NOTE
3. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
(A)
Basis of Preparation
These
financial statements were prepared on a going concern basis. The Company has
determined that the going concern basis of preparation is appropriate based on
its estimates and judgments of future performance of the Company, future events
and projected cash flows. At each balance sheet date, the Company evaluates its
estimates and judgments as part of its going concern assessment. Based on its
assessment, the Company believes there are sufficient financial and cash
resources to finance the Company as a going concern in the next twelve months.
Accordingly, management has prepared the financial statements on a going concern
basis.
(B) Principles of
Consolidation
The
condensed consolidated financial statements include the financial statements of
Network CN Inc., its subsidiaries and variable interest entities. All
significant intercompany transactions and balances have been eliminated upon
consolidation.
(C) Use of
Estimates
In
preparing condensed consolidated financial statements in conformity with GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates. Differences from those estimates are
reported in the period they become known and are disclosed to the extent they
are material to the condensed consolidated financial statements taken as a
whole.
(D) Cash and Cash
Equivalents
Cash
includes cash on hand, cash accounts, and interest bearing savings accounts
placed with banks and financial institutions. For purposes of the cash flow
statements, the Company considers all highly liquid investments with original
maturities of three months or less at the time of purchase to be cash
equivalents. As of March 31, 2008 and 2007, the Company had no cash
equivalents.
(E) Allowance for Doubtful
Accounts
Allowance
for doubtful accounts is made against accounts receivable to the extent they are
considered to be doubtful. Accounts receivable in the balance sheet are stated
net of such allowance. The Company records its allowance for doubtful accounts
based upon its assessment of various factors. The Company considers historical
experience, the age of the accounts receivable balances, the credit quality of
its customers, current economic conditions, and other factors that may affect
customers’ ability to pay to determine the level of allowance
required.
(F) Equipment, Net
Equipment
is stated at cost, less accumulated depreciation. Depreciation is provided using
the straight-line method over the estimated useful life of the assets, which is
from three to five years. When equipment is retired or otherwise disposed of,
the related cost and accumulated depreciation are removed from the respective
accounts, and any gain or loss is reflected in the statement of operations.
Repairs and maintenance costs on equipment are expensed as
incurred.
Construction
in progress represents the costs incurred in connection with the construction of
roadside advertising panels and mega-size advertising panels of the Companies.
No depreciation is provided for construction in progress until such time as the
assets are completed and placed into service. When completed, the roadside
advertising panels and mega-size advertising panels have economic life of 5
years and 7 years respectively.
(G) Intangible Assets, Net
Intangible
assets are stated at cost, less accumulated amortization and provision for
impairment loss. Intangible assets that have indefinite useful lives are not
amortized. Other intangible assets with finite useful lives are amortized on
straight-line basis over their estimated useful lives of 16 months to 20 years.
The amortization methods and estimated useful lives of intangible assets are
reviewed regularly.
(H) Impairment of Long-Lived
Assets
Long-lived
assets, including intangible assets with definite lives, are reviewed for
impairment whenever events or changes in circumstance indicate that the carrying
amount of the assets may not be recoverable. An intangible asset that is not
subject to amortization is reviewed for impairment annually or more frequently
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. An impairment loss is recognized when the
carrying amount of a long-lived asset and intangible assets exceeds the sum of
the undiscounted cash flows expected to be generated from the asset’s use and
eventual disposition. An impairment loss is measured as the amount by which the
carrying amount exceeds the fair value of the asset calculated using a
discounted cash flow analysis.
(I) Deferred Charges,
Net
Deferred
charges are fees and expenses directly related to an issuance of convertible
promissory notes, including placement agents’ fee. Deferred charges are
capitalized and amortized over the life of the convertible promissory notes
using the effective interest method. Amortization of deferred charges is
included in interest expense on the consolidated statements of operations while
the unamortized balance is included in deferred charges on the consolidated
balance sheet.
(J) Convertible Promissory
Notes and Warrants
In 2007,
the Company issued 12% convertible promissory note and warrants and 3%
convertible promissory notes and warrants. In 2008, the Company issued
additional warrants to purchase shares of the Company’s common stock and
warrants to purchase shares of the Company’s common stocks. The Company
allocated the proceeds of the convertible promissory notes between convertible
promissory notes and the financial instruments related to warrants associated
with convertible promissory notes based on their relative fair values at
commitment date. The fair value of the financial instruments related to warrants
associated with convertible promissory notes was determined utilizing the
Black-Scholes option pricing model and the respective allocated proceeds to
warrants is recorded in additional paid-in capital. The embedded beneficial
conversion feature associated with convertible promissory notes was recognized
and measured by allocating a portion of the proceeds equal to the intrinsic
value of that feature to additional paid-in capital in according to Emerging
Issues Task Force (“EITF”) Issue No. 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio” and EITF Issue No. 00-27, “Application of Issue
No. 98-5 to Certain Convertible Instruments.”
The
portion of debt discount resulting from allocation of proceeds to the financial
instruments related to warrants associated with convertible promissory notes is
being amortized to interest expense over the life of the convertible promissory
notes, using the effective yield method. For portion of debt discount resulting
from allocation of proceeds to the beneficial conversion feature, it is
recognized as interest expenses over the minimum period from the date of
issuance to the date of earliest conversion, using the effective yield
method.
In
addition, the Company fully redeemed 12% promissory notes due May 2008 which was
issued in November 2007 at a redemption price equal to 100% of the principal
amount of $5,000,000 plus accrued and unpaid interest. The Company recognized
the unamortized portion of the associated deferred charges and debt discount as
expenses included in amortization of deferred charges and debt discount on the
consolidated statements of operation during the period of
extinguishment.
(K) Revenue
Recognition
For hotel
management services, the Company recognizes revenue in the period when the
services are rendered and collection is reasonably assured.
For tour
services, the Company recognizes services-based revenue when the services have
been performed. Guangdong Tianma International Travel Service Co., Ltd
(“Tianma”) offers independent leisure travelers bundled packaged-tour products,
which include both air-ticketing and hotel reservations. Tianma’s packaged-tour
products cover a variety of domestic and international
destinations.
Tianma
organizes inbound and outbound tour and travel packages, which can incorporate,
among other things, air and land transportation, hotels, restaurants and tickets
to tourist destinations and other excursions. Tianma books all elements of such
packages with third-party service providers, such as airlines, car rental
companies and hotels, or through other tour package providers and then resells
such packages to its clients. A typical sale of tour services is as
follows:
|
1.
|
Tianma,
in consultation with sub-agents, organizes a tour or travel package,
including making reservations for blocks of tickets, rooms, etc. with
third-party service providers. Tianma may be required to make deposits,
pay all or part of the ultimate fees charged by such service providers or
make legally binding commitments to pay such fees. For air-tickets, Tianma
normally books a block of air tickets with airlines in advance and pays
the full amount of the tickets to reserve seats before any tours are
formed. The air tickets are usually valid for a certain period of time. If
the pre-packaged tours do not materialize and are eventually not formed,
Tianma will resell the air tickets to other travel agents or customers.
For hotels, meals and transportation, Tianma usually pays an upfront
deposit of 50-60% of the total cost. The remaining balance is then settled
after completion of the tours.
|
|
2.
|
Tianma,
through its sub-agents, advertises tour and travel packages at prices set
by Tianma and sub-agents.
|
|
3.
|
Customers
approach Tianma or its appointed sub-agents to book an advertised packaged
tour.
|
|
4.
|
The
customers pay a deposit to Tianma directly or through its appointed
sub-agents.
|
|
5.
|
When
the minimum required number of customers (which number is different for
each tour based on the elements and costs of the tour) for a particular
tour is reached, Tianma will contact the customers for tour confirmation
and request full payment. All payments received by the appointed
sub-agents are paid to Tianma prior to the commencement of the
tours.
|
|
6.
|
Tianma
will then make or finalize corresponding bookings with outside service
providers such as airlines, bus operators, hotels, restaurants, etc. and
pay any unpaid fees or deposits to such
providers.
|
Tianma is
the principal in such transactions and the primary obligor to the third-party
providers, regardless of whether it has received full payment from its
customers. In addition, Tianma is also liable to the customers for any claims
relating to the tours, such as accidents or tour services. Tianma has adequate
insurance coverage for accidental loss arising during the tours. The Company
utilizes a network of sub-agents who operate strictly in Tianma’s name and can
only advertise and promote the business of Tianma with the prior approval of
Tianma.
For
advertising services, the Company recognizes revenue in the period when
advertisements are either aired or published.
(L) Stock-based
Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment”, a
revision to SFAS No. 123,
“Accounting for Stock-Based Compensation”, and superseding APB Opinion
No. 25, “Accounting for Stock
Issued to Employees” and its related implementation guidance. Effective
January 1, 2006, the Company adopted SFAS 123R, using a modified prospective
application transition method, which establishes accounting for stock-based
awards in exchange for employee services. Under this application, the Company is
required to record stock-based compensation expense for all awards granted after
the date of adoption and unvested awards that were outstanding as of the date of
adoption. SFAS 123R requires that stock-based compensation cost is measured at
grant date, based on the fair value of the award, and recognized in expense over
the requisite services period.
Common
stock, stock options and warrants issued to other than employees or directors in
exchange for services are recorded on the basis of their fair value, as required
by SFAS No. 123R, which is measured as of the date required by EITF
Issue 96-18, “Accounting
for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services”. In accordance with
EITF 96-18, the non-employee stock options or warrants are measured at
their fair value by using the Black-Scholes option pricing model as of the
earlier of the date at which a commitment for performance to earn the equity
instruments is reached (“performance commitment date”) or the date at which
performance is complete (“performance completion date”). The stock-based
compensation expenses are recognized on a straight-line basis over the shorter
of the period over which services are to be received or the vesting period.
Accounting for non-employee stock options or warrants which involve only
performance conditions when no performance commitment date or performance
completion date has occurred as of reporting date requires measurement at the
equity instruments then-current fair value. Any subsequent changes in the market
value of the underlying common stock are reflected in the expense recorded in
the subsequent period in which that change occurs.
(M) Income
Taxes
The
Company accounts for income taxes under SFAS No. 109, “Accounting for Income
Taxes”. Under SFAS 109, deferred tax assets and liabilities are provided
for the future tax effects attributable to temporary differences between the
financial statement carrying amounts of assets and liabilities and their
respective tax bases, and for the expected future tax benefits from items
including tax loss carry forwards.
Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or reversed. Under SFAS 109, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(N) Comprehensive Income
(Loss)
The
Company follows SFAS No. 130, “Reporting Comprehensive
Income” for the reporting and display of its comprehensive income (loss)
and related components in the financial statements and thereby reports a measure
of all changes in equity of an enterprise that results from transactions and
economic events other than transactions with the shareholders. Items of
comprehensive income (loss) are reported in both the consolidated statement of
operations and comprehensive loss and the consolidated statement of
stockholders’ equity.
(O) Earnings
(Loss) Per
Common Share
Basic
earnings (loss) per common share are computed in accordance with SFAS
No. 128, “Earnings Per Share” by dividing the net income (loss)
attributable to holders of common stock by the weighted average number of shares
of common stock outstanding during the period. Diluted earnings (loss) per share
is computed by dividing net income (loss) by the weighted average number of
common shares including the dilutive effect of common share equivalents then
outstanding.
The
diluted net loss per share is the same as the basic net loss per share for the
three months ended March 31, 2008 and 2007 as all potential ordinary shares
including stock options and warrants are anti-dilutive and are therefore
excluded from the computation of diluted net loss per share.
(P) Operating
Leases
Leases
where substantially all the rewards and risks of ownership of assets remain with
the leasing company are accounted for as operating leases. Payments made under
operating leases are charged to the consolidated statements of operations on a
straight-line basis over the lease period.
(Q) Foreign Currency
Translation
The
Company uses the United States dollar as its functional and reporting currency.
Monetary assets and liabilities denominated in currencies other than the United
States dollar are remeasured into the United States dollar at the rates of
exchange at the balance sheet date. Transactions in currencies other than the
United States dollar during the year are converted into the United States dollar
at the rates of exchange at the transaction dates. Exchange differences are
recognized in the statement of operations.
On
consolidation, balance sheets of subsidiaries denominated in currencies other
than the United States dollar are translated into the United States dollar at
the rates of exchange at the balance sheet date. Statements of operations of
subsidiaries denominated in currencies other than the United States dollar are
translated into the United States dollar at average rates of exchange during the
year. Exchange differences resulting from the translation of financial
statements denominated in currencies other than the United States dollar and the
effect of exchange rate changes on intercompany transactions of a long-term
investment nature are accumulated and credited or charged directly to a separate
component of shareholders’ equity (deficit) and are reported as other
comprehensive income (loss).
The
assets and liabilities of the Company’s subsidiaries denominated in currencies
other than United States (“U.S.”) dollars are translated into U.S. dollars using
the applicable exchange rates at the balance sheet date. For statement of
operations’ items, amounts denominated in currencies other than U.S. dollars
were translated into U.S. dollars using the average exchange rate during the
period. Equity accounts were translated at their historical exchange rates. Net
gains and losses resulting from translation of foreign currency financial
statements are included in the statements of stockholders’ equity as accumulated
other comprehensive income (loss). Foreign currency transaction gains and losses
are reflected in the statements of operations.
(R) Fair Value of Financial
Instruments
The
carrying value of the Company’s financial instruments, which consist of cash,
accounts receivables, prepaid expenses and other current assets, accounts
payable, accrued expenses and other payables, approximates fair value due to the
short-term maturities.
The
carrying value of the Company’s financial instruments related to warrants
associated with convertible promissory notes issued in 2007 is stated at a value
being equal to the allocated proceeds of convertible promissory notes based on
the relative fair value of notes and warrants. In the measurement of the fair
value of these instruments, the Black-Scholes option pricing model is utilized,
which is consistent with the Company’s historical valuation techniques. These
derived fair value estimates are significantly affected by the assumptions used.
The allocated value of the financial instruments related to warrants associated
with convertible promissory notes is recorded as an equity, which does not
require to mark-to-market as of each subsequent reporting period.
(S) Concentration of Credit
Risk
The
Company places its cash with various financial institutions. The Company
believes that no significant credit risk exists as these cash investments are
made with high-credit-qualify financial institutions.
All the
revenue of the Company and a significant portion of the Company’s assets are
generated and located in China. The Company’s business activities and accounts
receivables are mainly from tour services and advertising services. Deposits are
usually collected from customers in advance and the Company performs ongoing
credit evaluation of its customers. The Company believes that no significant
credit risk exists as credit loss.
(T) Segmental
Reporting
SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information”
establishes standards for reporting information about operating segments on a
basis consistent with the Company’s internal organization structure as well as
information about geographical areas, business segments and major customers in
financial statements. The Company’s operating segments are organized internally
primarily by the type of services rendered. It is the management’s view that the
services rendered by the Company are of three operating segments: Media Network,
Travel Network and Investment Holding.
(U) Recent Accounting
Pronouncements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. The
objective of SFAS 157 is to increase consistency and comparability in fair value
measurements and to expand disclosures about fair value
measurements. SFAS 157 defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. SFAS 157 applies under other
accounting pronouncements that require or permit fair value measurements and
does not require any new fair value measurements. The provisions of SFAS No. 157
are effective for fair value measurements made in fiscal years beginning after
November 15, 2007. The adoption of this statement did not have a material effect
on the Company's future reported financial position or results of
operations.
In
February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities –
Including an Amendment of FASB Statement No. 115”. This statement
permits entities to choose to measure many financial instruments and certain
other items at fair value. Most of the provisions of SFAS No. 159 apply only to
entities that elect the fair value option. However, the amendment to SFAS No.
115 “Accounting for Certain Investments in Debt and Equity Securities” applies
to all entities with available-for-sale and trading securities. SFAS No. 159 is
effective as of the beginning of an entity’s first fiscal year that begins after
November 15, 2007. Early adoption is permitted as of the beginning of a fiscal
year that begins on or before November 15, 2007, provided the entity also elects
to apply the provision of SFAS No. 157, “Fair Value Measurements”. The adoption
of this statement did not have a material effect on the Company's financial
statements.
