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ChinaNet Online Holdings, Inc. 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
f10q_112111.htm
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, 2011

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)
 
 Nevada
 20-4672080
 (State or other jurisdiction of incorporation or organization)
 (I.R.S. Employer Identification No.)   

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)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 x No o

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 17, 2011 the registrant had 20,039,920 shares of common stock outstanding.

 
 
 

 
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
  PAGE
     
Item 1. Financial Statements
 
     
 
     
 
     
 
     
 
     
   
   
     
 
     
     
   
     
   
     
     
     
 
 
 

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
September 30,
2011
   
December 31,
2010
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
Assets
           
Current assets:
           
  Cash and cash equivalents
  $ 21,280     $ 15,590  
  Accounts receivable
    6,147       4,319  
  Other receivables
    10,558       7,811  
  Prepayment and deposit to suppliers
    3,334       3,325  
  Due from equity investment affiliate
    42       -  
  Due from related parties
    390       185  
  Deposit for acquisitions
    -       1,512  
  Other current assets
    147       31  
     Total current assets
    41,898       32,773  
                 
                 
Investment in and loan to equity investment affiliates
    588       7,162  
Property and equipment, net
    1,916       2,010  
Intangible assets, net
    3,197       51  
Contingent consideration receivable
    119       -  
Goodwill
    1,950       -  
Total Assets
  $ 49,668     $ 41,996  
                 
Liabilities and Equity
               
Current liabilities:
               
  Accounts payable
  $ 105     $ 174  
  Advances from customers
    848       2,120  
  Other payables
    272       10  
  Accrued payroll and other accruals
    391       470  
  Due to related parties
    160       291  
  Due to Control Group
    -       81  
  Due to director
    -       559  
  Taxes payable
    3,186       2,193  
  Dividend payable
    288       255  
     Total current liabilities
    5,250       6,153  
                 
                 
Long-term liabilities:
               
  Deferred tax liability-non current
    434       -  
  Long-term borrowing from director
    137       132  
Total Liabilities
    5,821       6,285  
                 
Commitments and contingencies
               
 
 
F-1

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except for number of shares and per share data)
             
   
September 30,
2011
   
December 31,
2010
 
   
(US $)
   
(US $)
 
   
(Unaudited)
       
             
Equity:
           
Series A convertible preferred stock (US$0.001 par value; authorized 8,000,000
   shares; issued and outstanding Nil and 2,877,600 shares at September 30,
   2011 and December 31, 2010, respectively; aggregate liquidation preference
   amount: $288 and $7,449, including accrued but unpaid dividends of $288
   and $255, at September 30, 2011 and December 31, 2010, respectively)
          -             3  
Common stock (US$0.001 par value; authorized 50,000,000 shares; issued and
   outstanding 20,039,920 shares and 17,102,320 shares at September 30, 2011
   and December 31, 2010, respectively)
      20         17  
Additional paid-in capital
    18,086       18,614  
Statutory reserves
    1,587       1,587  
Retained earnings
    21,166       14,630  
Accumulated other comprehensive income
    1,979       930  
Total ChinaNet Online Holdings, Inc.’s stockholders’ equity
    42,838       35,781  
                 
Noncontrolling interest
    1,009       (70 )
Total equity
    43,847       35,711  
                 
Total Liabilities and Equity
  $ 49,668     $ 41,996  
 

 

 

 
See notes to consolidated financial statements
 
 
F-2

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
(In thousands)
   
Nine months ended
   
Three months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Sales
                       
   To unrelated parties
  $ 21,987     $ 30,304     $ 6,329     $ 8,631  
   To related parties
    547       872       89       265  
      22,534       31,176       6,418       8,896  
Cost of sales
                               
   From unrelated parties
    8,047       15,791       3,369       3,110  
   From related party
    821       -       49       -  
      8,868       15,791       3,418       3,110  
                                 
Gross margin
    13,666       15,385       3,000       5,786  
                                 
Operating expenses
                               
   Selling expenses
    2,198       2,187       575       851  
   General and administrative expenses
    2,726       2,410       861       815  
   Research and development expenses
    1,100       605       376       276  
      6,024       5,202       1,812       1,942  
                                 
   Income from operations
    7,642       10,183       1,188       3,844  
                                 
Other income (expenses):
                               
  Changes in fair value of warrants
    -       1,861       -       -  
  Interest income
    9       8       5       4  
  Share of losses in equity investment affiliates
    (180 )     -       (75 )     -  
  Gain on deconsolidation of subsidiary
    232       -       -       -  
  Other income (expenses)
    5       7       -       4  
      66       1,876       (70 )     8  
                                 
Income before income tax expense and noncontrolling interest
    7,708       12,059       1,118       3,852  
  Income tax expense
    861       304       107       25  
Net income
    6,847       11,755       1,011       3,827  
  Net loss attributable to noncontrolling interest
    96       127       100       50  
Net income attributable to ChinaNet Online Holdings, Inc.
    6,943       11,882       1,111       3,877  
 
 
F-3

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME (CONTINUED)
(In thousands, except for number of shares and per share data)
 
   
Nine Months ended
   
Three months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(US $)
   
(US $)
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
                         
  Dividend on Series A convertible preferred stock
    (407 )     (612 )     (85 )     (190 )
                                 
Net income attributable to common stockholders of ChinaNet Online Holdings, Inc.
  $ 6,536     $ 11,270     $ 1,026     $ 3,687  
                                 
Earnings per share
                               
Earnings per common share
                               
  Basic
  $ 0.37     $ 0.68     $ 0.06     $ 0.22  
  Diluted
  $ 0.34     $ 0.57     $ 0.06     $ 0.19  
                                 
Weighted average number of common shares outstanding:
                               
  Basic
    17,806,818       16,676,752       18,632,103       16,939,961  
  Diluted
    20,265,764       20,905,796       18,632,103       20,916,463  
                                 
Comprehensive Income
                               
  Net income
  $ 6,847     $ 11,755     $ 1,011     $ 3,827  
  Foreign currency translation gain
    1,074       442       330       365  
    $ 7,921     $ 12,197     $ 1,341     $ 4,192  
Comprehensive Income
                               
  Comprehensive loss attributable to noncontrolling interest
  $ (71 )   $ (127 )   $ (98 )   $ (50 )
  Comprehensive income attributable to ChinaNet’s Online Holdings, Inc.
    7,992       12,324       1,439       4,242  
    $ 7,921     $ 12,197     $ 1,341     $ 4,192  
 
See notes to consolidated financial statements
 
 
F-4

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

       
       
       
   
Nine months ended September 30,
 
   
2011
   
2010
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
             
Cash flows from operating activities
           
  Net income
  $ 6,847     $ 11,755  
Adjustments to reconcile net income to net cash provided by operating activities
               
  Depreciation and amortization
    727       275  
  Share-based compensation expenses
    237       177  
  Changes in fair value of warrants
    -       (1,861 )
  Share of (earnings) losses in  equity investment  affiliates
    180       -  
  Gain on deconsolidation of subsidiary
    (232 )     -  
  Gain on disposal of property and equipment
    (3 )     -  
  Deferred taxes
    (65 )     -  
Changes in operating assets and liabilities
               
  Accounts receivable
    (1,591 )     (1,195 )
  Other receivables
    3,768       2,095  
  Prepayment and deposit to suppliers
    (19 )     (24 )
  Due from related parties
    (195 )     283  
  Other current assets
    (113 )     (141 )
  Accounts payable
    (72 )     77  
  Advances from customers
    (1,320 )     76  
  Other payables
    238       (5 )
  Accrued payroll and other accruals
    (67 )     104  
  Due to Control Group
    (82 )     (738 )
  Due to director
    (559 )     389  
  Due to related parties
    (138 )     (24 )
  Taxes payable
    902       (8 )
Net cash provided by operating activities
    8,443       11,235  
                 
Cash flows from investing activities
               
  Purchases of property and equipment
    (245 )     (389 )
  Purchase of intangible assets
    (1,438 )     (59 )
   Cash from acquisition of VIEs
    24       -  
   Cash effect on deconsolidation of a subsidiary
    (184 )     -  
   Payment for acquisition of VIEs
    (2,183 )     -  
   Long-term investment in equity investment affiliate
    (166 )     -  
   Disposal of investment in equity investment affiliate
    1,076       -  
Net cash used in investing activities
    (3,116 )     (448 )

