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ChinaNet Online Holdings, Inc. 10-Q 2010 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
quarterly period ended September 30,
2010
or
o 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: 000-52672
ChinaNet
Online Holdings, Inc.
(Exact
name of registrant as specified in its charter)
No.3
Min Zhuang Road, Building 6
Yu Quan Hui Gu Tuspark,
Haidian District, Beijing, PRC 100195
(Address
of principal executive offices) (Zip Code)
+86-10-51600828
(Registrant’s
telephone number, including area code)
Indicate
by check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days: Yes x No o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).* Yes o No o
*The
registrant has not yet been phased into the Interactive Data
requirements.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o
Accelerated filer o Non-accelerated
filer (Do not check if a smaller reporting company) o Smaller
reporting company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
As
of November 12, 2010 the registrant
had 17,078,720 shares of common stock
outstanding. TABLE
OF CONTENTS
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
BALANCE SHEETS
(In
thousands)
PART
I. FINANCIAL INFORMATION
Item 1.
Financial Statements
1
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
BALANCE SHEETS (CONTINUED)
(In
thousands, except for number of shares and per share data)
See notes
to the consolidated financial statements 2
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In
thousands)
3
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
STATEMENTS OF INCOME AND
COMPREHENSIVE
INCOME （CONTINUED）
(In
thousands, except for number of shares and per share data)
See notes
to the consolidated financial statements 4
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands)
5
CHINANET
ONLINE HOLDINGS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (CONTINUED)
(In
thousands)
See notes
to the consolidated financial statements 6
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ChinaNet
Online Holdings, Inc. (formerly known as Emazing Interactive, Inc.), (the
“Company”), was incorporated in the State of Texas in April 2006 and
re-domiciled to become a Nevada corporation in October 2006. From the date of
the Company’s incorporation until June 26, 2009, when the Company consummated
the Share Exchange, the Company’s activities were primarily concentrated in web
server access and company branding in hosting web based e-games.
On June
26, 2009, the Company entered into a Share Exchange Agreement (the “Exchange
Agreement”), with (i) China Net Online Media Group Limited, a company organized
under the laws of British Virgin Islands (“China Net BVI”), (ii) China Net BVI’s
shareholders, Allglad Limited, a British Virgin Islands company (“Allglad”),
Growgain Limited, a British Virgin Islands company ("Growgain"), Rise King
Investments Limited, a British Virgin Islands company (“Rise King BVI”), Star
(China) Holdings Limited, a British Virgin Islands company (“Star”), Surplus
Elegant Investment Limited, a British Virgin Islands company (“Surplus”), Clear
Jolly Holdings Limited, a British Virgin Islands company (“Clear” and together
with Allglad, Growgain, Rise King BVI, Star and Surplus, the “China Net BVI
Shareholders”), who together owned shares constituting 100% of the issued and
outstanding ordinary shares of China Net BVI (the “China Net BVI Shares”) and
(iii) G. Edward Hancock, the principal stockholder of the Company at that time.
Pursuant to the terms of the Exchange Agreement, the China Net BVI Shareholders
transferred to the Company all of the China Net BVI Shares in exchange for the
issuance of 13,790,800 shares (the “Exchange Shares”) of the
Company’s common stock (the “Share Exchange”). As a result of the Share
Exchange, China Net BVI became a wholly owned subsidiary of the Company and the
Company is now a holding company, which through certain contractual arrangements
with operating companies in the People’s Republic of China (the “PRC”), which
engages in providing advertising, marketing and communication services to small
and medium companies in China through www.28.com (the
portal website of the Company’s PRC Variable Interest Entity), TV media and bank
kiosks.
The
Company’s wholly owned subsidiary, China Net BVI was incorporated in the British
Virgin Islands on August 13, 2007. On April 11, 2008, China Net BVI became the
parent holding company of a group of companies comprised of CNET Online
Technology Limited, a Hong Kong company (“China Net HK”), which established and
is the parent company of Rise King Century Technology Development (Beijing) Co.,
Ltd., a wholly foreign-owned enterprise (“WFOE”) established in the PRC (“Rise
King WFOE”). The Company refers to the transactions that resulted in China Net
BVI becoming an indirect parent company of Rise King WFOE as the “Offshore
Restructuring.” Through a series of contractual agreements, the Company operates
its business in China primarily through Business Opportunity Online (Beijing)
Network Technology Co., Ltd. (“Business Opportunity Online”), Beijing CNET
Online Advertising Co., Ltd. (“Beijing CNET Online”). Beijing CNET Online owns
51% of Shanghai Borongdingsi Computer Technology Co., Ltd. (“Shanghai
Borongdingsi”). Business Opportunity Online, Beijing CNET Online and Shanghai
Borongdingsi, were incorporated on December 8, 2004, January 27, 2003 and August
3, 2005, respectively. From time to time, we refer to them collectively as the
“PRC Operating Entities.” 7
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Shanghai
Borongdingsi is 51% owned by Beijing CNET Online. Beijing CNET Online and
Shanghai Borongdingsi entered into a cooperation agreement in June 2008,
followed up with a supplementary agreement in December 2008, to conduct bank
kiosk advertisement business. The business is based on a bank kiosk cooperation
agreement between Shanghai Borongdingsi and Henan provincial branch of China
Construction Bank which allows Shanghai Borongdingsi or its designated party to
conduct in-door advertisement business within the business outlets throughout
Henan Province. The bank kiosk cooperation agreement has a term of eight years
starting August 2008. However, Shanghai Borongdingsi was not able to conduct the
advertisement as a stand-alone business due to the lack of an advertisement
business license and supporting financial resources. Pursuant to the
aforementioned cooperation agreements, Beijing CNET Online committed to purchase
equipment, and to provide working capital, technical and other related support
to Shanghai Borongdingsi. Beijing CNET Online owns the equipment used in the
kiosk business, is entitled to sign contracts in its name on behalf of the
business, and holds the right to collect the advertisement revenue generated
from the bank kiosk business exclusively until the recovery of the cost of
purchase of the equipment. Thereafter, Beijing CNET Online has agreed to
distribute 49% of the succeeding net profit generated from the bank kiosk
advertising business, if any, to the minority shareholders of Shanghai
Borongdingsi.
