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, 2003
/ / 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. 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, 188 CONNAUGHT ROAD WEST, N/A
HONG KONG (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER: 011-852-2876-2900
PACIFICNET.COM INC., 7808 CREEKRIDGE CIRCLE, SUITE101 BLOOMINGTON, MN 55439
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(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: $1,217,000.The aggregate
market value of the common stock held by non-affiliates of the registrant as of
December 31, 2003 was approximately $4,055,986, based upon the closing sale
price of $5.34 per share as reported by The Nasdaq Small Cap Market on such
date. There were 7,713,977 shares of the Company's common stock outstanding on
March 25, 2004.
Transitional Small Business Disclosure Format (check one): YES / / NO /X/
DOCUMENTS INCORPORATED BY REFERENCE - NONE
TABLE OF CONTENTS
PART I
1. Description of Business 3
2. Description of Property 11
3. Legal Proceedings 12
4. Submission of Matters to a Vote of Security Holders 12
PART II
5. Market for Common Equity and Related Stockholder Matters 12
6. Management's Discussion and Analysis or Plan of Operation 13
7. Financial Statements 17
8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 41
8A. Controls and Procedures 41
PART III
9. Directors and Executives Officers 41
10. Executive Compensation 44
11. Security Ownership of Certain Beneficial Owners and Management 46
12. Certain Relationships and Related Transactions 47
13. Exhibits and Reports on Form 8-K 48
14. Principal Accountant Fees and Services 49
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.
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
PacificNet Inc. (referred to herein as "PacificNet" or the "Company")
was incorporated in the state of Delaware on April 8, 1987. The Company is
focused on systems integration, network communications, customer relationship
management (CRM) solutions, information technology solutions and
telecommunications in Asia. The Company, through its subsidiaries, invests,
operates and provides value-added telecom services (VAS) in China including call
centers, telemarketing, customer relationship management (CRM), interactive
voice response (IVR), short messaging services (SMS), multimedia messaging
services (MMS), voice over internet protocol (VoIP), mobile applications,
calling cards, and sales and distribution of telecom services. The Company
intends to continue to grow by acquiring and managing growing technology and
network communications businesses with established products and customers in
Asia.
The Company's business strategy is to take a leading role in a rapidly
expanding business sector, namely the information technology solution provision
and network communication businesses in Asia and the greater People's Republic
of China region. The Company's business can be classified into the following
operating units:
- PacificNet Solutions Ltd. (referred to herein as "PacSo"), 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 Communications Ltd. (referred to herein as "PacComm"), a
subsidiary of PacificNet is a leading provider of VAS services
including call centers, CRM, telemarketing, data-mining services,
mobile data services such as short message services (SMS), multi-media
message services (MMS), unified messaging services (UMS),
location-based service (LBS), wireless application protocol (WAP), and
binary runtime environment for wireless (BREW)based CDMA applications,
mobile commerce, roaming, paging, wireless internet, virtual private
network (VPN) and voice over internet protocol (VoIP) services in the
Greater China Region. In December 2003, PacComm completed an agreement
to acquire a 50% controlling interest in Epro Telecom Holdings Limited
(Epro), one of the largest providers of value-added telecom services
(VAS), interactive voice response (IVR), mobile chatting, and
voice-portal services in Greater China with over 500 employees, 1,000
call center seats and processes over 100,000 calls daily.
- PacificNet Limited - is a distributor and reseller of
telecommunication, networking and computer equipment. In conjunction
with the Company's business of providing telecommunication services,
PacificNet Limited is also engaged in telecommunication product
distributions, which includes the resale of PABX telephone systems,
basic switches and router equipments and mobile phone accessories
targeted for retail customers.
- PacificNet Tech (SZ) Limited (referred to herein as "SZ") is a
subsidiary of PacificNet located in Shenzhen, the People's Republic of
China ("PRC"). SZ was established to expand the Company's research,
development, marketing and distribution opportunities in the PRC.
- PacificNet Strategic Investment Holdings Limited (referred to herein as
"PSI") is a subsidiary of PacificNet. In December 2003, PSI completed
an agreement to acquire 51% of the shares of a private PRC company,
Beijing Linkhead Technologies Limited Co., (Linkhead), a leading
provider of value-added telecom service (VAS), interactive voice
response (IVR), mobile chatting, and voice-portal services in Greater
China.
3
- Beijing Linkhead Technologies Limited Co., (referred to herein as
"Linkhead") a People's Republic of China 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 (NYSE:
CHA), China Mobile (NYSE: CHL), China Unicom (NYSE: CHU), UTStarcom
(Nasdaq: UTSI). 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.
- Epro Telecom Holdings Limited - Epro Telecom Holdings Limited (Epro), a
company incorporated in the Hong Kong Special Administrative Region of
the People's Republic of China, is engaged in the business provision of
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.
The Company has ceased its participation with International Elite
Limited (IEL) in the joint venture company, PacificNet Communications Limited -
Macao Commercial Offshore (the "Joint Venture"). Pursuant to the terms of the
Equity Joint Venture Agreement, signed on December 21, 2002, the Company was
required to obtain the requisite regulatory and shareholder approval to issue 34
million shares of the Company's common stock in connection with the Joint
Venture transaction. The Company still has not received the necessary regulatory
and shareholder approval to issue the shares. Since the Company was unable to
obtain shareholder approval, the board of directors of the Company determined
that it was in the best interest of the Company to terminate its interest in the
Joint Venture. Since the Company has not obtained regulatory and shareholder
approval of the joint venture transaction, the Company does not consolidate the
assets, liabilities, revenues and expenses of the Joint Venture. The Company has
cancelled all revenues in its financial records and returned to IEL all profits
earned in 2003 from the Joint Venture contracts. The Company will no longer seek
approval to issue the 34 million shares to the Joint Venture.
PRINCIPAL CUSTOMERS
The Company's customers are located in Hong Kong, mainland China and other
regions of Asia. For the year ended December 31, 2003, the Company's principal
customers included Sony and Swire Travel Ltd. The Company's business
relationship with each of its customers is based on a long-term mutual
beneficial relationships. The Company believes that the acquisitions of two
leading value added services providers, Beijing Linkhead Technologies Company,
Limited and Epro Telecom Holdings Limited, enhances the Company's ability to
market its customer relationship management (CRM) and value added services (VAS)
in Greater China and strengthens the Company's customer profile by including
major telecom operators such as China Telecom (NYSE: CHA), China Unicom (NYSE:
CHU) and PCCW (NYSE: PCW). A brief description of Company's customers is as
follows:
4
CHINA TELECOM - China Telecom Corporation Limited provides wireline telephone,
data, Internet and leased line services in Shanghai Municipality, Guangdong
Province, Jiangsu Province and Zhejiang Province of the People's Republic of
China. China Telecom offers a range of telecommunications services to
residential and business customers, including local, domestic long distance and
international long distance telephone services, Internet and managed data,
leased line and other related services.
CHINA MOBILE - China Mobile (Hong Kong) Limited provides a full range of mobile
telecommunications services in 21 service regions in Mainland China, consisting
of 16 provinces (Guangdong, Zhejiang, Jiangsu, Fujian, Henan, Hainan, Hebei,
Liaoning, Shandong, Anhui, Jiangxi, Sichuan, Hubei, Hunan, Shaanxi and Shanxi),
four municipalities (Beijing, Shanghai, Tianjin and Chongqing) and one
autonomous region (Guangxi Zhuang Autonomous Region). China Mobile offers mobile
telecommunications services principally using the global system for mobile
communications (GSM) standard. Its GSM networks reach all cities and counties
and major roads and highways within its service regions.
CHINA UNICOM - China Unicom Limited is an integrated telecommunications operator
in China, offering a wide range of telecommunications services, including
cellular, international and domestic long-distance, data, Internet and paging
services. The controlling shareholder, Unicom Group, possess the exclusive
license to offer code division multiple access (CDMA) cellular services in
China. It has constructed CDMA networks nationwide. It completed construction of
the initial phase of its CDMA network at the end of 2001. China Unicom has
leased capacity on Unicom's Group network and operates the CDMA network in the
cellular service areas.
PCCW - PCCW Limited is a telecommunications service provider in Hong Kong. PCCW
is comprised of segments such as Telecommunications Services (TSS). In the TSS
segment, PCCW provides fixed-line telecommunications services which includes
Internet access and multimedia content, and Business eSolutions through which
PCCW offers systems integration, applications development, network integration
and application-management services, information technology (IT) solutions,
business broadband Internet access, hosting and facilities management services
and Internet data centers within Hong Kong and greater China.
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, fiber optic broadband networks and radio broadcasting.
Hutchinson's Hong Kong mobile operations currently have a subscriber base of
about 1.8 million, representing the largest share of the local mobile market.
Hutchison 3G HK Limited (www.three.com.hk), a joint venture with NTT DoCoMo and
NEC, is the first operator in Hong Kong to roll out 3G video mobile services in
January 2004.
SUNDAY - SUNDAY Communications Limited is a developer and provider of wireless
communications and data services, including the sales of mobile phones and
wireless data services, in Hong Kong. It offers its services under the brand
name SUNDAY. Since early 2000, SUNDAY has started launching various wireless
data services through which its subscribers could utilize ringtone or logo
downloads, quiz games, message dedication or participate in mobile community
chat by the use of short messaging services or media messaging services. SUNDAY
was granted a mobile carrier license in Hong Kong in October 2001 to construct
and operate a 3G (third-generation) 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.
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.
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.
5
THE HONG KONG HOUSING AUTHORITY (HA) - The Hong Kong Housing Authority is a
department of the Hong Kong Special Administrative Region of the People's
Republic of China (HKSAR). HA determines and implements public housing programs
within the government's overall housing policy framework. Apart from planning
and building public housing, HA 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 carparks. In
addition, it acts as the government's agent for clearing land, preventing
squatting and implementing improvements in squatter areas. HA also assists
low-income families to become home owners.
SERVICES
The Company provides various services to its customers including:
CUSTOMER RELATIONSHIP MANAGEMENT. We provide solid experience in call center
operation and management and active involvement in the evolution of the customer
contact industry.
VOICE AND IP RELATED SERVICES. We provide extensive experience in voice and IP
related products in the value-added industry and plan to expand to more
data-oriented services for mobile users.
CONSULTING SERVICES. We consult with our customers to establish online
e-business environments. Consulting services include the identification of
specific content nature, user-friendly interface, overall web themes and
designs, target user groups, web advertising and integrated online solutions.
TRAINING SERVICES. We offer comprehensive training programs and consulting
services available for call center management professionals at all levels.
Our subsidiary Epro is a leading provider of outsourced call center,
telemarketing, CRM, SMS, and other value-added telecom services (VAS),
interactive voice response (IVR) 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 1000
workstations and 500 agents, and provides 24x7x365 multi-lingual inbound and
outbound services.
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 maximize
the return on investment of their CRM operations.
3. Call Center Management Software Products and Solutions
Epro's software products include: WISE-xb Call Center agent performance
management and reporting software, and Automatic Call Distribution (ACD) System,
Unified Messaging System (UMS), SMS, and other value added services.
SALES AND MARKETING
Historically, the Company has not engaged in any significant marketing
activities and has relied primarily on its reputation for quality and efficiency
among its customers and leveraging its strategic investors to obtain new
business.
BACKLOG
There was no significant backlog of services to render to customers for PacComm,
PacificNet and PacSo as of December 31, 2003.