 
F-5

 
CHINANET ONLINE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)

   
Nine months ended September 30,
 
   
2011
   
2010
 
   
(US $)
   
(US $)
 
   
(Unaudited)
   
(Unaudited)
 
             
Cash flows from financing activities
           
Cash investment contributed by noncontrolling interest
    377       144  
Dividend paid to Series A convertible preferred stockholders
    (374 )     (605 )
Increase of short-term loan to third parties
    -       (2,257 )
Net cash provided by (used in) financing activities
    3       (2,718 )
                 
Effect of foreign currency fluctuation on cash and cash equivalents
    360       255  
                 
Net increase in cash and cash equivalents
    5,690       8,324  
                 
  Cash and cash equivalents at beginning of the period
    15,590       13,917  
  Cash and cash equivalents at end of the period
  $ 21,280     $ 22,241  
                 
Supplemental disclosure of cash flow information
               
                 
  Interest paid
  $ -     $ -  
  Income taxes paid
  $ 158     $ 1,242  
  Income taxes refunded
  $ -     $ 921  
                 
Non-cash transactions:
               
Warrant  liability reclassify to additional paid in capital
  $ -     $ 7,703  
Restricted stock and options granted for future service
  $ 63     $ 159  
 

 
See notes to consolidated financial statements
 
 
F-6

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1.     Organization and nature of operations
 
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”) in the aggregate 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 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 operating subsidiary), TV media and bank kiosks,  through certain contractual arrangements with operating companies in the People’s Republic of China (the “PRC”).

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.”

PRC regulations prohibit direct foreign ownership of business entities providing internet content, or ICP services in the PRC, and restrict foreign ownership of business entities engaging in advertisement business. In October 2008, a series of contractual arrangements (the “Contractual Agreements” or “VIE Agreements”) were entered into among Rise King WFOE and Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”), Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities”) and its common individual owners (the “PRC Shareholders” or the “Control Group”). The Contractual Agreements allowed China Net BVI through Rise King WFOE to, among other things, secure significant rights to influence the PRC Operating Entities’ business operations, policies and management, approve all matters requiring shareholder approval, and the right to receive 100% of the income earned by the PRC Operating Entities.  In return, Rise King WFOE provides consulting services to the PRC Operating Entities.  In addition, to ensure that the PRC Operating Entities and the PRC Shareholders perform their obligations under the Contractual Arrangements, the PRC Shareholders have pledged to Rise King WFOE all of their equity interests in the PRC Operating Entities.  They also entered into an option agreement with Rise King WFOE which provides that at such time that current restrictions under PRC law on foreign ownership of Chinese companies engaging in the Internet content, information services or advertising business in China are lifted, Rise King WFOE may exercise its option to purchase the equity interests in the PRC Operating Entities directly (See Note 2 for significant terms of these Contractual Arrangements).

At the time the above Contractual Agreements were signed, the controlling shareholder of China Net BVI was Rise King BVI, who holds 55% of the Company’s common stock. The sole registered shareholder of Rise King BVI, Mr. Yang Li, who owned 10,000 shares of common stock of Rising King BVI, entered into slow-walk agreements with each of the Control Group individuals, pursuant to which, upon the satisfaction of certain conditions, the Control Group individuals had the option to purchase the 10,000 shares of Rise King BVI, (4,600 by Mr. Handong Cheng, 3,600 by Mr. Xuanfu Liu and 1,800 by Ms. Li Sun, acting as nominee for Mr. Zhang Zhige) owned by Mr. Yang Li, at a purchase price of US$ 1 per share (the par value of Rise King BVI’s common stock).  Under the terms of the slow-walk agreement, the Control Group had the right to purchase the shares as follows: (1) one-third of the shares when China Net BVI and its PRC subsidiary and VIEs (“the Group”) generates at least RMB 100,000,000 of the gross revenue for twelve months commencing on January 1, 2009 and ending on December 31, 2009 (the “Performance Period I”);  (2) one-third of the shares when the Group generates at least RMB 60,000,000 of the gross revenue for six months commencing on January 1, 2010 and ending on June 30, 2010 (the “Performance Period II); (3) one-third of the shares when the Group generates at least RMB 60,000,000 of the gross revenue for six months commencing on July 1, 2010 and ending on December 31, 2010 (the “Performance Period III”).  In the event that the Group did not achieve the performance targets specified above, then the Control Group individuals could have exercised the Option at the Alternative Exercise Price (which was US$ 2 per share), on the date that the Acquisition was completed or abandoned.  Each Control Group individual could have purchased one-third of the total number of shares that he or she was eligible to purchase under the slow-walk agreement upon the satisfaction of each condition described above.
 
 
F-7

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

The Control Group individuals also entered an Entrustment Agreement with Rise King BVI, pursuant to which, based on the 55% equity interest held in the Group directly or indirectly, Rise King BVI entrusted the Control Group to manage the Group companies by irrevocably authorizing the Control Group to act on behalf of Rise King BVI, as the exclusive agents and attorneys with respect to all matters concerning Rise King BVI’s holdings in the Group, during the term of the Entrustment Agreement, including the rights of attending the shareholders’ meeting; exercising all the shareholder’s rights and shareholder’s voting rights enjoyed by Rise King BVI under the laws and the articles of associations of the Company and each of the Group Companies, (collectively “the Group”) including without limitation voting for and making decisions on the increase or decrease of the authorized capital/registered capital, issuing company bonds, merger, division, dissolution, liquidation of the Group or change of Group’s type, amendment to the articles of association of the Group, designating and appointing the legal representatives (the chairman of the Board), directors, supervisors, general managers and other senior officers of the Group. The Control Group also agrees and confirms that each of them shall act in concert with one another when exercising all of their rights (including but not limited to the voting rights) authorized to them in this Agreement. The Entrustment Period commenced on the execution date of the agreement and was effective  for a period of ten years, unless earlier terminated.

As described above, each of Mssrs. Handong Cheng, and Xuanfu Liu and Ms. Li Sun entered into Share Transfer Agreements (slow-walk agreement) with Mr. Yang Li, the sole shareholder of Rise King BVI, which beneficially owns an aggregate of 7,434,940 shares of the Company’s Common Stock, (the “Subject Shares”). On March 30, 2011, pursuant to the terms of the Share Transfer Agreement, Ms. Li Sun transferred her right to acquire 18% of the shares of Rise King BVI under the Share Transfer Agreement to Mr. Zhige Zhang, the chief financial officer of the Company.  On March 30, 2011, each of Mssrs. Handong Cheng, Xuanfu Liu and Zhige Zhang (the “PRC Persons”) exercised their right to purchase the outstanding stock of Rise King BVI.  On the same date, the Entrustment Agreement originally entered into among Rise King BVI and the Control Group was terminated. As a result of these transactions, the ownership of Rise King BVI was transferred from Mr. Yang Li to the PRC Persons.  Rise King BVI has sole voting and dispositive power over the Subject Shares.  The PRC Persons may be deemed to share voting power over the shares as a result of their collective ownership of all of the outstanding stock of Rise King BVI.

Pursuant to the above Contractual Agreements, all of the equity owners' rights and obligations of the VIEs were assigned to Rise King WFOE, which resulted in the equity owners lacking the ability to make decisions that have a significant effect on the VIEs, and Rise King WFOE's ability to extract the profits from the operation of the VIEs, and assume the residual benefits of the VIEs. Because Rise King WFOE and its indirect parent are the sole interest holders of the VIEs, the Company included the assets, liabilities, revenues and expenses of the VIEs in its consolidated financial statements, which is consistent with the provisions of FASB Accounting Standards Codification ("ASC") Topic 810 “Consolidation”, subtopic 10.

As a result of the Share Exchange on June 26, 2009, the former China Net BVI shareholders owned 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. 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.

As of the date of the Share Exchange, through the above Contractual Agreements, the Company operates its business in China primarily through Business Opportunity Online and 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.

Shanghai Borongdingsi is owned 51% 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 business 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.
 