On June
24, 2010, one of the Company’s subsidiaries, Business Opportunity Online
(Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), together
with three other individuals, who were not affiliated with the Company or any of
its subsidiaries or Variable Interest Entities (“VIEs”), established a new
company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen
Mingshan”). Shenzhen Mingshan is 51% owned by Business Opportunity Online and
49% owned by the other three individuals. Shenzhen Mingshan is
located in Shenzhen City, Guangdong province of PRC and is primarily engaged in
designing, developing and selling internet based software, developing online
games, designing and developing the related websites and providing the related
internet and information technology services necessary to operate such games and
websites. As of September 30, 2010, Business Opportunity Online has invested
approximately RMB 4,000,000 (approximately US$587,000) in Shenzhen
Mingshan. Shenzhen Mingshan is currently in the start-up
stage.
a) Change of
reporting entity and basis of presentation
As a
result of the Share Exchange on June 26, 2009, the former China Net BVI
shareholders became owners of a majority of the common stock of the
Company. The transaction was regarded as a reverse acquisition whereby
China Net BVI was considered to be the accounting acquirer as its shareholders
retained control of the Company after the Share Exchange, although the Company
is the legal parent company. The share exchange was treated as a
recapitalization of the Company. As such, China Net BVI (and its
historical financial statements) is the continuing entity for financial
reporting purposes. Pursuant to the terms of the Share Exchange, Emazing
Interactive, Inc. was delivered with zero assets and zero liabilities at time of
closing. Following the Share Exchange, the company changed its name from Emazing
Interactive, Inc. to ChinaNet Online Holdings, Inc. The financial statements
have been prepared as if China Net BVI had always been the reporting company and
then on the share exchange date, had changed its name and reorganized its
capital stock.
The
accompanying unaudited interim consolidated financial statements include the
accounts of the Company, and its subsidiaries and VIEs, China Net BVI, China Net
HK, Rise King WFOE, Beijing CNET Online and Business Opportunity Online and
Shenzhen Mingshan. According to the agreements between Beijing CNET
Online and Shanghai Borongdingsi, although Beijing CNET Online legally owns 51%
of Shanghai Borongdingsi’s interests, Beijing CNET Online only controls the
assets and liabilities related to the bank kiosk business, which has been
included in the financial statements of Beijing CNET Online, but does not
control the other assets of Shanghai Borongdingsi, thus, Shanghai Borongdingsi’s
financial statements were not consolidated by the Company. 8
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (“US GAAP”) for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X, as promulgated by the Securities
and Exchange Commission (the “SEC”). Accordingly, they do not include all of the
information and notes required by US GAAP for annual financial statements.
However, management believes that the disclosures are adequate to ensure the
information presented is not misleading.
In the
opinion of management, the accompanying unaudited consolidated financial
statements reflect all adjustments, consisting only of normal recurring entries,
which are necessary for a fair presentation of the results for the interim
periods presented. These financial statements should be read in conjunction with
the audited financial statements and notes thereto included in the Company’s
Form 10-K for the fiscal year ended December 31, 2009 filed with the SEC on
March 31, 2010. The results of operations for the interim periods presented are
not indicative of the operating results to be expected for the Company’s fiscal
year ending December 31, 2010.
b)
Principles
of Consolidation
The
consolidated financial statements include the financial statements of all the
subsidiaries and VIEs of the Company. All transactions and balances between the
Company and its subsidiaries and VIEs have been eliminated upon
consolidation.
c)
Use
of estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the related disclosure of contingent assets and liabilities at
the date of these consolidated financial statements, and the reported amounts of
revenue and expenses during the reporting period. Management bases these
estimates on historical experiences and the best information available at the
time the estimates are made; however, actual results could differ from those
estimates. US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, contingencies and
results of operations. While management has based their assumptions and
estimates on the facts and circumstances existing as of September 30, 2010,
final amounts may differ from these estimates.
d)
Foreign
currency translation and transactions
The
functional currency of the Company is United States dollars (“US$”), and the
functional currency of China Net HK is Hong Kong dollars (“HK$”). The
functional currency of the Company’s PRC operating entities is Renminbi (“RMB”),
and PRC is the primary economic environment in which the Company
operates. 9
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For
financial reporting purposes, the financial statements of the Company’s PRC
operating entities, which are prepared using the RMB, are translated into the
Company’s reporting currency, the US$. Assets and liabilities are translated
using the exchange rate at each balance sheet date. Revenue and
expenses are translated using average rates prevailing during each reporting
period, and stockholders’ equity is translated at historical exchange rates.
Adjustments resulting from the translation are recorded as a separate component
of accumulated other comprehensive income in stockholders’ equity.
Transactions
denominated in currencies other than the functional currency are translated into
the functional currency at the exchange rates prevailing at the dates of the
transactions. The resulting exchange differences are included in the
determination of net income of the consolidated financial statements for the
respective periods.
The
exchange rates used to translate amounts in RMB into US$ for the purposes of
preparing the consolidated financial statements are as follows:
No
representation is made that the RMB amounts could have been, or could be
converted into US$ at the above rates.
e)
Cash and
cash equivalents
Cash and
cash equivalents consist of cash on hand and bank deposits, which are
unrestricted as to withdrawal and use. The Company considers all
highly liquid investments with original maturities of three months or less at
the time of purchase to be cash equivalents. 10
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
f)
Accounts
receivable, net
Accounts
receivable are recorded at net realizable value consisting of the carrying
amount less an allowance for uncollectible accounts as needed. The allowance for
doubtful accounts is the Company’s best estimate of the amount of probable
credit losses in the Company’s existing accounts receivable. The Company
determines the allowance based on aging data, historical collection experience,
customer specific facts and economic conditions. Account balances are charged
off against the allowance after all means of collection have been exhausted and
the potential for recovery is considered remote. The Company did not
have any off-balance-sheet credit exposure relating to its customers, suppliers
or others.
g)
Inventories
Inventories,
consisting mainly of low value consumable articles are stated at the lower of
cost or market value. Inventories are charged to expense when being
withdrawn.
h)
Property
and equipment, net
Property
and equipment are recorded at cost less accumulated depreciation. Depreciation
is calculated on the straight-line method after taking into account their
respective estimated residual values over the following estimated useful
lives:
Depreciation
expenses are included in selling expenses, general and administrative expenses
and research and development expenses.