In
December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
160, “Noncontrolling Interests in Consolidated Financial Statements – an
amendment of ARB No. 51”. This statement improves the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements by establishing
accounting and reporting standards that require; the ownership interests in
subsidiaries held by parties other than the parent and the amount of
consolidated net income attributable to the parent and to the noncontrolling
interest be clearly identified and presented on the face of the consolidated
statement of income, changes in a parent’s ownership interest while the parent
retains its controlling financial interest in its subsidiary be accounted for
consistently, when a subsidiary is deconsolidated, any retained noncontrolling
equity investment in the former subsidiary be initially measured at fair value,
entities provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners. SFAS No. 160 affects those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. SFAS No. 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. The
Company is currently assessing the impact of adopting
SFAS No. 141 (R) and SFAS No. 160 on its financial
statements and related disclosures.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(SFAS 161). This statement is intended
to improve transparency in financial reporting by requiring enhanced disclosures
of an entity’s derivative instruments and hedging activities and their effects
on the entity’s financial position, financial performance, and cash flows.
SFAS 161 applies to all derivative
instruments within the scope of SFAS 133, “Accounting for Derivative Instruments
and Hedging Activities” (SFAS 133) as well as related hedged items, bifurcated
derivatives, and nonderivative instruments that are designated and qualify as
hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust
qualitative disclosures and expanded quantitative disclosures. SFAS 161 is effective prospectively for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application permitted. The Company
is currently assessing the impact of adopting SFAS 161 on its
financial statements and related disclosures.
NOTE
4. RECLASSIFICATION
Certain
prior year amounts have been reclassified to conform to the current period’s
presentation. The reclassification did not have an effect on total revenues,
total expenses, loss from operations, net loss and net loss per
share.
NOTE
5. SUBSIDIARIES AND VARIABLE
INTEREST ENTITIES
Details
of the Company’s principal consolidated subsidiaries and variable interest
entities as of March 31, 2008 were as follows:
|
|
Place
of
incorporation
|
Ownership
interest
attributable to
the Company
|
Principal activities
|
|
NCN
Group Limited
|
British
Virgin Islands
|
|
100%
|
Investment
holding
|
|
NCN
Media Services Limited
|
British
Virgin Islands
|
|
100%
|
Investment
holding
|
|
NCN
Management Services Limited
|
British
Virgin Islands
|
|
100%
|
Investment
holding
|
|
Crown
Winner International Limited
|
Hong
Kong
|
|
100%
|
Investment
holding
|
|
CityHorizon
Limited
|
Hong
Kong
|
|
100%
|
Investment
holding
|
|
NCN
Group Management Limited
|
Hong
Kong
|
|
100%
|
Provision
of administrative and management services
|
|
NCN
Huamin Management Consultancy (Beijing) Company Limited
|
The
PRC
|
|
100%
|
Provision
of administrative and management services
|
|
Shanghai
Quo Advertising Company Limited
|
The
PRC
|
|
100%
|
Provision
of advertising services
|
|
Xuancaiyi
(Beijing) Advertising Company Limited
|
The
PRC
|
|
51%
|
Provision
of advertising services
|
|
Guangdong
Tianma International Travel Service Co., Ltd.
|
The
PRC
|
|
55%
|
Provision
of tour services
|
|
NCN
Landmark International Hotel Group Limited
|
British
Virgin Islands
|
|
99.9%
|
Provision
of hotel management services
|
|
Beijing
NCN Landmark Hotel Management Limited
|
The
PRC
|
|
99.9%
|
Provision
of hotel management services
|
|
Teda
(Beijing) Hotels Management Limited
|
The
PRC
|
|
100%
|
Dormant
and undergo wind down process
|
|
NCN
Asset Management Services Limited
|
British
Virgin Islands
|
|
100%
|
Dormant
|
|
NCN
Travel Services Limited
|
British
Virgin Islands
|
|
100%
|
Dormant
|
|
NCN
Financial Services Limited
|
British
Virgin Islands
|
|
100%
|
Dormant
|
|
NCN
Hotels Investment Limited
|
British
Virgin Islands
|
|
100%
|
Dormant
|
|
NCN
Pacific Hotels Limited
|
British
Virgin Islands
|
|
100%
|
Dormant
|
|
Linkrich
Enterprise Advertising and Investment Limited
|
Hong
Kong
|
|
100%
|
Dormant
|
|
CityHorizon
Limited (Note 6)
|
British
Virgin Islands
|
|
100%
|
Investment
holding
|
|
Hui
Zhong Lian He Media Technology Co., Ltd (Note 6)
|
The
PRC
|
|
100%
|
Provision
of high-tech services
|
|
Beijing
Hui Zhong Bo Na Media Advertising Co., Ltd (Note 6)
|
The
PRC
|
|
100%
|
Provision
of advertising services
|
|
Hui
Zhi Bo Tong Media Advertising Beijing Co., Ltd (Note 6)
|
The
PRC
|
|
100%
|
Provision
of advertising services
|
|
|
Hong
Kong
|
|
100%
|
Dormant
|
|
Profit
Wave Investment Limited
|
Hong
Kong
|
|
100%
|
Dormant
|
Remarks
:
The
Company established its wholly owned subsidiaries, Crown Eagle Investment
Limited and Profit Wave Investment Limited in January 2008.
NOTE
6. BUSINESS
COMBINATIONS
(a) Acquisition
of CityHorizon BVI
On
January 1, 2008, the Company and its wholly owned subsidiary CityHorizon
Limited, a Hong Kong company (“CityHorizon Hong Kong”), entered into a Share
Purchase Agreement with CityHorizon Limited, a British Virgin Islands company
(“CityHorizon BVI”), Hui Zhong Lian He Media Technology Co., Ltd., a wholly
owned subsidiary of CityHorizon BVI (“Lianhe”), Beijing Hui Zhong Bo Na Media
Advertising Co., Ltd., a wholly owned subsidiary of CityHorizon BVI (“Bona”),
and Liu Man Ling, an individual and sole shareholder of CityHorizon BVI pursuant
to which the Company, through its subsidiary CityHorizon Hong Kong, acquired
100% of the issued and outstanding shares of CityHorizon BVI from Liu Man Ling.
Pursuant to the Share Purchase Agreement, the Company in January 2008 paid the
Liu Man Ling US$5,000,000 in cash and issued Liu Man Ling 1,500,000 shares of
restricted common stock of par value of $0.001 each, totaling $3,738,000. The
total purchase consideration was $8,738,000. The acquisition will strengthen the
Company’s Media Network in China.
The
acquisition has been accounted for using the purchase method of accounting and
the results of operations of CityHorizon BVI, Lianhe and Bona have been included
in the Company's consolidated statement of operations since the completion of
the acquisition on January 1, 2008.
The
allocation of the purchase price is as follows:
|
Cash
|
|
$ |
2,427,598 |
|
|
Prepayments
for advertising operating rights
|
|
|
2,450,794 |
|
|
Prepayments
and other current assets
|
|
|
170,347 |
|
|
Equipment,
net
|
|
|
1,995,702 |
|
|
Intangible
assets, net
|
|
|
1,973,865 |
|
|
Liabilities
assumed
|
|
|
(280,306 |
) |
|
Total
purchase price
|
|
$ |
8,738,000 |
|
Intangible
assets represent application systems internally developed by Lianhe for
controlling LED activities. Based on a valuation performed by an independent
valuer, the fair value of the application systems as of the date of acquisition
amounted to RMB31,000,000 (equivalent to US$4,252,564). This fair value, after
deducting negative goodwill of $2,278,699 arising from business combination with
Cityhorizon BVI, Lianhe and Bona, equaled to $1,973,865. Such net amount was
amortized over the useful lives of the application systems.
(b) Consolidation of variable interest entity - Botong
On
January 1, 2008, the Company caused its subsidiary, Lianhe, to enter into a
series of commercial agreements with Hui Zhi Bo Tong Media Advertising Beijing
Co., Ltd (“Botong”), a company organized under the laws of the PRC, and their
respective registered shareholders, pursuant to which Lianhe provides exclusive
technology and management consulting services to Botong in exchange for services
fees, which amount to substantially all of the net income of Botong. Each of the
registered PRC shareholders of Botong also entered into equity pledge agreements
and option agreements, which cannot be amended or terminated except by written
consent of all parties, with Lianhe. Pursuant to these equity pledge agreements
and option agreements, each shareholder pledged such shareholder’s interest in
Botong for the performance of such Botong’s payment obligations under its
respective exclusive technology and management consulting services agreements.
In addition, Lianhe has been assigned all voting rights by the shareholders of
Botong and has the option to acquire the equity interests of Botong at a
mutually agreed purchase price which shall first be used to repay any loans
payable to Lianhe or any affiliate of Lianhe by the registered PRC
shareholders.
In
addition, Lianhe committed to extend loan totaling US$137,179 as of January 1,
2008 to the registered shareholders of Botong for the purpose of financing such
shareholders’ investment in Botong. Through the above contractual arrangement,
Lianhe was the primary beneficiary of Botong which was a variable interest
entity as defined under FIN 46 (Revised), “Consolidation of Variable Interest
Entities”. The results of operations of Botong have been included in the
Company's consolidated statement of operations since January 1,
2008.
On
January 1, 2008, the net assets of Botong was as follows:
|
|
|
$ |
653 |
|
|
Prepaid
expenses and other current assets
|
|
|
102,154 |
|
|
Equipment,
net
|
|
|
599,348 |
|
|
Intangible
asset
|
|
|
551,031 |
|
|
Liabilities
assumed
|
|
|
(1,116,007
|
) |
|
Net
assets
|
|
$ |
137,179 |
|
Identifiable
intangible right of $551,031 is measured at fair value as of the effective date
of Lianhe and Botong entering into the above commercial agreements and is
amortized over the remaining contract period of Botong’s advertising
right.
The
following table set forth information for intangible assets subject to
amortization and intangible asset subject to amortization as of March 31, 2008
and December 31, 2007:
|
|
|
As
of
March
31, 2008
(Unaudited)
|
|
|
As
of
December
31, 2007
(Audited)
|
|
|
Amortized
intangible rights
|
|
|
|
|
|
|
|
Gross
carrying amount
|
|
$ |
8,376,298 |
|
|
|
7,825,267 |
|
|
Less:
accumulated amortization
|
|
|
(1,209,424 |
) |
|
|
(999,106 |
) |
|
Less:
provision for impairment loss
|
|
|
(711,611 |
) |
|
|
(711,611 |
) |
|
Amortized
intangible rights, net
|
|
|
6,455,263 |
|
|
|
6,114,550 |
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized
intangible right
|
|
|
|
|
|
|
|
|
|
Gross
carrying amount
|
|
|
815,902 |
|
|
|
815,902 |
|
|
Less:
provision for impairment
|
|
|
(815,902 |
) |
|
|
(815,902 |
) |
|
Unamortized
intangible right, net
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
application systems
|
|
|
|
|
|
|
|
|
|
Gross
carrying amount
|
|
$ |
1,973,865 |
|
|
|
- |
|
|
Less:
accumulated amortization
|
|
|
(49,347 |
) |
|
|
- |
|
|
Amortized
application systems, net
|
|
|
1,924,518 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets,
net
|
|
$ |
8,379,781 |
|
|
|
6,114,550 |
|
The
increase in amortized intangible rights and amortized application systems were
attributable to the consolidation of Botong and the acquisition of Cityhorizion
BVI respectively. Please refer to Note 6 – Business Combinations for details.
Total amortization expense of intangible assets of the Company for the quarters
ended March 31, 2008 and 2007 amounted to $259,665 and $79,471
respectively.
NOTE
8. CONVERTIBLE PROMISSORY NOTES
AND WARRANTS
(a) 12%
Convertible Promissory Note and Warrants
On
November 12, 2007, the Company entered into a 12% Note and Warrant Purchase
Agreement with Wei An Developments Limited (“Wei An”) with respect to the
purchase by Wei An a convertible promissory note in the principal account of
$5,000,000 at interest rate of 12% per annum (the “12% Convertible Promissory
Note”). The 12% Convertible Promissory Note is convertible into the
Company’s common stock at the conversion price of $2.40 per share. Pursuant
to the agreement, the Company is subject to a commitment fee of 2% of the
principal amount of the 12% Convertible Promissory Note. The term of the 12%
Convertible Promissory Note is six months and the Company has the option to
extend the 12% Convertible Promissory Note by an additional six-month period at
an interest rate of 14% per annum and be subject to an additional commitment fee
of 2% of the principal amount of the note. However, the Company has the right to
prepay all or any portion of the amounts due under the note at any time without
penalty or premium. In addition, pursuant to the Warrant Purchase Agreement, the
Company issued warrants to purchase up to 250,000 shares of the Company’s common
stock at the exercise price of $2.30 per share, which are exercisable for a
period of two years.
On
February 13, 2008, the Company fully redeemed 12% promissory notes due May 2008
which was issued in November 2007 at a redemption price equal to 100% of the
principal amount of $5,000,000 plus accrued and unpaid interest. No penalty or
premium was charged for such early redemption. The Company recognized the
unamortized portion of the associated deferred charges and debt discount as
expenses included in amortization of deferred charges and debt discount on the
consolidated statements of operation during the period of
extinguishment.
(b) 3%
Convertible Promissory Notes and warrants
On
November 19, 2007, the Company, Quo Advertising and the Designated Holders (as
defined in the Purchase Agreement), entered into a 3% Note and Warrant Purchase
Agreement (the “Purchase Agreement”) with affiliated investment funds of
Och-Ziff Capital Management Group (the “Investors”). Pursuant to the Purchase
Agreement, the Company agreed to issue 3% Senior Secured Convertible Notes due
June 30, 2011 in the aggregate principal amount of up to $50,000,000 (the “3%
Convertible Promissory Notes”) and warrants to acquire an aggregate amount of
34,285,715 shares of common stock of the Company (the “Warrants”).
The 3%
Convertible Promissory Notes and Warrants are issued and issuable in three
tranches, with Convertible Notes in the aggregate principal amount of
$6,000,000, Warrants exercisable for 2,400,000 shares at $2.50 per share and
Warrants exercisable for 1,714,285 shares at $3.50 per share, issued on 19
November, 2007, Convertible Notes in the aggregate principal amount of
$9,000,000, Warrants exercisable for 3,600,000 shares at $2.50 per share and
Warrants exercisable for 2,571,430 shares at $3.50 per share issued on 28
November 2007, and Convertible Notes in the aggregate principal amount of
$35,000,000, Warrants exercisable for 14,000,000 shares at $2.50 per share and
Warrants exercisable for 10,000,000 shares at $3.50 per share to be issued in
the third tranche, which was completed in January 2008. The warrants shall
expire on June 30, 2011, pursuant to the Purchase Agreement.
The 3%
Convertible Promissory Notes bear interest at 3% per annum payable semi-annually
in arrears and mature on June 30, 2011. The 3% Convertible Promissory Notes are
convertible into shares of common stock at an initial conversion price of $1.65
per share, subject to customary anti-dilution adjustments. In addition, the
conversion price will be adjusted downward on an annual basis if the Company
should fail to meet certain annual earnings per share (“EPS”) targets described
in the Purchase Agreement. In the event of a default, or if the Company’s actual
EPS for any fiscal year is less than 80% of the respective EPS target, certain
of the investors may require the Company to redeem the 3% Convertible Promissory
Notes at 100% of the principal amount, plus any accrued and unpaid interest,
plus an amount representing a 20% internal rate of return on the then
outstanding principal amount. The Warrants grant the holders the right to
acquire shares of common stock at $2.50 and $3.50 per share, subject to
customary anti-dilution adjustments. The exercise price of the Warrants will
also be adjusted downward whenever the conversion price of the 3% Convertible
Promissory Notes is adjusted downward in accordance with the provisions of the
Purchase Agreement.
On
January 31, 2008, the Company issued $35,000,000 in 3% Convertible Promissory
Notes and amended and restated $15,000,000 in 3% Convertible Promissory Notes
issued in late 2007. In addition, the Company issued additional warrants to
purchase 14,000,000 shares of the Company’s common stock at $2.50 per share and
warrants to purchase 10,000,000 shares of the Company’s common stock at $3.50
per share. Concurrently with the Third Closing, the Company loaned substantially
all the proceeds from 3% Convertible Promissory Notes to its direct wholly owned
subsidiary, NCN Group Limited (“NCN Group”), and such loan was evidenced by an
intercompany note issued by NCN Group in favor of the Company (the “NCN Group
Note”). The Company entered into a Security Agreement, dated as of January 31,
2008 pursuant to which the Company granted to the collateral agent for the
benefit of the Investors a first-priority security interest in certain of its
assets, including the NCN Group Note and 66% of the shares of NCN Group. In
addition, NCN Group and certain of the Company’s indirect wholly owned
subsidiaries each granted the Company a security interest in certain of the
assets of such subsidiaries to, among other things, secure the NCN Group Note
and certain related obligations.
As of
March 31, 2008, none of the conversion options and warrants associated with the
above convertible promissory notes was exercised.