 
F-8

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
On June 24, 2010, one of the Company’s VIEs, Business Opportunity Online, together with three other individuals, who were not affiliated with the Company, formed a new company, Shenzhen City Mingshan Network Technology Co., Ltd. (“Shenzhen Mingshan”). The registered capital and paid-in capital of Shenzhen Mingshan was RMB10,000,000 and RMB5,000,000, respectively. Shenzhen Mingshan is 51% owned by Business Opportunity Online and 49% owned collectively by the other three individuals.  Shenzhen Mingshan is located in Shenzhen City, Guangdong Province of the PRC and is primarily engaged in developing and designing of internet based software, online games and the related operating websites and providing related internet and information technology services necessary to operate such games and websites. On January 6, 2011, as approved by the shareholders of Shenzhen Mingshan, an independent third party investor, who was not affiliated with the Company, invested RMB15,000,000 (approximately US$2,283,070) cash into Shenzhen Mingshan and Shenzhen Mingshan’s registered capital and paid-in capital increased from RMB10,000,000 (approximately US$1,466,000) and RMB5,000,000 (approximately US$733,000) to RMB25,000,000 (approximately US$3,786,000) and RMB20,000,000 (approximately US$3,029,000), respectively.  Therefore, beginning on January 6, 2011, the new investor became the majority shareholder of Shenzhen Mingshan.  The Company’s share of the equity interest in ShenZhen Minshan decreased from 51% to 20.4% and the Company ceased to have a controlling financial interest in ShenZhen Mingshan, but still retains an investment in and significant influence over Shenzhen Mingshan.

On December 6, 2010, Rise King WFOE entered into a series of exclusive contractual arrangements, which were similar to the Contractual Agreements discussed above, with Rise King (Shanghai) Advertisement Media Co., Ltd. (“Shanghai Jing Yang”), a company incorporated under the PRC laws in December 2009 and primarily engaged in advertisement business, pursuant to which the Company, through its wholly owned subsidiary, Rise King WFOE obtained all of the equity owners' rights and obligations of Shanghai Jing Yang, and the ability to extract the profits from the operation and assume the residual benefits of Shanghai Jing Yang, and hence became the sole interest holder of Shanghai Jing Yang.  As of the date these contractual agreements were signed, Shanghai Jing Yang had not establish any resources to conducted any business activities by itself and the carrying amount of the net assets of Shanghai Jing Yang which was all cash and cash equivalents approximate fair values due to their short maturities. Therefore, Shanghai Jing Yang’s accounts were included in the Company’s consolidated financial statements with no goodwill recognized in accordance to ASC Topic 810 “Consolidation”.

On December 8, 2010, the Company, through one of its VIEs, Shanghai Jing Yang acquired a 49% interest of a newly established company, Beijing Yang Guang Media Investment Co., Ltd. (“Beijing Yang Guang”) for cash consideration of RMB 7,350,000 (approximately US$1,112,000), which represents 49% of Beijing Yang Guang’s paid-in capital and net assets of RMB15,000,000 (approximately US$2,269,000). In August, 2011, Shanghai Jing Yang sold back its 49% equity interest in Beijing Yang Guang to the majority shareholder of Beijing Yang Guang for a cash consideration of RMB7,350,000, which was equal to the consideration paid when Shanghai Jing Yang acquired the 49% equity interest in December 2010.

The Company, through one of its VIEs, Beijing CNET Online, entered into an equity interest acquisition agreement with the shareholders of Quanzhou Zhi Yuan Marketing Planning Co., Ltd. (“Quanzhou Zhi Yuan”) and Quanzhou Tian Xi Sun He Advertisement Co., Ltd. (“Quanzhou Tian Xi Shun He”), (collectively “the acquirees”) on December 18, 2010 and December 22, 2010, to acquire a 100% equity interest in Quanzhou Zhi Yuan and a 51% equity interest in Quanzhou Tian Xi Shun He, respectively. These acquisitions were subsequently consummated on January 4, 2011 and February 23, 2011, respectively (see Note 4).  Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He are both independent advertising companies based in Fujian province of the PRC, which provide comprehensive branding and marketing services to over fifty small to medium sized companies focused mainly in the sportswear and clothing industry. In June 2011, Beijing CNET Online entered into an additional agreement with the noncontrolling interest of Quanzhou Tian Xi Shun He to purchase the remaining 49% equity interest of Quanzhou Tian Xi Shun He for a cash consideration of RMB7,200,000 (approximately US$1,114,000). On June 27, 2011, this transaction was approved and registered with the relevant PRC government authorities of Quanzhou City, Fujian Province of PRC and on the same date, Quanzhou Tian Xi Shun He became a wholly owned subsidiary of Beijing CNET Online.
 
 
F-9

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
On January 28, 2011, one of the Company’s VIEs, Business Opportunity Online, formed a new wholly owned subsidiary, Business Opportunity Online (Hubei) Network Technology Co., Ltd. (“Business Opportunity Online Hubei”).  Business Opportunity Online Hubei is mainly engaged in internet advertisement design, production and promulgation.

On March 1, 2011, one of the Company’s VIEs, Business Opportunity Online, together with an individual, who was not affiliated with the Company, formed a new company, Beijing Chuang Fu Tian Xia Network Technology Co., Ltd. (“Beijing Chuang Fu Tian Xia”). The registered capital of Beijing Chuang Fu Tian Xia is RMB1,000,000 (approximately US$152,000).  Business Opportunity Online and the co-founding individual invested RMB510,000 (approximately US$77,500) and RMB490,000 (approximately US$74,500) cash in Beijing Chuang Fu Tian Xia, respectively, representing 51% and 49% of the equity interests of  Beijing Chuang Fu Tian Xi, respectively. In addition to capital investment, the co-founding individual is required to provide the controlled domain names, www.liansuo.com and www.chuangye.com to be registered under the established subsidiary.  This subsidiary is mainly engaged in providing and operating internet advertising, marketing and communication services to small and medium companies through the websites associated the above mentioned domain names.  As of September 30, 2011, www.liansuo.com is currently in its first stage of operation, while www.chuangye.com is currently in its fourth round of testing on services and functionalities with the entrepreneurial communities.

On April 18, 2011, the Company, through one of its VIEs, Business Opportunity Online Hubei formed a new wholly owned company, Hubei CNET Advertising Media Co., Ltd. (“Hubei CNET”). The registered capital and paid in capital of Hubei CNET is RMB1,000,000 (approximately US$152,205).  Hubei CNET is mainly engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On April 18, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, together with an individual, who was not affiliated with the Company, formed a new company, Zhao Shang Ke Network Technology (Hubei) Co., Ltd. (“Zhao Shang Ke Hubei”). The registered capital of Zhao Shang Ke Hubei is RMB2,000,000 (approximately US$306,000).  Business Opportunity Online Hubei and the co-founding individual invested RMB1,020,000 (approximately US$156,000) and RMB980,000 (approximately US$150,000) cash in Zhao Shang Ke Hubei, respectively, and hence owned 51% and 49% of the equity interests of  Zhao Shang Ke Hubei, respectively.  Zhao Shang Ke Hubei is mainly engaged in providing advertisement design, production, promulgation and most importantly sales channels expansion services.
 
On July 1, 2011, one of the Company’s VIEs, Quanzhou Zhi Yuan, formed a new wholly owned company, Xin Qi Yuan Advertisement Planning (Hubei) Co., Ltd. (“Xin Qi Yuan Hubei”). The registered capital and paid in capital of Xin Qi Yuan HuBei is RMB100,000 (approximately US$15,470).  Xin Qi Yuan Hubei is mainly engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On July 1, 2011, one of the Company’s VIEs, Quanzhou Tian Xi Shun He, formed a new wholly owned company, Mu Lin Sen Advertisement (Hubei) Co., Ltd. (“Mu Lin Sen Hubei”). The registered capital and paid in capital of Mu Lin Sen HuBei is RMB100,000 (approximately US$15,470).  Mu Lin Sen Hubei is mainly engaged in advertisement design, production, promulgation and providing the related adverting and marketing consultancy services.