When
property and equipment are retired or otherwise disposed of, resulting gain or
loss is included in net income or loss in the year of disposition for the
difference between the net book value and proceeds received
thereon. Maintenance and repairs which do not improve or extend the
expected useful lives of the assets are charged to expenses as
incurred.
i)
Intangible
assets, net
Purchased
software is initially recorded at costs and amortized on a straight-line basis
over the estimated useful economic life of 3 years.
j)
Impairment
of long-lived assets
Long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of long-lived assets to be held and used
is measured by a comparison of the carrying amount of the asset to the estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future undiscounted cash flows, an impairment loss is recognized for the
difference between the carrying amount of the asset and its fair value. There
were no impairment losses incurred for the nine and three months ended September
30, 2010 and 2009. 11
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
k)
Fair
Value
Accounting
Standard Codification™ (“ASC”) Topic 820 defines fair value as the exchange
price that would be received for an asset or paid to transfer a liability (an
exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the
measurement date. This topic also establishes a fair value hierarchy which
requires classification based on observable and unobservable inputs when
measuring fair value. There are three levels of inputs that may be used to
measure fair value:
Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter.
The
carrying values of cash and cash equivalents, trade and other receivables,
prepayments, payables and other liabilities approximate fair values due to their
short maturities.
Assets
and liabilities measured at fair value on a non-recurring basis are summarized
as follows:
Due to
lack of the liquidity of the Company’s underlying stock and other factors, the
Company estimated the fair value of the warrant liabilities based upon
observable inputs such as quoted prices for similar securities, quoted price in
markets that are not active or other inputs that are observable to determine the
fair value of the warrant liabilities.
Warrant
liabilities measured at fair value as of December 31, 2009 was related to the
investor and placement agent warrants that were issued as a result of the
Company’s August 2009 Financing contained a “Down-round protection provision”
whereby for a period of twelve (12) months following December 31, 2009 (the
effective date of the Registration Statement) in the event the Company issued
any additional shares of Common Stock or securities exercisable, convertible or
exchangeable for Common Stock at a price per share less than the exercise price
then in effect or without consideration. As described in Note 17 and
according to ASC Topic 815, subtopic 40, the “Down-round protection” provision
is not considered to be an input to the fair value of a fixed-for-fixed option
on equity shares which lead to the Warrants to fail to be qualified as indexed
to the Company’s own stock and then fail to meet the scope exceptions of ASC
Topic 815. Therefore, the Company accounted for the Warrants as derivative
liabilities under ASC Topic 815. Pursuant to ASC Topic 815, derivative
should be measured at fair value and re-measured at fair value with changes in
fair value recorded in earnings at each reporting period. 12
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On March
29, 2010, the Company and the holders of the Warrants entered into agreements to
amend certain provisions of the Warrants. The amendment to the investor and
placement agent warrants removes the “Down-round protection” rights that were
applicable if the Company were to issue new shares of common stock or common
stock equivalents at a price per share less than the exercise price of the
Warrants. In addition, the amendment to the warrants added a
provision to grant the holders of a majority of the warrants an approval right
until December 31, 2010, over any new issuance of shares of common stock or
common stock equivalents at a price per share less than the exercise price of
the warrants.
As a
result of this amendment, the Warrants issued in the August 2009 financing were
qualified as indexed to the Company’s own stock and then met the scope
exceptions of ASC Topic 815, and were eligible to be reclassified as
equity. In accordance to ASC Topic 815, the classification of a
contract should be reassessed at each balance sheet date. If the classification
required under this ASC changes as a result of events during the period, the
contract should be reclassified as of the date of the event that caused the
reclassification. If a contract is reclassified from an asset or a
liability to equity, gains or losses recorded to account for the contract at
fair value during the period that the contract was classified as an asset or a
liability should not be reversed. Therefore, the Company re-measured
the fair value of the Warrants as of March 29, 2010, the date of the event that
caused the classification, which was approximately US$ 7,703,000 and
reclassified the amount to equity as additional paid-in capital. The
gain of the changes in fair value during the period that the Warrants were
classified as a derivative liability, which was approximately US$ 1,861,000 was
recorded in earnings for the nine month period ended September 30,
2010.
There was
no asset or liability measured at fair value on a non-recurring basis as of
September 30, 2010.
l)
Revenue
recognition
The
Company's revenue recognition policies are in compliance with ASC Topic
605 “Revenue Recognition”. In accordance with ASC Topic 605, revenues are
recognized when the four of the following criteria are met: (i) persuasive
evidence of an arrangement exists, (ii) the service has been rendered,
(iii) the fees are fixed or determinable, and (iv) collectability is
reasonably assured.
Sales
Sales
include revenues from reselling of advertising time purchased from TV stations
and internet advertising, reselling of internet advertising spaces and other
advertisement related resources. No revenue from advertising-for-advertising
barter transactions was recognized because the transactions did not meet the
criteria for recognition in ASC Topic 605, subtopic 20. Advertising
contracts establish the fixed price and advertising services to be
provided. Pursuant to advertising contracts, the Company provides
advertisement placements in different formats, including but not limited to
banners, links, logos, buttons, rich media and content integration. Revenue is
recognized ratably over the period the advertising is provided and, as such, the
Company considers the services to have been delivered. The Company treats all
elements of advertising contracts as a single unit of accounting for revenue
recognition purposes. Based upon the Company’s credit assessments of
its customers prior to entering into contracts, the Company determines if
collectability is reasonably assured. In situations where
collectability is not deemed to be reasonably assured, the Company recognizes
revenue upon receipt of cash from customers, only after services have been
provided and all other criteria for revenue recognition have been
met. 13
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
m) Cost of
sales
Cost of
sales primarily includes the cost of media advertising time, internet
advertisement related resources and other technical services purchased from
third parties, labor cost and benefits and PRC business tax.