6
COMPETITION
The market in which we compete is highly competitive and fragmented. We expect
competition to persist and intensify in the future. Our competitors include
small firms offering specific applications, divisions of large entities, large
independent firms and, most significantly, the in-house operations of clients or
potential clients. A number of competitors have or may develop greater
capabilities and resources than ours. Because our primary competitors are
in-house operations of existing or potential clients, our performance and growth
could be negatively impacted if our existing clients decide to provide in-house
customer care services that currently are outsourced, or if potential clients
retain or increase their in-house customer service and product support
capabilities. In addition, competitive pressures from current or future
competitors could cause our services to lose market acceptance or result in
significant price erosion.
EMPLOYEES
As of December 31, 2003, the Company and its subsidiaries had 650 employees and
contractors. The Company has not experienced any labor stoppages. None of the
Company's employees are covered by collective bargaining agreements.
RESEARCH AND DEVELOPMENT
The Company places great emphasis on the continued enhancement of its existing
products and solutions, including designing, development 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. These products and solutions
include:
o color ringback tone systems;
o value-added services for mobile users;
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;
o voice mail systems; 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.
RISK FACTORS
In addition to the other information in this annual report, the following
factors should be considered carefully in evaluating the Company's business and
prospects. THE FOLLOWING MATTERS, AMONG OTHERS, MAY HAVE A MATERIAL ADVERSE
EFFECT ON THE BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR
PROSPECTS, FINANCIAL OR OTHERWISE, OF THE COMPANY. 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
BECAUSE WE HAVE A LIMITED OPERATING HISTORY THERE MAY NOT BE SUFFICIENT
INFORMATION FOR YOU TO EVALUATE OUR FUTURE GROWTH. We were founded and commenced
operations in July 1999. We have a limited operating history from which
investors can base evaluations of its business and prospects. In addition, our
prospects must be considered in light of the risks and uncertainties inherent in
and traditionally encountered by companies in an early stage of development in
new and rapidly evolving markets. As of December 31, 2003, we had incurred
losses aggregating $29,850,000.
7
OUR GROWTH STRATEGY TO ACQUIRE COMPANIES AND FORM STRATEGIC ALLIANCES MAY NOT BE
SUCCESSFUL, AND IF IT IS NOT, OUR ABILITY TO GENERATE REVENUES THROUGH THESE
VEHICLES MAY BE IMPAIRED.
One component of our growth strategy is to pursue strategic acquisitions of
companies in China that have services, products, technologies, industry
specializations or geographic coverage that extend or complement our existing
business. We also intend to actively identify and acquire assets and
technologies from business that are complementary to our existing portal
business. There can be no assurance that we will be able to successfully
identify, acquire on favorable terms or integrate such companies. If any
acquisition or joint venture is completed, there can be no assurance that such
acquisition will enhance our business, results of operations or financial
condition. As part of its growth strategy, the Company may also pursue
opportunities to undertake strategic alliances in the form of joint ventures.
Joint ventures involve many of the same risks as acquisitions, as well as
additional risks associated with possible lack of control of the joint ventures.
Any such future acquisitions may be subject to a number of risks, including:
o the diversion of management time and resources;
o the difficulty of assimilating the operations and personnel of the
acquired companies;
o the potential disruption of our ongoing business;
o the difficulty of incorporating acquired technology and rights into our
products and services;
o unanticipated expense related to technology integration;
o difficulties in maintaining uniform standards, controls, procedures and
policies;
o the impairment of relationships with employees and customers as a
result of any integration of new management personnel;
o potential unknown liabilities associated with acquired business.
Further, in connection with these acquisitions and joint venture transactions we
plan to issue shares of our common stock. The price of our stock has fluctuated
in the past and may continue to do so. If the value of our stock declines, or
other adverse circumstances arise, we face the risk that the parties to these
acquisitions or joint ventures may seek ways to terminate the transaction, or,
may hinder or prevent us from accessing important information regarding the
financial and business operations of these companies. 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. Moreover, the resources expended in identifying and consummating
acquisitions and joint ventures may be significant. Furthermore, any
acquisitions we decide to pursue may be subject to the approval of the relevant
PRC government authorities, as well as any applicable PRC rules and regulations.
The occurrence of any such events could have a material adverse effect.
The Company may in the future face increased competition for acquisition and
joint venture opportunities, which may inhibit the Company's ability to
consummate suitable acquisitions or joint ventures on terms favorable to the
Company. The Company may require additional debt or equity financing for future
acquisitions or joint ventures, which financing may not be available on terms
favorable to the Company, if at all. The Company recently acquired controlling
interests in Epro Telecom Holdings Limited and in Beijing Linkhead Technologies
Co., Ltd. The Company expects these acquisitions to strengthen its position as a
provider of outsourced call center, telemarketing, customer relationship
management and value added services. However, the anticipated benefits of these
acquisitions may not be achieved.
WE RELY ON ESTABLISHED CUSTOMER RELATIONSHIPS TO GENERATE NEW CONSULTING
SERVICES CUSTOMERS AND WITHOUT ANY ADDITIONAL MARKETING WE FACE THE RISK THAT WE
WILL NOT BE ABLE TO OBTAIN NEW CUSTOMERS. We do not have an internal marketing
team. In order to generate new consulting services customers, we rely primarily
on customer referrals from relationships established by our executive management
and business unit leaders. Without a marketing team our ability to generate new
consulting services customers will be limited to our customer referrals, and if
we are unable to successfully maintain existing relationships, and generate new
consulting services customers in a cost-effective manner, our ability to
generate revenues through our consulting services business could be severely
limited.
8
OUR OPERATIONS COULD BE CURTAILED IF WE ARE UNABLE TO OBTAIN ANY REQUIRED
ADDITIONAL FINANCING ON FAVORABLE TERMS, IF AT ALL. Since inception, our
investments and operations have been financed through sales of our common stock.
We currently have an available bank line of $110,000 out of a total credit line
of $1,309,000. As of December 31, 2003, we had $3,823,000 in cash and cash
equivalents. Subsequent to December 31, 2003, we completed a private placement
of our common stock in which we received approximately $3,000,000 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. 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 generate revenue.
COMPETITION. The market in which we compete is highly competitive and
fragmented. We expect competition to persist and intensify in the future. Our
competitors include small firms offering specific applications, divisions of
large entities, large independent firms and, most significantly, the in-house
operations of clients or potential clients. A number of competitors have or may
develop greater capabilities and resources than ours. Similarly, there can be no
assurance that additional competitors with greater resources than ours will not
enter our market. Because our primary competitors are in-house operations of
existing or potential clients, our performance and growth could be negatively
impacted if our existing clients decide to provide in-house customer care
services that currently are outsourced or if potential clients retain or
increase their in-house customer service and product support capabilities.
Specially, increasing competition in relation to CRM and VAS services in the PRC
has led to a reduction in the telecommunication services fee. Such profit margin
decreases could adversely affect the Company's profitability. In addition,
competitive pressures from current or future competitors could cause our
services to lose market acceptance or result in significant price erosion, which
would have a material adverse effect upon our business, results of operations or
financial condition.
DEPENDENCE ON KEY PERSONNEL. We are highly dependent on the services of Tony
Tong, our Chairman and Chief Executive Officer and Victor Tong, our President,
as well as other principal members of our management team. Our executives not
only manage our day to day business operations, but are essential to our ability
to establish and maintain relationships with our customers. Continued growth and
profitability will depend upon our ability to maintain our current leadership
infrastructure and recruit and retain qualified, and experienced executive
personnel. Competition in our industry for executive-level personnel is strong
and there can be no assurance that we will be able to hire, motivate and retain
highly effective executive employees.
RISKS RELATED TO OUR TECHNOLOGY AND EQUIPMENT
RISK OF BUSINESS INTERRUPTION. Our operations are dependent upon our ability to
protect our call centers, data centers, computer and telecommunications
equipment and software systems against damage from fire, power loss,
telecommunications interruption or failure, hacker attacks, natural disaster 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 it may incur.
RISKS ASSOCIATED WITH TECHNOLOGY. Our 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 have a material adverse effect on our
business, results of operations or financial condition. Our future success also
will be highly dependent upon our ability to enhance existing services and
introduce new services or products to respond to changing technological
developments. There can be no assurance that we can successfully develop and
bring to market any new services or products in a timely manner, that such
services or products will be commercially successful or that competitors'
technologies or services will not render our products or services noncompetitive
or obsolete.
9
RISK RELATED TO OUR TECHNOLOGY AND EQUIPMENT
DEPENDENCE ON KEY INDUSTRIES. Our clients are concentrated primarily in the
telecommunications, telemarketing and technology industries, and to a lesser
extent, the insurance and financial services industries. Our business and growth
is largely dependent on the continued demand for our services from these
industries and current trends in such industries to outsource certain customer
care services. A general economic downturn in any of these industries or a
slowdown or reversal of the trend in any of these industries to outsource
certain customer care services could have a material adverse effect on our
business, results of operations or financial condition.
RISKS ASSOCIATED WITH DOING BUSINESS IN ASIA
THERE ARE SUBSTANTIAL RISKS ASSOCIATED WITH OUR ASIAN OPERATIONS. The
establishment and expansion of international operations has required significant
management attention and resources since our founding. All of our current and
anticipated future revenues are or are expected to be derived from Asia. Our
international operations are subject to additional risks, including the
following, which, if not planned and managed properly, could materially
adversely affect our business, financial condition and operating results,
language barriers and other difficulties in staffing and managing foreign
operations;
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;
o seasonal reductions in business activity; and
o potentially uncertain or adverse tax consequences.
In addition, changes in the political and overall economic conditions of the
Asian region, which are outside the control of management, could have a material
adverse effect on our business, operating results and financial condition. 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. To date, we have not engaged in any
hedging transactions in connection with our international operations.
INTERNAL POLITICAL RISKS. Our operations and assets in 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.
SALES IMPACT DUE TO SEVERE ACUTE RESPIRATORY SYNDROME (SARS). The outbreak of
SARS in the PRC in early 2003, following official acknowledgement of the disease
by the authorities in April 2003, had impacted retail sales in general,
including that of related telecommunications services. It was observed that
consumer spending in the PRC was significantly reduced due to self-imposed
restriction on peoples' mobility within some major cities. There can be no
assurance that new SARS cases will not recur. The crisis of outbreak of bird flu
is another unknown factor may cause strong impact in the global economy growth.
If this happens, the Company's sales and financial position will be adversely
affected.
NON-RENEWAL OF BUSINESS LICENSES. In order to expand our business into mainland
China our activities will require business licenses. This requires a review and
approval of our activities by various national and local agencies of the Chinese
government. There can be no assurance that current Chinese government, or
successors, will continue to approve of our activities or grant or renew our
licenses. Our inability to obtain needed approvals or licenses would have a
material adverse effect on our business, financial condition and results of
operations.
10
LACK OF REMEDIES AND IMPARTIALITY UNDER CHINESE LEGAL SYSTEM. Unlike the United
States, China has a civil law system based on written statutes in which judicial
decisions have little precedence value. 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. 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.
FOREIGN CORRUPT PRACTICES ACT. The Company is subject to the United States
Foreign Corrupt Practices Act, which generally 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 that may compete with us, are not subject to these prohibitions.
Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices
occur from time-to-time in China. We have attempted to implement safeguards to
prevent losses from such practices and to discourage such practices by our
employees and agents. There is no assurance, however, that we will not suffer
such losses or that our employees or other agents will not engage in such
conduct for which we might be held responsible.
OUR STOCK PRICE IS HIGHLY VOLATILE. Our stock price has fluctuated dramatically.