On July 1, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, together with an individual who is not affiliated with the Company formed a new company, Sheng Tian Network Technology (Hubei) Co., Ltd. (“Sheng Tian Hubei”).  The registered capital and paid in capital of Sheng Tian Hubei is RMB2,000,000 (approximately US$309,410). Business Opportunity Online Hubei and the co-founding individual invested RMB1,020,000 (approximately US$157,800) and RMB980,000 (approximately US$151,610) cash in Sheng Tian Hubei, respectively, and hence owned 51% and 49% of the equity interests of  Sheng Tian Hubei, respectively.  Sheng Tian Hubei is mainly engaged in computer system design, development and promotion; software development and promotion, and providing the related technical consultancy services.

On September 5, 2011, one of the Company’s VIEs, Business Opportunity Online Hubei, formed a new wholly owned company, Chongqing Business Opportunity Online Technology Co., Ltd. (“Business Opportunity Online Chongqing”). The registered capital and paid in capital of Business Opportunity Online Chongqing is RMB2,000,000 (approximately US$312,285). Business Opportunity Online Chongqing is mainly engaged in internet advertisement design, production and promulgation.

 
F-10

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)>
 
 
As of September 30, 2011, the Company operated its business primarily in China through its PRC subsidiary and PRC operating entities, or VIEs.
 
2.     Variable Interest Entities
 
To satisfy PRC laws and regulations, the Company conducts certain business in the PRC through its Variable Interest Entities (“VIEs”).

As described in Note 1, On October 8, 2008, a series of contractual arrangements (the “VIE Agreements”) were entered into among Rise King WFOE and Business Opportunity Online, Beijing CNET Online (collectively the “PRC Operating Entities”) and its common individual owners (the “PRC Shareholders” or the “Control Group”). As a result of entering into these VIE Agreements signed between Rise King WFOE and the PRC Operating Entities, the Company includes the assets, liabilities, revenues and expenses of these PRC Operating Entities and its subsidiaries in its consolidated financial statements.

The significant terms of the VIE Agreements are summarized below:

Exclusive Business Cooperation Agreements: Pursuant to the Exclusive Business Cooperation Agreements entered into by and between Rise King WFOE and each of the PRC Operating Entities, Rise King WFOE has the exclusive right to provide to the PRC Operating Entities complete technical support, business support and related consulting services during the term of these agreements, which includes but is not limited to technical services, business consultations, equipment or property leasing, marketing consultancy system integration, product research and development, and system maintenance. In exchange for such services, each PRC Operating Entity has agreed to pay a service fee to Rise King WFOE equal to 100% of the net income of each PRC Operating Entity. Adjustments may be made upon approval by Rise King WFOE based on services rendered by Rise King WFOE and operational needs of the PRC Operating Entities. The payment shall be made on a monthly basis, if at year end, after an audit of the financial statements of any PRC Operating Entities, there is determined to be any shortfall in the payment of 100% of the annual net income, such PRC Operating Entity shall pay such shortfall to Rise King WFOE. Each agreement has a ten-year term. The term of these agreements may be extended if confirmed in writing by Rise King WFOE prior to the expiration of the term. The extended term shall be determined by Rise King WFOE, and the PRC Operating Entities shall accept such extended term unconditionally.

Exclusive Option Agreements: >Under the Exclusive Option Agreements entered into by and among Rise King WFOE, each of the PRC Shareholders irrevocably granted to Rise King WFOE or its designated person an exclusive option to purchase, to the extent permitted by PRC law, a portion or all of their respective equity interest in any PRC Operating Entities for a purchase price of RMB 10 or a purchase price to be adjusted to be in compliance with applicable PRC laws and regulations. Rise King WFOE or its designated person has the sole discretion to decide when to exercise the option, whether in part or in full. Each of these agreements has a ten-year term, subject to renewal at the election of Rise King WFOE.
 
Equity Pledge Agreements: >Under the Equity Pledge Agreements entered into by and among Rise King WFOE, the PRC Operating Entities and each of the PRC Shareholders, the PRC Shareholders pledged all of their equity interests in the PRC Operating Entities to guarantee the PRC Operating Entities’ performance of its obligations under the Exclusive Business Cooperation Agreements. If the PRC Operating Entities or any of the PRC Shareholders breaches its/his/her respective contractual obligations under these agreements, or upon the occurrence of one of the events regarded as an event of default under each such agreement, Rise King WFOE, as pledgee, will be entitled to certain rights, including the right to dispose of the pledged equity interests. The PRC Shareholders of the PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that would prejudice Rise King WFOE's interest, and to notify Rise King WFOE of any events or upon receipt of any notices which may affect Rise King WFOE's interest in the pledge. Each of the equity pledge agreements will be valid until all the payments related to the services provided by Rise King WFOE to the PRC Operating Entities due under the Exclusive Business Cooperation Agreements have been fulfilled. Therefore, the equity pledge agreements shall only be terminated when the payments related to the ten-year Exclusive Business Cooperation Agreement are paid in full and the WFOE does not intend to extend the term of the Exclusive Business Cooperation Agreement.

Irrevocable Powers of Attorney: >The PRC Shareholders have each executed an irrevocable power of attorney to appoint Rise King WFOE as their exclusive attorney-in-fact to vote on their behalf on all PRC Operating Entities matters requiring shareholder approval. The term of each power of attorney is valid so long as such shareholder is a shareholder of the respective PRC Operating Entities.

 
F-11

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
On December 6, 2010, Rise King WFOE entered into a series of exclusive contractual arrangements, which were similar to the VIE Agreements discussed above, with Rise King (Shanghai) Advertisement Media Co., Ltd. (“Shanghai Jing Yang”), a company incorporated under the PRC laws in December 2009 and primarily engaged in advertisement business, pursuant to which the Company, through its wholly owned subsidiary, Rise King WFOE obtained all of the equity owners' rights and obligations of Shanghai Jing Yang, and the ability to extract the profits from the operation and assume the residual benefits of Shanghai Jing Yang, and hence became the sole interest holder of Shanghai Jing Yang. Therefore, the Company also includes the assets, liabilities, revenues and expenses of Shanghai Jing Yang in its consolidated financial statements.

As a result of these VIE Agreements, the Company through its wholly-owned subsidiary, Rise King WFOE, was granted with unconstrained decision making rights and power over key strategic and operational functions that would significantly impact the PRC Operating Entities or the VIEs’ economic performance, which includes but is not limited to the development and execution of the overall business strategy; decision making for merger and acquisition targets and execution of merger and acquisition plans; business partnership strategy development and execution; government liaison; operation management and review; and human resources recruitment and compensation and incentive strategy development and execution. Rise King WFOE also provides comprehensive services to the VIEs for their daily operations, such as operational technical support, office administration technical support, accounting support, general administration support and technical support for products and services. As a result of the Exclusive Business Cooperation Agreements, the Equity Pledge Agreements and the Exclusive Option Agreements, the Conpany will bear all of the VIEs’ operating costs in exchange for 100% of the net income of the VIEs. Under these agreements, the Company has the absolute and exclusive right to enjoy economic benefits similar to equity ownership through the VIE Agreements with our PRC Operating Entities and their shareholders.

These contractual arrangements may not be as effective in providing the Company with control over the VIEs as direct ownership. Due to its VIE structure, the Company has to rely on contractual rights to effect control and management of the VIEs, which exposes it to the risk of potential breach of contract by the shareholders of the VIEs for a number of reasons. For example, their interests as shareholders of the VIEs and the interests of the Company may conflict and the Company may fail to resolve such conflicts; the shareholders may believe that breaching the contracts will lead to greater economic benefit for them; or the shareholders may otherwise act in bad faith. If any of the foregoing were to happen, the Company may have to rely on legal or arbitral proceedings to enforce its contractual rights, including specific performance or injunctive relief, and claiming damages. Such arbitral and legal proceedings may cost substantial financial and other resources, and result in a disruption of the Company’s business, and the Company cannot assure that the outcome will be in its favor. Apart from the above risks, there are no significant judgments or assumptions regarding enforceability of the contracts.

In addition, as all of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through either arbitration or litigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could further limit the Company’s ability to enforce these contractual arrangements. Furthermore, these contracts may not be enforceable in China if PRC government authorities or courts take a view that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons. In the event the Company is unable to enforce these contractual arrangements, it may not be able to exert effective control over the VIEs, and its ability to conduct its business may be materially and adversely affected.