The
following table details the accounting treatment of the convertible promissory
notes:
|
|
|
12%
Convertible
Promissory
Note
|
|
|
3%
Convertible
Promissory
Notes
(first
and
second
tranche)
|
|
|
3%
Convertible
Promissory
Notes
(third
tranche)
|
|
|
Total
|
|
|
Proceeds
of convertible promissory notes
|
|
$ |
5,000,000 |
|
|
$ |
15,000,000 |
|
|
$ |
35,000,000 |
|
|
$ |
55,000,000 |
|
|
Allocation
of proceeds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocated
relative fair value of warrants
|
|
|
(333,670 |
) |
|
|
(2,490,000 |
) |
|
|
(5,810,000 |
) |
|
|
(8,633,670 |
) |
|
Allocated
intrinsic value of beneficial conversion feature
|
|
|
- |
|
|
|
(4,727,272 |
) |
|
|
(11,030,303 |
) |
|
|
(15,757,575 |
) |
|
Total
net proceeds of the convertible promissory notes as of March 31,
2008
|
|
|
4,666,330 |
|
|
|
7,782,728 |
|
|
|
18,159,697 |
|
|
|
30,608,755 |
|
|
Prepayment
of convertible promissory notes
|
|
|
(5,000,000 |
) |
|
|
- |
|
|
|
- |
|
|
|
(5,000,000 |
) |
|
Amortization
of debt discount for the quarter ended March, 2008
|
|
|
333,670 |
|
|
|
4,881,191 |
|
|
|
11,221,587 |
|
|
|
16,436,448 |
|
|
Net
carrying value of convertible promissory notes
|
|
$ |
- |
|
|
$ |
12,663,919 |
|
|
$ |
29,381,284 |
|
|
$ |
42,045,203 |
|
Warrant
and Beneficial Conversion Features
The fair
value of the financial instruments associated with warrants of both 12%
convertible promissory note and 3% convertible promissory notes was determined
utilizing Black-Scholes option pricing model, which is consistent with the
Company’s historical valuation methods. The following assumptions and estimates
were used in the Black-Scholes option pricing model: (1) 12% convertible
promissory note: volatility of 182%; an average risk-free interest rate of
3.52%; dividend yield of 0%; and an expected life of 2 years, (2) 3% convertible
promissory notes: volatility of 47%; an average risk-free interest rate of
3.30%; dividend yield of 0%; and an expected life of 3.5 years.
The
warrants issued in connection with 12% convertible promissory note and 3%
convertible promissory notes meet the criteria of EITF 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock”
for equity classification. Accordingly, the conversion features do not
require derivative accounting. The intrinsic value of beneficial conversion
feature is calculated in according to EITF Issue No. 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratio” and EITF Issue No. 00-27, “Application of Issue No. 98-5 to
Certain Convertible Instruments”. For 3% convertible promissory note, as
the effective conversion price after allocating a portion of the proceeds to the
warrants was less than the Company’s market price of common stock at commitment
date, it was considered to have a beneficial conversion feature while for 12%
convertible promissory note, no beneficial conversion feature existed. The value
of beneficial conversion feature is recorded as a reduction in the carrying
value of the convertible promissory notes against additional paid-in capital. As
3% convertible promissory notes are convertible at the date of issuance, the
respective debt discount equivalent to the value of beneficial conversion
feature is fully amortized through interest expense as of the date of
issuance.
Amortization of Deferred Charges and
Debt Discount
The
amortization of deferred charges and debt discount for the three months ended
March 31, 2008 were as follows:
|
|
|
Warrants
|
|
|
Conversion
Features
|
|
|
Deferred
Charges
|
|
|
Total
|
|
|
12%
convertible promissory note
|
|
$ |
259,204 |
|
|
|
-
|
|
|
|
80,700 |
|
|
|
339,904 |
|
|
3%
convertible promissory notes
|
|
$ |
309,747 |
|
|
|
11,030,303 |
|
|
|
110,576 |
|
|
|
11,450,626 |
|
|
Total
|
|
$ |
568,951 |
|
|
|
11,030,303 |
|
|
|
191,276 |
|
|
|
11,790,530 |
|
NOTE
9. COMMITMENTS AND
CONTINGENCIES
(a) Commitments
1. Rental
Lease Commitment
The
Company’s existing rental leases do not contain significant restrictive
provisions. The following is a schedule by year of future minimum lease
obligations under non-cancelable rental operating leases as of March 31,
2008:
|
Nine months ending
December 31,2008
|
|
$ |
348,321 |
|
|
Fiscal
year ending December
31,
|
|
|
|
|
|
2008
|
|
$ |
348,321 |
|
|
2009
|
|
|
329,547 |
|
|
2010
|
|
|
145,160 |
|
|
2011
|
|
|
9,288 |
|
|
Total
|
|
$ |
828,407 |
|
2. Annual
Rights and Operating Fee Commitment
Since
November 2006, the Company, through its subsidiaries NCN Media Services Limited,
Quo Advertising , Xuancaiyi, Bona and Botong has acquired rights from third
parties to operate 12,984 roadside advertising panels and 14 mega-size
advertising panels for periods ranging from 16 months to 20 years.
The
following table sets forth the estimated future annual commitment of the Company
with respect to the rights 12,984 roadside advertising panels and 14 mega-size
advertising panels that the Company held as of March 31, 2008:
|
|
|
(In millions)
|
|
|
Nine
months ending December
31,2008
|
|
$ |
16.8 |
|
|
Fiscal year ending
December 31,
|
|
|
|
|
|
2008
|
|
|
16.8 |
|
|
2009
|
|
|
14.1 |
|
|
2010
|
|
|
3.8 |
|
|
2011
|
|
|
3.7 |
|
|
2012
|
|
|
3.7 |
|
|
Thereafter
|
|
|
24.8 |
|
|
Total
|
|
$ |
66.9 |
|
3.
Capital commitments
At March
31, 2008, the Company had commitments for capital projects in progress in
connection with construction of roadside advertising panels and mega-size
advertising panels of approximately $12,493,000.
(b) Contingencies
The
Company accounts for loss contingencies in accordance with SFAS 5, “Accounting
for Loss Contingencies” and other related guidelines. Set forth below is a
description of certain loss contingencies as of March 31, 2008 and management’s
opinion as to the likelihood of loss in respect of loss
contingency.
The
Company’s 55%-owned subsidiary, Tianma, is a defendant in proceedings brought in
the Guangzhou Yuexiu District Court. The proceedings were finalized on October
9, 2006. The facts surrounding the proceeding are as follows:
Guangdong
Yongan Travel Agency (“Yongan”) arranged a local tour in April 2001. Yongan
rented a car from an agent of Tianma but the car did not belong to Tianma. A car
accident happened during the tour, causing 20 injuries and one death. Guangzhou
Police issued a proposed determination on the responsibilities of the accidents
on May 18, 2001. The proposal determined that the driver who used a
non-functioning car was fully liable for the accident. Those tourists sued
Yongan for damages and Guangzhou Intermediate People’s Court made a final
judgment in 2004 that Yongan was liable and Yongan paid approximately RMB2.2
million ($302,000) to the injured. In 2005, Yongan sued the agent of Tianma,
Tianma and the car owner. In October 2006, the Guangzhou Yuexiu District Court
made a judgment that the agent was liable to pay RMB2.1 million ($288,000) plus
interest for damages. Tianma and the car owner have joint-and-several
liabilities.
Tianma is
now appealing the court’s decision. The Company believes that there is a
reasonably high chance of overturning the court’s decision. In addition, the
Company has been indemnified for any future liability upon the acquisition by
the prior owners of Tianma. Accordingly, no provision has been made by the
Company
to the above claims as of March 31, 2008.
NOTE
10. STOCKHOLDERS’
EQUITY
(a) Stock,
Options and Warrants Issued for Services
1. In
February 2006, the Company issued an option to purchase up to 225,000 shares of
common stock to its legal counsel at an exercise price of $0.10 per share. So
long as the counsel’s relationship with the Company continues, one-twelfth of
the shares underlying the option vest and become exercisable each month from the
date of issuance. The option may be exercised for 120 days after termination of
the relationship. The fair market value of the option was estimated on the grant
date using the Black-Scholes option pricing model as required by SFAS 123R with
the following assumptions and estimates: expected dividend 0%, volatility 147%,
a risk-free rate of 4.5% and an expected life of one (1) year. The value of an
option recognized during the quarters ended March 31, 2008 and 2007 were $nil
and $1,317 respectively. The options were exercised in April 2007.
2. In
August 2006, the Company issued a warrant to purchase up to 100,000 shares of
restricted common stock to a consultant at an exercise price $0.70 per share.
One-fourth of the shares underlying the warrant become exercisable every 45 days
beginning from the date of issuance. The warrant shall remain exercisable until
August 25, 2016. The fair market value of the warrant was estimated on the grant
date using the Black-Scholes option pricing model as required by SFAS 123R with
the following assumptions and estimates: expected dividend 0%, volatility 192%,
a risk-free rate of 4.5% and an expected life of one (1) year. The value
recognized for the quarters ended March 31, 2008 and 2007 was approximately $nil
and $10,145 respectively.
3. In
April 2007, the Company issued 45,000 S-8 shares of common stock of par value of
$0.001 each, totaling $18,000 to its legal counsel for services
rendered.
4. In
April 2007, the Company issued 377,260 S-8 shares of common stock of par value
of $0.001 each, totaling $85,353 to its directors and officers for services
rendered.
5. In
July 2007, NCN Group Management Limited entered into Executive Employment
Agreements (the “Agreements”) with Godfrey Hui, Chief Executive Officer, Daniel
So, Managing Director, Daley Mok, Chief Financial Officer, Benedict Fung, the
President, and Stanley Chu, General Manager. Pursuant to the Agreements, each
executive was granted shares of the Company’s common stock subject to annual
vesting over five years in the following amounts: Mr. Hui, 2,000,000
shares; Mr. So, 2,000,000 shares; Dr. Mok 1,500,000 shares; Mr. Fung 1,200,000
shares and Mr. Chu, 1,000,000 shares. In connection with these stock grants and
in accordance with SFAS 123R, the Company recognized non-cash stock-based
compensation of $699,300
and $nil included in Payroll on the consolidated statement of operations for the
quarters ended March 31, 2008 and 2007 respectively. Out of the total
shares granted under the Agreements, on January 2, 2008, an aggregate of 660,000
S-8 shares with par value of $0.001 each were vested and issued to the concerned
executives.
6. In
August 2007, the Company issued 173,630 shares of restricted common stock of par
value of $0.001 each, totaling $424,004 to a consultant for services rendered.
The value of stock grant is fully amortized and recognized during the six months
ended December 31, 2007.
7. In
August 2007, the Company issued 230,000 S-8 shares of common stock of par value
of $0.001 each, totaling $69,500 to its directors and officers for services
rendered.
8.
In September, 2007, the Company entered into a service agreement with
independent directors, Peter Mak, Gerd Jakob, Edward Lu, Ronglie Xu and Joachim
Burger. Pursuant to the service agreements, each independent director was
granted shares of the Company’s common stock subject to a vesting period of ten
months in the following amounts: Peter Mak:15,000 shares; Ronglie Xu:15,000
shares; Joachim Burger:15,000 shares, Gerd Jakob:10,000 shares and Edward
Lu:10,000 shares. In connection with these stock grants and in accordance with
SFAS 123R, the Company recognized $43,485 and $nil of non-cash stock-based
compensation included in Payroll on the consolidated statement of operation for
the quarters ended March, 2008 and 2007 respectively.
9. In
November 2007, the Company was obligated to issue a warrant to purchase up to
300,000 shares of restricted common stock to a placement agent for provision of
agency services in connection with the issuance of 3% convertible promissory
notes as mentioned in Note 8 – Convertible Promissory Notes and Warrants at an
exercise price $3.0 per share which are exercisable for a period of two years.
The fair value of the warrant was estimated on the grant date using the
Black-Scholes option pricing model as required by SFAS 123R with the following
weighted average assumptions: expected dividend 0%, volatility 182 %, a
risk-free rate of 4.05 % and an expected life of two (2) year. The value of the
warrant recognized for the quarter ended March 31, 2008 was
$31,985.
10. In
December 31, 2007, the Company committed to grant 235,000 S-8 shares of common
stock to certain employees of the Company for their services rendered during the
year ended December 31, 2007. In connection with these stock grants and in
accordance with SFAS 123R, the Company fully recognized non-cash stock-based
compensation of $611,000 in Payroll on the consolidated statement of operation
for the year ended December 31, 2007. Such 235,000 S-8 shares of par value of
$0.001 each were issued on January 2, 2008.
(b)
Stock Issued for
Acquisition
1. In
January 2007, in connection with the acquisition of Quo Advertising, the Company
issued 300,000 shares of restricted common stock of par value of $0.001 each,
totaling $843,600.
2. In
January 2008, in connection with the acquisition of CityHorizon BVI, the Company
issued 1,500,000 shares of restricted common stock of par value of $0.001 each,
totaling $3,738,000 as part of consideration.
(c) Stock
Issued for Private Placement
In April
2007, the Company issued and sold 500,000 shares of restricted common stock of
par value of $0.001 each, totaling $1,500,000 in a private placement. No
investment banking fees were incurred as a result of this
transaction.
(d) Conversion
Option and Stock Warrants Issued in Notes Activities
On
November 12, 2007, pursuant to the 12% Note and Warrant Purchase Agreement of
$5,000,000, the Company issued warrants to purchase up to 250,000 shares of the
Company’s common stock at the exercise price of $2.30 per share, which are
exercisable for a period of two years to Wei An. The allocated proceeds to the
warrants of $333,670 based on the relative fair value of 12% Convertible
Promissory Notes and warrants were recorded as reduction in the carrying value
of the note against additional-paid in capital. As the effective conversion
price is higher than the Company’s market price of common stock at commitment
date, no beneficial conversion existed. Please refer to Note 8 – Convertible
Promissory Note and Warrant for details.
On
November 19, 2007, pursuant to the 3% Note and Warrant purchase Agreement, the
Company issued warrants to purchase up to 2,400,000 shares of the Company’s
common stock at the exercise price of $2.5 per share and 1,714,285 shares of the
Company’s common stock at the exercise price of $3.5 per share associated with
the convertible notes of $6,000,000 in the first closing. On November 28, 2007,
the Company also issued warrants to purchase up to 3,600,000 shares of the
Company’s common stock at the exercise price of $2.5 per share and 2,571,430
shares of the Company’s common stock at the exercise price of $3.5 per share.
The allocated proceeds to these warrants were $2,490,000 in aggregate which were
recorded as reduction in the carrying value of the notes against additional
paid-in capital. As the effective conversion price after allocating a portion of
the proceeds to the warrants was less than the Company’s market price of common
stock at commitment date, it was considered to have a beneficial conversion
feature with value of $4,727,272 recorded as a reduction in the carrying value
of the notes against additional paid-in capital. Please refer to Note 8 –
Convertible Promissory Note and Warrant for details.
On
January 31, 2008, the Company issued $35,000,000 in 3% Convertible Promissory
Notes and amended
and restated $15,000,000 in 3% Convertible Promissory Notes issued in late 2007.
In addition, the Company issued additional warrants to purchase 14,000,000
shares of the Company’s common stock at $2.50 per share and warrants to purchase
10,000,000 shares of the Company’s common stock at $3.50 per share. Concurrently
with the Third Closing, the Company loaned substantially all the proceeds from
3% Convertible Promissory Notes to its direct wholly owned subsidiary, NCN Group
Limited (“NCN Group”), and such loan was evidenced by an intercompany note
issued by NCN Group in favor of the Company (the “NCN Group Note”). The Company
entered into a Security Agreement, dated as of January 31, 2008 pursuant to
which the Company granted to the collateral agent for the benefit of the
Investors a first-priority security interest in certain of its assets, including
the NCN Group Note and 66% of the shares of NCN Group. In addition, NCN Group
and certain of the Company’s indirect wholly owned subsidiaries each granted the
Company a security interest in certain of the assets of such subsidiaries to,
among other things, secure the NCN Group Note and certain related
obligations. The allocated proceeds to these warrants were $5,810,000
in aggregate which were recorded as reduction in the carrying value of the notes
against additional paid-in capital. As the effective conversion price after
allocating a portion of the proceeds to the warrants was less than the Company’s
market price of common stock at commitment date, it was considered to have a
beneficial conversion feature with value of $11,030,303 recorded as a reduction
in the carrying value of the notes against additional paid-in capital. Please
refer to Note 8 – Convertible Promissory Note and Warrant for
details.