There is a significant risk that the market price of the common stock will
decrease in the future in response to any of the following factors, some of
which are beyond our control:
o variations in our quarterly operating results;
o announcements that our revenue or income are below analysts'
expectations;
o general economic slowdowns;
o changes in market valuations of similar companies;
o sales of large blocks of our common stock;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o fluctuations in stock market prices and volumes, which are particularly
common among highly volatile securities of internationally based
companies
ITEM 2. DESCRIPTION OF PROPERTY.
A description of the Company's property follows:
HONG KONG - The Company maintains its corporate headquarters and development
center in Hong Kong located at Unit 2710, Hong Kong Plaza, 188 Connaught Road
West, Hong Kong, where it leases approximating 1,000 square feet floor for a
monthly rental fee of $650. Substantially all of the Company's operations are
run from this facility. The Company leases this space from a shareholder.
The Company's Call Center is located at Units 601-603 New Bright Building, 11
Sheung Yuet Road, Kowloon Bay, Kowloon where it leases approximately 17,739
square feet for a monthly fee of $16,365 and branch office is located at Units
2-3, 17th Floor, Nan Fung Commercial Centre, 19 Lam Lok Street, Kowloon Bay,
Hong Kong where it leases approximately 2,359 square feet for a monthly rental
fee of $1,815.
UNITED STATES - The Company's current U.S. corporate office is located at 860
Blue Gentian Road, Suite 360, Eagan, Minnesota 55121, where it subleases space
for a monthly rental fee of $1,000.
CHINA - The Company's current Chinese corporate office is located at Room 1708,
Tower B, Stars Plaza, Hongli Road, FuTian District, Shenzhen, China where it
leases approximately 1,000 square feet for a monthly rental fee of $449. The
Company leases this space from a shareholder. The Company's offices are located
in Beijing , Shanghai and Shenzhen. Details are as follows:
Locations Area (Square Feet)
--------- ------------------
1601, 26 Building, 3 Block, Anzhenxili, ChaoYang District, Beijing 4,306
1407, 2 Building, Hengji Plaza, 547 Tianmuxilu, Shanghai 2,153
901, Tower A, Tian An High-Tech Plaza, Tian An Cyber Park, Fu Tian District, Shenzhen 1,076
11
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company held its 2003 Annual Meeting of Stockholders at its Hong Kong
Corporate office on December 24, 2003. At such meeting the following directors
were elected. Tony Tong, Victor Tong, ShaoJian Wang, Yue Tang, David Fisher and
Peter Wang.
The following proposals were also voted on at the meeting:
RATIFICATION AND APPROVAL OF THE PREVIOUS ISSUANCE OF SHARES OF THE COMPANY'S
COMMON STOCK TO DIRECTORS AND OFFICERS OF THE COMPANY AS COMPENSATION FOR
SERVICES PROVIDED TO THE COMPANY.
FOR - 3,021,798
WITHHELD - 1,506,740
ABSTAIN - 159,317
RATIFICATION OF AMENDMENT OF THE COMPANY'S 1998 STOCK OPTION PLAN TO INCREASE
THE NUMBER OF SHARES THAT MAY BE GRANTED AS STOCK OPTION AWARDS UNDER THE 1998
PLAN.
FOR - 2,847,660
WITHHELD - 1,506,740
ABSTAIN - 159,317
RATIFICATION OF THE APPOINTMENT OF CLANCY AND CO P.L.L.C., AS INDEPENDENT
AUDITORS FOR THE COMPANY FOR FISCAL YEAR 2003:
FOR - 4,691,071
WITHHELD - 5,677
ABSTAIN - 21
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is listed on The Nasdaq SmallCap Market
under the symbol "PACT". Effective at the open of business on January 6, 2003,
every five (5) shares of the Company's issued and outstanding common stock was
combined into one (1) share of fully paid and non-assessable common stock of the
Company.
The following table sets forth the range of high and low bid prices
reported by Nasdaq in each fiscal quarter from January 1, 2002 to December 31,
2003. The high and low bid prices reported by Nasdaq, have been adjusted to give
effect to the reverse split. The quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not represent actual
transactions.
HIGH LOW
---- ---
FISCAL 2002
Quarter Ended March 31, 2002 $1.50 $0.85
Quarter Ended June 30, 2002 $2.25 $0.70
Quarter Ended September 30, 2002 $1.05 $0.40
Quarter Ended December 31, 2002 $1.95 $0.50
FISCAL 2003
Quarter Ended March 31, 2003 $3.65 $0.30
Quarter Ended June 30, 2003 $3.09 $2.30
Quarter Ended September 30, 2003 $10.29 $2.18
Quarter Ended December 31, 2003 $6.41 $4.10
FISCAL 2004
January 1, 2004 - March 25, 2004 * $7.00 $4.98
* Reflects partial period
As of March 25, 2004, there were approximately 3,000 record holders of
the common stock. The Company has not paid any cash dividends on its common
stock, and it currently intends to retain any future earnings to fund the
development and growth of its business.
12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
FORWARD-LOOKING STATEMENTS. 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.
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 or plan of operations
are 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 bad debts, inventories, intangible assets, income taxes and
contingencies. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
Management believes the following critical accounting policies reflect its more
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 could be objectively measured and recognized as an asset
for accounting purposes at the time it is acquired or developed its future
economic benefits. Some costs and expenses are recognized as expenses as costs
incurred during the period provide no discernible future benefits, or costs
recorded as assets in prior periods no longer provide discernible benefits, and
allocating costs either on the basis of association with revenue or among
several accounting periods is considered to serve no useful purposes.
13
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.
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.
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
were to 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.
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, 2003 DECEMBER 31, 2002
----------------- -----------------
Revenues 100.0% 100.0%
Cost of Revenues (57.4) (77.1)
Gross Margin 42.6 22.9
Selling, general and administrative expense (226.6) (125.6)
Depreciation and amortization (6.2) (11.4)
PROVISION FOR WRITTEN OFF FIXED ASSETS (17.1) -
OPERATING LOSS (207.3) (114.1)
Interest income, net 2.2 1.4
Sundry income 4.4 -
Provision for impairment of affiliated companies - (4.2)
Provision for income taxes (2.6) -
Minority interest 49.0 (4.6)
Discontinued operations - (4.6)
NET LOSS (154)% (126)%
14
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
REVENUES, COST OF REVENUES AND GROSS MARGIN. Revenues for the year ended
December 31, 2003 were $1,217,000, a decrease of $1,102,000 from $2,319,000 for
the year ended December 31, 2002. Cost of revenues for the year ended December
31, 2003 were $698,000, a decrease of $1,089,000 from $1,787,000 for the year
ended December 31, 2002. Cost of revenues, as a percentage of revenues, was 57%
for the year ended December 31, 2003 compared with 77% for the year ended
December 31, 2002. The decrease in revenues and cost of revenues is the result
of a reduction of operations in IT Systems Integration. Gross margin for the
year ended December 31, 2003 was $519,000, a decrease of $13,000 from $532,000
for the year ended December 31, 2002, resulting from the reduction of revenues
as compared to 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, General and
Administrative expenses totaled $2,758,000 for the year ended December 31, 2003,
a decrease of $154,000 from $2,912,000 for the year ended December 31, 2002. The
decrease in selling, general and administrative expenses is the result of
reducing the size of our operations, which resulted in decreased premises costs
and staff costs.
INTEREST INCOME. Interest income was $27,000 for the year ended December 31,
2003, as compared to $33,000 for the year ended December 31, 2002. The decrease
is due to a lower interest rate in 2003 compared to 2002.
WRITTEN-OFF OF TANGIBLE AND INTANGIBLE ASSETS. As of balance sheet date, the
Company reviews the carrying amounts of its tangible and intangible assets to
determine whether there is any indication that those assets have to make
provision for the impairment loss. The Company decided to write off tangible
assets of $208,000 and intangible assets which mainly include research and
development of $761,000. The costs and expenses are recognized as expenses as
costs incurred during the period provide no discernible future benefits
PROVISION FOR IMPAIRMENT LOSS OF AFFILIATED COMPANIES. The Company's provision
for impairment loss of affiliated companies totaled $97,000 for the year ended
December 31, 2002, and related to the Company's investments in Xmedia ($95,000)
and in PacSo ($2,000).
DISCONTINUED OPERATIONS. Discontinued operations represents the net loss
resulting from the Company's downsizing of its operations in Laptizen during the
forth quarter of 2001. Revenues were $15,000 and net loss was $107,000 for 2002
respectively.
INCOME TAXES. The income taxes for one of the Company's subsidiaries was $32,000
for the year ended December 31, 2003 and $0 for the year ended December 31,
2002. The increase in income taxes was the result of the operating profit
generated by the subsidiary.
MINORITY INTERESTS. Minority interests for the year ended December 31, 2003
totaled $596,000, which represents the Company's existing interest in its
subsidiary PacSo of $25,000, and its interest in newly acquired subsidiaries,
Epro of $380,000 and Linkhead of $191,000 respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, the Company had cash and cash equivalents of
$3,823,000, and working capital of $1,442,000 as compared to $3,694,000 and
$3,081,000, respectively at December 31, 2002.
Net cash used in operating activities was $905,000 for the year ended December
31, 2003 as compared to net cash used in operating activities of $2,172,000 for
the year ended December 31, 2002. Net cash provided by operating activities in
the year ended December 31, 2003 was primarily due to a net loss of $1,878,000,
increased by noncash items and changes in operating assets totaling $595,000 and
totaling $378,000, respectively. Net cash used in operating activities of
$2,172,000 for the year ended December 31, 2002 was primarily due to a net loss
of $2,921,000, increased by noncash items totaling $1,036,000 and decreased by
changes in operating assets totaling $287,000.
Net cash used in investing activities for the year ended December 31, 2003 was
$311,000 as compared to cash used in investing activities for the year ended
December 31, 2002 of $36,000. The cash used in investing activities in the year
ended December 31, 2003 was primarily due to the acquisition of subsidiary
companies of $211,000. The cash used in investing activities in the year ended
December 31, 2002 was primarily from purchases of property and equipment of
$14,000 and purchase of affiliate company interests of $22,000.
15
Net cash provided by financing activities for the year ended December 31, 2003
was $1,345,000 as compared to net cash provided by financing activities of
$4,560,000, for the year ended December 31, 2002. The cash provided by financing
activities for the year ended December 31, 2003, resulted from advances under
bank line credit of $634,000, proceeds from new bank loans and financing leases
totaling $766,000 and proceeds from exercise of stock options and warrants of
$410,000, and reduced by repayments of bank loans of $465,000. The net cash
provided by financing activities of $4,560,000 for the year ended December 31,
2002, resulted primarily from $4,000,000 received in connection with the sale of
2,725,000 shares of common stock, and advances under bank line credit of
$565,000.
WORKING CAPITAL. The Company's working capital decreased by $1,639,000 to
$1,442,000 at December 31, 2003, as compared to $3,081,000 at December 31, 2002.
When compared to balances at December 31, 2002, the decreased in working capital
at December 31, 2003 reflects an increase in current liabilities of $3,915,000,
compared to an increase in current assets of $2,276,000.
PROPERTY AND EQUIPMENT ADDITIONS. For the year ended December 31, 2003,
additions to property and equipment aggregated $29,000 for the expansion of the
CRM and call center business in Hong Kong. The Company also wrote off computer
equipment and furniture and fixtures of $208,000 considered to have no future
economic benefit.