Summarized below is the information related to the consolidated VIEs’ assets and liabilities as of September 30, 2011 and December 31, 2010, respectively:

   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
Assets
           
Current assets:
           
   Cash and cash equivalents
  $ 14,398     $ 6,535  
  Accounts receivable, net
    3,621       1,487  
  Other receivables
    10,547       7,803  
  Prepayment and deposit to suppliers
    3,334       3,322  
  Due from related parties
    227       156  
  Deposit for acquisitions
    -       1,512  
  Other current assets
    135       2  
Total current assets
    32,262       20,817  
                 
Investment in and advance to unconsolidated investee
    588       7,162  
Property and equipment, net
    1,486       1,445  
Intangible assets, net
    3,152       -  
Contingent consideration receivable
    119       -  
Goodwill
    1,950       -  
Total Assets
  $ 39,557     $ 29,424  
                 
Liabilities
               
Current liabilities:
               
  Accounts payable
  $ 105     $ 174  
  Advances from customers
    848       783  
  Other payables
    277       10  
  Accrued payroll and other accruals
    229       162  
  Due to related parties
    160       155  
  Due to Control Group
    11       91  
  Taxes payable
    2,500       1,753  
Total current liabilities
    4,130       3,128  
                 
Deferred tax Liabilities-non current
    434       -  
Total Liabilities
  $ 4,564     $ 3,128  

 
F-12

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)>
 
All of the VIEs’ assets can only be used to settle the obligations of the VIEs. Conversely, liabilities recognized by the consolidated VIEs do not represent additional claims on the Company’s assets.

For the nine months ended September 30, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$18,016,000, cost of sales of approximately US$8,620,000, operating expenses of approximately US$4,036,000 and net income before allocation to non-controlling interests of approximately US$4,920,000.

For the three months ended September 30, 2011, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$6,255,000, cost of sales of approximately US$3,409,000, operating expenses of approximately US$1,205,000 and net income before allocation to non-controlling interests of approximately US$1,427,000.

For the nine months ended September 30, 2010, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$22,865,000, cost of sales of approximately US$15,327,000, operating expenses of approximately US$3,554,000 and net income before allocation to non-controlling interests of approximately US$3,687,000.

For the three months ended September 30, 2010, the financial performance of the VIEs reported in the Company’s consolidated statements of income and comprehensive income includes sales of approximately US$5,036,000, cost of sales of approximately US$2,917,000, operating expenses of approximately US$1,351,000 and net income before allocation to non-controlling interests of approximately US$747,000.
 
3.     Summary of significant accounting policies
 
a)  
Basis of presentation
 
The consolidated interim financial statements include the financial statements of the Company and its subsidiaries and VIEs. All significant inter-company transactions and balances have been eliminated in consolidation.
 
 
F-13

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The consolidated interim financial information as of September 30, 2011 and for the nine and three months ended September 30, 2011 and 2010 have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures, which are normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have not been included. The interim consolidated financial information should be read in conjunction with the financial statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, previously filed with the SEC.

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s consolidated financial position as of September 30, 2011, its consolidated results of operations for the nine and three months ended September 30, 2011 and 2010, and its consolidated cash flows for the nine months ended September 30, 2011 and 2010, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.
 
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. 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 kiosks business, which has been included in the financial statements of Beijing CNET Online, but does not control other assets of Shanghai Borongdingsi, thus, Shanghai Borongdingsi’s financial statements were not consolidated by the Company.
 
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. The Company continually evaluates these estimates and assumptions based on the most recently available information, historical experience and various other assumptions that the Company believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.
 
d)  
Reclassification
 
Certain prior period amounts have been regrouped to conform to the current period presentation, which did not have any impact to the Company’s prior period’s consolidated financial position, consolidated results of operations and consolidated cash flows
 
e)  
Foreign currency translation and transactions
 
The functional currency of the Company’s US holding 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 subsidiary and VIEs is Renminbi (“RMB”), and PRC is the primary economic environment in which the Company operates.
 
For financial reporting purposes, the financial statements of the Company’s PRC operating subsidiary and VIEs, which are prepared using the RMB, are translated into the Company’s reporting currency, the United States Dollar (“U.S. dollar”). 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.

 
F-14

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The exchange rates used to translate amounts in RMB into US$ for the purposes of preparing the consolidated financial statements are as follows:
 
   
September 30,
2011
   
December 31,
2010
 
             
Balance sheet items, except for equity accounts
  6.4018     6.6118  
             
   
Nine months ended September 30,
 
    2011     2010  
Items in the statements of income and comprehensive income, and statements cash flows
  6.5060     6.8164  
             
   
Three months ended September 30,
 
    2011     2010  
Items in the statements of income and comprehensive income, and statements cash flows
  6.4231     6.7803  
             
 
No representation is made that the RMB amounts could have been, or could be converted into US$ at the above rates.
 
f)  
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.
 
g)  
Accounts receivable
 
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.
 
h)  
Investment in equity investment affiliates
 
Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting in accordance to ASC Topic 323 “Equity Method and Joint Ventures”. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee companies’ board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee companies. Under the equity method of accounting, an investee company’s accounts are not reflected within the Company’s consolidated balance sheets and statements of income and comprehensive income; however, the Company’s share of the earnings or losses of the investee company is reflected in the caption “Share of earnings (losses) in equity investment affiliates” in the consolidated statements of income and comprehensive income. The Company’s carrying value (including loan to the investee) in equity method investee companies is reflected in the caption “Investment in and loan to equity investment affiliates” in the Company’s consolidated balance sheets.
 
When the Company’s carrying value in an equity method investee company is reduced to zero, no further losses are recorded in the Company’s consolidated financial statements unless the Company guaranteed obligations of the investee company or has committed additional funding. When the investee company subsequently reports income, the Company will not record its share of such income until it equals the amount of its share of losses not previously recognized.

 
F-15

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
i)  
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:
 

Vehicles
5 years
Office equipment
3-5 years
Electronic devices
5 years
 
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.
 
j)  
Intangible assets, net
 
Purchased software and software platform is initially recorded at cost and amortized on a straight-line basis over the estimated useful economic life.
 
Intangible assets other than goodwill acquired through various acquisitions (see Note 4) are amortized on a straight-line basis over their expected useful economic lives.
 
If an acquired intangible asset is determined to have an indefinite useful life, it should not be amortized until its useful life is determined to be no longer indefinite.  The Company reviews intangible assets' remaining useful lives in each reporting period.  If such an asset is later determined to have a finite useful life, the asset will be tested for impairment.  That asset will then be amortized prospectively over its estimated remaining useful life and accounted for in the same way as intangible assets subject to amortization.
 
The Company accounted for website development costs in accordance with ASC Topic 350-50, which requires that certain costs related to the development or purchase of internal-use software and systems as well as the costs incurred in the application development stage related to its website be capitalized and amortized over the estimated useful life of the software or system. ASC Topic 350-50 also require that costs related to the preliminary project stage, data conversion and post implementation/operation stage of an internal-use software development project be expensed as incurred.
 
Based on the Company analysis of its website development cost which is subject to capitalization in accordance with ASC Topic 350-50 incurred for the development of www.liansuo.com and www.chuangye.com, the Company didn’t capitalize such cost, as the amount was considered immaterial, which was mainly the labor cost of its R&D staff.
 
k)  
Impairment of long-lived assets
 
Long-lived assets, which include tangible long-lived assets and intangible 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.
 
For the nine and three months ended September 30, 2011 and 2010, the Company did not record any impairment losses associated with long-lived assets.
 
l)  
Goodwill

 
F-16

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of the Company's acquisitions of interests in its subsidiaries.
 
Goodwill is not depreciated or amortized but is tested for impairment at the reporting unit level at least on an annual basis, and between annual tests when an event occurs or circumstances change that could indicate that the asset might be impaired.  The test consists of two steps. First, identify potential impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with Topic 805, “Business Combinations.”
 
Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment in estimating the fair value of reporting units includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.
 
m)  
Deconsolidation
 
The Company accounts for deconsolidation of a subsidiary in accordance with ASC Topic 810 “Consolidation”.
 