n)
Advertising
costs
Advertising
costs for the Company’s own brand building are not includable in cost of sales,
they are expensed when incurred and are included in “selling expenses” in the
statement of income and comprehensive income. For the nine month period ended
September 30, 2010 and 2009, advertising expenses for the Company’s own brand
building were approximately US$1,534,000 and US$2,330,000, respectively. For the
three month period ended September 30, 2010 and 2009, advertising expenses for
the Company’s own brand building were approximately US$585,000 and US$353,000,
respectively.
o)
Research
and development expenses
Research
and development costs are charged to expense when incurred. Expenses for
research and development for the nine month period ended September 30, 2010 and
2009 were approximately US$605,000 and US$347,000 respectively. For the three
month period ended September 30, 2010 and 2009, expenses for research and
development were approximately US$275,000 and 133,000,
respectively.
p)
Income
taxes
The
Company adopts ASC Topic 740 “Income Taxes” and uses liability method to
accounts for income taxes. Under this method, deferred tax assets and
liabilities are determined based on the difference between of the financial
reporting and tax bases of assets and liabilities using enacted tax rates that
will be in effect in the period in which the differences are expected to
reverse. The Company records a valuation allowance to offset deferred tax assets
if based on the weight of available evidence, it is more-likely-than-not that
some portion, or all, of the deferred tax assets will not be realized. The
effect on deferred taxes of a change in tax rates is recognized in income
statement in the period that includes the enactment date. The Company had no
deferred tax assets and liabilities recognized for the nine month period ended
September 30, 2010 and for the year ended December 31, 2009.
q)
Uncertain
tax positions
The
Company adopts ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13,
“Accounting for Uncertainty in Income Taxes”), which prescribes a more likely
than not threshold for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. This Interpretation also
provides guidance on recognition of income tax assets and liabilities,
classification of current and deferred income tax assets and liabilities,
accounting for interest and penalties associated with tax positions, accounting
for income taxes in interim periods, and income tax disclosures. For the
nine month period ended September 30, 2010 and 2009, the Company did not have
any interest and penalties associated with tax positions and did not have any
significant unrecognized uncertain tax positions. 14
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
r)
Share-based
Compensation
The
Company accounted for share-based compensation in accordance with ASC Topic 718,
which requires that share-based payment transactions be measured based on the
grant-date fair value of the equity instrument issued and recognized as
compensation expense over the requisite service period, or vesting
period.
s) Comprehensive
income
The
Company accounts for comprehensive income in accordance with ASC Topic 220,
Comprehensive Income, which establishes standards for reporting and displaying
comprehensive income and its components in the consolidated financial
statements. Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances excluding
transactions resulting from investments from owners and distributions to owners.
Accumulated other comprehensive income, as presented on the accompanying
consolidated balance sheets are the cumulative foreign currency translation
adjustments.
t) Noncontrolling
interest
The
Company accounts for noncontrolling interest in accordance with ASC Topic
810-10-65, which requires the Company to present noncontrolling interests
(previously referred to as minority interests) as a separate component of total
shareholders’ equity on the consolidated balance sheet and the consolidated
net income attributable to the parent and the noncontrolling interest be clearly
identified and presented on the face of the consolidated income and
comprehensive income statement.
Noncontrolling
interest on the consolidated balance sheet as of September 30, 2010 represents
the noncontrolling interest shareholders’ proportionate share of the equity of
the Company’s consolidated majority-owned subsidiary Shenzhen
Mingshan. Net loss attributable to noncontrolling interest on the
consolidated income and comprehensive income statement represents the
noncontrolling interest shareholders’ proportionate share of the net loss
incurred for the three and nine months ended September 30, 2010 of Shenzhen
Minshan.
u) Earnings
per share
Earnings
per share are calculated in accordance with ASC Topic 260, “Earnings Per Share”.
Basic earnings per share is computed by dividing income attributable to common
stockholders by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per share reflect the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. Common shares issuable upon the
conversion of the convertible preferred shares are included in the computation
of diluted earnings per share on an “if-converted” basis when the impact is
dilutive. The dilutive effect of outstanding common stock warrants is reflected
in the diluted earnings per share by application of the treasury stock method
when the impact is dilutive. 15
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
v) Commitments
and contingencies
The
Company has adopted ASC 450 subtopic 20, “Loss Contingencies” in
determining its accruals and disclosures with respect to loss contingencies.
Accordingly, estimated losses from loss contingencies are accrued by a charge to
income when information available prior to issuance of the financial statements
indicates that it is probable that a liability have been incurred and the amount
of the loss can be reasonably estimated. Legal expenses associated with the
contingency are expensed as incurred. If a loss contingency is not probable or
reasonably estimable, disclosure of the loss contingency is made in the
financial statements when it is at least reasonably possible that a material
loss could be incurred.
w)
Recent
accounting pronouncements
In July
2010, the FASB issued Accounting Standard Update (“ASU”) 2010-20, “Receivables
(Topic 310): Disclosures about the Credit Quality of Financing Receivables and
the Allowance for Credit Losses”. This ASU amends Topic 310 to
improve the disclosures that an entity provides about the credit quality of its
financing receivables and the related allowance for credit losses. As a result
of these amendments, an entity is required to disaggregate by portfolio segment
or class certain existing disclosures and provide certain new disclosures about
its financing receivables and related allowance for credit losses. For public
entities, the disclosures as of the end of a reporting period are effective for
interim and annual reporting periods ending on or after December 15, 2010. The
disclosures about activity that occurs during a reporting period are effective
for interim and annual reporting periods beginning on or after December 15,
2010. Except for the expanded disclosure requirements, the adoption of this ASU
is not expected to have a material impact on the Company’s consolidated
financial statements.
Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies that do not require adoption until a future date are
not expected to have a material impact on the Company’s Consolidated Financial
Statements upon adoption.
3.
Cash
and cash equivalents
4.