ISSUANCE OF COMMON STOCK. For the year ended December 31, 2003, the Company
issued (i) 16,725 shares with cash consideration of $27,000 to settle expenses,
(ii) 200,000 shares as a result of providing compensation for the Chief
Executive Officer according to the employment contract, and (iii) 240,000 shares
as a result of exercise of share options and warrants with cash consideration of
$410,000.
CASH NEEDS FOR THE FORESEEABLE FUTURE. As of December 31, 2003, the Company had
approximately $4 million of cash and cash equivalents. The Company believes it
has sufficient cash to satisfy cash requirements for at least the next twelve
months of operations, however, it expects that its cash needs for the
foreseeable future will arise primarily from working capital requirements,
technology development and capital expenditures. In the event that additional
credit facilities are required, the Company believes that these additional
credit facilities can be negotiated at market rates currently in effect. The
Company believes that these sources will be adequate to meet anticipated cash
requirements for the next twelve months.
INFLATION. Inflation has not had a material impact on the Company's business in
recent years.
CURRENCY EXCHANGE FLUCTUATIONS. All of Company's revenues are denominated either
in United States 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. There can be no assurance that RMB-to-United
States dollar or Hong Kong dollar-to-United States dollar exchange rates will
remain stable. 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 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.
SEASONALITY AND QUARTERLY FLUCTUATIONS. The Company has not experienced
fluctuations in quarterly revenues from its e-commerce solutions business since
inception. The Company believes that its business is not subject to seasonal and
quarterly fluctuations. However, since the Company, in its current form of
business operations as an Asian IT solutions and consulting company, has only
been in existence since July 1999, the Company does not have a sufficient
operating history to determine whether seasonal and quarterly fluctuations exist
within its business lines.
16
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 Public Accountants 18
Consolidated Balance Sheets - As of December 31, 2003 and 2002 19
Consolidated Statements of Operations - For the Years Ended
December 31, 2003 and December 31, 2002 20
Consolidated Statements of Changes in Stockholders' Equity
- For the Years Ended December 31, 2003 and December 31, 2002 21
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 2003 and December 31, 2002 22
Notes to Consolidated Financial Statements 23
17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
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, 2003 and 2002, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the years then ended. These 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 auditing standards generally accepted
in the United States of America. 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, 2003 and 2002, 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
March 30, 2004
18
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except par values and share numbers)
DECEMBER 31, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents $ 3,823 $ 3,694
Restricted cash - pledged bank deposit (Note 8) 212 --
Accounts Receivables (net of allowance for doubtful
accounts of $0 as of December 31, 1,890 220
2003 and $255 as of December 31, 2002)
Inventories (Note 3) 76 --
Other Current Assets 286 97
------------- -------------
Total Current Assets 6,287 4,011
Property and Equipment, net (Note 6) 466 284
Goodwill (Note 5) 420 19
------------- -------------
TOTAL ASSETS $ 7,173 $ 4,314
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank Line of Credit (Note 7) $ 1,199 $ 565
Bank Loans-current portion (Note 8) 1,405 --
Capital Lease Obligations - current portion (Note 9) 152 --
Accounts Payable 1,007 224
Accrued Expenses 360 141
Subscription Payable (Note 10) 722 --
------------- -------------
Total Current Liabilities 4,845 930
------------- -------------
Long-term liabilities:
Bank Loans - non current portion (Note 8) 377 --
Capital Lease Obligations - non current portion (Note 9) 149 --
------------- -------------
Total Long-Term Liabilities 526 --
------------- -------------
TOTAL LIABILITIES 5,371 930
Minority Interest in Consolidated Subsidiary (110) 131
Commitments and Contingencies (Note 7)
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, 2003 - 6,163,977 shares, 5,363,977 outstanding
December 31, 2002 - 4,907,252 shares 1 1
Treasury Stock, at cost (800,000 shares) (5) (5)
Additional Paid-In Capital 31,790 31,253
Cumulative Other Comprehensive Loss (24) (24)
Accumulated Deficit (29,850) (27,972)
------------- -------------
Total Stockholders' Equity 1,912 3,253
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,173 $ 4,314
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
19
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands of United States dollars, except loss per share and share amounts)
2003 2002
------------ ------------
YEAR ENDED DECEMBER 31:
Revenues $ 1,217 $ 2,319
------------ ------------
Cost of Revenues (698) (1,787)
------------ ------------
Gross Margin 519 532
Selling, General and Administrative expenses (2,758) (2,912)
Depreciation and amortization (76) (264)
Provision for written off of fixed assets (208) --
------------ ------------
LOSS FROM OPERATIONS (2,523) (2,644)
Interest Income 27 33
Sundry income 54 --
------------ ------------
LOSS BEFORE INCOME TAXES, MINORITY INTEREST AND DISCONTINUED OPERATIONS (2,442) (2,611)
Provision for income taxes (Note 12) (32) --
Provision for impairment loss of affiliated companies (Note 5) -- (97)
Minority Interests 596 (106)
------------ ------------
LOSS BEFORE DISCONTINUED OPERATIONS (1,878) (2,814)
------------ ------------
LOSS FROM DISCONTINUED OPERATIONS (NOTE 2) -- (107)
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS ($ 1,878) ($ 2,921)
------------ ------------
BASIC AND DILUTED LOSS PER COMMON SHARE:
Loss from continuing operations ($ 0.36) ($ 0.67)
Loss from discontinued operations -- ($ 0.03)
------------ ------------
Net loss ($ 0.36) ($ 0.70)
BASIC AND DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 5,234,744 4,191,816
The accompanying notes are an integral part of these consolidated financial statements.
20
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands of United States dollars, except loss per share and share amounts)
CUMULATIVE
ADDITIONAL OTHER TOTAL
PREFERRED COMMON PAID-IN COMPREHENSIVE ACCUMULATED TREASURY STOCKHOLDERS'
STOCK STOCK CAPITAL INCOME/(LOSS) DEFICIT STOCK EQUITY
--------- --------- ------------ ------------- ------------ ---------- -------------
BALANCE AT DECEMBER 31, 2001
(1,634,628 SHARES) $ -- $ -- $ 26,755 $ (22) $ (25,051) $ -- $ 1,682
COMPREHENSIVE LOSS:
Net loss -- -- -- -- (2,921) -- (2,921)
Change in Cumulative Effect
of Foreign Currency
Translation -- -- -- (2) -- -- (2)
------------
TOTAL COMPREHENSIVE LOSS (2,923)
------------
Issuance of common stock for
services (337,007 shares) -- -- 263 -- -- -- 263
Issuance of common stock to
acquire fixed assets
(155,058 shares) -- -- 186 -- -- -- 186
Issuance of common stock to
satisfy liabilities
(60,585 shares) -- -- 50 -- -- -- 50
Issuance of common stock for
cash (2,725,000 shares) -- 1 3,999 -- -- -- 4,000
Treasury Stock acquired, at
cost (4,970 shares) -- -- -- -- -- (5) (5)
Share adjustment (56 shares
reduction) -- -- -- -- -- -- --
--------- --------- ------------ ------------- ------------ ---------- -------------
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)
-----------
Shares returned to the treasury
(800,000 shares) -- -- -- -- -- -- --
Issuance of common stock to
satisfy services (16,725
shares) -- -- 27 -- -- -- 27
Issuance of common stock for
officer's exercise of stock
options as part of employment
compensation (200,000 shares) -- -- 100 -- -- -- 100
Exercise of stock options and
warrants 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
========= ========= ============ ============= ============= ========== =============
The accompanying notes are an integral part of these consolidated financial statements.
21
PACIFICNET INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars, except loss per share and share amounts)
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,878) $ (2,921)
Adjustment to reconcile net loss to net cash used in operating activities:
Expenses settled by issuance of common shares 127 313
Minority Interest (596) 98
Loss on disposal of fixed assets 208 142
Provision for impairment of software development costs 761 122
Provision for impairment of affiliated companies -- 97
Provision for write-off of goodwill 19 --
Depreciation 72 154
Amortization 4 110
Changes in:
Accounts receivable and other current assets 272 145
Inventories -- 93
Other payables and accrued expenses 106 (525)
------------ ------------
Net cash used in operating activities (905) (2,172)
------------ ------------
CASH FLOWS FROM INVESTMENT ACTIVITIES
Increase in restricted cash-pledged bank deposits (52) --
Acquisition of property and equipment (29) (14)
Acquisition of intangible assets (19) --
Acquisition of subsidiaries (211) --
Acquisition of affiliate company interests -- (22)
------------ ------------
Net cash used in investing activities (311) (36)
------------ ------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Advances under bank line of credit 634 565
Proceeds from sale of common stock -- 4,000
Proceeds from exercise of stock options and warrants 410 --
Repayment of amount borrowed (465) --
New bank loans 717 --
New finance lease 49 --
Purchases of treasury stock -- (5)
------------ ------------
Net cash provided by financing activities 1,345 4,560
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH -- (2)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 129 2,350
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,694 1,344
------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,823 $ 3,694
------------ ------------
CASH PAID FOR:
Interest 54 8
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 $ 313
Common stock issued to acquire fixed assets $ -- $ 186
The accompanying notes are an integral part of these consolidated financial statements.
22
PACIFICNET INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in United States dollars unless otherwise stated)
1. 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.
PacificNet is an Asian information technology solutions provider that
develops and implements full service information technology ("IT")
solutions. In fiscal year 2002, the Company reduced the
business-to-business electronic commerce initiatives to focus on IT
consulting services and the licensing of proprietary software
technologies. The Company provides telecommunication voice and data
network communications products and services. The Company's business
strategy is to expand its role in the rapidly growing business sector,
namely the IT solution provision and network communication businesses,
in the Asian market, particularly the greater PRC region.
Operating Risks - 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.
2. BUSINESS DISPOSITIONS AND RESCINDED TRANSACTIONS
Business Disposition - In September 2001, the Board of Directors of the
Company approved a plan not to further invest in Laptizen.com Limited
("Laptizen") subsidiary. Laptizen is a Hong Kong value added reseller
of computer systems. As of December 31, 2001 all activities related to
Laptizen had significantly reduced and the Company planned to liquidate
Laptizen. During the year ended December 31, 2001, the Company
wrote-off associated Laptizen goodwill of $89,000. Revenue and net loss
information related to Laptizen operations is as follows (in
thousands):
YEAR ENDED DECEMBER 31,
2003 2002
------- -------
REVENUES $ -- $ 15
NET LOSS $ -- $ (107)
Rescinded transaction - The Company has ceased its participation with
International Elite Limited (IEL) in the joint venture company,
PacificNet Communications Limited - Macao Commercial Offshore (the
"Joint Venture"). Pursuant to the terms of the Equity Joint Venture
Agreement, signed on December 21, 2002, the Company was required to
obtain the requisite regulatory and shareholder approval to issue 34
million shares of the Company's common stock in connection with the
Joint Venture transaction. The Company still has not received the
necessary regulatory and shareholder approval to issue the shares.
Since the Company was unable to obtain shareholder approval, the board
of directors of the Company determined that it was in the best interest
of the Company to terminate its interest in the Joint Venture. Since
the Company has not obtained regulatory and shareholder approval of the
joint venture transaction and the Company does not control the
operating and financing decisions of the joint venture, the Company
does not consolidate the assets, liabilities, revenues and expenses of
the joint venture. The Company will no longer seek approval to issue
the 34 million shares to the Joint Venture and the original 800,000
deposit shares held in escrow were canceled and returned to the
Company's treasury. The termination agreement was signed on March 30,
2004. (See Note 15)
23
The following 2003 unaudited quarterly interim information has been
restated to present the results of operations for the Company as a
result of the joint venture termination (in thousands):
March 31 June 30 September 30
-------- ------- ------------
Revenues $ 92 $ 220 $ 344
Net loss $ (614) $ (846) $ (1,032)
Basic and diluted loss per share $ (0.12) $(0.15) $ (0.20)
The net effect of the restatement for the 2003 quarterly interim
information was as follows:
March 31 - overstatement of revenues of $1,175,000, understatement of
net loss of $337,000, and understatement of loss per share of $0.06 per
share.