 In accordance with ASC Topic 810-10-40-5, the parent shall account for the deconsolidation of a subsidiary by recognizing a gain or loss in net income attributable to the parent, measured as the difference between:
 
a. The aggregate of all of the following:
 
1. The fair value of any consideration received;
 
2. The fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated;
 
3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
 
b. The carrying amount of the former subsidiary’s assets and liabilities.
 
n)  
Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary
 
The Company accounted for changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary in accordance with ASC Topic 805 Business Combination, subtopic 10, which requires the transaction be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent and reallocated the subsidiary’s accumulated comprehensive income, if any, among the parent and the noncontrolling interest through an adjustment to the parent’s equity.
 
o)  
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.
 
 
F-17

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Sales include revenues from internet advertising generated from the Company’s portal websites, reselling of internet advertising spaces and other internet advertisement related resources purchased from other portal websites, reselling of advertising time purchased from TV stations and brand management and sales channel building services. 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.
 
p)  
Cost of sales
 
Cost of sales primarily includes the cost of media advertising time, internet advertisement related resources and other technical services purchased, director labor cost and PRC business tax.
 
q)  
Advertising costs
 
Advertising costs for the Company’s own brand building are not includable in cost of sales, they are expensed when incurred or amortized over the estimated beneficial period and are included in “selling expenses” in the statement of income and comprehensive income. For the nine months ended September 30, 2011 and 2010, advertising expenses for the Company’s own brand building were approximately US$1,193,000 and US$1,534,000, respectively. For the three months ended September 30, 2011 and 2010, advertising expenses for the Company’s own brand building were approximately US$170,000 and US$585,000, respectively.
 
r)  
Research and development expenses
 
Research and development costs are charged to expense when incurred. Expenses for research and development for the nine months ended September 30, 2011 and 2010 were approximately US$1,100,000 and US$605,000, respectively. Expenses for research and development for the three months ended September 30, 2011 and 2010 were approximately US$376,000 and US$276,000, respectively.
 
s)  
Income taxes
 
The Company adopted ASC Topic 740 “Income taxes” and uses the liability method to account for income taxes.  Under this method, deferred tax assets and liabilities are determined based on the difference between 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.
 
t)  
Uncertain tax positions
 
The Company adopted ASC Topic 740-10-25-5 through 740-10-25-7 and 740-10-25-13, 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 and three months ended September 30, 2011 and 2010, the Company did not have any interest and penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions.
 
u)  
Share-based Compensation
 
 
F-18

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The Company accounts for share-based compensation to employees in accordance with ASC Topic 718 “Compensation-Stock Compensation” 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.
 
v)  
Noncontrolling interest
 
The Company accounts for noncontrolling interests in accordance with ASC Topic 810-10-45, 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. ASC Topic 810-10-45 also requires that losses attributable to the parent and the noncontrolling interest in a subsidiary be attributed to those interests even if it results in a deficit noncontrolling interest balance.
 
w)  
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.
 
x)  
Earnings / (loss) per share
 
Earnings / (loss) 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.
 
y)  
Commitments and contingencies
 
The Company has adopted ASC 450 “Contingencies” subtopic 20, 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.
 
z)  
Fair value measurements
 
The Company’s financial instruments primarily consist of cash and cash equivalents, accounts receivable, other receivables, prepayment and deposits, investment in and loan to equity investment affiliates, accounts payable, advances from customers, accruals and other payables. The carrying values of these financial instruments approximate fair values due to their short maturities.
 
ASC Topic 820, Fair Value Measurement and Disclosures, 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:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities.

 
F-19

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.
 
aa)  
Recent accounting pronouncements affecting the Company
 
In September 2011, the FASB issued ASU No. 2011-08, “Intangibles-Goodwill and Other” (Topic 350): Testing Goodwill for Impairment. This ASU is intended to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the amendments in this ASU, an entity is permitted to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. The amendments in this Update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial position and results of operations upon adoption.
 
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 position and results of operations upon adoption.
 
4.     Acquisitions
 
In order to further diversify the channels of the Company’s advertisement and marketing campaign services, achieve an entry into Fujian Province, a base of fast growing small to medium enterprises and expand its market opportunities from franchises, dealerships and merchants looking to expand their businesses domestically in China, the Company acquired a 100% equity interest and a 51% equity interest in Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He, respectively. As described in Note 1, the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and the acquisition of a 51% equity interest in Quanzhou Tian Xi Shun He were consummated on January 4, 2011 and February 23, 2011, respectively.

Each acquisition was accounted for using the acquisition method of accounting in accordance with ASC Topic 805 “Business Combinations”, and accordingly the acquired assets and liabilities were recorded at their fair values on the dates of acquisitions and the results of their operations have been included in the Company’s results of operations since the dates of their acquisitions.

The income approach is applied for identifiable intangible assets and noncontrolling interests’ valuation, based on a five-year financial projection and using the discounted cash flow method to calculate the present value of the future economic benefits. Key inputs used for such valuation include: weighted average cost of capital (“WPCC”), discount rate, and terminal growth rate. The income approach explicitly recognizes that the current value of an asset is premised upon the expected receipt of future economic benefits focusing on the income producing capability of a business or an asset.   It measures the current value of a business or asset by calculating the present value of its future economic benefits such as earnings, cost savings, tax deduction, and proceeds from disposition.  Indications of value are developed by discounting these benefits to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risk associated with the particular investment which reflects both current return requirements of the market and specific investment. The discount rate selected is generally based on rates of return available from alternative investments of similar type and quality as of each assessment date. The Monte Carlo simulation is applied for the valuation of contingent consideration.  Contingent consideration arose from a term stipulated in the acquisition agreements with the sellers, which was that if pretax profit for 2012 and 2011 increases by less than 30% while compared to audited pretax profit of the prior year, the sellers need to compensate the acquirer for the difference between target pretax profit and actual result achieved then.

Goodwill recognized from these transactions mainly represented the expected operational synergies upon acquisition of these subsidiaries and intangibles not qualifying for separate recognition.  Goodwill is nondeductible for income tax purpose in the tax jurisdiction of these acquisition transactions incurred.

 
 
F-20

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Acquisition of Quanzhou Zhi Yuan

On December 18, 2010, the Company, through one of its VIEs, Beijing CNET Online entered into an equity interest acquisition agreement with the shareholders of Quanzhou Zhi Yuan.  According to the acquisition agreement, the Company agreed to pay an aggregate cash consideration of RMB9,500,000 (approximately US$1,446,000) in exchange for a 100% equity interest in Quanzhou Zhi Yuan.  The Company prepaid a deposit of RMB6,500,000 (approximately US$983,000) of the cash consideration to an independent agent who was entrusted by both of the counter-parties upon signing the agreement, the shareholders of Quanzhou Zhi Yuan would then fulfill the related obligations and process the relevant legal procedures and formalities as required in the acquisition agreements to complete the transaction.  On January 4, 2011, the acquisition of a 100% equity interest in Quanzhou Zhi Yuan was approved and registered with the relevant PRC government authorities of Quanzhou City, Fujian Province, and the prepaid cash consideration deposit was released to the shareholders of the Quanzhou Zhi Yuan accordingly. The Company determined the acquisition date of Quanzhou Zhi Yuan as of January 4, 2011, because this was the date both counter-parties had completed their obligations and received the corresponding benefits as outlined in the acquisition agreements and also the date the control of the acquiree were officially and legally transferred to the Company in fact.  As of September 30, 2011, the Company has paid the remaining purchase price of RMB3,000,000 (approximately US$464,110) to the seller for the 100% equity interest in Quanzhou Zhi Yuan.