Accounts
receivable
16
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
All of
the accounts receivable are non-interest bearing. As of November 15,
2010, approximately US$1,070,000 of Accounts receivable had been subsequently
collected. Management believes that there will not be any collectability issue
about these accounts receivable, therefore additional allowance for doubtful
accounts is not required for the nine and three months ended September 30,
2010.
5.
Other
receivables
Advance
deposits for TV advertisement bidding were deposits made by the Company to
participate in the biddings for TV advertisement time of 2010 in several TV
stations, and had been all subsequently collected in the first quarter of fiscal
year 2010. Short-term loan to third parties were temporary loans, unsecured, no
interest bearing and approximately US$1,493,000 had been collected in October
2010. Management believes no allowance for doubtful accounts is required for
these other receivables for the nine and three month period ended September 30,
2010.
6.
Prepayment
and deposit to suppliers
17
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Contract
execution guarantee to TV advertisement and internet resources providers are
paid as a contractual deposit to the Company’s service
providers. These amounts will be used to offset the service fee needs
to be paid to the service providers in the last month of each contract
period.
According
to the contracts signed between the Company and its suppliers, the Company is
normally required to pay the contract amount in advance. These
prepayments will be transferred to cost of sales when the related services are
provided.
Therefore,
management believes that there will not be any collectability issue about these
deposits and prepayments, and no allowance for doubtful accounts is required for
the nine and three months ended September 30, 2010.
7.
Due
from related parties
These
related parties are directly or indirectly owned by the Control Group (see note
12) or the management of the Company. Amount due from Beijing
Hongfujiali Information Technology Co., Ltd. as of December 31, 2009, which
amounted to approximately US$439,000 was an advance deposit for participating in
year 2010 advertising resources bidding and had been collected in January
2010. Amount due from Soyilianmei Advertising Co., Ltd. as of
September 30, 2010, which amounted to approximately US$143,000 was related to
the internet advertising resources purchased by the Company on behalf this
related party. The rest of the related party balances as of September
30, 2010 were outstanding payments for advertising services the Company provided
to these related parties.
8.
Property
and equipment
Property
and equipment consist of the following:
18
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Depreciation
expenses in aggregate for the nine months ended September 30, 2010 and 2009 were
approximately US$253,000 and $134,000, respectively. For the three months ended
September 30, 2010 and 2009, depreciation expenses in aggregate were
approximately US$90,000 and US$49,000, respectively.
9.
Intangible
assets, net
Amortization
expenses in aggregate for the nine and three months ended September 30, 2010 and
2009 were approximately US$1,000 and nil, respectively.
10.
Accrued
payroll and other accrues
11. Due
to related parties
The
related parties listed above are directly or indirectly owned by the Control
Group (see note 12) and the Company provided advertising services to them. The
advance payments listed above were received from these parties for advertising
services that will be provided in the future. 19
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
12. Due
to Control Group
Mr.
Handong Cheng, Mr. Xuanfu Liu and Ms. Li Sun, the owners of the Company’s PRC
VIEs, Business Opportunities Online, and Beijing CNET Online before the Offshore
Restructuring, are collectively referred to as the “Control Group”.
Due to
Control Group were amounts paid by Control Group individuals on behalf of the
Company which mainly included staff salary, performance bonus and cost of
resources purchased.
During
the three months ended September 30, 2010, the Company repaid the Control Group
approximately US$738,000.
13. Due
to director
Due to
director represents the operating expenses paid by director on behalf of the
Company.
14.
Taxation
1)Income
tax
i). The
Company is incorporated in the state of Nevada. Under the current law
of Nevada, the Company is not subject to state corporation income
tax. The Company became a holding company and does not conduct any
substantial operations of its own after the Share Exchange. No provision for
federal corporate income tax has been made in the financial statements as the
Company has no taxable income for the nine month period ended September 30,
2010. 20
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ii).
China Net BVI was incorporated in the British Virgin Islands
(“BVI”). Under the current law of the BVI, the Company is not subject
to tax on income or capital gains. Additionally, upon payments of
dividends by China Net to its shareholders, no BVI withholding tax will be
imposed.
iii).
China Net HK was incorporated in Hong Kong and does not conduct any substantial
operations of its own. No provision for Hong Kong income tax has been made in
the financial statements as China Net HK has no taxable income for the nine
month period ended September 30, 2010. Additionally, upon payment of dividends
by China Net HK to its shareholders, no Hong Kong withholding tax will be
imposed.
iv). The
Company’s PRC operating entities, being incorporated in the PRC, are governed by
the income tax laws of the PRC and are subject to PRC enterprise income tax
(“EIT”). Effective from January 1, 2008, the EIT rate of PRC was
changed from 33% to 25%, and applies to both domestic and foreign invested
enterprises.
21
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2)
Business tax and relevant surcharges
Revenue
of advertisement services is subject to a 5.5% business tax and 3% cultural
industry development surcharge of the net service income after deducting amount
paid to ending media promulgators. Revenue of internet technical support
services is subjected to a 5% to 5.5% business tax. Business tax
charged was included in cost of sales.
3)
Value added tax
As a
small-scale value added taxpayer, revenue from sales of self-developed software
of Rise King WFOE is subject to a 3% value added tax.
As of
September 30, 2010 and December 31, 2009, taxes payable consist of:
22
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
15. Dividend
payable
Dividend
to Series A convertible stockholders was accrued at the per annum rate of 10%
and calculated based on US$2.5 per share liquidation preference and the actual
number of days of each share of the Series A convertible stock outstanding for
each of the respectively reporting period.
During
the nine months ended September 30, 2010, the Company paid approximately
US$605,000 dividends to its Series A convertible stockholders.
16. Long-term
borrowing from director
Long-term
borrowing from director was a non-interest bearing loan from a director of the
Company relating to the long-term investment in the Company’s wholly-owned
subsidiary Rise King WFOE.
17.