NOTE
11. RELATED PARTY
TRANSACTIONS
During
the quarters ended March 31, 2008 and 2007, the Company have not entered into
any material transactions or series of transactions that would be considered
material in which any officer, director or beneficial owner of 5% or more of any
class of the Company’s capital stock, or any immediate family member of any of
the preceding persons, had a direct or indirect material interest:
NOTE
12. NET LOSS PER COMMON
SHARE
Net loss
per share information for the quarters ended March 2008 and 2007 was as follows:
|
|
|
2008
|
|
|
2007
|
|
|
Numerator:
|
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(18,813,760 |
) |
|
$ |
(3,214,395 |
) |
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding, basic
|
|
|
71,418,201 |
|
|
|
67,520,718 |
|
|
Effect
of dilutive securities
|
|
|
|
|
|
|
|
|
|
Options
and warrants
|
|
|
- |
|
|
|
- |
|
|
Weighted
average number of shares outstanding, diluted
|
|
|
71,418,201 |
|
|
|
67,520,718 |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings/(Losses)
per ordinary share – basic and diluted
|
|
|
|
|
|
|
|
|
|
Net
loss per share – basic and diluted
|
|
$ |
(0.26 |
) |
|
$ |
(0.05 |
) |
The
diluted net loss per share is the same as the basic net loss per share for the
quarters ended March 31, 2008 and 2007 as all potential ordinary shares
including stock options and warrants are anti-dilutive and are therefore
excluded from the computation of diluted net loss per share. The securities that
could potentially dilute basic earnings (loss) per share in the future that were
not included in the computation of diluted earnings (loss) per share because of
anti-dilutive effect as of March 31, 2008 and 2007 were summarized as
follows:
|
|
|
2008
|
|
|
2007
|
|
|
Potential
common equivalent shares:
|
|
|
|
|
|
|
|
Stock
options for services
|
|
|
- |
|
|
|
287,032 |
|
|
Stock
warrants for services (1)
|
|
|
64,869 |
|
|
|
77,141 |
|
|
Conversion
feature associated with convertible promissory notes to common
stock
|
|
|
10,466,200 |
|
|
|
- |
|
|
Common
stock to be granted to directors executives and employees for services
(including nonvested shares)
|
|
|
7,105,000 |
|
|
|
- |
|
|
Total
|
|
|
17,636,069 |
|
|
|
364,173 |
|
Remarks:
|
(1)
|
As
of March 31, 2008, the number of potential common equivalent shares
associated with warrants issued for services was 64,869 which was related
to a warrant to purchase 100,000 common stock issued by the Company to a
consultant in 2006 for service rendered at an exercise price of $0.70,
which expired in August 2016.
|
NOTE
13. BUSINESS
SEGMENTS
The
Company has changed their operating segments in 2007 as a result of change of
internal organization structure by management. Each segment operates
exclusively. The Company’s Media Network segment provides marketing
communications consultancy services to customers in China. The Company’s Travel
Network segment provides tour services as well as management services to hotels
and resorts in China. The Company’s Investment Holding segment represents the
companies which provide administrative and management services to its
subsidiaries or fellow subsidiaries. The accounting policies of the segments are
the same as described in the summary of significant accounting policies. There
are no inter-segment sales.
|
For
the Three Months Ended March 31, 2008
|
|
Media
Network
|
|
|
Travel
Network
|
|
|
Investment
Holding
|
|
|
Total
|
|
|
Revenue
|
|
$ |
584,167 |
|
|
$ |
8,458,482 |
|
|
$ |
- |
|
|
$ |
9,042,649 |
|
|
Loss
from operations
|
|
|
(4,799,017 |
) |
|
|
15,434 |
|
|
|
(1,994,741 |
) |
|
|
6,778,324 |
|
|
Depreciation
and amortization
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-Equipment
and intangible assets
|
|
|
429,403 |
|
|
|
2,396 |
|
|
|
10,159 |
|
|
|
441,958 |
|
|
-Deferred
charges and debt discount
|
|
|
- |
|
|
|
- |
|
|
|
11,790,530 |
|
|
|
11,790,530 |
|
|
Interest
expense
|
|
|
|
|
|
|
|
|
|
|
346,625 |
|
|
|
346,625 |
|
|
Assets
|
|
|
43,457,567 |
|
|
|
1,899,768 |
|
|
|
12,074,903 |
|
|
|
57,432,238 |
|
|
Capital
Expenditures
|
|
|
3,087,514 |
|
|
|
5,285 |
|
|
|
1,064 |
|
|
|
3,093,863 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Three Months Ended March 31, 2007
|
|
Media
Network
|
|
|
Travel
Network
|
|
|
Investment
Holding
|
|
|
Total
|
|
|
Revenue
|
|
$ |
393,899 |
|
|
$ |
2,375,828 |
|
|
$ |
- |
|
|
$ |
2,769,727 |
|
|
Loss
from operations
|
|
|
98,327 |
|
|
|
(104,447 |
) |
|
|
(3,230,727 |
) |
|
|
(3,236,847 |
) |
|
Depreciation
and amortization-equipment and intangible
assets
|
|
|
353 |
|
|
|
1,597 |
|
|
|
88,243 |
|
|
|
90,193 |
|
|
Assets
|
|
|
755,422 |
|
|
|
981,833 |
|
|
|
8,020,054 |
|
|
|
9,757,309 |
|
|
Capital
Expenditures
|
|
|
2,712 |
|
|
|
(1,546 |
) |
|
|
6,975 |
|
|
|
8,141 |
|
CAUTIONARY
STATEMENTS
The
following management’s discussion and analysis of financial condition and
results of operations is based upon and should be read in conjunction with the
Company’s consolidated financial statements and the notes thereto included in
“Part I — Financial Information, Item 1.
Financial
Statements.” All amounts are
expressed in U.S. dollars.
OVERVIEW
Network
CN Inc. (“we” or “the Company”), originally incorporated on September 10, 1993,
is a Delaware company with headquarters in the Hong Kong Special Administrative
Region, the People’s Republic of China (“the PRC” or “China”). It was operated
by different management teams in the past, under different operating names,
pursuing a variety of business ventures. The most recent former name was Teda
Travel Group, Inc. On August 1, 2006, the Company changed its name to “Network
CN Inc.” in order to better reflect the Company’s vision under its new and
expanded management team.
Our
business plan is to build a nationwide information and entertainment network in
the PRC. To achieve this goal, we have established two business divisions: our
Media Business division and our Non-Media Business division. During the latter
half of 2006, we adjusted our primary focus away from our Non-Media Business to
our Media Business and began building a media network with the goal of becoming
a nationwide leader in out-of-home, digital display advertising, roadside LED
digital video panels and mega-size video billboards. We took the first step in
November 2006 by securing a media-related contract for installing and managing
outdoor LED advertising video panels. In 2007, we acquired Shanghai Quo
Advertising Company Limited (“Quo Advertising”), an advertising agency in
Shanghai, China and Xuancaiyi (Beijing) Advertising Company Limited
(“Xuancaiyi”), an advertising agency in Beijing, China. In 2008, the Company and
its wholly owned subsidiary CityHorizon Limited, a Hong Kong company
(“CityHorizon Hong Kong”), completed the acquisition of 100% of the issued and
outstanding shares of CityHorizon Limited, a British Virgin Islands
company,(“CityHorizon BVI”) and by entering into a series of commercial
agreements giving effective control of Quo Advertising, Bona and Botong to the
Company, we secured rights to operate mega-size digital video billboards and
roadside LED panels in prominent cities in the PRC and began generating revenues
from our Media Business. As of March 31, 2008, we have installed 11,117 roadside
LED panels, 167 roadside rolling light boxes and 12 mega-sized digital
billboards, a portion of which were put into operation during this
quarter. In 2008, we expect to continue to place additional LED panels into
operation, which will contribute to the Company’s media business revenue in the
coming quarters.
Our
Non-Media Business is composed of two sectors: Travel Network and e-Network.
Through our Travel Network we provide agency tour services and hotel management
services. In 2006, we acquired 55% of the equity interest in Guangdong Tianma
International Travel Service Co., Ltd. (“Tianma”), a company organized under the
laws of the PRC and engaged in the provision of tour services to customers both
inside and outside of the PRC. In 2006 and 2007, we earned substantially all of
our revenues from tour services. Our Travel Network also provides day-to-day
management services to hotels and resorts in the PRC. Revenue from hotel
management services declined in 2007 as a result of a decrease in the number of
hotel properties that we manage. In 2008, we expect that the strong economic
growth in China will continue and consumer spending in the travel service
industry will continue to be strong. In addition, events such as the 2008
Beijing Olympics and the World Expo to be held in Shanghai in 2010, will occur
in the next few years which we believe will support the growth of travel
industry in China. At the same time, we expect to face increasing competition
from hotels and airlines as they increase selling efforts or engage in alliances
with other travel service providers.
Through
our e-Network, we plan to establish a fully integrated and comprehensive
business- to-business (B2B) and business-to consumer (B2C) travel network by
providing a broad range of products and services. The development of our
e-Network is still in the planning stage and we do not expect to generate
substantial
revenues from our e-Network in the near future.
Management’s
current focus is on developing its Media Business, while less resources will be
deployed for its Non-Media business division.
For
more information relating to the Company’s
business, please see the section entitled “Description
of Business” in
the Annual Report
on
Form 10-KSB as filed by Network CN Inc. with the United States Securities and
Exchange Commission
on March
24, 2008.
The
preparation of our financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
ongoing basis, we evaluate our estimates, including but not limited to those
related to income taxes and impairment of long-lived assets. We base our
estimates on historical experience and on various other assumptions and factors
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Based on our
ongoing review, we plan to adjust to our judgments and estimates where facts and
circumstances dictate. Actual results could differ from our
estimates.
We
believe the following critical accounting policies are important to the
portrayal of our financial condition and results and require our management's
most difficult, subjective or complex judgments, often because of the need to
make estimates about the effect of matters that are inherently
uncertain.
(1) Equipment, Net
Equipment
is stated at cost, less accumulated depreciation. Depreciation is provided using
the straight-line method over the estimated useful life of the assets, which is
from three to five years. When equipment is retired or otherwise disposed of,
the related cost and accumulated depreciation are removed from the respective
accounts, and any gain or loss is reflected in the statement of operations.
Repairs and maintenance costs on equipment are expensed as
incurred.
Construction
in progress represents the costs incurred in connection with the construction of
roadside advertising panels and mega-size advertising panels of the Companies.
No depreciation is provided for construction in progress until such time as the
assets are completed and placed into service. When completed, the roadside
advertising panels and mega-size advertising panels have economic life of 5
years and 7 years respectively.
(2) Intangible Assets, Net
Intangible
assets are stated at cost, less accumulated amortization and provision for
impairment loss. Intangible assets that have indefinite useful lives are not
amortized. Other intangible assets with finite useful lives are amortized on
straight-line basis over their estimated useful lives of 16 months to 20 years.
The amortization methods and estimated useful lives of intangible assets are
reviewed regularly.
(3) Impairment of Long-Lived
Assets
Long-lived
assets, including intangible assets with definite lives, are reviewed for
impairment whenever events or changes in circumstance indicate that the carrying
amount of the assets may not be recoverable. An intangible asset that is not
subject to amortization is reviewed for impairment annually or more frequently
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. An impairment loss is recognized when the
carrying amount of a long-lived asset and intangible assets exceeds the sum of
the undiscounted cash flows expected to be generated from the asset’s use and
eventual disposition. An impairment loss is measured as the amount by which the
carrying amount exceeds the fair value of the asset calculated using a
discounted cash flow analysis.
(4) Deferred Charges,
Net
Deferred
charges are fees and expenses directly related to an issuance of convertible
promissory notes, including placement agents’ fee. Deferred charges are
capitalized and amortized over the life of the convertible promissory notes
using the effective interest method. Amortization of deferred charges is
included in interest expense on the consolidated statements of operations while
the unamortized balance is included in deferred charges on the consolidated
balance sheet.
(5) Convertible Promissory
Notes and Warrants
In 2007,
the Company issued a 12% convertible promissory note and warrants and 3%
convertible promissory notes and warrants. In 2008, the Company issued
additional 3% convertible promissory notes and warrants to purchase shares of
the Company’s common stock. The Company allocated the proceeds of the
convertible promissory notes between convertible promissory notes and the
financial instruments related to warrants associated with convertible promissory
notes based on their relative fair values at commitment date. The fair value of
the financial instruments related to warrants associated with convertible
promissory notes was determined utilizing the Black-Scholes option pricing model
and the respective allocated proceeds to warrants is recorded in additional
paid-in capital. The embedded beneficial conversion feature associated with
convertible promissory notes was recognized and measured by allocating a portion
of the proceeds equal to the intrinsic value of that feature to additional
paid-in capital in according to Emerging Issues Task Force (“EITF”) Issue No.
98-5, “Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratio” and EITF Issue No. 00-27, “Application of Issue
No. 98-5 to Certain Convertible Instruments.”
The
portion of debt discount resulting from allocation of proceeds to the financial
instruments related to warrants associated with convertible promissory notes is
being amortized to interest expense over the life of the convertible promissory
notes, using the effective yield method. For the portion of debt discount
resulting from allocation of proceeds to the beneficial conversion feature, it
is recognized as interest expense over the
minimum period from the date of issuance to the date of earliest conversion,
using the effective yield method. In addition, the Company fully redeemed the
12% convertible promissory note due May 2008 originally issued in November 2007
at a redemption price equal to 100% of the principal amount of $5,000,000 plus
accrued and unpaid interest. The Company recognized the unamortized portion of
the associated deferred charges and debt discount as expenses included in
amortization of deferred charges and debt discount on the consolidation
statements of operation during the period of extinguishment.
(6) Revenue
Recognition
For hotel
management services, the Company recognizes revenue in the period when the
services are rendered and collection is reasonably assured.
For tour
services, the Company recognizes services-based revenue when the services have
been performed. Guangdong Tianma International Travel Service Co., Ltd
(“Tianma”) offers independent leisure travelers bundled packaged-tour products,
which include both air-ticketing and hotel reservations. Tianma’s packaged-tour
products cover a variety of domestic and international
destinations.
Tianma
organizes inbound and outbound tour and travel packages, which can incorporate,
among other things, air and land transportation, hotels, restaurants and tickets
to tourist destinations and other excursions. Tianma books all elements of such
packages with third-party service providers, such as airlines, car rental
companies and hotels, or through other tour package providers and then resells
such packages to its clients. A typical sale of tour services is as
follows:
1. Tianma,
in consultation with sub-agents, organizes a tour or travel package, including
making reservations for blocks of tickets, rooms, etc. with third-party service
providers. Tianma may be required to make deposits, pay all or part of the
ultimate fees charged by such service providers or make legally binding
commitments to pay such fees. For air-tickets, Tianma normally books a block of
air tickets with airlines in advance and pays the full amount of the tickets to
reserve seats before any tours are formed. The air tickets are usually valid for
a certain period of time. If the pre-packaged tours do not materialize and are
eventually not formed, Tianma will resell the air tickets to other travel agents
or customers. For hotels, meals and transportation, Tianma usually pays an
upfront deposit of 50-60% of the total cost. The remaining balance is then
settled after completion of the tours.
2. Tianma,
through its sub-agents, advertises tour and travel packages at prices set by
Tianma and sub-agents.
3. Customers
approach Tianma or its appointed sub-agents to book an advertised packaged
tour.
4. The
customers pay a deposit to Tianma directly or through its appointed
sub-agents.
5. When
the minimum required number of customers (which number is different for each
tour based on the elements and costs of the tour) for a particular tour is
reached, Tianma will contact the customers for tour confirmation and request
full payment. All payments received by the appointed sub-agents are paid to
Tianma prior to the commencement of the tours.
6. Tianma
will then make or finalize corresponding bookings with outside service providers
such as airlines, bus operators, hotels, restaurants, etc. and pay any unpaid
fees or deposits to such providers.
Tianma is
the principal in such transactions and the primary obligor to the third-party
providers, regardless of whether it has received full payment from its
customers. In addition, Tianma is also liable to the customers for any claims
relating to the tours, such as accidents or tour services. Tianma has adequate
insurance coverage for accidental loss arising during the tours. The Company
utilizes a network of sub-agents who operate strictly in Tianma’s name and can
only advertise and promote the business of Tianma with the prior approval of
Tianma.
For
advertising services, the Company recognizes revenue in the period when
advertisements are either aired or published.