The following table summarizes the assignment of fair value to identifiable assets and liabilities assumed as of January 4, 2011 (the acquisition date of Quanzhou Zhi Yuan):

   
Fair Value
   
Amortization Period
 
   
US$(’000)
   
(Years)
 
             
Cash and cash equivalents
  $ 11        
Accounts receivables
    17        
Property and equipment, net
    57        
Other current liabilities
    (13 )      
Deferred tax liabilities
    (196 )      
Acquired intangible assets:
             
Trade Name
    113    
Indefinite
 
        Contract Backlog
    18     0.7  
        Customer Relationship
    547     8  
        Non-Compete Agreement
    106     5  
Goodwill:
             
Assembled Workforce
    20        
Other unidentifiable intangibles
    708        
      728        
               
Total Value
  $ 1,388        
               
Purchase price
  $ 1,440        
Contingent consideration receivable
    (52 )      
Total amount to be allocated
  $ 1,388        
 
Acquisition of Quanzhou Tian Xi Shun He

On December 22, 2010, the Company, through one of its VIEs, Beijing CNET Online, entered into an equity interest acquisition agreement with the shareholders of Quanzhou Tian Xi Shun He.  Pursuant to the terms of the acquisition agreement, the Company agreed to pay an aggregate cash consideration of RMB7,500,000 (approximately US$1,142,000) in exchange for a 51% equity interest in Quanzhou Tian Xi Shun He.  The Company prepaid a deposit of RMB3,500,000 (approximately US$529,000) of the cash consideration to an independent agent who was entrusted by both of the counter-parties upon signing the agreement, the shareholders of Quanzhou Tian Xi Shun He would then fulfill the related obligations and process the relevant legal procedures and formalities as required in the acquisition agreements to complete the transaction.  On February 23, 2011, the acquisition of a 51% equity interest in Quanzhou Tian Xi Shun He was approved and registered with the relevant PRC government authorities of Quanzhou City, Fujian Province, and the prepaid cash consideration deposit was released to the shareholders of the Quanzhou Tian Xi Shun He accordingly. The Company determined the acquisition date of Quanzhou Zhi Yuan as of February 23, 2011, because this was the date both counter-parties had completed their obligations and received the corresponding benefits as outlined in the acquisition agreements and also the date the control of the acquiree was officially and legally transferred to the Company in fact.  As of September 30, 2011, the Company has settled the remaining purchase price of RMB4,000,000 (approximately US$618,810) to the seller for the 51% equity interest in Quanzhou Tian Xi Shun He.
 
 
F-21

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
The following table summarized the assignment of fair value to identifiable assets and liabilities assumed as of February 23, 2011 (the acquisition date of Quanzhou Tian Xi Shun He):
 
   
Fair Value
   
Amortization Period
 
   
US$(’000)
   
(Years)
 
             
Cash and cash equivalents
  $ 12        
Accounts receivables and other receivables
    55        
Property and equipment, net
    41        
Other current liabilities
    (34 )      
Deferred tax liabilities
    (289 )      
Acquired intangible assets:
             
Trade Name
    182    
Indefinite
 
        Contract Backlog
    170     0.6  
        Customer Relationship
    722     9  
        Non-Compete Agreement
    83     5  
Goodwill:
             
Assembled Workforce
    23        
Other unidentifiable intangibles
    1,143        
      1,166        
               
Total Value
    2,108        
               
Purchase price
    1,138        
Fair value of non-controlling interest
    1,034        
Contingent consideration receivable
    (64 )      
Total amount to be allocated
    2,108        

Based on the Company’s assessment of the acquired companies' financial performance on its own or in total, it is not considered material to the Company. Thus the Company believes that the presentation of pro forma financial information with regard to a summary of the results of operations of the Company for the business combination is not necessary.
 
5.     Cash and cash equivalents
 
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Cash on hand
    133       39  
Bank deposit
    21,147       15,551  
      21,280       15,590  
 
 
F-22

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
6.     Accounts receivable

   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Accounts receivable
    6,147       4,319  
Allowance for doubtful debts
    -       -  
Accounts receivable, net
    6,147       4,319  

The majority of the Company’s accounts receivable balances as of September 30, 2011 is within a six months credit period and there are no balances due over one year. Management believes that there will not be any collectability issue for these accounts receivable, therefore no allowance for doubtful accounts is required for the nine and three months ended September 30, 2011.
 
7.     Other receivables

   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Short-term loan for marketing campaign
    3,905       3,781  
Short-term loans to third parties
    252       3,781  
Short-term loan to Beijing Yang Guang
    6,248       -  
Receivables for disposal of the investment in Beijing Yang Guang
    81       -  
Staff advances for normal business purpose
    72       249  
      10,558       7,811  

Short-term loan for marketing campaign: for one of its major marketing campaigns, the Company made a marketing-related loan of RMB25,000,000 (approximately US$3,905,000) to a TV series of 36 episodes, called “Xiao Zhan Feng Yun”. This TV series is produced for the commemoration of “The Republican Revolution of 1911” (the Chinese bourgeois democratic revolution led by Dr. Sun Yat-sen which overthrew the Qing Dynasty) and has been broadcasted on CCTV 8 and www.sina.com.cn from September 2011, and is continually selling its broadcasting rights to other provincial TV channels for additional exposure.  By participating in this TV series, the Company will be shown during the credit at the closing of each episode with its logo presented and also shown as a separate card during the closing before the credit screen. This loan had a length of approximately one year and is expected to have a return rate of 20%.

The Company loaned third parties on a subjective term of searching and/or obtaining lower cost value-added communication channels. Any of the third parties are required to pay back the capital within three months or on demand if no satisfied search result is provided. The acquired resources are primarily used for self-advertising and marketing or advertising for clients in internet bundle packages in second and third tier cities or regions.

The short-term loan to Beijing Yang Guang of RMB40,000,000 (approximately US$6,248,000) was reclassified from investment in and loan to equity investment affiliates account upon the Company’s disposal of the investment in Beijing Yang Guang as  Beijing Yang Guang was no longer an equity investment affiliate of the Company. The loan was for working capital purpose, interest free and will be collected by the end of fiscal 2011. (See Note 12)
 
 
 
F-23

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
As of September 30, 2011, receivables for disposal of the investment in Beijing Yang Guang represented the remaining consideration receivable for the Company’s disposal of the 49% equity interest in Beijing Yang Guang of approximately US$55,000, which was subsequently received in October 2011, and the Company’s pro-rata share of the net income generated by Beijing Yang Guang during the period when the Company held 49% equity interest of Beijing Yang Guang of approximately US$26,000, transferred from investment in and loan to equity investment affiliates account upon disposal of the investment in Beijing Yang Guang, the amount  was also subsequently collected in early November 2011. (See Note 12)

Management believes no allowance for doubtful accounts is required for these other receivables for the nine and three months ended September 30, 2011.
 
8.     Prepayments and deposit to suppliers

   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Contract execution guarantees to TV advertisement  and internet resources providers
    2,292       2,778  
Prepayments to TV advertisement and internet resources providers
    980       413  
Prepayment to online game operating service provider
    -       91  
Other deposits and prepayments
    62       43  
      3,334       3,325  
 
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 that 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.
 
9.     Due from equity investment affiliates
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Shenzhen Mingshan
    42       -  
 
Shenzhen Mingshan is an equity investment affiliate of the Company.  Amounts due from Shenzhen Mingshan as of September 30, 2011 were mainly related to the hosted computer servers sold to Shenzhen Mingshan by the Company during the nine months ended September 30, 2011.
 
 
F-24

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
10.   Due from related parties
 
   
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Beijing Fengshangyinli Technology Co., Ltd.
    131       -  
Beijing Telijie Century Environmental Technology Co., Ltd.
    174       39  
Soyilianmei Advertising Co., Ltd.
    85       146  
      390       185  
 
These related parties are directly or indirectly owned by the Control Group or the management of the Company.  Control Group refers to Mr. Handong Cheng, Mr. Xuanfu Liu and Ms. Li Sun (acting as nominee for Mr. Zhang Zhige), the owners of the Company’s PRC Operating Entities, Business Opportunities Online and Beijing CNET Online before the Offshore Restructuring.
 
Amount due from Soyilianmei Advertising Co., Ltd. was related to the internet advertising resources purchased by the Company on behalf of this related party.  The rest of the related party balances were outstanding receivables for the advertising services the Company provided to these related parties.
 
11.   Deposit for acquisitions
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Quanzhou Zhi Yuan
    -       983  
Quanzhou Tian Xi Shun He
    -       529  
      -       1,512  
 
As described in Note 4, the Company prepaid RMB6,500,000 (approximately US$983,000) and RMB3,500,000 (approximately US$529,000) of the cash consideration for the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and a 51% equity interest in Quanzhou Tian Xi Shun He, respectively, as deposits to an independent agent who was entrusted by both of the counter-parties upon signing the agreement.  The shareholders of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He would then fulfill the related obligations and process the relevant legal procedures and formalities as required in the acquisition agreements to complete the transaction. As agreed by all parties, the completion dates of these acquisition transactions and the transfer of the control of the acquirees were the dates that the equity interest transfers were approved and registered with the relevant PRC government authorities and the prepaid cash consideration would be released to the shareholders of the acquirees on their respective transaction completion date.  Therefore, as of December 31, 2010, the cash considerations prepaid were recorded as deposit for acquisitions.
 