Warrant
liabilities
On August
21, 2009 (the “Closing Date”), the Company entered into a securities purchase
agreement (the “Purchase Agreement”), with several investors, including
institutional, accredited and non-US persons and entities (the “Investors”),
pursuant to which the Company sold units, comprised of 10% Series A Convertible
Preferred Stock, par value US$0.001 per share (the “Series A preferred stock”),
and two series of warrants, for a purchase price of US$2.50 per unit (the
“August 2009 Financing”). The Company sold 4,121,600 units in the
aggregate, which included (i) 4,121,600 shares of Series A preferred stock, (ii)
Series A-1 Warrant to purchase 2,060,800 shares of common stock at an exercise
price of US$3.00 per share with a three-year term, and (iii) Series A-2 Warrants
to purchase 2,060,800 shares of common stock at an exercise price of US$3.75
with a five-year term. Net proceeds were approximately US$9,162,000,
net of issuance costs of approximately US$1,142,000. TriPoint Global
Equities, LLC acted as placement agent and received (i) a placement fee in the
amount equal to 8% of the gross proceeds and (ii) warrants to purchase up to
329,728 shares of common stock at an exercise price of US$2.50, 164,864 shares
at an exercise price of US$3.00 and 164,864 shares at an exercise price of
US$3.75 respectively, with a five-year term (“Placement agent warrants” and
together with the Series A-1 Warrant and Series A-2 Warrant, the
“Warrants”). 23
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The
Warrants have an initial exercise price which is subject to adjustments in
certain circumstances for stock splits, combinations, dividends and
distributions, reclassification, exchange or substitution, reorganization,
merger, consolidation or sales of assets, issuance of additional shares of
common stock or equivalents. The Warrants may not be exercised if it
would result in the holder beneficially owning more than 9.99% of the Company’s
outstanding common shares. That limitation may be waived to the warrant holders
by sending a written notice to the Company not less than 61 days prior to the
date that they would like to have the limitation waived.
Accounting for
warrants
As
described in Note 2 k), the Company analyzed the Warrants in accordance to ASC
Topic 815 “Derivatives and Hedging” to determine whether the Warrants meet the
definition of a derivative under ASC Topic 815 and if so, whether the Warrants
meet the scope exception of ASC Topic 815, which is that contracts issued or
held by the reporting entity that are both (1) indexed to its own stock and (2)
classified in stockholders’ equity shall not be considered to be derivative
instruments for purposes of ASC Topic 815. The Company adopted the
provisions of ASC Topic 815 subtopic 40, which applies to any freestanding
financial instruments or embedded features that have the characteristics of a
derivative, as defined by ASC Topic 815 and to any freestanding financial
instruments that are potentially settled in an entity’s own common
stock. As a result of adopting ASC Topic 815 subtopic 40, the Company
concluded that the Warrants issued in the August 2009 financing should be
treated as a derivative liability, because the Warrants are entitled to a price
adjustment provision to allow the exercise price to be reduced, in the event the
Company issues or sells any additional shares of common stock at a price per
share less than the then-applicable exercise price or without consideration,
which is typically referred to as a “Down-round protection” or “anti-dilution”
provision. According to ASC Topic 815 subtopic 40, the “Down-round
protection” provision is not considered to be an input to the fair value of a
fixed-for-fixed option on equity shares which leads the Warrants fail to be
qualified as indexed to the Company’s own stock and then to fail to meet the
scope exceptions of ASC Topic 815. Therefore, the Company accounted for the
Warrants as derivative liabilities under ASC Topic 815. Pursuant to
ASC Topic 815, derivatives should be measured at fair value and re-measured at
fair value with changes in fair value recorded in earnings at each reporting
period.
On March
29, 2010, the Company and the holders of the Warrants entered into agreements to
amend certain provisions of the Warrants. The amendment to the investor and
placement agent warrants removes the “Down-round protection” rights that were
applicable if the Company were to issue new shares of common stock or common
stock equivalents at a price per share less than the exercise price of the
Warrants. In addition, the amendment to the warrants added a
provision to grant the holders of a majority of the warrants an approval right
until December 31, 2010, over any new issuance of shares of common stock or
common stock equivalents at a price per share less than the exercise price of
the warrants. 24
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As a
result of this amendment, the Warrants issued in the August 2009 financing were
qualified as indexed to the Company’s own stock and then met the scope
exceptions of ASC Topic 815, and were eligible to be reclassified as
equity. In accordance to ASC Topic 815, the classification of a
contract should be reassessed at each balance sheet date. If the classification
required under this ASC changes as a result of events during the period, the
contract should be reclassified as of the date of the event that caused the
reclassification. If a contract is reclassified from an asset or a
liability to equity, gains or losses recorded to account for the contract at
fair value during the period that the contract was classified as an asset or a
liability should not be reversed. Therefore, the Company re-measured
the fair value of the Warrants as of March 29, 2010, the date of the event that
caused the classification, which was approximately US$ 7,703,000 and
reclassified the amount to equity as additional paid-in capital. The
gain of the changes in fair value during the period that the Warrants were
classified as a derivative liability, which was approximately US$ 1,861,000 was
recorded in earnings for the nine month period ended September 30,
2010.
The
following table summarized the above transactions:
Placement agent
warrants
In
accordance with ASC Topic 340 subtopic 10 section S99-1, “specific incremental
costs directly attributable to a proposed or actual offering of securities may
properly be deferred and charged against the gross proceeds of the
offering.” In accordance with the SEC accounting and reporting manual
“cost of issuing equity securities are charged directly to equity as deduction
of the fair value assigned to share issued.” Accordingly, the Company
concluded that the warrants issued to the placement agents are directly
attributable to the August 2009 financing. If the Company had not
issued the warrants to the placement agent, the Company would have had to pay
the same amount of cash as the fair value. Therefore, the Company
deducted the total fair value of the Placement agent warrants as of the
Commitment Date which was approximately US$733,000 as a deduction of the fair
value assigned to the Series A preferred stock.
The
Placement Agent Warrants were also entitled to the benefits of the “Down-round
protection” provision upon issuance and subsequently removed on March 29, 2010
as described above. Therefore, it was reclassified to equity on March
29, 2010. The changes in fair value of the placement agent warrants
before the reclassification had been recorded in earnings for each respective
reporting period.