(7) Stock-based
Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment”, a
revision to SFAS No. 123,
“Accounting for Stock-Based Compensation”, and superseding APB Opinion
No. 25, “Accounting for Stock
Issued to Employees” and its related implementation guidance. Effective
January 1, 2006, the Company adopted SFAS 123R, using a modified prospective
application transition method, which establishes accounting for stock-based
awards in exchange for employee services. Under this application, the Company is
required to record stock-based compensation expense for all awards granted after
the date of adoption and unvested awards that were outstanding as of the date of
adoption. SFAS 123R requires that stock-based compensation cost is measured at
grant date, based on the fair value of the award, and recognized in expense over
the requisite services period.
Common
stock, stock options and warrants issued to other than employees or directors in
exchange for services are recorded on the basis of their fair value, as required
by SFAS No. 123R, which is measured as of the date required by EITF
Issue 96-18, “Accounting
for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services”. In accordance with
EITF 96-18, the non-employee stock options or warrants are measured at
their fair value by using the Black-Scholes
option pricing model as of the earlier of the date at which a commitment for
performance to earn the equity instruments is reached (“performance commitment
date”) or the date at which performance is complete (“performance completion
date”). The stock-based compensation expenses are recognized on a straight-line
basis over the shorter of the period over which services are to be received or
the vesting period. Accounting for non-employee stock options or warrants which
involve only performance conditions when no performance commitment date or
performance completion date has occurred as of reporting date requires
measurement at the equity instruments then-current fair value. Any subsequent
changes in the market value of the underlying common stock are reflected in the
expense recorded in the subsequent period in which that change
occurs.
(8) Income
Taxes
The
Company accounts for income taxes under SFAS No. 109, “Accounting for Income Taxes.”
Under SFAS 109, deferred tax assets and liabilities are provided for the
future tax effects attributable to temporary differences between the financial
statement carrying amounts of assets and liabilities and their respective tax
bases, and for the expected future tax benefits from items including tax loss
carry forwards.
Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or reversed. Under SFAS 109, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(9) Foreign Currency
Translation
The
Company uses the United States dollar as its functional and reporting currency.
Monetary assets and liabilities denominated in currencies other than the United
States dollar are remeasured into the United States dollar at the rates of
exchange at the balance sheet date. Transactions in currencies other than the
United States dollar during the year are converted into the United States dollar
at the rates of exchange at the transaction dates. Exchange differences are
recognized in the statement of operations.
On
consolidation, balance sheets of subsidiaries denominated in currencies other
than the United States dollar are translated into the United States dollar at
the rates of exchange at the balance sheet date. Statements of operations of
subsidiaries denominated in currencies other than the United States dollar are
translated into the United States dollar at average rates of exchange during the
year. Exchange differences resulting from the translation of financial
statements denominated in currencies other than the United States dollar and the
effect of exchange rate changes on intercompany transactions of a long-term
investment nature are accumulated and credited or charged directly to a separate
component of shareholders’ equity (deficit) and are reported as other
comprehensive income (loss).
The
assets and liabilities of the Company’s subsidiaries denominated in currencies
other than United States (“U.S.”) dollars are translated into U.S. dollars using
the applicable exchange rates at the balance sheet date. For statement of
operations’ items, amounts denominated in currencies other than U.S. dollars
were translated into U.S. dollars using the average exchange rate during the
period. Equity accounts were translated at their historical exchange rates. Net
gains and losses resulting from translation of foreign currency financial
statements are included in the statements of stockholders’ equity as accumulated
other comprehensive income (loss). Foreign currency transaction gains and losses
are reflected in the statements of operations.
(10) Fair Value of Financial
Instruments
The
carrying value of the Company’s financial instruments, which consist of cash,
accounts receivables, prepaid expenses and other current assets, accounts
payable, accrued expenses and other payables, approximates fair value due to the
short-term maturities.
The
carrying value of the Company’s financial instruments related to warrants
associated with convertible promissory notes issued in 2007 is stated at a value
being equal to the allocated proceeds of convertible promissory notes based on
the relative fair value of notes and warrants. In the measurement of the fair
value of these instruments, the Black-Scholes option pricing model is utilized,
which is consistent with the Company’s historical valuation techniques. These
derived fair value estimates are significantly affected by the assumptions used.
The allocated value of the financial instruments related to warrants associated
with convertible promissory notes is recorded as an equity, which does not
require to mark-to-market as of each subsequent reporting period.
(11) Recent Accounting
Pronouncements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” The
objective of SFAS 157 is to increase consistency and comparability in fair value
measurements and to expand disclosures about fair value
measurements. SFAS 157 defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. SFAS 157 applies under other
accounting pronouncements that require or permit fair value measurements and
does not require any new fair value measurements. The provisions of SFAS No. 157
are effective for fair value measurements made in fiscal years beginning after
November 15, 2007. The adoption of this statement is not expected to have a
material effect on the Company's future reported financial position or results
of operations.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB
Statement No. 115.” This statement permits entities to choose to measure many
financial instruments and certain other items at fair value. Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option. However, the amendment to SFAS No. 115 “Accounting for Certain
Investments in Debt and Equity Securities” applies to all entities with
available-for-sale and trading securities. SFAS No. 159 is effective as of the
beginning of an entity’s first fiscal year that begins after November 15, 2007.
Early adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provision of SFAS No. 157, “Fair Value Measurements.” The adoption of this
statement is not expected to have a material effect on the Company's financial
statements.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51.” This statement
improves the relevance, comparability, and transparency of the financial
information that a reporting entity provides in its consolidated financial
statements by establishing accounting and reporting standards that require; the
ownership interests in subsidiaries held by parties other than the parent and
the amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income, changes in a parent’s ownership interest while
the parent retains its controlling financial interest in its subsidiary be
accounted for consistently, when a subsidiary is deconsolidated, any retained
noncontrolling equity investment in the former subsidiary be initially measured
at fair value, entities provide sufficient disclosures that clearly identify and
distinguish between the interests of the parent and the interests of the
noncontrolling owners. SFAS No. 160 affects those entities that have
an outstanding noncontrolling interest in one or more subsidiaries or that
deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal
years, and interim periods within those fiscal years, beginning on or after
December 15, 2008. Early adoption is prohibited. The
Company is currently assessing the impact of adopting
SFAS No. 141 (R) and SFAS No. 160 on its financial
statements and related disclosures.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(SFAS 161). This statement is intended to improve transparency in financial
reporting by requiring enhanced disclosures of an entity’s derivative
instruments and hedging activities and their effects on the entity’s financial
position, financial performance, and cash flows. SFAS 161 applies to all
derivative instruments within the scope of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” (SFAS 133) as well as related hedged items,
bifurcated derivatives, and nonderivative instruments that are designated and
qualify as hedging instruments. Entities with instruments subject to SFAS 161
must provide more robust qualitative disclosures and expanded quantitative
disclosures. SFAS 161 is effective prospectively for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008,
with early application permitted. The Company is currently assessing the
impact of adopting SFAS 161 on its financial statements and related
disclosures.
RESULTS
OF OPERATIONS
For
the three months ended March 31, 2008 and 2007
Revenues
In the
three months ended March 31, 2008 our revenues were derived primarily from the
sale of tour services, although revenues from advertising services also
increased during the period. Revenues increased by 226% to $9,042,649
for the three months ended March 31, 2008, as compared to $2,769,727 for the
corresponding prior year period. The increase was primarily attributable to an
increase in travel services revenues generated from Tianma. Revenues from
travel services and advertising services for the three months ended March
31, 2008 were $8,458,482 and $584,167, respectively, as compared to
$2,375,828 and $393,899, respectively, for the corresponding prior year period,
an increase of 256% and 48%, respectively.
Cost
of Travel Services
Cost of
tour services increased by 251% to $8,301,823 for the three months ended March
31, 2008 compared to $2,364,924 for the corresponding prior year period, as a
result of the increase in the sale of tour services and the increase in fuel
prices. The fuel price surge started in 2007 and crude oil prices rose to US$100
per barrel. Since fuel is a major cost component for airlines and other travel
providers, rising prices have increased our operating expenses and had an
adverse impact on the profitability of our tour services.
Cost
of Advertising Services
Cost of
advertising services for the three months ended March 31, 2008 was $3,437,630
and $246,682, respectively, an increase of 1293% over the corresponding prior
year periods. The significant increase was attributable to the acquisition of
Quo Advertising, Botong and Bona in 2007 and 2008. The increase was mainly
attributable to amortization of advertising rights and depreciation of LED
panels as the Company started to generate LED advertising income in late
2007.
Professional
Fees
Professional
fees for the three months ended March 31, 2008 decreased by 56% to $1,221,303
compared to $2,776,490 for the corresponding prior year period, primarily due
to a decrease in the number of shares of the Company's common stock issued
for services in the current period.
Payroll
Payroll
for the three months ended March 31, 2008 was $1,609,487, an increase of 377% as
compared to $337,394 for the corresponding prior year period. The significant
increase was mainly due to (1) an increase in the number of employees
attributable to the acquisition of Quo Advertising, Botong and Bona,
and (2) an increase in the amount of non-cash stock-based compensation
for directors and officers’ services rendered in accordance to SFAS
123R.
Other
Selling, General and Administrative
Other
selling, general and administrative expenses for the three months ended March
31, 2008 were $1,250,730, compared to $281,084 for the corresponding prior year
period, an increase of 345%. The increase was primarily due to an increase in
amortization of intangible assets related to the acquisitions of Botong and
Lianhe. Rental expense, entertainment and staff benefits also increased in part
as a result of these acquisitions as well as costs associated with the rapid
expansion of our corporate structure.
Net
loss
The
Company incurred a net loss of $18,813,760 for the three months ended March 31,
2008, an increase of 485% compared to a net loss of $3,214,395 for the
corresponding prior year period. The increase in net loss was driven by several
factors: (1) the increase in amortization of deferred charges and a debt
discount associated with the issuance of convertible promissory notes in 2007
and 2008. The value of beneficial conversion feature is recorded as a reduction
in the carrying value of the convertible promissory notes against additional
paid-in capital. As 3% convertible promissory notes are convertible at the date
of issuance, the respective debt discount being equal to the value of beneficial
conversion feature of $11,030,303 is fully amortized through interest expense as
of the date of issuance. (2) the increase in amortization charges of intangible
assets of $130,847 which was due to identifiable intangible assets of
were revalued as the effective control started over Botong and Lianhe (3)
increase in cost of advertising services related to our media business as
mention above, and (5) an increase in professional fees, payroll and other
selling, general and administrative expenses recorded by the Company as a result
of our expansion.
As of
March 31, 2008, the Company had cash and cash equivalents of $17,384,582
compared to $2,233,528 as of December 31, 2007, representing an increase of
$15,151,054. The increase was attributable to issuance of convertible promissory
notes during the period.
Net cash
utilized by operating activities for the three months ended March 31, 2008 was
$9,073,783, as compared with $1,764,233 for the corresponding prior year period.
The increase in net cash used in operating
activities was attributable to an increase in fees paid to acquire rights
to install and operate LED panels and billboards.
Net cash
used in investing activities for the three months ended March 31, 2008 was
$5,256,633, compared with net cash used of $54,140 for the corresponding
prior year period. For the three months ended March 31, 2008, the investing
activities consisted primarily of the purchase of equipment related to our
media business as well as costs associated with the acquisitions of
Quo Advertising and CityHorizon BVI.
Net cash
provided by financing activities was $28,900,000 for the three months ended
March 31, 2008, compared with cash used in financing activities of $2,340
for the corresponding prior year period. The increase was primarily attributable
to the issuance of $35,000,000 in 3% Convertible Promissory Notes in 2008
and the amendment and restatement of $15,000,000 in 3% Convertible Promissory
Notes issued in late 2007, offset by $5,000,000 paid to redeem outstanding 12%
promissory notes due May 2008.
Capital
Expenditures
We
continue to seek opportunities to enter new markets, increase market share or
broaden service offerings through acquisitions. During the period ended March
31, 2008, we acquired assets of $2,684,884, financed through working
capital.
Commitments
Since
November 2006, the Company, through its subsidiaries, NCN Media Services
Limited, Quo Advertising, Xuancaiyi and Bona, have acquired rights from third
parties to operate 12,984 roadside LED panels and 14 mega-sized digital
billboards for periods ranging from 2 to 20 years.
A summary
of the estimated future annual rights and operating fee commitments based on the
12,984 roadside LED panels and 14 mega-sized digital billboards as of March 31,
2008 is as follows:
|
|
|
(In millions)
|
|
|
Nine
months ending December
31,2008
|
|
$ |
16.8 |
|
|
Fiscal year ending
December 31,
|
|
|
|
|
|
2008
|
|
|
16.8 |
|
|
2009
|
|
|
14.1 |
|
|
2010
|
|
|
3.8 |
|
|
2011
|
|
|
3.7 |
|
|
2012
|
|
|
3.7 |
|
|
Thereafter
|
|
|
24.8 |
|
| |
|
$
|
66.9
|
|
The
Company is also responsible for the cost of installing part of the 12,984
roadside LED panels and 14 mega-sized digital billboards. The Company estimates
that the capital investment including installation costs for each roadside LED
panel is approximately $20,000 to $25,000, and for each mega-sized digital
billboard, depending on its size, is about $600,000 to $2,000,000. As such, the
total capital expenditure for these projects will be approximately $12
million.
In
addition to the funds raised through private placements in 2007 and 2008, the
Company is considering issuing new equity securities as well as arranging debt
instruments to finance these projects. The Company’s rights to install the
panels are not subject to a detailed installation timetable, so we are not under
any time pressure to raise necessary capital.
We do not
have any off-balance sheet financing arrangements.
Item
3. Quantitative and Qualitative Disclosure About Market Risk
The
following discussion about our market risk involves forward-looking statements.
Actual results could differ from those projected in the forward-looking
statements. We are exposed to market risk related to changes in interest rates
and foreign currency exchange rates. We do not use derivative financial
instruments for speculative or trading purposes.
Interest rate sensitivity –
The Company has no significant interest-bearing assets, the Company’s
income and operating cash flows are substantially independent of changes in
market rates. The Company’s fair value interest-rate risk arises from
convertible notes which were issued at fixed rates.
Foreign currency exchange risk
– We face exposure to
adverse movements in foreign currency exchange rates. Because our financial
results are denominated in U.S. dollars, our foreign currency exchange exposure
is related to the fact that our business transactions are denominated in RMB and
our funding will be denominated in USD, fluctuations in exchange rates between
USD and RMB will affect our balance sheet and financial results. Our assets and
liabilities related to RMB were related to accounts receivable and payables.
Since July 2005, RMB is no longer pegged to the USD but is pegged
against a basket of currencies as a whole in order to keep a more stable
exchange rate for international trading. With the very strong economic growth in
China in the last few years, RMB is facing a very high pressure to appreciate
against USD. Such pressure may result in more fluctuations in exchange
rates and in turn our business may suffer from higher foreign currency
exchange rate risk. There are very few options available in China to
hedge our exposure to exchange rate fluctuations. In addition, hedging
transactions are generally prohibited in the PRC financial markets, and more
important, the frequent changes in PRC exchange control regulations limit
our hedging ability for RMB. As of March 31, 2008, we do not expect an increase
or decrease in the foreign exchange rate for RMB will have a material impact on
our financial position. We have not hedged against foreign currency
fluctuations.
(a) Evaluation of Disclosure
Controls and Procedures. Under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, we conducted an evaluation of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
as of the end of the period covered by this Quarterly Report on Form 10-Q (the
“Evaluation Date”). The purpose of this evaluation is to determine if, as of the
Evaluation Date, our disclosure controls and procedures were operating
effectively such that the information, required to be disclosed in our
Securities and Exchange Commission (“SEC”) reports (i) was recorded, processed,
summarized and reported within the time periods specified
in SEC rules and forms, and (ii) was accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required
disclosure.
Based on this evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that, as of
the Evaluation Date, our disclosure controls and procedures were
operating effectively.
(b) Changes in Internal
Control over
Financial Reporting. There have been no significant changes in
our internal controls over financial reporting that occurred during the first
quarter of fiscal year 2008 that have materially affected, or are reasonably
likely to materially affect our internal controls over financial
reporting.
Limitations
on the Effectiveness of Disclosure Controls and Procedures.
Disclosure controls and
procedures and other procedures that are designed to ensure that information
required to be disclosed in our reports filed or submitted under the Exchange
Act are recorded, processed, summarized and reported, within the time period
specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act is accumulated and communicated to
management, including our Chief Executive Officer and Chief Financial Officer as
appropriate, to allow timely decisions regarding required
disclosure.
