGS OF INVESTEE COMPANY. The Company
recorded $4,000 in equity earnings in its investee company for the six month
ended June 30, 2005 compared with $17,000 for the same period in the prior year,
derived primarily from 30%-owned investee, Cheer Era Limited, which was acquired
in April 2004.
INCOME TAXES. A tax provision of approximately $57,000 was made for the six
months ended June 30, 2005 for prudence, as a result of increasing profit before
taxes for some of the subsidiaries based on management best estimates.
MINORITY INTEREST. Share of earnings by minority interest for the six months
ended June 30, 2005 was $1,185,000, as compared with $651,000 for the same
period in the prior year representing increased sharing of earnings by newly
acquired subsidiaries such as PACT 3G, Clickcom, Smartime since June 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS. As of June 30, 2005, the Company had cash and cash
equivalents of $5,364,000 as compared to $6,764,000 at December 31, 2004.
WORKING CAPITAL. The Company's working capital increased to $16,666,000 at June
30, 2005, as compared to $ 16,185,000 at December 31, 2004. When compared to
balances at December 31, 2004, the increase in working capital at June 30, 2005
was due to cash proceeds received for the exercise of options and warrants of
approximately $981,000 offset by consideration paid for the acquisition of
Clickcom and Guangzhou 3G.
NET CASH FROM OPERATING ACTIVITIES. Net cash used in operating activities was
$74,000 for the six months ended June 30, 2005 as compared to net cash used in
operating activities of $1,139,000 for the six months ended June 30, 2004. The
decrease in net cash used in operating activities in the six months ended June
30, 2005 was primarily due to decrease in restricted cash by $2,796,000 and
increase in earnings for the period ended June 30, 2005. Net cash used in
operating activities of $1,139,000 for the six months ended June 30, 2004,
resulted primarily from net earnings of $192,000, increased by noncash items
totaling $1,326,000 and decreased by changes in operating assets of $2,657,000.
NET CASH FROM INVESTING ACTIVITIES. Net cash used in investing activities was
$5,605,000 for the six months ended June 30, 2005, representing an increase of
$3,782,000 from $1,823,000 net cash used in investing activities for the prior
period. The decrease in net cash used in investing activities in the six months
ended June 30, 2005 was primarily due to the acquisition of Guangzhou 3G and
Clickcom. Net cash used in investing activities for the six months ended June
30, 2004 was $1,823,000 representing the acquisition of subsidiary companies,
interest in investee company, and property and equipment of $1,160,000, $385,000
and $278,000, respectively. The additions to property and equipment were for the
expansion of the CRM and call centre business in Hong Kong.
NET CASH FROM FINANCING ACTIVITIES. Net cash raised in financing activities for
the six months ended June 30, 2005 was $4,279,000, an increase of $1,939,000
from prior period, representing funds raised primarily through issuance of
shares for acquisitions of $1,977,000, proceeds from stock options and warrants
exercised totaled $981,000 and increased in bank borrowing of $727,000 during
the six months ended June 30, 2005. Net cash provided by financing activities
for the six months ended June 30, 2004 was $2,340,000 representing net proceeds
from issuance of common stock of $2,813,000, net proceeds from post acquisition
of share capital - subsidiaries of $564,000, net cash proceeds received from the
exercise of stock options of $74,000 and advances under bank loans of
$1,913,000, offset by repayments on debt of $2,928,000 and repurchase of
treasury shares of $96,000.
RELATED PARTY TRANSACTIONS:
Loan receivable from related parties
As at June 30, 2005, there was a total loan receivable of US$1,157,000 due from
related parties including US$603,000 due from Cheer Era (30% owned by PACT),
US$192,000 due from a director of PACT's subsidiary, Solutek, and US$362,000 due
from the shareholder of Yueshen, a subsidiary of PACT. The terms of these three
related parties loan receivables are below:
16
Loan to Cheer Era
As at June 30, 2005, there was a total loan receivable of US$603,000 outstanding
from Cheer Era, a 30% owned investee of PACT. The purpose of the loan was a
working capital loan to finance the expansion of Cheer Era's business in Europe
and North America. The repayment of this loan will be due around end of 2005
with 8% interest per annum, plus 8% penalty interest in case of overdue. The
loan is collateralized with 149,459 PACT shares owned by the two equity owners
of Cheer Era having 70% majority stake in Cheer Era, and the remaining assets
and equity ownership of Cheer Era.