June 30 - overstatement of revenues of $2,334,000, understatement of
net loss of $694,000, and understatement of loss per share of $0.12 per
share.
September 30 - overstatement of revenues of $3,510,000, understatement
of net loss of $1,033,000, and understatement of loss per share of
$0.20.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. 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.
b. Investments in Affiliated Companies
-----------------------------------
Investments in the Company's subsidiaries or joint venture are fully
consolidated in accordance with SFAS No. 94, "Consolidation of All
Majority-Owned Subsidiaries," because the voting power authorizing all
major operating and financing decisions for the subsidiaries or joint
venture rests with the board of directors of the Company.
c. Revenue Recognition
-------------------
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. 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.
24
d. 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, our estimates of
the recoverability of receivables could be further adjusted.
e. 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.
f. 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.
g. 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.
h. 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.
i. 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.
25
j. 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."
k. 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.
l. 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
year ended December 31, 2003, the Company did not capitalize (2002: $0)
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 (2002: $93,545). The Company
amortized capitalized software development costs of $106,837 in 2002.
m. Loss 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 and excludes the
dilutive effect of stock options and warrants because to do so would be
antidilutive. All per share and per share information are adjusted
retroactively to reflect stock splits and changes in par value.
26
n. 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 options granted at fair market value until they are exercised.
Upon exercise, net proceeds including tax benefits realized, are
credited to equity. The pro forma disclosure requirements of SFAS No.
123 are included in Note 11.
o. 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.
p. Advertising Costs
-----------------
Advertising costs are expensed as incurred and amounted to $9,114 in
2003 (2020: $4,954).
q. Cash Equivalents
----------------
Highly liquid investments with maturity of three months or less at the
time of acquisition are considered cash equivalents.
r. 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 13).
s. 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.
t. Fair Value of Financial Instruments
-----------------------------------
For certain of the Company's financial instruments, including cash and
cash equivalents, accounts receivable, bank lines of credit, accounts
payable and accrued liabilities, the carrying amounts approximate fair
value due to their short maturities.
27
4. RECENT ACCOUNTING PRONOUNCEMENTS
New pronouncements by the Financial Accounting Standards Board (FASB)
that have recently become effective or are yet to be effective are SFAS
No. 145 through SFAS No. 150 and Interpretations No. 45 and No. 46,
none of which are expected to have a significant affect on the
Company's financial statements:
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." Among other provisions, SFAS No. 145 rescinds
SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt."
Accordingly, gains or losses from extinguishment of debt shall not be
reported as extraordinary items unless the extinguishment qualifies as
an extraordinary item under the criteria of Accounting Principles Board
("APB") Opinion No. 30, "Reporting the Results of Operations--Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." Gains or
losses from extinguishment of debt that do not meet the criteria of APB
No. 30 should be reclassified to income from continuing operations in
all prior periods presented.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 provides
guidance related to accounting for costs associated with disposal
activities covered by SFAS No. 144 or with exit or restructuring
activities previously covered by Emerging Issues Task Force ("EITF")
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." SFAS No. 146 supercedes EITF Issue No.
94-3 in its entirety. SFAS No. 146 requires that costs related to
exiting an activity or to a restructuring not be recognized until the
liability is incurred. SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" was issued in July 2002. SFAS No. 146
addresses significant issues regarding the recognition, measurement and
reporting of costs that are associated with exit and disposal
activities, including restructuring activities, including (1) costs to
terminate contracts that are not capital leases; (2) costs to
consolidate facilities or relocate employees; and (3) termination
benefits provided to employees who are involuntarily terminated under
the terms of a one-time benefit arrangement that is not an ongoing
benefit arrangement or an individual deferred-compensation contract.
The provisions of this Statement will be effective for exit or disposal
activities initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "ACQUISITIONS OF CERTAIN
FINANCIAL INSTITUTIONS, AN AMENDMENT OF FASB STATEMENTS NO. 72 AND 144
AND FASB INTERPRETATION NO. 9," which applies to the acquisition of all
or part of a financial institution, except for a transaction between
two or more mutual enterprises. SFAS No. 147 removes the requirement in
SFAS No. 72 and Interpretation 9 thereto, to recognize and amortize any
excess of the fair value of liabilities assumed over the fair value of
tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset. This statement requires that those
transactions be accounted for in accordance with SFAS No. 141,
"BUSINESS COMBINATIONS," and SFAS No. 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS." In addition, this statement amends SFAS No. 144,
"ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," to
include certain financial institution-related intangible assets. This
statement is effective for acquisitions for which the date of
acquisition is on or after October 1, 2002, and is not applicable to
the Company.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN
45"), "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others."
FIN 45 requires that a liability be recorded in the guarantor's balance
sheet upon issuance of a guarantee. In addition, FIN 45 requires
disclosures about the guarantees that an entity has issued, including a
rollforward of the entity's product warranty liabilities. Initial
recognition and measurement provisions of the Interpretation are
applicable on a prospective basis to guarantees issued or modified
after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December
15, 2002. As of December 31, 2002, the company did not have any
outstanding guarantees.
28
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation, Transition and Disclosure," an amendment to
SFAS 123, "Accounting for Stock-Based Compensation," SFAS No. 148
provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also requires that disclosures of the pro
forma effect of using the fair value method of accounting for
stock-based employee compensation be displayed more prominently and in
a tabular format. Additionally, SFAS No. 148 requires disclosure of the
pro forma effect in interim financial statements. The transition and
annual disclosure requirements of SFAS No. 148 are effective for fiscal
year ending after December 31, 2002. The Company has elected to
continue using the intrinsic value method of accounting for stock-based
compensation. Therefore, the amendment to SFAS 123 will not have any
effect on the companies' financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51." FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective
for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired
prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after June 15, 2003.
In April 2003, the FASB issued SFAS No. 149, "Accounting for Amendment
of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under FASB
Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. This Statement is generally effective for contracts entered
into or modified after June 30, 2003, and all provisions should be
applied prospectively. This statement does not affect the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity," which establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). This Statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective
at the beginning of the first interim period beginning after June 15,
2003. It is to be implemented by reporting the cumulative effect of a
change in an accounting principle for financial instruments created
before the issuance date of the Statement and still existing at the
beginning of the interim period of adoption. Restatement is not
permitted. This statement does not affect the Company.
29
5. GOODWILL AND INVESTMENTS IN AFFILIATED COMPANIES
Goodwill consists of the following as of December 31, 2003 (in
thousands):
PURCHASE PRICE/
DESCRIPTION AMOUNT OWNERSHIP % AND BUSINESS DESCRIPTION
----------- ------ ------------------------------------
GOODWILL:
PacificNet Solutions Limited $19 60% ownership; IT solution and system integration
that specializes in systems integration, software
application, and e-business solutions services in
Hong Kong and Greater China.
Epro Telecom Holdings Limited $567 $3,500,000 payable in cash and common stock;
50% ownership; Value-added telecom services (VAS),
call center and customer relationship management
(CRM) services in Hong Kong and Greater China.
(See Note 10)
Beijing Linkhead Technologies Co., Ltd $ (147) $4,973,000 payable in cash and common stock;
51% ownership; 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 in Greater
China. (See Note 10)
Less: Goodwill written off (19)
---------
$ 420
---------
Investments in affiliated companies and goodwill consist of the following
as of December 31, 2002 (in thousands):
COLLATERAL/OWNERSHIP % AND BUSINESS
DESCRIPTION AMOUNT DESCRIPTION
----------- ------ -----------------------------------
INVESTMENTS IN AFFILIATED COMPANIES:
Xmedia Holdings Inc 95 25% ownership; provides new media business
development and marketing to advertisers.
Less: Provision for Impairment (95)
-------
$ --
-------
GOODWILL:
PacificNet Solutions Limited $ 21 60% ownership; IT solution and system integration
that specializes in systems integration, software
application, and e-business solutions services in
Hong Kong and Greater China.
Less: Provision for Amortization (2)
-------
19
-------
30
6. PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following as of December 31 (in
thousands):
2003 2002
------------------------
Office furniture, fixtures and leasehold improvements $ 4 $ 47
Computers and office equipment 4,938 463
Motor Vehicles -- 16
Less: Accumulated depreciation (4,476) (242)
------------------------
Net Property and Equipment $ 466 $ 284
========================
Depreciation charged to expense during the years ended December 31,
2003 and 2002 was $72,000 and $154,000
7. COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company leases warehouse and office space under
operating leases for two years with fixed monthly rentals. None of the
leases included contingent rentals. Lease expense charged to operations
for 2003 amounted to $109,000 (2002: $231,000). Future minimum lease
payments under non-cancelable operating leases at December 31:
2004 $ 215
2005 82
---------
$ 297
=========
BANK LINE OF CREDIT (2003): The Company has an overdraft banking
facility from our major bankers, DBS Bank (Hong Kong) Limited and
Citibank NA Hong Kong, in the amount of $1,309,000 (HK$10,200,000),
which is secured by a pledge of the Company's fixed deposits in the
amount of $923,000 (HK$7,000,000), 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.
(2002): The Company has an overdraft banking facility from our major
banker, DBS Bank (Hong Kong) Limited, in the amountof $1,026,000
(HK$8,000,000), which is secured by a pledge of the Company's fixed
deposits, in the amount of $923,000 (HK$7,000,000), 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, 2002, the Company
utilized US $565,000 of the above mentioned banking facility.
COMMON STOCK (contingent shares) - See details in Note 10.
CONTINGENCIES - From time to time the Company is subject to certain
asserted and unasserted claims encountered in the normal course of
business. It is the Company's belief that the resolution of these
matters will not have a material adverse effect on its financial
position or results of operations, however, the Company cannot provide
assurance that damages that result in a material adverse effect to its
financial position or results of operations will not be imposed in
these matters. The Company accounts for contingent liabilities when it
is probable that future expenditures will be made and such expenditures
can be reasonably estimated.
31
8. BANK LOANS
Bank loans represent the following at December 31:
2003 2002
------------------------
Secured [1] $ 1,776 $ --
Unsecured $ 6 $ --
Less: current portion (1,405) $ --
------------------------
Non current portion $ 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; charge over certain trade receivables of a subsidiary of the
Company; and pledged bank deposits of a subsidiary of the Company in
the amount of $212,000 (2002: $0).
Aggregate future maturities of borrowing for the next five years are as
follows: (2004: $1,405,000; 2005: $302,000; 2006: $75,000; 2007: $0;
and 2008: $0)
The Company has established lines of credit with quality financial
institutions of approximately $1,540,000 (HKD$12,000,000) to finance
general working capital requirements and trade transactions. Interest
is charged at the bank's prime lending rate plus 0.5%-2% per annum
depending on the reason for the utilization of the line, i.e. overdraft
protection, receivable financing, etc. At December 31, 2003, the
Company had available unused lines of credit of approximately $557,000.