The
Company’s 55%-owned subsidiary, Tianma, is a defendant in proceedings brought in
Guangzhou Yuexiu District Court. The proceedings were finalized on October 9,
2006. The facts surrounding the proceeding are as follows:
Guangdong
Yongan Travel Agency (“Yongan”) arranged a local tour in April 2001. Yongan
rented a car from an agent of Tianma but the car did not belong to Tianma. A car
accident happened during the tour, causing 20 injuries and one death. Guangzhou
Police issued a proposed determination on the responsibilities of the accidents
on May 18, 2001. The proposal determined that the driver who used a
non-functioning car was fully liable for the accident. Those tourists sued
Yongan for damages and Guangzhou Intermediate People’s Court made a final
judgment in 2004 that Yongan was liable and Yongan paid approximately RMB2.2
million ($302,000) to the injured. In 2005, Yongan sued the agent of Tianma,
Tianma and the car owner. In October 2006, the Guangzhou Yuexiu District Court
made a judgment that the agent was liable to pay RMB2.1 million ($288,000) plus
interest for damages. Tianma and the car owner have joint-and-several
liabilities.
Tianma is
now appealing the court’s decision. The Company believes that there is a
reasonably high chance of overturning the court’s decision. In addition, the
Company has been indemnified for any future liability upon the acquisition by
the prior owners of Tianma.
Other
than as described above, we are not aware of any material, active or pending
legal proceedings against the Company, nor are we involved as a plaintiff in any
material proceeding or pending litigation. There are no proceedings adverse to
the Company in which any of our directors, officers or affiliates of the
Company, any owner of record or beneficiary of more than 5% of any class of
voting securities of the Company, or security holder is a party or has a
material interest.
Item
1A. Risk Factors
1. Risks Related to Operating
Our Business in China
All of
our assets and revenues are derived from our operations located in China.
Accordingly, our business, financial condition, results of operations and
prospects are subject, to a significant extent, to economic, political and legal
developments in China.
The
PRC’s economic, political and social conditions, as well as governmental
policies, could affect the financial markets in China, our liquidity and our
ability to access to capital and to operate our business.
The PRC
economy differs from the economies of most developed countries in many respects,
including the extent of government involvement, level of development, growth
rate, and control of foreign exchange and allocation of resources. While the PRC
economy has experienced significant growth over the past several years, growth
has been irregular, both geographically and among various sectors of the
economy. The PRC government has implemented various measures to encourage
economic growth and guide the allocation of resources. Some of these measures
benefit the overall PRC economy, but may also have a negative effect on the
Company. The PRC economy has been transitioning from a planned economy to a more
market-oriented economy. Although the PRC government has implemented measures
since the late 1970’s emphasizing the utilization of market forces for economic
reform, the reduction of state ownership of productive assets and the
establishment of improved corporate governance in business enterprises, a
substantial portion of productive assets in China are still owned by the PRC
government. In addition, the PRC government continues to play a significant role
in regulating industry development by imposing industrial policies. The PRC
government also exercises significant control over China’s economic growth
through allocating resources, controlling payment of foreign
currency-denominated obligations, establishing monetary policy and providing
preferential treatment to particular industries or companies. Since late 2003,
the PRC government has implemented a number of measures, such as raising bank
reserves against deposit rates to place additional limitations on the ability of
commercial banks to make loans and raise interest rates, in order to slow down
specific segments of China’s economy, which is believed to be overheating. These
actions, as well as future actions and policies of the PRC government, could
materially affect our liquidity and our ability to access to capital and to
operate our business.
China's
central bank announced on January 16, 2008 that it would raise the required
reserve ratio for commercial banks by half a percentage point as of January
25, 2008. As a result, the ratio was raised to 15 %, the highest since
1984. The intention of this action, together with other stringent monetary
policies, is to reduce lending power in an effort to cool down the economic
overheating. Together with this action, the central bank raised the reserve
ratio 11 times and benchmark interest rates six times from last
year. China's stock market benchmark Shanghai Composite Index almost
doubled in 2007 and the economy expanded 11.5 % in the first three quarters of
2007.
Such move
is due to the fact that the PRC government is concerned about
the appreciation of the RMB and accelerating inflation pressure. In January
2008, China's macro data showed a slightly decrease in both the trade surplus
and money supply from November. China’s December trade surplus is
US$22.7
billion and it shows a jump of 48 % from a year earlier. Due to the export
surplus, M2, the broadest measure of money supply, rose 16.7 % to US$5.55
trillion from a year earlier. Along with the trade surplus growth, it helps push
up foreign reserves to a total US$1.53 trillion by the end of 2007. At the same
time, economic growth is likely to continue accelerating. Inflation in China
surged to 6.9 % in November 2007, the fastest since 1996.
It is
expected that the PRC government will continue to institute further tightening
measures. The interest rate and the reserve requirement ratio would likely go
higher in this year. These actions, together with other actions and policies of
the PRC government, could materially affect our liquidity and
operations.
Our
operations in China may be adversely affected by changes in the policies of the
PRC government.
The
political environment in the PRC may adversely affect the Company’s business
operations. PRC has been operating as a socialist state since 1949 and is
controlled by the Communist Party of China. In recent years, however, the
government has introduced reforms aimed at creating a “socialist market economy”
and policies have been implemented to allow business enterprises greater
autonomy in their operations. Changes in the political leadership of the PRC may
have a significant effect on laws and policies related to the current economic
reforms program, other policies affecting business and the general political,
economic and social environment in the PRC, including the introduction of
measures to control inflation, changes in the rate or method of taxation, the
imposition of additional restrictions on currency conversion and remittances
abroad, foreign investment and so on. Since most of our operating assets and
revenues are derived from our operations located in China, our business and
financial condition, results of operations and prospects are closely subject to
economic, political and legal developments in China. Moreover, economic reforms
and growth in the PRC have been more successful in certain provinces than in
others, and the continuation or increases of such disparities could affect the
political or social stability of the PRC.
Our
business development in China may be affected by the introduction of Enterprise
Income Tax Law (the EIT Law) effective from January 1, 2008.
The EIT
Law was promulgated by the National People’s Congress on March 16, 2007 to
introduce a new uniform taxation regime in the PRC. Both resident and
non-resident enterprises deriving income from the PRC will be subject to this
EIT Law from January 1, 2008. It replaces the previous two different tax rates
applied to foreign-invested enterprises and domestic enterprises by only one
single income tax rate applied for all enterprises in the PRC. Under this EIT
Law, except for some hi-tech enterprises which are subject to EIT rates of 15%,
the general applicable EIT rate in the PRC is 25%. We may not enjoy tax
incentives for our
further established companies in the PRC and therefore our tax advantages over
domestic enterprises may be diminished. As a result, our business development in
China may be adversely affected.
The
PRC government exerts substantial influence over the manner in which the Company
must conduct its business activities.
Only
recently has the PRC government permitted greater provincial and local economic
autonomy and private economic activities. The PRC government has exercised and
continues to exercise substantial control over virtually every sector of the
Chinese economy through regulation and state ownership. Accordingly, any
decision not to continue to support recent economic reforms and to return to a
more centrally planned economy, regional or local variations in the
implementation of economic policies could have a significant effect on economic
conditions in the PRC or particular regions. The Company may be requested to
divest the interests it then holds in Chinese properties or joint ventures. Any
such developments could have a material affect on the business, operations,
financial condition and prospects of the Company.
Future
inflation in China may inhibit economic activity and therefore affect our
operations.
Recently,
the Chinese economy has experienced periods of rapid expansion. During this
period, there have been high rates of inflation. As a result, the PRC government
adopted various corrective and cool-down measures designed to restrict the
availability of credit or regulate growth and contain inflation. While inflation
has moderated since 1995, high inflation would cause the PRC government to
impose controls on credit and/or prices, which could inhibit economic activity
in China, and thereby affecting the Company’s business operations and prospects
in the PRC.
We
may be restricted from exchanging RMB to other currencies in a timely
manner.
At the
present time, Renminbi (“RMB”) is not an exchangeable currency. The Company
receives nearly all of its revenue in RMB, which may need to be exchanged to
other currencies, primarily U.S. dollars, and remitted outside of the PRC.
Effective from July 1, 1996, foreign currency “current account” transactions by
foreign investment enterprises, including Sino-foreign joint ventures, are no
longer subject to the approval of State Administration of Foreign Exchange
(“SAFE”, formerly, “State Administration of Exchange Control”), but need only a
ministerial review, according to the Administration of the Settlement, Sale and
Payment of Foreign Exchange Provisions promulgated in 1996 (the “FX
regulations”). “Current account” items include international commercial
transactions, which occur on a regular basis, such as those relating to trade
and provision of services. Distributions to joint venture parties also are
considered a “current account transaction”. Other non-current account items,
known as “capital account” items, remain subject to SAFE approval. Under current
regulations, the Company can obtain foreign currency in exchange
for RMB from swap centers authorized by the government. The Company does not
anticipate problems in obtaining foreign currency to satisfy its requirements;
however, there is no assurance that foreign currency shortages or changes in
currency exchange laws and regulations by the PRC government will not restrict
the Company from exchanging RMB in a timely manner. If such shortages or changes
in laws and regulations occur, the Company may accept RMB, which can be held or
reinvested in other projects.
We
may suffer from exchange rate risks that could result in foreign currency
exchange loss.
Because
our business transactions are denominated in RMB and our funding will be
denominated in USD, fluctuations in exchange rates between USD and RMB will
affect our balance sheet and financial results. Since July 2005, RMB has
been no longer solely pegged with USD but is pegged against a basket of
currencies as a whole in order to keep a more stable exchange rate for
international trading. With the very strong economic growth in China in the last
few years, RMB is facing a very high pressure to appreciate against USD. Such
pressure would result in more fluctuations in exchange rates and in turn our
business would suffer from higher foreign currency exchange rate
risk.
There are
very limited hedging tools available in China to hedge our exposure in exchange
rate fluctuations. They are also ineffective in the sense that these hedges
cannot be performed in the PRC financial market, and more important, the
frequent changes in PRC exchange control regulations would limit our hedging
ability for RMB.
Risks
from the outbreak of severe acute respiratory syndrome (SARS) and avian flu in
various parts of China, Hong Kong and elsewhere.
Since
early 2003, mainland China, Hong Kong and certain other countries, largely in
Asia, have been experiencing an outbreak of a new and highly contagious form of
atypical pneumonia, now known as severe acute respiratory syndromes, or SARS.
This outbreak has resulted in significant disruption to the lifestyles of the
business and economic activity in the effected areas. Areas in Mainland China
that have been affected include areas where the Company has business and
management operations. Although the outbreak is now generally under control in
China, the Company cannot predict at this time whether the situation may again
deteriorate or the extent of its effect on the Company’s business and
operations. Moreover, there are many Asian countries including China that report
incidents of avian flu. Although this virus is spread through poultry
populations, it is reported in many incidents that the virus can cause an
infection to humans and is often fatal. Any outbreak of SARS or avian flu may
result the closure of our offices or other businesses where we provide our
advertising and hotel services. The occurrences of such diseases
would also affect our out-of-home advertising network to advertisers. The
advertisers may stop purchasing the advertising time and severely interrupt our
business and operations.
The
Company cannot assure that this outbreak, particularly if the situation worsens,
will not significantly reduce the Company’s revenues, disrupt the Company’s
staffing or otherwise generally disrupt the Company’s operations.
Due
to our assets are located in PRC, stockholders may not receive distributions
that they would otherwise be entitled to if we were declared bankruptcy or
insolvency.
Due to
the Company’s assets are located in PRC, the assets of the Company may be
outside of the jurisdiction of U.S. courts to administer if the Company was the
subject of an insolvency or bankruptcy proceeding. As a result, if the Company
was declared bankrupt or insolvent, the Company’s stockholders may not be able
to receive the distributions on liquidation that they are otherwise entitled to
under U.S. bankruptcy law.
If
any of our PRC companies becomes the subject of a bankruptcy or liquidation
proceeding, we may lose the ability to use and enjoy those assets, which could
materially affect our business, ability to generate revenue and the market price
of our common stock.
To comply
with PRC laws and regulations relating to foreign ownership restrictions in the
advertising and travel businesses, we currently conduct our operations in China
through contractual arrangements with shareholders of Tianma and through
commercial agreements with shareholders of Quo Advertising, Lianhe, Bona and
Botong. As part of these arrangements, these persons hold some of the
assets that are important to the operation of our business. If any of these
entities files for bankruptcy and all or part of their assets become subject to
liens or rights of third-party creditors, we may be unable to continue some or
all of our business activities, which could affect our business, financial
condition and results of operations.
Our
acquisitions of Tianma, Quo Advertising, Xuancaiyi, Lianhe and Bona were
structured to attempt to fully comply with PRC rules and regulations. However,
such arrangements may be adjudicated by relevant PRC government agencies as not
being in compliance with PRC governmental regulations on foreign investment in
traveling and advertising industries and such structures may limit our control
with respect to such entities.
Since
2001, the PRC Government has only allowed foreign investors to operate
a travel business in China if the foreign investors have a record of travel
operations outside China for at least three years with annual revenue of USD 40
million. The minimum capital investment is RMB 4 million and the foreign
investors must be members of the China Tourism Association.
Moreover, foreign investors are restricted from running
outbound travel services. In order to penetrate this market, we acquired a
majority interest of Tianma, a travel agency headquartered in the Guangdong
province of the PRC in June 2006 through certain contractual arrangements. With
the grant of the International Travel Agency Business License by China National
Tourism Administration, Tianma is allowed to operate outbound travel services.
Through our contractual arrangements, we designated a PRC citizen to hold 55% of
the equity interest of Tianma in trust for our benefit. Tianma directly operates
our traveling agent business.
Since
2005, the PRC government has allowed foreign investors to directly own 100% of
an advertising business if the foreign investor has at least three years of
direct operations in the advertising business outside of China or to own less
than 100% if the foreign investor has at least two years of direct operations in
the advertising industry outside of China. As we do not currently directly
operate an advertising business outside of China, we are not entitled to
directly own 100% of an advertising business in China.
Our
advertising business was run through our contractual arrangements with our PRC
operating subsidiary Quo Advertising. Quo Advertising was owned by two PRC
citizens designated by us and directly operated our advertising network
projects. In January 2008, we restructured our advertising business after
further acquiring two media subsidiaries, Lianhe and Bona. We, through
our newly acquired company, Lianhe, entered into an exclusive management
consulting services agreement and an exclusive technology consulting services
agreement with each of Quo Advertising, Bona and Botong. In addition, Lianhe
also entered into an equity pledge agreement and an option purchase agreement
with each of the shareholders of Quo Advertising, Bona and Botong pursuant to
which these shareholders pledged 100% of their shares to Lianhe and granted
Lianhe the option to acquire their shares at a mutually agreed purchase price
which shall first be used to repay any loans payable to Lianhe or any affiliate
of Lianhe by the registered PRC shareholders. These commercial arrangements
enable us to exert effective control on these entities, and transfer their
economic benefits to us for financial results consolidation.
We have
been and will continue to be dependent on these PRC operating companies to
operate our traveling agent and advertising business in the near future. If our
existing PRC operating subsidiaries are found to be in violation of any PRC laws
or regulations and fail to obtain any of the required permits or approvals
under any relevant PRC regulations, we could be penalized. It would have an
effect on our ability to conduct business in these aspects.
The
PRC government regulates the travel agency, advertising and Internet industries.
If we fail to obtain or maintain all pertinent permits and approvals or if the
PRC government imposes more restrictions on these industries, our business may
be affected.
The PRC
government regulates the travel agency, advertising and Internet industries. We
are required to obtain applicable permits or approvals from different regulatory
authorities to conduct our business, including separate licenses for Internet
content provision, advertising and travel agency activities. If we fail to
obtain or maintain any of the required permits or approvals, we may be subject
to various penalties, such as fines or suspension of operations in these
regulated businesses, which could severely disrupt our business operations. As a
result, our financial condition and results of operations may be
affected.
We
have attempted to comply with the PRC government regulations regarding licensing
requirements by entering into a series of agreements with our affiliated Chinese
entities. If the PRC laws and regulations change, our business in China may be
affected.
To comply
with the PRC government regulations regarding licensing requirements, we have
entered into a series of agreements with our affiliated Chinese entities to
exert operational control and secure consulting fees and other payments from
them. We have been advised by our PRC legal counsel that our arrangements with
our affiliated Chinese entities are valid under current PRC laws and
regulations. However, we cannot assure that we will not be required to
restructure our organization structure and operations in China to comply with
changing and new PRC laws and regulations. Restructuring of our operations may
result in disruption of our business, diversion of management attention and the
incurrence of substantial costs.