18. Series
A convertible preferred shares
Key terms
of the Series A preferred stock sold by the Company in the August 2009 financing
are summarized as follows:
Dividends
Dividends
on the Series A preferred stock shall accrue and be cumulative from and after
the issuance date. For each outstanding share of Series A preferred
stock, dividends are payable at the per annum rate of 10% of the Liquidation
Preference Amount of the Series A preferred stock. Dividends are
payable quarterly within thirty (30) days following the last Business Day of
each August, November, February and May of each year (each, a “Dividend Payment
Date”), and continuing until such stock is fully converted. The Company shall
have the right, at its sole and exclusive option, to pay all or any portion of
each and every quarterly dividend that is payable on each Dividend Payment Date,
either (i) in cash, or (ii) by issuing to the holder of Series A preferred stock
such number of additional Conversion Shares which, when multiplied by US$2.5
would equal the amount of such quarterly dividend not paid in
cash. 25
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Voting
Rights
The
Series A preferred stock holders are entitled to vote separately as a class on
matters affecting the Series A Preferred Stock and with regard to certain
corporate matters set forth in the Series A Certificate of Designation, so long
as any shares of the Series A preferred stock remain outstanding. Holders of the
Series A Preferred Stock are not, however, entitled to vote on general matters
along with holders of common stock.
Liquidation
Preference
In the
event of the liquidation, dissolution or winding up of the affairs of the
Company, whether voluntary or involuntary (each, a “Liquidation”), the holders
of the Series A preferred stock then outstanding shall be entitled to receive,
out of the assets of the Company available for distribution to its stockholders,
an amount equal to US$2.5 per share of the Series A preferred stock, plus any
accrued but unpaid dividends thereon, whether or not declared, together with any
other dividends declared but unpaid thereon, as of the date of Liquidation
(collectively, the “Series A Liquidation Preference Amount”) before any payment
shall be made or any assets distributed to the holders of the common stock or
any other junior stock. If upon the occurrence of Liquidation, the assets thus
distributed among the holders of the Series A shares shall be insufficient to
permit the payment to such holders of the full Series A Preference Amount, then
the entire assets of the Company legally available for distribution shall be
distributed ratably among the holders of the Series A preferred
stock.
Conversion
Rights
Voluntary
Conversion:
At any
time on or after the date of the initial issuance of the Series A preferred
stock, the holder of any such shares of Series A preferred stock may, at such
holder’s option, subject to the limitations described below in “Conversion Restriction”,
elect to convert all or portion of the shares of Series A preferred stock held
by such person in a number of fully paid and non-assessable shares of common
stock equal to the quotient of Liquidation preference amount of the Series A
preferred stock divided by the initial conversion price of US$2.5. The initial
conversion price may be adjusted for stock splits and combinations, dividend and
distributions, reclassification, exchange or substitution, reorganization,
merger, consolidation or sales of assets, issuance of additional shares of
common stock or equivalents with lower price or without considerations etc, as
stimulated in the Certification of Designation.
Mandatory
Conversion:
All
outstanding shares of the Series A preferred stock shall automatically convert
into shares of Common Stock, subject to the limitations described below in “Conversion Restriction”, at
the earlier to occur of (i) twenty-four month anniversary of the Closing Date,
and (ii) at such time that the Volume Weighted Average Price of the Company’s
common stock is no less than US$5.00 for a period of ten (10) consecutive
trading days with the daily volume of the Common Stock of at least 50,000 shares
per day. 26
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Conversion
Restriction
Holders
of the Series A preferred stock may not convert the preferred stock to common
shares if the conversion would result in the holder beneficially owning more
than 9.99% of the Company’s outstanding common shares. That limitation may be
waived by a holder of the Series A preferred stock by sending a written notice
to the Company on not less than 61 days prior to the date that they would like
to waive the limitation.
Registration Rights
Agreement
In
connection with the Financing, the Company entered into a registration rights
agreement (the “RRA”) with the Investors in which the Company agreed to file a
registration statement (the “Registration Statement”) with the Securities and
Exchange Commission to register the shares of Common Stock underlying the Series
A Preferred Stock (the “Conversion Shares”) and the Warrants (the “Warrant
Shares”), thirty (30) days after the closing of the Financing. The
Company has agreed to use its best efforts to have the Registration Statement
declared effective within 150 calendar days after filing, or 180 calendar days
after filing in the event the Registration Statement is subject to a “full
review” by the SEC.
The
Company is required to keep the Registration Statement continuously effective
under the Securities Act until such date as is the earlier of the date when all
of the securities covered by that registration statement have been sold or the
date on which such securities may be sold without any restriction pursuant to
Rule 144 (the “Financing Effectiveness
Period”). The Company will pay liquidated damages of 2% of
each holder’s initial investment in the Units sold in the Financing per month,
payable in cash, up to a maximum of 10%, if the Registration Statement is not
filed or declared effective within the foregoing time periods or ceases to be
effective prior to the expiration of the Financing Effectiveness
Period. However, no liquidated damages shall be paid with respect to
any securities being registered that the Company are not permitted to include in
the Financing Registration Statement due to the SEC’s application of Rule
415.
The
Company evaluated the contingent obligation related to the RRA liquidated
damages in accordance to ASC Topic 825 “Financial Instruments” subtopic 20,
which required the contingent obligation to make future payments or otherwise
transfer consideration under a registration payment arrangement, whether issued
as a separate agreement or included as a provision of a financial instrument or
other agreement be separately recognized and measured in accordance with ASC
Topic 450 “Contingencies”. The shares of common stock underlying the
Series A preferred stock (the “Conversion Shares”) and the Warrants (the
“Warrant Shares”) have been successfully registered by the
Company. Therefore, the Company concluded that such obligation was
not probable to incur and no contingent obligation related to the RRA liquidated
damages needs to be recognized.