9. 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, 2003 for each of the next five years are as follows:
(2004: $173,000; 2005: $85,000; 2006: $70,000; 2007: $0; and 2008: $0)
Capital lease obligations represent the following at December 31:
2003 2002
------------------------
Total minimum lease payments $ 328 $ --
Interest expense relating to future periods 27 --
------------------------
Present value of the minimum lease payments 301 --
Less: current portion (152) --
------------------------
Non current portion $ 149 $ --
========================
Following is a summary of fixed assets held under capital leases at
December 31:
2003 2002
------------------------
Computers and office equipment $ 268 $ --
Less: accumulated depreciation (205) --
------------------------
$ 63 $ --
========================
32
10. BUSINESS ACQUISITIONS AND 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 as follows:
Epro Telecom Holdings Limited [1] $ 500,000
Beijing Linkhead Technologies Co., Limited [2] $ 222,500
---------
$ 722,500
=========
[1] Epro Telecom Holdings Limited - 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 of
common stock to Epro. The remaining 500,000 shares of common stock are
to be held by an Escrow Agent and released in specified amounts based
on the achievement of certain earnings criteria. 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.
[2] Beijing Linkhead Technologies Co., Limited - 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 of common stock to
Linkhead. The remaining 600,000 shares of common stock are to be held
by an Escrow Agent and released in specified amounts based on the
achievement of certain earnings criteria. 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.
The Company has consolidated the financial results of the
above-mentioned companies at December 31, 2003, because concurrent with
signing the agreements, the Company obtained 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 transferred on that date. Further,
the Company obtained the benefits derived and/or detriments incurred
with respect to the acquired companies. Therefore, since the Company
has a controlling financial interest and controls the operating and
financing decisions of the acquired companies, the Company fully
consolidates their assets, liabilities, revenues and expenses.
The following unaudited pro forma information is based on the
assumption that the acquisitions took place as of the beginning of the
period, with comparative information for the immediately preceding
period as though the acquisitions had been completed at the beginning
of the period. The financial information for Linkhead has not been
included for 2002 because it was not in existence.
2003 2002
----------- -----------
Net revenues $ 6,825 $ 8,252
=========== ===========
Net loss $ 1,793 $ 3,396
=========== ===========
Basic and diluted loss per share $ 0.32 $ 0.80
=========== ===========
33
11. STOCKHOLDERS' EQUITY
a) ALLOTMENT AND REPURCHASE OF COMMON STOCK
Common Stock -
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 and, (iii) 240,000
shares as a result of the exercise of stock options and warrants for
cash consideration of $410,000,
For the year ended December 31, 2002, the Company issued (i) 155,058
shares with a market value of $186,000 to acquire fixed assets, (ii)
60,585 shares with a market value of $50,000 to satisfy certain current
liabilities, (iii) 337,007 shares with a market value of $263,000 to
settle the expenses, and (iv) 2,725,000 shares for private placement of
$4,000,000. The private placements were as follows:
(a) $520,000 Private Placement -- In January 2002, the Company
completed a $520,000 private placement by issuing 325,000 shares of
restricted common stock at a price of $1.60 per share. The issuance of
shares represented 19.9% of the number of shares issued and outstanding
prior to the closing of transaction in January 2002.
(b) $3,480,000 Private Placement -- 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.
Treasury Stock - For the year ended December 31, 2003, the Company
returned to treasury 800,000 shares issued as a deposit for a business
acquisition that was terminated (See Note 2 for details). For the year
ended December 31, 2002, the Company repurchased 4,970 shares of common
stock for a total of $5,000.
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. 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.
34
The status of the Stock Option Plan as of December 31, 2003, is as follows:
OPTIONS EXERCISE PRICE
------- --------------
Outstanding, December 31, 2001 123,400 $4.15-$9.375
Granted 221,933 $0.50-$9.375
Canceled (32,733) $0.50-$9.375
----------
Options outstanding, December 31, 2002 312,600 $0.50-$9.375
Granted 963,000 $1.75-$4.25
Exercised (350,000) $0.50-$1.90
Canceled -- $0.50-$9.375
----------
Options outstanding, December 31, 2003 925,600 $0.50-$9.375
==========
Options exercisable, end of year 145,600 $0.50-$9.375
==========
Additional information on options outstanding and exercisable as of
December 31, 2003 is as follows:
WEIGHTED
WEIGHTED AVERAGE AVERAGE REMAINING
EXERCISE PRICE OPTIONS CONTRACTUAL LIFE
------------------------------------------------
Options outstanding $ 3.02 925,600 2.38 years
Options exercisable $ 1.73 145,600 1.47 years
The fair value of options granted during 2003 and 2002, respectively
was approximately $2.17 and $1.55 per option based on the Black-Scholes
option pricing model using valuation assumptions of: a) average
remaining contractual life of three years; b) expected volatility of
129.8% and 183.6%, c) dividend yield of 0%; and d) a risk free interest
rate of 2.5% and 4.00%.
The Company's net loss and net 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):
2003 2002
-------------- --------------
Net loss
As reported $ (1,878) $ (2,921)
Pro forma (3,968) (3,097)
Net loss per share
As reported $ (0.36) $ (0.70)
Pro forma (0.76) (0.74)
c) WARRANTS
Fiscal Year 2003: For the year ended December 31, 2003, 100,000
warrants at an exercise price of $1.75 have been exercised.
Fiscal Year 2002: 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. (See Note 13)
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.
12. INCOME TAXES
Hong Kong profits tax has been provided at a rate of 17.5% (2002: 16%)
on the estimated assessable profits arising in Hong Kong for each of
the years ended December 31, 2003 and 2002. Provision for Hong Kong
profits tax for 2003 was $32,000 (2002: $0.) There is no provision for
U.S. federal income tax due to the Company's loss position.
35
Deferred tax asset represents the tax benefit of U.S. net operating
loss carryforwards as follows:
2003 2002
----------- -----------
Non current deferred tax asset $ 1,146 $ 884
Valuation allowance (1,146) (884)
----------- -----------
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% (2002: 16%). 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 2003 2002
------ --------- --------
Company, including discontinued operations $ (771) $(1,357)
Hong Kong subsidiaries (1,107) (1,564)
--------- --------
Total $ (1,878) $(2,921)
--------- --------
No tax benefits have been recorded related to the loss generated by the
Company or any of its 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:
2003 2002
--------- --------
United States federal income tax rate (34.0)% (34.0)%
Tax losses not recognized 9.7 9.6
Effect of different tax rates in foreign jurisdictions 24.3 24.4
--------- --------
Effective income tax rate -- % -- %
--------- --------
The valuation allowance increased by $456 and $712 at December 31, 2003
and 2002, respectively. The Company has net operating loss
carryforwards of approximately $3,300 available to offset future
income, which expire through 2022. Pursuant to the Tax Reform Act of
1986, annual utilization of the Company's net operating loss
carryforwards may be limited if a cumulative change in ownership of
more than 50% is deemed to occur within any three-year period.
13. RELATED PARTY TRANSACTIONS
Employment Agreement - The Company has an employment agreement with its
President and Chief Executive Officer. The employment agreement
provides for $100,000 cash compensation plus $60,000 annual share
compensation until April 1, 2005. The officer who 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. Under the Company's stock option plan, the President and CEO
was granted an option to acquire 200,000 shares at an exercise price
per share of $0.50, which has been exercised during the year.
36
Fiscal Year 2002: 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 represents 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.
The Company received $105,450 from Webplus Inc in which one of the
directors of the Company also served as a director of Webplus Inc.
14. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table set forth selected quarterly financial information
for the fiscal 2003 quarters ended December 31, 2003 and for the fiscal
2002 quarters ended December 31, 2002. The operating results for any
given quarter are not necessarily indicative of results for any future
periods (in thousands).
Fiscal 2003 Quarter Ended Fiscal 2002 Quarter Ended
--------------------------------------- -----------------------------------------
31-Mar 30-Jun 30-Sep 31-Dec 31-Mar 30-Jun 30-Sep 31-Dec
Revenue $ 92 $ 128 $ 124 $ 873 $ 1,396 $ 723 $ 187 $ 13
Gross margin/(Loss) 56 82 28 353 298 (256) 99 (121)
Loss from operations (450) (248) (243) (1,582) (303) (340) (483) (1,518)
Other items, net (164) 16 57 736 22 21 5 (15)
Provision for impairment
of affiliated companies -- -- -- -- (7) (7) (8) (75)
Loss from discontinued
Operations -- -- -- -- -- -- -- (107)
----------------------------------------- -----------------------------------------
Net loss $ (614) $ (232) $ (186) $ (846) $ (365) $ (376) $(1,251) $ (929)
----------------------------------------- -----------------------------------------
BASIC AND DILUTED LOSS PER SHARE:
Loss from continuing
operations $ (0.09) $ (0.04) $ (0.05) $ (0.26) $ (0.11) $ (0.09) $ (0.12) $ (0.36)
Other items, net (0.03) -- 0.01 0.12 0.01 0.01 -- --
Provision for impairment
losses of affiliated companies -- -- -- -- -- -- -- (0.02)
Net losses from
discontinued operations -- -- -- -- -- -- 0.01 (0.03)
----------------------------------------- -----------------------------------------
Net losses $ (0.12) $ (0.04) $ (0.04) $ (0.14) $ (0.14) $ (0.10) $ (0.32) $ (0.22)
========================================= =========================================
37
15. EVENTS SUBSEQUENT TO DECEMBER 31, 2003
Private placement of Common Stock - In January, 2004, the Company
closed a $3 million equity private placement in which an aggregate of
617,285 common shares of the Company were issued and warrants to
purchase up to an aggregate of 154,320 common shares of the Company
were issued to a group of institutional investors.
Termination of joint venture - See details in Note 2.
[END OF AUDITED FINANCIAL STATEMENTS]
In December, 2003, we executed and completed the following agreements:
Epro Telecom Holdings Limited - to acquire a 50% controlling interest.
The total purchase price paid was approximately $3.5 million payable in
cash ($500,000) and 600,000 shares of our common stock.
Beijing Linkhead Technologies Co., Limited - to acquire a 51% ownership
interest. The total purchase price paid was approximately $5 million
payable in cash ($222,500) and 950,000 shares of our common stock
The following pro forma financial results reflects the historical
consolidated balance sheet of the Company and its subsidiaries as of
December 31, 2003 and 2002, and the statements of operations for the
years ended December 31, 2003 and 2002 after giving effect to the
acquisition. The pro forma financial results do not include operations
of Linkhead for 2002 because Linkhead was not in existence.
38
PACIFICNET INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands of United States dollars, except par values and share numbers)
DECEMBER 31, 2003
PRO-FORMA PROFORMA
HISTORICAL ADJUSTMENT RESULT
------------ ------------ ------------
Cash and cash equivalents $ 3,823 (722) $ 3,101
Restricted cash - pledged bank deposit 212 -- 212
Accounts Receivables (net of allowance
for doubtful accounts of $0 as of
December 31, 2003) 1,890 -- 1,890
Inventories 76 -- 76
Other Current Assets 286 -- 286
------------ ------------ ------------
Total Current Assets 6,287 (722) 5,565
Property and Equipment, net 466 -- 466
Goodwill 420 2,839 3,259 (a)
------------ ------------ ------------
TOTAL ASSETS $ 7,173 $ 2,117 $ 9,290
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank Overdraft $ 1,199 -- $ 1,199
Bank Loans-current portion 1,405 -- 1,405
Capital lease obligations -
current portion 152 -- 152
Accounts Payable 1,007 -- 1,007
Accrued Expenses 360 -- 360
Subscription Payable 722 (722) -- (c)
------------ ------------ ------------
Total Current Liabilities 4,845 (722) 4,123
------------ ------------ ------------
Long-term liabilities:
Bank Loans - non current portion 377 -- 377
Capital lease obligations -
non current portion 149 -- 149
------------ ------------ ------------
526 -- 526
------------ ------------ ------------
Minority Interest in
Consolidated Subsidiary (110) -- (110)
------------ ------------ ------------
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, 2003 - 6,163,977 shares
issued and 5,363,977 shares outstanding 1 -- 1
Treasury Stock, at cost (800,000) (5) -- (5)
Additional Paid-In Capital 31,790 2,750 34,540 (b)
Cumulative Other Comprehensive Loss (24) -- (24)
Accumulated Deficit (29,850) 89 (29,761)
------------ ------------ ------------
Total Stockholders' Equity 1,912 2,839 4,751
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,173 $ 2,117 $ 9,290
============ ============ ============
(a) Goodwill represents the Epro acquisition of $1,087,000 and the Linkhead
acquisition of $1,752,000
(b) Adjustment gives effect to additional paid-in capital resulting from
issuance of shares to Epro (200,000 shares) and Linkhead (350,000 shares)
of $1,000,000 and $1,750,000 respectively.