The
PRC legal system embodies uncertainties, which could limit law enforcement
availability.
The PRC
legal system is a civil law system based on written statutes. Unlike common law
systems, it is a system in which decided legal cases have little precedence. In
1979, the PRC government began to promulgate a comprehensive system of laws and
regulations governing economic matters in general. The overall effect of
legislation over the past 28 years has significantly enhanced the
protections afforded to various forms of foreign investment in China. Each of
our PRC operating subsidiaries and affiliates is subject to PRC laws and
regulations. However, these laws and regulations change frequently and the
interpretation and enforcement involve uncertainties. For instance, we may have
to resort to administrative and court proceedings to enforce the legal
protection that we are entitled to by law or contract. However, since PRC
administrative and court authorities have significant discretion in interpreting
statutory and contractual terms, it may be difficult to evaluate the outcome of
administrative court proceedings and the level of
law enforcement that we would receive in more developed legal systems. Such
uncertainties, including the inability to enforce our contracts, could affect
our business and operation. In addition, intellectual property rights and
confidentiality protections in China may not be as effective as in the United
States or other countries. Accordingly, we cannot predict the effect of future
developments in the PRC legal system, particularly with regard to the industries
in which we operate, including the promulgation of new laws. This may include
changes to existing laws or the interpretation or enforcement thereof, or the
preemption of local regulations by national laws. These uncertainties could
limit the availability of law enforcement, including our ability to enforce our
agreements with Tianma, Lianhe, Bona, Botong, and Quo Advertising with other
foreign investors.
Recent
PRC regulations relating to offshore investment activities by PRC residents may
increase our administrative burden and restrict our overseas and cross-border
investment activities. If our shareholders who are PRC residents fail to make
any required applications and filings under such regulations, we may be unable
to distribute profits and may become subject to liability under PRC
laws.
The PRC
National Development and Reform Commission, NDRC, and SAFE recently promulgated
regulations that require PRC residents and PRC corporate entities to register
with and obtain approvals from relevant PRC government authorities in connection
with their direct or indirect offshore investment activities. These regulations
apply to our shareholders who are PRC residents and may apply to any offshore
acquisitions that we make in the future.
Under the
SAFE regulations, PRC residents who make, or have previously made, direct or
indirect investments in offshore companies will be required to register those
investments. In addition, any PRC resident who is a direct or indirect
shareholder of an offshore company is required to file with the local branch of
SAFE any material change involving capital variation. This would include an
increase or decrease in capital, transfer or swap of shares, merger, division,
long-term equity or debt investment or creation of any security interest over
the assets located in China. If any PRC shareholder fails to make the required
SAFE registration, the PRC subsidiaries of that offshore parent company may be
prohibited from distributing their profits and the proceeds from any reduction
in capital, share transfer or liquidation, to their offshore parent company. The
offshore parent company may be prohibited from injecting additional capital into
their PRC subsidiaries. Moreover, failure to comply with the various SAFE
registration requirements described above could result in liability under PRC
laws for evasion of applicable foreign exchange restrictions.
We cannot
guarantee that all of our shareholders who are PRC residents will comply with
our request to obtain any registrations or approvals required under these
regulations or other related legislation.
Furthermore,
as the regulations are relatively new, the PRC government has yet to publish
implementing rules, and much uncertainty remains concerning the reconciliation
of the new regulations with other approval requirements. It is unclear how the
regulations concerning offshore or cross-border transactions will be implemented
by the relevant government authorities. The failure or inability of our PRC
resident shareholders to comply with these regulations may subject us to fines
and legal sanctions, restrict our overseas or cross-border investment
activities, limit our ability to inject additional capital into our PRC
subsidiaries, and the ability of our PRC subsidiaries to make distributions or
pay dividends, or affect our ownership structure. If any of the foregoing events
occur, our acquisition strategy, business operations and ability to distribute
profits to our investors could be affected.
The
PRC tax authorities may require us to pay additional taxes in connection with
our acquisitions of offshore entities that conduct their PRC operations through
their affiliates in China.
Our
operations and transactions are subject to review by the PRC tax authorities
pursuant to relevant PRC laws and regulations. However, these laws, regulations
and legal requirements change frequently, and their interpretation and
enforcement involve uncertainties. For instance, in the case of some of our
acquisitions of offshore entities that conducted their PRC operations through
their affiliates in China, we cannot assure our investors that the PRC tax
authorities will not require us to pay additional taxes in relation to such
acquisitions, in particular where the PRC tax authorities take the view that the
previous taxable income of the PRC affiliates of the acquired offshore entities
needs to be adjusted and additional taxes be paid. In the event that the sellers
failed to pay any taxes required under PRC laws in connection with these
transactions, the PRC tax authorities might require us to pay the tax together
with late-payment interest and penalties.
We
rely on our affiliated Chinese personnel to conduct travel and advertising
businesses. If our contractual arrangements and commercial agreement
arrangements with our affiliated Chinese personnel are violated, our related
businesses will be damaged.
As
mentioned earlier, we depend on commercial agreements and contractual
arrangements to run our advertising and traveling businesses respectively in
China. These agreements and contracts are governed by PRC laws and provide for
the resolution of disputes through arbitration or litigation in the PRC. Upon
arbitration or litigation, these contracts would be interpreted in accordance
with PRC laws and any disputes would be resolved in accordance with PRC legal
procedures. The uncertainties in the PRC legal system could disable us to
enforce these commercial agreements and contractual arrangements. Should such a
situation occur, we may be unable to enforce these agreements and contracts, and
unable to enforce our control over our operating subsidiaries to conduct our
businesses.
We
have limited business insurance coverage in China.
The
insurance industry in China is still at an early stage of development. Insurance
companies in China offer limited business insurance products. As a result, we
have limited business liability or disruption insurance coverage for our
operations in China. Any business disruption, litigation or natural disaster
might result in substantial costs and diversion of resources and have an effect
on our business and operating results.
Our
subsidiaries and affiliated Chinese entities in China are subject to
restrictions on paying dividends or making other payments to us, which may
restrict our ability to satisfy our liquidity requirements.
We rely
on dividends from our subsidiaries in China and consulting and other fees paid
to us by our affiliated Chinese entities. Current PRC regulations permit our
subsidiaries to pay dividends to us only out of their accumulated profits, if
any, determined in accordance with Chinese accounting standards and regulations.
In addition, our subsidiaries in China are required to set aside at least 10% of
their respective accumulated profits each year, if any, to fund certain reserve
funds. These reserves are not distributable as cash dividends. Further, if our
subsidiaries and affiliated Chinese entities in China incur debt on their own
behalf, the instruments governing the debt may restrict their ability to pay
dividends or make other payments to us, which may restrict our ability to
satisfy our liquidity requirements.
2. Risks Related to Our Media
Business
In early
2007, we have entered into a contract to acquire Quo Advertising to expand our
business operations in the media business. Since the acquisition, we have
successfully entered into several material business agreements in Beijing,
Shanghai, Nanjing, Wuhan and so on to manage and operate LED outdoor advertising
video panels and mega-size digital video billboards. In January 2008, we
restructured our advertising business after further acquiring the media
companies namely Lianhe and Bona. We anticipate that we would enter into
agreements in other major cities to strengthen our position in the out-of-home
media business in China. In addition to the risks described above in “Risks Related to Operating a
Business in China”, we are subject to additional risks related to our
media business.
The
media and advertising industries are highly competitive and we will compete with
companies that are larger and better capitalized.
We have
to compete with other advertising companies in the out-of-home advertising
market. We compete for advertising clients primarily in terms of network size
and coverage, locations of our LED panels and billboards, pricing, and range of
services that we can offer. We also face competition from advertisers in other
forms of media such as out-of-home television advertising network in commercial
buildings, hotels, restaurants, supermarkets and convenience chain stores. We
expect that the competition will be more severe in
the near future. The relatively low fixed costs and the practice of
non-exclusive arrangement with advertising clients would provide a very low
barrier for new entrants in this market segment. Moreover, international
advertising media companies have been allowed to operate in China since 2005,
exposing us to even greater competition.
Moreover,
it becomes more difficult to increase the number of desirable locations in major
cities because most of the locations have already been occupied by our
competitors and limitation by municipal zoning and planning policies. In other
cities, although we could increase the locations, they would only generate less
economic return to the Company. Anyway, we anticipate the economic return would
increase with the pace of economic development of these cities. If we are unable
to increase the placement of our out-of-home advertising market, we may be
unable to expand our client base to sell advertising time slots on our network
or increase the rates we charge for time slots. As a consequence of this, our
operating margins and profitability may be reduced, and may result in a loss of
market share. Since we are a new entrant to this market segment, we have less
competitive advantages than the existing competitors in terms of experience,
expertise, and marketing force. The Company is tackling these problems by
further acquisition of well-established advertising company like Quo
Advertising, Lianhe and Bona. We cannot guarantee that we will be able to
compete against new or existing competitors to generate profit.
Moreover,
due to the less desirable locations currently the Company has, we can only
charge the advertisers for at a lower rates. If the Company is unable to
continuously secure more desirable locations for deployment of our advertising
poster frames, we may be unable or need to lower our rates to attract
advertisers to purchase time slots from us to generate satisfactory
profit.
If
we cannot enter into further agreements for roadside LED video panels and
mega-size digital video billboards in other major cities in China, we may be
unable to grow our revenue base and hence unable to generate higher levels of
revenue.
The
Company continues geographic expansion in media network by entering into
business cooperation agreements with local advertising companies to operate and
manage our roadside LED video panels and mega-size digital video billboards in
China. We have concluded several major agreements and are currently searching
for more opportunities. Nevertheless, many of the most desirable locations in
the major cities have been occupied by our competitors. If we are unable to or
need to pay extra considerations in order to enter into any new agreements, it
may highly increase our costs of sales and may be unable to convince our
advertisers to purchase more advertising time and generate our satisfactory
profits.
If
we are unable to attract advertisers to advertise on our networks, we will be
unable to grow our revenue base to generate revenues.
We charge
our advertisers based on the time that is used on our roadside LED video panels
and mega-size digital video billboards. The desire of advertisers to advertise
on our out-of-home media networks depends on the size and coverage of the
networks, the desirability of the locations of the LED panels and billboards,
our brand name and charging rate. If we fail to increase the number of
locations, displays and billboards in our networks to provide the advertising
services to suit the needs of our advertisers, we may be unable to attract them
to purchase our advertising time to generate revenues.
If
the public does not accept our out-of-home advertising media, we will be unable
to generate revenue.
The
out-of-home advertising network that we are developing is a rather new concept
in China. It is too early to conclude whether the public accept this advertising
means or not. In case the public finds any element like audio or video features
in our media network to be disruptive or intrusive, advertisers may withdraw
their requests for purchasing time slots from us and to advertise on other
networks. On the contrary, if the viewing public is receptive toward our
advertising network, our advertisers will continue to purchase the time from us.
As such, together with other uncertainties like locations coverage, acceptance
by public etc, we may be unable to generate satisfactory revenue in our media
network business.
We
may be subject to government regulations in installing our out-of-home roadside
LED video panels and mega-size digital video billboards advertising
network.
The
placement and installation of LED panels and billboards are subject to municipal
zoning requirements and governmental approvals. It is necessary to obtain
approvals for construction permits from the relevant supervisory departments of
the PRC government for each installation of roadside LED video panel and
mega-size digital video billboard. However, we cannot provide any guarantee that
we can obtain all the relevant government approvals for all of our installations
in China. If such approvals are not granted, we will be unable to install LED
panels or billboards on schedule, or may incur more installation
costs.
If
we are unable to adapt to changing advertising trends and the technology needs
of advertisers and consumers, we will not be able to compete effectively and we
will be unable to increase or maintain our revenues, which may affect our
business prospects and revenues.
The
market for out-of-home advertising requires us to research new advertising
trends and the technology needs of advertisers and consumers, which may require
us to develop new features and enhancements for our advertising network. The
majority of our displays use medium-size roadside LED video panels. We also use
mega-size LED digital video billboards. We are currently researching ways that
we may be able to utilize other technology such as cable or broadband
networking, advanced audio technologies and high-definition panel technology.
Development and acquisition costs may have to be incurred in order to
keep pace
with new technology needs but we may not have the financial resources necessary
to fund and implement future technological innovations or to replace obsolete
technology. Furthermore, we may fail to respond to these changing technology
needs. For instance, if the use of wireless or broadband networking capabilities
on our advertising network becomes a commercially viable alternative and meets
all applicable PRC legal and regulatory requirements, and we fail to implement
such changes on our out-of-home network and in-store network or fail to do so in
a timely manner, our competitors or future entrants into the market who do take
advantage of such initiatives could gain a competitive advantage over us. If we
cannot succeed in developing and introducing new features on a timely and
cost-effective basis, advertiser demand for our advertising networks may
decrease and we may not be able to compete effectively or attract advertising
clients, which would have an effect on our business prospects and
revenues.
3. Risks Related to Our Travel
Business
In
addition to the risks described above in “Risks Related to Operating a Business
in China”, we are subject to additional risks related to our travel
business.
The
travel industry is highly competitive, which may influence our ability to
compete with other market participants.
We
operate in markets that contain numerous competitors. Our ability to remain
competitive, attract and retain business and leisure travelers depends on our
success in distinguishing the quality, value and efficiency of our services from
those offered by others. If we are unable to compete in these areas, this could
limit our operating margins, diminish our market share and reduce our
earnings.
We
are subject to the range of operating risks to travel-related
industry.
The
profitability of travel-related industry that we operate in may be affected by a
number of factors, including:
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International
and regional economic conditions;
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the
availability of and demand for hotel rooms and
apartments;
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the
desirability of particular locations and changes in travel patterns of
domestic and foreign travelers;
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taxes
and government regulations that influence or determine wages, prices,
interest rates, and other costs;
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the
availability of capital to allow us and joint venture partners to fund
investments;
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the
increase in wages and labor costs, energy, mortgage interest rates,
insurance, transportation and fuel, and other
expenses.
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Any one
or more of these factors could limit or reduce the demand on the travel services
market.
The
uncertain pace of the lodging and travel industry’s recovery will continue to
influence our financial results and growth.
Both the
Company and the
lodging industry were hurt by several events occurring over the last few years,
including SARS and avian flu, and the terrorist attacks on New York and
Washington. Although showing some improvements in Asia Pacific, business and
leisure travel from United States and Europe remained depressed as some
potential travelers reduced or avoided discretionary travel in light of safety
concerns and economic declines stemming from erosion in consumer confidence.
Although both the lodging and travel industries are recovering, the duration and
full extent of that recovery remain unclear. Accordingly, our financial results
and growth could be harmed if that recovery stalls or is
reversed.
Our
travel operations are subject to international and regional
conditions.
Although
we conduct our business in China, our activities are susceptible to changes in
the performance of international and regional economies, as foreign travelers
constitute a fair percentage of travel population. In recent years, our business
has been hurt by decreases in travel resulting from SARS and downturns in US and
Europe economic conditions. Our future economic performance is subject to the
uncertain magnitude and duration of the economic growth in China, the prospects
of improving economic performance in other regions, the unknown pace of any
business travel recovery that results, and the occurrence of any future
incidents in China in which we operate.
Future
increase in fuel prices and the possible downturn in the US and global economies
in 2008 may inhibit economic activity and therefore affect our travel
operations.
The
travel business is facing two more uncertainties. First, fuel prices have surged
by 48 % in 2007 and as of February 2008 the crude oil price rise to US$100 per
barrel. Since fuel is a major cost component for airlines and traffic, the
rising fuel price has had an adverse impact on the costs of our travel business
and results lower our profitability. Second, there are indications of an
economic downturn in the US and global economies in 2008, which could have an
adverse effect on China's economic growth, which would then have a negative
impact on the China travel market.
Our
ability to grow is in part dependent upon future acquisitions.
The
process of identifying, acquiring and integrating future acquisitions may
constrain valuable management resources, and our failure to integrate future
acquisitions may result in the loss of key employees and the dilution of
stockholder value and have an adverse effect on our operating results. We have
acquired existing businesses and expect to continue pursuing strategic
acquisitions in the future. Completing any potential future acquisitions could
cause significant diversions of management time and resources.
Acquisition
transactions involve inherent risks such as:
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uncertainties
in assessing the value, strengths, weaknesses, contingent and other
liabilities and potential profitability of acquisition or other
transaction candidates;
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the
potential loss of key personnel of an acquired
business;
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the
ability to achieve identified operating and financial synergies
anticipated to result from an acquisition or other
transaction;
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problems
that could arise from the integration of the acquired
business;
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unanticipated
changes in business, industry or general economic conditions that affect
the assumptions underlying the acquisition or other transaction rationale;
and
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unexpected
development costs that adversely affect our
profitability.