Security Escrow
Agreement
The
Company entered into a securities escrow agreement with the Investors (the
“Escrow Agreement”), pursuant to which Rise King Investment Limited, a British
Virgin Islands company (the “Principal Stockholder”), initially placed 2,558,160
shares of Common Stock (the “Escrow Shares”) into an escrow
account. Of the Escrow Shares, 1,279,080 shares (equivalent to 50% of
the Escrow Shares) were held as security for the achievement of audited net
income equal to or greater than $7.7 million for the fiscal year 2009 (the “2009
Performance Threshold”) and the remaining 1,279,080 of the Escrow Shares are
being held as security for the achievement of audited net income equal to or
greater than $14 million for the fiscal year 2010 (the “2010 Performance
Threshold”). 27
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
If the
Company achieves at least 95% of the applicable Performance Threshold, all of
the Escrow Shares for the corresponding fiscal year shall be returned to the
Principal Stockholder. If the Company achieves less than 95% of the applicable
Performance Threshold, the Investors shall receive in the aggregate, on a pro
rata basis (based upon the number of shares of Series A preferred stock or
conversion shares owned by each such Investor as of the date of distribution of
the Escrow Shares), 63,954 shares of the Escrow Shares for each percentage by
which the applicable Performance Threshold was not achieved up to the total
number of Escrow Shares for the applicable fiscal year. Any Escrow
Shares not delivered to any investor because such investor no longer holds
shares of Series A preferred stock or conversion shares shall be returned to the
Principal Stockholder.
For the
purposes of the Escrow Agreement, net income is defined in accordance with US
GAAP and reported by the Company in its audited financial statements for each of
the fiscal years ended 2009 and 2010; provided, however, that net income for
each of fiscal years ended 2009 and 2010 shall be increased by any non-cash
charges incurred (i) as a result of the Financing , including without
limitation, as a result of the issuance and/or conversion of the Series A
Preferred Stock, and the issuance and/or exercise of the Warrants, (ii) as a
result of the release of the Escrow Shares to the Principal Stockholder and/or
the investors, as applicable, pursuant to the terms of the Escrow Agreement,
(iii) as a result of the issuance of ordinary shares of the Principal
Stockholder to Messrs. Handong Cheng and Xuanfu Liu and Ms. Li Sun (the “PRC
Shareholders”), upon the exercise of options granted to the PRC Shareholders by
the Principal Stockholder, (iv) as a result of the issuance of warrants to any
placement agent and its designees in connection with the Financing, (v) the
exercise of any warrants to purchase common stock outstanding and
(vi) the issuance under any performance based equity incentive plan that the
Company adopts.
Because
the 2009 performance threshold has been met, 1,279,080 Shares (50% of the Escrow
Shares) were released to the Principal Stockholder.
In
accordance to ASC Topic 718 and ASU No. 2010-05—Compensation—Stock Compensation:
Escrowed Share Arrangements and the Presumption of Compensation. The
Company evaluated the substance of this arrangement and whether the presumption
of compensation has been overcome. According to the Security Escrow Agreement
signed between the Company and its investors, the release of these escrow shares
to the Principal Stockholder or distributed to the investors without regard to
the continued employment of any of the Company’s directors or officers, and this
arrangement is in substance an inducement made to facilitate the financing
transaction on behalf of the Company, rather than as
compensatory. Therefore, the Company concluded that this arrangement
should be recognized and measured according to its nature and reflects as a
deduction of the proceeds allocated to the newly issued securities with no
compensation expenses recorded in earnings.
Fair Value of the Series A
preferred stock:
Fair
value is generally based on independent sources such as quoted market prices or
dealer price quotations. To the extent certain financial instruments trade
infrequently or are non-marketable securities, they may not have readily
determinable fair values. The Company estimated the fair value of the Warrants
and Series A preferred stock using various pricing models and available
information that management deems most relevant. Among the factors considered in
determining the fair value of financial instruments are discounted anticipated
cash flows, the cost, terms and liquidity of the instrument, the financial
condition, operating results and credit ratings of the issuer or underlying
company, the quoted market price of similar traded securities, and other factors
generally pertinent to the valuation of financial instruments. 28
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Accounting for the Series A
preferred stock
The
Series A preferred stock has been classified as permanent equity as there was no
redemption provision at the option of the holders that not within the control
the Company on or after an agreed upon date. The Company evaluated the embedded
conversion feature in its Series A preferred stock to determine if there was an
embedded derivative requiring bifurcation. The Company concluded that
the embedded conversion feature of the Series A preferred stock does not
required to be bifurcated because the conversion feature is clearly and closely
related to the host instrument.
Allocation of the proceeds
at commitment date and calculation of beneficial conversion
feature
The
following table summarized the allocation of proceeds to the Series A preferred
stock and the Warrants:
The
Company then evaluated whether a beneficial conversion feature exists by
comparing the operable conversion price of Series A preferred stock with the
fair value of the common stock at the commitment date. The Company
concluded that the fair value of common stock was greater than the operable
conversion price of Series A preferred stock at the commitment date and the
intrinsic value of the beneficial conversion feature is greater than the
proceeds allocated to the Series A preferred stock. In accordance to
ASC Topic 470 subtopic 20, if the intrinsic value of beneficial conversion
feature is greater than the proceeds allocated to the Series A preferred stock,
the amount of the discount assigned to the beneficial conversion feature is
limited to the amount of the proceeds allocated to the Series A preferred
stock. Accordingly, the total proceeds allocated to Series A
preferred stock were allocated to the beneficial conversion feature with a
credit to Additional paid-in capital upon the issuance of the Series A preferred
stock. Since the Series A preferred stock may convert to the
Company’s common stock at any time on or after the initial issuing date, all
discount was immediately recognized as a deemed dividend and a reduction to net
income attributable to common shareholders. 29
CHINANET
ONLINE HOLDINGS, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
According
to Staff Accounting Bulletin Topic 5.A: “Miscellaneous Accounting-Expenses of
offering” (“ASC Topic 340 subtopic 10 section S99-1”), “specific incremental
costs directly attributable to a proposed or actual offering of securities may
properly be deferred and charged against the gross proceeds of the
offering”. And in accordance with the SEC accounting and reporting
manual “cost of issuing equity securities are charged directly to equity as
deduction of the fair value assigned to share issued”. Accordingly,
the Company deducted the direct issuing cost paid in cash which were
approximately US$1,142,000 from the assigned fair value to the Series A
preferred stock.
19. Related
party transactions
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