(c) Adjustment gives effect to cash paid for acquisition of Epro and Linkhead
of $500,000 and $222,000, respectively.
39
PACIFICNET INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands of United States dollars, except loss per share and share amounts)
YEAR ENDED DECEMBER 31, 2003 YEAR ENDED DECEMBER 31, 2002
PRO-FORMA PROFORMA PRO-FORMA PROFORMA
HISTORICAL ADJUSTMENT RESULT HISTORICAL ADJUSTMENT RESULT
------------ ------------ ------------ ------------ ------------ ------------
Revenues $ 1,217 $ 5,608 $ 6,825 $ 2,319 $ 5,933 $ 8,252
------------ ------------ ------------ ------------ ------------ ------------
Cost of Revenues (698) (3,797) (4,495) (1,787) (4,932) (6,719)
------------ ------------ ------------ ------------ ------------ ------------
Gross Margin 519 1,811 2,330 532 1,001 1,533
Selling, General and
Administrative expenses (2,758) (1,337) (4,095) (2,912) (1,299) (4,211)
Depreciation and amortization (76) (316) (392) (264) (442) (706)
Provision for written off of
fixed assets (208) -- (208) -- (268) (268)
------------ ------------ ------------ ------------ ------------ ------------
PROFIT /(LOSS) FROM
OPERATIONS (2,523) 158 (2,365) (2,644) (1,008) (3,652)
Interest Income 27 -- 27 33 2 35
Sundry income 54 37 91 -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Profit / (Loss) before
Income Taxes and Minority
Iinterest (2,442) 195 (2,247) (2,611) (1,006) (3,617)
Provision for income taxes (32) (51) (83) -- (64) (64)
Provision for impairment
loss of affiliated companies -- -- -- (97) -- (97)
Minority Interests 596 (59) 537 (106) 488 382
------------ ------------ ------------ ------------ ------------ ------------
Profit/(Loss) $ (1,878) $ 85 $ (1,793) (2,814) (582) (3,396)
============ ============ ============ ============ ============ ============
BASIC AND DILUTED LOSS PER
COMMON SHARE:
Profit/(Loss) from
continuing operations $ (0.36) $ (0.32) $ (0.67) $ (0.80)
Basic and diluted weighted
average number of shares
outstanding 5,234,744 550,000 5,647,244 (d) 4,191,816 100,000 4,266,816
(d) The increase resulted from the issuance of 200,000 shares and 350,000 shares
to Epro and Linkhead, respectively, and assumes the shares were outstanding as
of the first day of the period presented, for 2003 and for 2002 the increase
resulted from the issuance of 100,000 shares to Epro. No pro forma adjustment is
required for 2002 as Linkhead was incorporated in 2003.
40
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.
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 March 28, 2004:
Name Age Title
----------------------------- --------- -----------------------------------------------------
Tony Tong 36 Chairman, Chief Executive Officer, and Director
Victor Tong 33 President, Secretary, and Director
ShaoJian (Sean) Wang 39 Chief Financial Officer, Vice President, and Director
Richard C.H. Lo 36 Director
David Fisher 54 Director
Peter Wang 49 Director
Michael Ha 33 Director
Executive officers of the Company are appointed at the discretion of
the Board of Directors with no fixed term. There are no family relationships
between or among any of the executive officers or directors of the Company other
than the relationship between Mr. Tony Tong and Mr. Victor Tong.
The following is a brief description of each director's and executive
officer's business experience:
Mr. Tony Tong, age 36, is the Chairman, CEO, Executive Director, and
founder of The Company. 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. From 1993 to 1994, Mr. Tong worked
for Information Advantage, Inc., 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. From 1992 to 1993, Mr. Tong worked as a Business Process
Re-engineering Consultant at Andersen Consulting (now Accenture). From 1990 to
1991, Mr. Tong worked for ADC Telecommunication), a global supplier of telecom
equipment. Mr. Tong's R&D achievements include being the inventor and patent
holder of US Patent Number 6,012,066 (granted by US Patent and Trademark Office)
titled "Computerized Work Flow System, 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), 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 graduated with Bachelor of
Mechanical/Industrial Engineering Degree from the University of Minnesota and
served on the Computer Engineering Department Advisory Board and was an Adjunct
Professor at the University of Minnesota, USA. Mr. Tong is the son of ChoSam
Tong and the brother of Victor Tong.
41
Mr. Victor Tong, age 33, is the President, Company Secretary, and
Executive Director. Mr. Victor Tong was formerly the President of KeyTech, a
leading information technology consulting company based in Minneapolis,
Minnesota. In 1994, Victor and Tony Tong co-founded Talent Information
Management ("TIM"), an IT services and consulting company in Minnesota, the
parent company of The Company. Mr. Victor Tong gained his consulting, systems
integration, and technical expertise through his experience at Andersen
Consulting (now Accenture), American Express, 3M, and the Superconductivity
Center at the University of Minnesota. In 1999, he was recognized in
"CityBusiness 40 Under 40" as one of the 40 people under the age of 40 years who
is the next generation of Twin Cities business and community leaders. Mr. Tong
is also the vice president and co-founder of the Chinese American Business
Association of Minnesota, a non-profit membership organization serving the
Chinese business community in the improvement of the economic and social status
of its members and other Chinese American entrepreneurs in Minnesota. Mr. Tong
graduated with honors and received the Bachelor of Science in Physics from the
University of Minnesota, USA. Mr. Tong is the brother of Tony Tong and the son
of ChoSam Tong.
Mr. ShaoJian (Sean) Wang, age 39, is the Chief Financial Officer and
Vice President of International Business. Mr. Wang is also Director of Thian
Bing Investments Pte Ltd - a Singapore based investment holding company, a
Director on the board of Alliance PKU Co. Ltd - a company owned and controlled
by Guanghua School of Management, Peking University; Director of the board of
Portcullis International Group - a Singapore based investment consulting
company; and Director and Partner of the Overseas Chinese Scholar Fund, a
leading venture capital firm headquartered in Zhongguancun Beijing and
Guangzhou, China. Mr. Wang started his professional career as a Market/Financial
analyst with Ecolab Inc. in 1987, where he moved quickly to become Territory
Manager and Marketing Manager. In 1990, Mr. Wang was posted to Ecolab's Asia
Pacific regional headquarters as Business Development Manager. In 1992, Mr. Wang
was appointed to Country Manager of Ecolab for Indonesia. Mr. Wang is an
investor and Director in Alliance PKU Co. Ltd. which owns two premier companies
in China. Alliance PKU Consulting is a leading management consulting firm in
China, and Beidabiz & E-learning Co. (a venture of Peking University) is a
well-known online education provider. Mr. Wang also advises some local
governments in China. The Municipal government of Yantai appointed him as the
city's representative for investment. He worked with the Wei Fang government on
setting up the Agricultural Development Park. Mr. Wang attended Peking
University and received his MBA degree at the Carlson School of Management,
University of Minnesota, and the B.S. in Economics at Hemline University.
Mr. Richard Chi Ho Lo, age 36, is the Chief Executive Officer of
Fulldiamond Limited, an investment and consulting firm in financial, real estate
and venture advisory work. He is currently director of several start-up
companies in Hong Kong and the United States. Mr. Lo is the former Managing
Director of Associated Capital Limited and former Executive Director of two
publicly listed companies in HK. Mr. Lo holds a B.A. degree from the University
of California, Los Angeles (UCLA) and obtained his MBA in Finance and Investment
from the University of Hull in England.
Mr. David F. Fisher, age 54, is a Director. From 1999 to 2003, Mr.
Fisher served as Commissioner of Administration and Office of Technology for the
State of Minnesota, and chief technical advisor to Governor Jesse Ventura. Mr.
Fisher also served on the Minnesota Secretary of State Executive Council, as a
member of the Minnesota Governor's Cabinet, and was responsible for the general
management and operations of the Minnesota state government, overseeing 1,000
full time employees with annual budget of $250 million. He is responsible for
establishing and executing statewide policy and operations for government
telecommunications and information technology. From 1994 to 1999, Mr. Fisher
served as Vice President and General Counsel and Corporate Secretary of ADC
Telecommunications, Inc., a multinational telecommunications equipment
manufacturer and distributor. While at ADCT, Mr. Fisher managed a legal,
contract and regulatory staff of twenty-seven, managed more than two dozen
complex acquisition transactions, which included negotiating business joint
ventures, alliances and contract relationships. From 1980 to 1994, Mr. Fisher
served as Vice President, International and Associate General Counsel for the
Pillsbury Company, a multinational consumer foods producer and distributor based
in Minneapolis, Minnesota, USA. Prior to that, Mr. Fisher was a trial attorney
with Henson & Efron, P.A., and engaged in general legal practice in corporate
commercial transactions, acquisitions and divestitures, litigation, securities
and employment law, contract drafting and negotiation, and antitrust compliance.
Mr. Fisher has served on the board of directors of Minnesota Technology, Inc.,
and on the International and Public Policy Committees of the Telecommunications
Industry Association. Mr. Fisher is an adjunct professor of law at the Hamline
University School of Law. Mr. Fisher received his Juris Doctor, Magna Cum Laude,
Valedictorian, at the Washburn University School of Law, and Bachelor of Arts at
the University of Minnesota. Mr. Fisher was a Bush Foundation Fellow and studied
public policy at Kennedy School of Government, Harvard University.
42
Mr. Peter Wang, age 49, is a Director. Mr. Wang serves as Chief
Executive Officer in 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 has 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 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.
Mr. Michael Chun Ha, aged 33, is a Director. 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 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.
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 2003, 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 for Mr. Peter Wang, who did not file his
Form 3 on a timely basis.
43
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.
Long Term Compensation
----------------------
Annual Compensation Awards
------------------------- ------------- ------------------------------------ ------------------------------ --------------
Restricted Stock All Other
Name/Principal Position Fiscal Year Salary ($) Bonus ($) Other ($) Stock Award ($) Options Comp. ($)
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ --------------
Tony Tong, CEO 2003 $100,000 - - - 120,000
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ --------------
2002 $110,000 - - $57,900 206,000 -
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ --------------
2001 $106,226 - $15,384 50,000 $53,333 (1)
------------------------- ------------- ----------- ----------- ------------ ----------------- ------------ --------------
--------------------
(1) Represents amounts received for life and health insurance coverage.