On January 4, 2011 and February 23, 2011, the acquisition of a 100% equity interest in Quanzhou Zhi Yuan and the acquisition of a 51% equity interest in Quanzhou Tian Xi Shun He were approved and registered with the relevant PRC government authorities of Quanzhou City, Fujian Province, respectively, and the prepaid cash consideration deposits were released to the shareholders of the acquirees in accordance. The Company determined the acquisition dates of Quanzhou Zhi Yuan and Quanzhou Tian Xi Shun He as of January 4, 2011 and February 23, 2011, respectively, and the prepaid cash deposits were accounted for as part of the purchase price allocation (see Note 4).
 
 
F-25

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
12.   Investment in and loan to equity investment affiliates
 
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Investment in equity investment affiliates
    588       1,112  
Loan to equity investment affiliates
    -       6,050  
      588       7,162  
 
The following table summarizes the movement of the investment in and advance to equity investment affiliates for the nine months ended September 30, 2011:
 
   
Beijing 
Yang Guang
   
Shenzhen
Mingshan
   
Total
 
   
US$(’000)
   
US$(’000)
   
US$(’000)
 
                   
Balance as of December 31, 2010 (audited)
    7,162       -       7,162  
Deconsolidation of Shenzhen Mingshan
    -       381       381  
Gain on deconsolidation of Shenzhen Mingshan
    -       229       229  
Loan to Beijing Yang Guang
    1,522       -       1,522  
Repayment from Beijing Yang Guang
    (1,547 )     -       (1,547 )
Additional investment to Shenzhen Mingshan
    -       169       169  
Share of earnings (losses) in equity investment affiliates
    26       (206 )     (180 )
Disposal of investment in Beijing Yang Guang
    (1,174 )     -       (1,174 )
Outstanding loan to Beijing Yang Guang transfer to other receivable account
    (6,248 )     -       (6,248 )
Exchange translation adjustment
    259       15       274  
Balances as of September 30, 2011 (unaudited)
    -       588       588  

Beijing Yang Guang:
 
Beijing Yang Guang was incorporated on October 25, 2010. On December 8, 2010, one of the Company’s VIEs, Shanghai Jing Yang acquired a 49% interest in Beijing Yang Guang for a cash consideration of RMB7,350,000 (approximately US$1,112,000) and became the noncontrolling interest holder of Beijing Yang Guang.  The investment in Beijing Yang Guang was accounted for under the equity method until the Company withdrew its investment and ceased to have any noncontolling interest in Beijing Yang Guang in August 2011. As of the date the Company disposed its 49% equity interest in Beijing Yang Guang, the Company has provided RMB40,000,000 (approximately US$6,050,000) working capital loan to Beijing Yang Guang.
 
For the nine and three months ended September 30, 2011, before the Company disposed of its investment in Beijing Yang Guang, the Company recognized its pro-rata share of earnings and losses in Beijing Yang Guang of approximately US$26,000 income  and a US$4,000 loss, respectively, which was reflected in the caption of “Share of earnings (losses) in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding increase (decrease) to the carrying value of the investment in Beijing Yang Guang in the Company’s consolidated balance sheet.
 
In August 2011, the Company withdrew its investment in Beijing Yang Guang and sold back its 49% equity interest to the majority shareholder of Beijing Yang Guang for a cash consideration of RMB7,350,000 (approximately US$1,148,000), which was equal to the amount the Company paid for the acquisition of the 49% equity interest in December 2010. Beijing Yang Guang also agreed to distribute to the Company its pro-rata share of net income generated by Beijing Yang Guang during the period when the Company held 49% of the equity interest of Beijing Yang Guang, which was approximately US$26,000. This amount was subsequently collected in early November 2011. As of the date the Company disposed its investment in Beijing Yang Guang, the carrying amount of the investment in Beijing Yang (excluding loan to Beijing Yang Guang) was RMB7,517,000, (approximately US$1,174,000). As of September 30, 2011, the Company had received a cash consideration of RMB7,000,000 (approximately US$1,093,000) The remaining purchase consideration of RMB350,000 (approximately US$55,000) was received in October 2011.  The difference between the carrying amount of the investment in Beijing Yang and the actual payment received as of September 30, 2011 was recorded in other receivables (See Note 7).
 
 
F-26

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
As of September 30, 2011, there was a RMB40,000,000 (approximately US$6,248,000) working capital loan to Beijing Yang Guang remain outstanding, which was transferred to other receivable account upon disposal of the investment in Beijing Yang Guang. This loan is interest-free and will be collected within the end of fiscal 2011.

Shenzhen Mingshan:

Shenzhen Mingshan was incorporated on June 24, 2010 by one of the Company’s VIEs, Business Opportunities Online and three other individuals who were not affiliated with the Company.  Shenzhen Mingshan was 51% owned by the Company and was a consolidated subsidiary of the Company from the date of incorporation through January 6, 2011.  On January 6, 2011, an independent third party investor invested RMB15,000,000 (approximately US$2,283,070) cash into Shenzhen Mingshan and hence obtained 60% equity interest of Shenzhen Mingshan. The Company’s share of equity interest then decreased from 51% to 20.4%. The carrying value of the investment to Shenzhen Mingshan immediately after the deconsolidation, which was approximately US$381,000, was included in the balance sheet as investment in equity investment affiliates.
 
The deconsolidation of Shenzhen Mingshan was accounted for in accordance with ASC Topic 810 “Consolidation”.  The Company recognized a gain of approximately US$229,000 upon deconsolidation of Shenzhen Mingshan, which has been recorded as a gain on deconsolidation of subsidiary in the Company’s consolidated statements of income and comprehensive income with a corresponding increase in the carrying value of the investment in Shenzhen Mingshan in the Company’s consolidated balance sheet.  This gain represents the excess of the fair value of the Company’s retained equity interest over its carrying value as of the date of deconsolidation.
 
The Company determined the estimated fair value of its retained equity interest in Shenzhen Mingshan based on the valuation of Shenzhen Mingshan used when an independent third party purchased equity in Shenzhen Mingshan, which purchase price was negotiated on an arm’s length basis.  Under these circumstances, the Company estimated the fair value of their non-controlling interest based on the fair value of controlling interest purchased by the independent third party.
 
In August 2011, the Company made a capital injection of RMB1,080,000 (approximately US$169,000) in cash to Shenzhen Mingshan for its portion of the unpaid registered capital, which was required to be fully contributed within two years from the incorporation of Shenzhen Mingshan. This amount was recorded as an increase of investment in equity investment affiliates in the Company’s consolidated balance sheet.
 
The Company applied the equity method of accounting prospectively from the date immediately after the deconsolidation. For the nine and three months ended September 30, 2011, the Company recognized its pro-rata share of losses in Shenzhen Mingshan of approximately US$206,000 and US$71,000, respectively, which was reflected in the caption of “Share of earnings (losses) in equity investment affiliates” in the Company’s consolidated statements of income and comprehensive income with a corresponding decrease to the carrying value of the investment in Shenzhen Mingshan in the Company’s consolidated balance sheet.
 

 
F-27

 
CHINANET ONLINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
13.   Property and equipment, net
 
        Property and equipment consist of the following:
 
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Vehicles
    604       584  
Office equipment
    1,311       1,183  
Electronic devices
    1,188       969  
Total property and equipment
    3,103       2,736  
Less: accumulated depreciation
    1,187       726  
      1,916       2,010  
 
Depreciation expenses in aggregate for the nine months ended September 30, 2011 and 2010 were approximately US$414,000 and US$253,000, respectively.
 
Depreciation expenses in aggregate for the three months ended September 30, 2011 and 2010 were approximately US$141,000 and US$90,000, respectively.
 
14.   Intangible assets, net
 
   
September 30,
2011
   
December 31,
2010
 
   
US$(’000)
   
US$(’000)
 
   
(Unaudited)
       
             
Intangible assets not subject to amortization:
           
    Trade Name
    305       -  
Intangible assets subject to amortization:
               
    Contract Backlog
    194       -  
    Customer Relationship
    1,307