Loan to Solutek's Director
As at June 30, 2005, there was a loan outstanding of US$192,000 receivable from
a director of Solutek, payable in three equal installments
of US$72,314 each, being principal plus interest, due on 14th of December for
three consecutive years ending 2007. The interest rate for the loan is 8% per
annum plus 5% penalty interest in case of overdue. The loan is collateralized
with 100,000 PACT shares owned by the borrowing director and Ms Iris Lo, and the
remaining assets of Smartime Holding Ltd.
Loan to Yueshen's Shareholder
As at June 30, 2005, a US$362,000 loan receivable was outstanding from the
shareholder of a PACT's subsidiary, Yueshen for the purpose of repaying the
working capital loan by the predecessor of Yueshen advanced prior to PACT's
acquisition. This loan is collateralized with PACT shares owned by the
shareholder of Yueshen.
Due to related party
As at June 30, 2005, a US$390,000 loan was outstanding from Linkhead to a
shareholder and director of Linkhead. On March 8 and April 5, 2005, US$100,000
and US$460,000 were advanced to Linkhead for a period of 6 months at zero
interest for working capital purposes. Prior to June 30, US$170,000 was repaid
to the shareholder resulting in a balance of US$390,000.
Common stock - exercise of warrants
For the three months ended June 30, 2005, we received $870,000 from Sino Mart
Management Limited ("Sino Mart") as a result of Sino Mart's exercise of a
warrant to purchase 600,000 shares of common stock at a price of $1.45 per
share. Background of the warrant (as disclosed in previous 10K, 10Q, and 14a
Proxy): On March 28 2002, we completed a $3,480,000 private placement by issuing
2,400,000 shares of common stock at a price of $1.45 per share to Sino Mart
Management Limited ("Sino Mart"), whose executive director Mr. TONG Cho-Sam 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
common stock at $1.45 per share. The warrant is fully exercisable beginning on
April 1, 2002. The $3,480,000 private placement transaction (including the
600,000 warrant) was approved at a special stockholder meeting held on March 25,
2002.
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.
17
On July 21, 2005, the Chinese government changed its policy of pegging the value
of the Renminbi to the U.S. dollar. This revaluation of the Renminbi is based on
a conversion of Renminbi (RMB) into United States dollars (USD) at an exchange
rate of USD1.00 = RMB8.11. Under the new policy, the Renminbi will be permitted
to fluctuate within a band against a basket of certain foreign currencies. This
change in policy resulted initially in an approximately 2.0% appreciation in the
value of the Renminbi against the U.S. dollar and could result in further and
more significant appreciations. Although the Company generates substantially all
of its revenues in Renminbi which has become more valuable in U.S. dollar terms,
the Company's U.S. dollar cash deposits are subject to foreign currency
translations which will impact net income.
For the financial figures stated in this Form 10-QSB, the conversion of Renminbi
(RMB) into U.S. dollar (USD) is based on the noon buying rate of
USD1.00=RMB8.2765 on June 30, 2005 in The City of New York for cable transfers
of RMB as certified for customs purposes by the Federal Reserve Bank of New
York. Therefore, the conversion rate is based on the rate prior to the Renminbi
revaluation on July 21, 2005.
There is a risk that fluctuations in the value of the Renminbi with respect to
other currencies could adversely affect our business and financial results.
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 2005.
CONTRACTUAL OBLIGATIONS.
We have significant cash resources to meet our contractual obligations as of
June 30, 2005, 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 $ 793,000 $ 793,000 -- -- --
Bank Loans $2,123,000 $ 923,000 $1,200,000 -- --
Capital leases $ 271,000 $ 135,000 $ 136,000 -- --
---------- ---------- ----------
Total cash contractual obligations $3,187,000 $1,851,000 $1,336,000
========== ========== ==========
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.
18
ITEM 3. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management,
including our principal executive officer and the principal accounting 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 principal executive officer and principal accounting
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.
19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
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)
20
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. (12)
10.15 PacificNet Inc. 2005 Stock Option Plan. (12)
10.16 Agreement for the Sale and Purchase of Shares in GuangZhou 3G
Information Technology Co., Ltd. (12)
14 Code of Ethics. (9)
21 List of Subsidiaries.
23.1 Consent of Clancy & Co. P.L.L.C. filed herewith.
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)
-------------
(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.
(12) Incorporated by reference to the Company's Form 10-KSB filed on April 19,
2005.
21
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: August 15, 2005 By: /s/ TONY TONG
----------------------------------------
Tony Tong
Chief Executive Officer
(Principal Executive Officer)
Date: August 15, 2005 By: /s/ WANG SHAO JIAN
----------------------------------------
Wang Shao Jian
Chief Financial Officer
(Principal Financial Officer)
22