OPTION GRANTS DURING 2003 FISCAL YEAR
(INDIVIDUAL GRANTS)
----------------------- ----------------------------- ---------------------------- ------------------- -----------------------
Percent of Total Options
Number of Securities Granted to Employees in Exercise or Expiration
Name Underlying Options Granted Fiscal Year Base Price Date
----------------------- ----------------------------- ---------------------------- ------------------- -----------------------
Tony Tong, CEO 70,000 64% $2.2 June 23, 2006
Tony Tong, CEO 50,000 36% $4.25 November 26, 2006
----------------------- ----------------------------- ---------------------------- ------------------- -----------------------
AGGREGATED OPTION EXERCISES DURING 2003 FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
--------------------- ----------------- -------------- ------------------------------------- ---------------------------------
SHARES NO. OF SECURITIES VALUE ($) OF UNEXERCISED IN-THE
ACQUIRED ON VALUE UNDERLYING MONEY OPTIONS AT FISCAL YEAR
NAME EXERCISE REALIZED($) UNEXERCISED OPTIONS/ END 12/31/03 (1)
--------------------- ----------------- -------------- ------------------------------------- ---------------------------------
Exercisable Unexercisable Exercisable Unexercisable
--------------------- ----------------- -------------- ----------------- ------------------- ---------------- ----------------
Tony Tong, CEO 200,000 394,000 6,000 120,000 $21,090 $274,300
--------------------- ----------------- -------------- ----------------- ------------------- ---------------- ----------------
44
AUDIT COMMITTEE OF THE BOARD OF DIRECTORS
The board of directors has established a separately designated stand
alone audit committee established in accordance with Section 3(a)(58)(A) of the
Securities Exchange Act of 1934, which is currently comprised of Mr. Richard Chi
Ho Lo, Mr. David F. Fisher and Mr. Michael Chun Ha. They are all considered
"independent" under the Nasdaq listing standards currently in effect. The audit
committee recommends to the board of directors the annual engagement of a firm
of independent accountants and reviews with the independent accountants the
scope and results of audits, our internal accounting controls and audit
practices and professional services rendered to us by our independent
accountants.
The board of directors has determined all audit committees are
financial experts and independent members of the board 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 shares 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, the Company entered into an Executive Employment
Contract with Tony Tong to serve as President and 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 of the
Company 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 net profit of
the Company.
CODE OF ETHICS
On May 14, 2003, we adopted a code of ethics that applies to our Chief
Executive Officer and Chief Financial Officer, and other persons who perform
similar functions. A copy of our Code of Ethics is filed as an exhibit to this
Annual Report on Form 10-K. 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.
45
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth as of March 28, 2003 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
BENEFICIALLY BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OWNED(2)
-------------------------------------------------------------------------------- --------------------- ------------------
Kin Shing Li (3) 1,750,000 25.9%
-------------------------------------------------------------------------------- --------------------- ------------------
Sino Mart Management Ltd. (4) 1,000,000 16.2%
c/o ChoSam Tong
-------------------------------------------------------------------------------- --------------------- ------------------
ChoSam Tong (5) 1,007,000 16.3%
-------------------------------------------------------------------------------- --------------------- ------------------
Tony Tong (6) 190,391 3.10%
-------------------------------------------------------------------------------- --------------------- ------------------
ShaoJian (Sean) Wang 39,400 *
-------------------------------------------------------------------------------- --------------------- ------------------
Victor Tong (7) 35,200 *
-------------------------------------------------------------------------------- --------------------- ------------------
Richard Chi Ho Lo 19,000 *
-------------------------------------------------------------------------------- --------------------- ------------------
David Fisher 5,000 *
-------------------------------------------------------------------------------- --------------------- ------------------
Peter Wang - -
-------------------------------------------------------------------------------- --------------------- ------------------
Michael Chun Ha - -
-------------------------------------------------------------------------------- --------------------- ------------------
ALL DIRECTORS AND OFFICERS AS A GROUP (7 PERSONS) 295,991 4.4%
-------------------------------------------------------------------------------- --------------------- ------------------
* Indicates less than one percent.
** Unless otherwise indicated, the address for each beneficial owner is: c/o
PacificNet Inc. Unit 2710, Hong Kong Plaza, 188 Connaught Road West, Hong Kong.
(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.
(2) 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.
(3) Information obtained from the Schedule 13D/A filed by Mr. Kin Shing Li on
October 14, 2003.
(4) Sino Mart Management Ltd. is owned by Mr. ChoSam Tong, the father of Mr.
Tony Tong.
(5) Includes shares of common stock of Sino Mart Management Ltd., which is owned
by Mr. ChoSamTong.
(6) Excludes 1,000,000 shares owned by Sino Mart Management Ltd., as to which
shares Mr. Tony Tong disclaims beneficial ownership.
(7) Excludes 1,000,000 shares owned by Sino Mart Management Ltd., as to which
shares Mr. Victor Tong disclaims beneficial ownership.
46
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth aggregate information regarding the
Company's equity compensation plans in effect as of December 31, 2003:
------------------------------------- ------------------------------ ----------------------------- ----------------------------
NUMBER OF SECURITIES TO BE NUMBER OF SECURITIES
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE REMAINING AVAILABLE FOR
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS EQUITY COMPENSATION PLANS
------------------------------------- ------------------------------ ----------------------------- ----------------------------
EQUITY COMPENSATION PLANS APPROVED 1,725,600 $2.32 725,000
BY SECURITY HOLDERS
------------------------------------- ------------------------------ ----------------------------- ----------------------------
EQUITY COMPENSATION PLANS NOT N/A N/A N/A
APPROVED BY SECURITY HOLDERS
------------------------------------- ------------------------------ ----------------------------- ----------------------------
TOTAL 1,725,600 $2.32 725,000
------------------------------------- ------------------------------ ----------------------------- ----------------------------
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.
47
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. (3)
2.3 Supplement to Share Exchange Agreement dated April 29, 2000, between
Registrant and holders of membership interests in PacificNet.com
LLC. (3)
2.4 Agreement dated September 30, 2000, among the Company and the
"Purchasers" named therein. (4)
2.5 Supplemental Agreement dated October 3, 2000, among the Company and
the "Purchasers" named therein. (4)
2.6 Deed of Waiver, dated October 3, 2000, by Creative Master Limited in
favor of the Company. (4)
3.1 Certificate of Incorporation, as amended.
Certificate of amendment of Certificate of Incorporation.
3.2 By Laws of the Company. (5)
3.3 Amendment to By Laws of the Company. (2)
4 Specimen Stock Certificate of the Company.
10.1 Form of Indemnification Agreement with officers and directors. (1)
10.2 Amendment to 1998 Stock Option Plan.
10.3 Form of Notice of Stock Option Grant and Stock Option Agreement
under the 1998 Stock Option Plan. (3)
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)
10.5 19.9% Private Placement and Amendments between Ho Shu-Jen and
PacificNet.com Inc.
10.6 Sub-Lease Agreement dated August 30, 2002 (11).
10.7 Agreement dated on December 1, 2003 for the Sale and Purchase of 50%
Shares in Epro Telecom Holdings Limited
10.8 Agreement dated on December15, 2003 for the Sale and Purchase of 51%
Shares in Beijing Linkhead Technologies Co., Ltd
14 Code of Ethics
31 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
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)
-----------------
(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 10-KSB filed on March 30,
1999.
(3) Incorporated by reference to the Company's Form 8-K filed on August 11,
2000.
(4) Incorporated by reference to the Company's Form 8-K filed on October 17,
2000.
(5) Incorporated by reference to the exhibits of the Company's registration
statement (file no. 33-14521-NY)
(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 8-K filed on March 28,2002.
(8) Incorporated by reference to the Company's Form 10-KSB filed on April 16,
2002.
(9) Incorporated by reference to the Company's Form 8-K filed on September 30,
2002.
(10) Incorporated by reference to the Company's Form 8-K filed on December 24,
2002.
(11) Incorporated by reference to the Company's 10-KSB filed on March 31, 2003.
REPORTS ON FORM 8-K:
On November 11, 2003, we filed a report on Form 8-K, under Items 7 and 9
to disclose that we issued a press release announcing our results of operations
and financial condition for the three and nine months ended September 30, 2003,
and attaching the press release as an exhibit
48
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During fiscal years ended December 31, 2002 and 2003, our principal
independent auditor was Clancy and Co., P.L.L.C. The following are the services
provided and the amount billed
AUDIT FEES
----------
The aggregate fees billed by Clancy and Co., P.L.L.C. for professional
services rendered for the audit of the Company's annual financial statements for
the fiscal years ended December31, 2003 and 2002, and for the review of the
financial statements included in the Company's Quarterly Reports on Form 10-QSB
for fiscal years 2003 and 2002 were $36,500 and $36,500, respectively.
AUDIT RELATED FEES
------------------
Other than the fees described under the caption "Audit Fees" above,
Clancy and Co., P.L.L.C did not bill any fees for services rendered to us during
fiscal years 2003 and 2002 for assurance and related services in connection with
the audit or review of our consolidated financial statements.
TAX FEES
--------
There were no fees billed by Clancy and Co., P.L.L.C. for tax services
rendered during the fiscal years ended December 31, 2003 and 2002.
ALL OTHER FEES
--------------
There were no fees billed by Clancy and Co., P.L.L.C. for other
professional services rendered during the fiscal years ended December 31, 2003
and 2002.
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.
49
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 2, 2004 BY: /S/ TONY TONG
-----------------
Tony Tong
Chief Executive Officer (Principal
Executive Officer)
Date: April 2, 2004 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 2, 2004
-------------------------
Tony Tong
/s/ VICTOR TONG Director, President and Secretary April 2, 2004
-------------------------
Victor Tong
/s/ SHAO JIAN WANG Director and CFO April 2, 2004
-------------------------
Shao Jian Wang
/s/ RICHARD CHI HO LO Director April 2, 2004
-------------------------
Richard Chi Ho Lo
/s/ DAVID FISHER Director April 2, 2004
-------------------------
David Fisher
/s/ PETER WANG Director April 2, 2004
-------------------------
Peter Wang
/s/ MICHAEL CHUN HA Director April 2, 2004
-------------------------
Michael Chun Ha
50
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. (3)
2.3 Supplement to Share Exchange Agreement dated April 29, 2000, between
Registrant and holders of membership interests in PacificNet.com
LLC. (3)
2.4 Agreement dated September 30, 2000, among the Company and the
"Purchasers" named therein. (4)
2.5 Supplemental Agreement dated October 3, 2000, among the Company and
the "Purchasers" named therein. (4)
2.6 Deed of Waiver, dated October 3, 2000, by Creative Master Limited in
favor of the Company. (4)
3.1 Certificate of Incorporation, as amended.
Certificate of amendment of Certificate of Incorporation.
3.2 By Laws of the Company. (5)
3.3 Amendment to By Laws of the Company. (2)
4 Specimen Stock Certificate of the Company.
10.1 Form of Indemnification Agreement with officers and directors. (1)
10.2 Amendment to 1998 Stock Option Plan.
10.3 Form of Notice of Stock Option Grant and Stock Option Agreement
under the 1998 Stock Option Plan. (3)
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)
10.5 19.9% Private Placement Agreement and Amendments between Ho Shu-Jen
and PacificNet.com Inc.
10.6 Sub-Lease Agreement dated August 30, 2002.(11)
10.7 Agreement dated on December 1, 2003 for the Sale and Purchase and
Subscription of Shares in Epro Telecom Holdings Limited
10.8 Agreement dated on December 15, 2003 for the Sale and Purchase of
Shares in Beijing Linkhead Technologies Co., Ltd
14 Code of Ethics
31 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
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)