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Financing
for future acquisitions may not be available on favorable terms, or at all. If
we identify an appropriate acquisition candidate for our businesses, we may not
be able to negotiate the terms of the acquisition successfully, finance the
acquisition or integrate the acquired business, technologies or employees into
our existing business and operations. Future acquisitions may not be well
received by the investment community, which may cause our stock price to
fluctuate. We cannot ensure that we will be able to identify or complete any
acquisition in the future.
Risks
relating to acts of God, terrorist activity and war could reduce the demand for
lodging, which may affect our revenues.
Acts of
God, such as natural disasters and the spread of contagious diseases, in the PRC
where we own and manage can cause a decline in the level of business and leisure
travel and reduce the demand for lodging. Wars (including the potential for
war), terrorist activity (including threats of terrorist activity), political
unrest and other forms of civil strife and geopolitical uncertainty can have a
similar result. Any one or more of these events may reduce the overall demand
for travel which could adversely affect our revenues.
Our
results are likely to fluctuate because of seasonality in the travel industry in
China.
Our
business experiences fluctuations, reflecting seasonal variations in demand for
travel services. For instance, the first quarter of each year generally
contributes the lowest portion of our annual net revenues primarily due to a
slowdown in business activity around and during the Chinese New Year holiday.
Consequently, our revenues may fluctuate from quarter to quarter throughout the
year.
4. Risks Related to Our
Developing e-Network Business
We target
for developing a comprehensive and fully integrated Internet travel services
platform focusing on providing a broad range of
products and services. This includes, but is not limited to (i) Accommodation
booking and sales; (ii) Travel agencies services for air-ticket sales and, tour
packages; (iii) e-ticketing for concerts, sports events, exhibitions, etc; (iv)
Sales and delivery of gifts and souvenirs; (v) e-payment function that directly
links to payment-clearing systems of national banks, financial institutions and
mobile phone operators. These products and services will be offered at
individual service outlets located in some hotel chains, other potential
locations and on a comprehensive online website. We plan to develop this
component as a complete travel and leisure network and substantial revenue
driver.
Our
success in e-Network depends on whether we can acquire well-established
companies and recruit expertise to consolidate and integrate our business
network.
We will
build our e-Shop brand through acquiring travel webs in China to capture
existing users. It is a faster and more effective method than building our own
travel web site from scratch to attract new users. We will also recruit
experienced personnel to develop and fine-tune such online shopping and booking
web site to suit our specific requirements. With this web site, we can provide a
trading platform to leverage on Media and Travel Networks and establish a
comprehensive e-Shop platform. Since expanding e-Shop
product coverage through merger and acquisitions is our key development
strategy, we will look for suitable companies to acquire. If we fail to find
suitable target company for acquisition, the progress of building our e-Network
may be affected.
Online
payment systems in China are at an early stage of development and may restrict
our ability to expand our online commerce service business.
Online
payment systems in China are at an early stage of development. Although major
Chinese banks are instituting online payment systems, these systems are not as
widely available or acceptable to consumers in China as that in the United
States and other developed countries. In addition, compared to countries like
the United States, only a limited number of consumers in China have credit cards
or debit cards. The lack of adequate
online payment systems may limit the number of online commerce transactions that
we can service. If online payment services cannot be developed, our ability to
grow our online commerce business may be limited.
The
Internet market has not been proven as an effective commercial medium in
China.
The
market for Internet products and services in China has only recently begun to
develop. The Internet penetration rate, even though it is growing, is still low
in China than those in the United States and other developed countries. Since
the Internet is not yet a well-proven secured medium for commerce in China, our
future operating results from online services will depend substantially upon the
increased use and acceptance of the Internet for distribution of products and
services and facilitation of commerce in China.
The
Internet may not become a viable commercial marketplace in China for various
reasons in the near future. More salient impediments to Internet development in
China include:
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consumer
dependence on traditional means of
commerce;
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inexperience
with the Internet as a sales and distribution
channel;
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inadequate
development of the necessary infrastructure to facilitate online
commerce;
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concerns
about security, reliability, cost, ease of deployment, administration and
quality of service associated with conducting business over the
Internet;
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inexperience
with credit card usage or with other means of electronic payment;
and
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limited
use of personal computers.
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If the
Internet were not widely accepted as a medium for online commerce in China, our
ability to grow our online business would be impeded.
The
continued growth of Chinese Internet market depends on the establishment of an
adequate telecommunications infrastructure.
Although
many private sector Internet service providers currently exist in China, almost
all access to the Internet is maintained through state owned telecommunication
operation under the administrative control and regulatory supervision of China’s
Ministry of Information Industry. In addition, the national networks in China
are connected to the Internet through government controlled international
gateways. These international gateways are the only channels through which a
Chinese user can connect to the international Internet network. We rely on China
Telecom and China Netcom to provide data communications capacity primarily
through local telecommunications lines. Although the government has announced
plans to develop the national information infrastructure, we cannot guarantee
that this infrastructure will be developed. In addition, we will have no access
to alternative networks and services, in the event of any infrastructure
disruption or failure. The Internet infrastructure in China may not support the
demands associated with continued growth in Internet usage and it may affect our
progress of building our e-Network business.
5. Risks Related To Regulation
of Our Business and to Our Structure
If
the PRC government finds that the agreements that establish the structure for
operating our China business do not comply with PRC governmental restrictions on
foreign investment in the travel and advertising industries, we could be subject
to severe penalties.
Our
travel operations are conducted by Tianma through our contractual arrangements.
Meanwhile, our media operations are conducted by Lianhe, Botong, Bona and Quo
Advertising though commercial agreements arrangement.
According
to the Rules on Cognizance of Qualification for Civil Aviation Transporting
Marketing Agencies (2006) and relevant foreign investment regulations
regarding to civil aviation business, a foreign investor currently cannot own
100% of an air ticketing agency in China. In addition, foreign invested air
ticketing agencies are not permitted to sell passenger tickets for domestic
flights in China. The principal regulation governing foreign ownership of travel
agencies in China is the Establishment of Foreign-controlled and Wholly
Foreign-owned Travel Agencies Tentative Provisions, as amended in February 2005.
Currently, qualified foreign investors have been permitted to establish or own a
travel agency upon the approval of the PRC government, subject to considerable
restrictions as to its scope of business. For instance, foreign travel agencies
cannot arrange for the travel of persons from mainland China to Hong Kong,
Macau, Taiwan or any other country. In addition, foreign travel agencies cannot
establish branches.
PRC
regulations require any foreign entities that invest in the advertising services
industry to have at least two years of direct operations in the advertising
industry outside of China. Beginning December 10, 2005, foreign investors
have been allowed to own directly 100% of PRC companies operating an advertising
business if the foreign entity has at least three years of direct operations in
the advertising business outside of China or less than 100% if the foreign
investor has at least two years of direct operations in the advertising
industry. We do not directly operate an advertising business outside of China
and cannot qualify under PRC regulations any earlier than two or three years
after we commence any such operations outside of China or until we acquire a
company that has directly operated an advertising business outside of
China for
the required period. Accordingly, our PRC operating subsidiaries are currently
unable to apply for the required licenses for providing advertising services in
China. Before 2008, all of our advertising business is run through Quo
Advertising, which is owned by two PRC citizens designated by us. Quo
Advertising holds the requisite licenses to provide advertising services in
China. We have entered into contractual agreements with the shareholders of Quo
Advertising, which provide us with the substantial ability to control Quo
Advertising and its subsidiaries.
In
January 2008, we restructured our advertising business after further acquiring
the media companies namely Lianhe and Bona. We, through our newly acquired
company, Lianhe, entered into an exclusive management consulting services
agreement and an exclusive technology consulting services agreement with each of
Quo Advertising, Bona and Botong. In addition, we entered into an equity pledge
agreement and an option agreement with each of the shareholders of Quo
Advertising, Bona and Botong and pursuant to which these shareholders had
pledged 100% of their shares to Lianhe and granted Lianhe the option to acquire
their shares at a mutually agreed purchase price which shall first be used to
repay any loans payable to Lianhe or any affiliate of Lianhe by the registered
PRC shareholders These commercial arrangements enable us to exert effective
control on these entities, and transfer their economic benefits to us for
financial results consolidation.
If we,
our existing or future PRC operating subsidiaries and affiliates are found to be
in violation of any PRC laws or regulations or fail to obtain or maintain any of
the required permits or approvals, the relevant PRC regulatory authorities,
including the State Administration for Industry and Commerce (SAIC), would have
broad discretion in dealing with such violations, including:
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·
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revoking
the business and operating licenses of our PRC subsidiaries and
affiliates;
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discontinuing
or restricting our PRC subsidiaries’ and affiliates’
operations;
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·
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imposing
conditions or requirements with which we or our PRC subsidiaries and
affiliates may not be able to
comply;
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requiring
us or our PRC subsidiaries and affiliates to restructure the relevant
ownership structure or operations;
or
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restricting
or prohibiting our use of the proceeds of this offering to finance our
business and operations in China.
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The
imposition of any of these penalties would result in a material and adverse
effect on our ability to conduct our business.
We
rely on contractual arrangements and commercial agreement arrangement with our
PRC operating companies and their shareholders for our China operations, which
may not be as effective in providing operational control as direct
ownership.
In the
past, the Company has relied on contractual arrangements with the shareholders
of Tianma and Quo Advertising to operate our travel and advertising businesses
respectively. In January 2008, we restructured our advertising business after
acquiring Lianhe and Bona. We, through our newly acquired company, Lianhe,
entered into a series of commercial agreements with each of Quo Advertising,
Bona and Botong and their respective registered shareholders. It enables us to
exert effective control over these entities, and to consolidate their financial
results. These contractual arrangements and commercial agreement arrangements
may not be as effective in providing us with control over Tianma and media
subsidiaries as direct ownership. If our PRC operating subsidiaries or any of
their subsidiaries and shareholders fails to perform their respective
obligations under these contractual arrangements and commercial agreement
arrangements, we may have to incur substantial costs and resources to enforce
such arrangements, and rely on legal remedies under PRC law. This would also
include seeking specific performance or injunctive relief, and claiming damages,
which we cannot guarantee to be effective.
Many of
these contractual arrangements and commercial agreement arrangements are
governed by PRC laws and provide for the resolution of disputes through either
arbitration or litigation in the PRC. Accordingly, these contracts would be
interpreted in accordance with PRC laws 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 limit our ability to enforce these
contractual arrangements. In the event we are unable to enforce these
contractual arrangements and commercial agreements, we may not be able to exert
effective control over our operating entities, and our ability to conduct our
business may be negatively affected.
Contractual
arrangements and commercial agreement arrangements we have entered into among
our subsidiaries and affiliated entities may be subject to scrutiny by the PRC
tax authorities and a finding that we owe additional taxes or are ineligible for
our tax exemption, or both, could substantially increase our taxes owed, and
reduce our net income and the value of your investment.
Under PRC
laws, arrangements and transactions among related parties may be subject to
audit or challenge by the PRC tax authorities. If any of the transactions we
have entered into among our subsidiaries and affiliates are found not to be on
an arm’s length basis or result in a reduction in tax under PRC laws, the PRC
tax authorities will disallow our tax savings, adjust the profits and losses of
our respective PRC entities and assess late payment interest and penalties
accordingly.
Our
business operations may be affected by legislative or regulatory
changes.
There are
no formal PRC laws or regulations that define or regulate out-of-home
advertising. It has been reported that the relevant PRC government authorities
are currently considering adopting new regulations governing out-of-home
advertising. We cannot predict the timing of establishing such regulations and
their impact on our Company. Changes in laws and regulations or the enactment of
new laws and regulations governing placement or content of out-of-home
advertising, may affect our business prospects and results of operations. For
instance, the PRC government has promulgated regulations allowing foreign
companies to hold a 100% equity interest in PRC advertising companies starting
from December 10, 2005. We are not certain how the PRC government will
implement this regulation or how it could affect our business and our
organization structure.
PRC
regulation of loans and direct investment by offshore holding companies to PRC
entities may delay or prevent us from raising finance to make loans or
additional capital contributions to our PRC operating subsidiaries and
affiliates.
As an
offshore holding company of our PRC operating subsidiaries and affiliates, we
may make loans to our PRC subsidiaries and consolidated PRC affiliated entities,
or we may make additional capital contributions to our PRC subsidiaries. Any
loans to our PRC subsidiaries or consolidated PRC affiliated entities are
subject to PRC regulations and approvals.
We may
also decide to finance Tianma or our advertising subsidiaries by means of
capital contributions. These capital contributions to Tianma or our advertising
subsidiaries must be approved by the PRC Ministry of Commerce or its local
counterpart. We cannot guarantee that we can obtain these government
registrations or approvals on a timely basis, if at all, with respect to future
loans or capital contributions by us to our operating subsidiaries. If we fail
to receive such registrations or approvals, these would adversely affect the
liquidity of our operating subsidiaries and our ability to expand the
business.
6. Risks Related to Corporate
and Stock Matters
The
loss of key management personnel could harm our business and
prospects.
We depend
on key personnel who may not continue to work for us. Our success substantially
depends on the continued employment of certain executive officers and key
employees, particularly Godfrey Hui who is our founder, Chairman and Chief
Executive Officer, and Daniel So, our Vice Chairman and Managing Director. Not
only do we rely on their expertise and experience in our business, we also need
their business vision, management skills, and good relationships with our
employees and major shareholders to achieve our business targets.
The loss
of services of these or other key officers or employees could harm our business.
If any of these individuals were to leave our company, our business and growth
prospects may be severely disrupted. We would face substantial difficulty in
hiring qualified successors and could experience a loss in productivity while
any such successor obtains the necessary training and experience.
The
market for the Company’s common stock is illiquid.
The
Company’s common stock is traded on the Over-the-Counter Bulletin Board. It is
thinly traded compared to larger and more widely known companies in its
industry. Thinly traded common stock can be more volatile than stock trading in
an active public market. The Company cannot predict the extent of an active
public market for its common stock.
We
have a limited operating history and if we are not successful in continuing to
grow our business, then we may have to scale back or even cease our ongoing
business operations.
The
Company has a limited operating history and is still in the development stage.
Our Company’s operations will be subject to all the risks inherent in the
establishment of a developing enterprise and the uncertainties arising from the
absence of a significant operating history. We may be unable to locate
recoverable reserves or operate on a profitable basis. We are in the development
stage and potential investors should be aware of the difficulties encountered.
If our business plan is not successful, and we are not able to operate
profitably, investors may lose some or all of their investments in our
Company.
Our
acquisitions of Tianma, Quo Advertising, Xuancaiyi, Lianhe, Bona and any future
acquisitions may expose us to potential risks and have an affect on our ability
to manage our business.
It is our
strategy to expand our business, especially in e-Network, through acquisitions
like that of Tianma, Quo Advertising, Xuancaiyi, Lianhe and Bona. We would keep
on searching for appropriate opportunities to acquire more businesses or to form
joint ventures, etc. that are complementary to our core business. For each
acquisition, our management encounters whatever difficulties during the
integration of new operations, services and personnel with our existing
operations. We may also expose ourselves to other potential risks like
unforeseen or hidden liabilities of the acquired companies, the allocation of
resources from our existing business to the new operations, uncertainties in
generating expected revenue, employee relationships and governing by new
regulations after integration. The occurrence of any of these unfavorable events
in our recent acquisitions or possible future acquisitions could have an effect
on our business, financial condition and results of operations.
There
may be unknown risks inherent in our acquisitions of Tianma, Quo Advertising,
Xuancaiyi, Lianhe and Bona.
Although
we had conducted due diligence with respect to the acquisition of Tianma, Quo
Advertising, Xuancaiyi, Lianhe and Bona, there is no assurance that all risks
associated with the companies have been revealed. To protect us from associated
liabilities, we have received guarantees of indemnification from the original
owners. However, if we were to enforce such guarantees, it could be very costly
and time consuming. The possibility of unknown risks in those acquisitions could
affect our business, financial condition and results of operations.
All
of our directors and officers are outside the United States. It may be difficult
for investors to enforce judgments obtained against officers or directors of the
Company.
All of
our directors and officers are nationals and/or residents of countries other
than the United States, and all their assets are located outside the United
States. As a result, it may be difficult for investors to effect service of
process on our directors or officers, or enforce within the United States or
Canada any judgments obtained against us or our officers or directors, including
judgments predicated upon the civil liability provisions of the securities laws
of the United States or any state thereof. Consequently, you may be prevented
from pursuing remedies under U.S. federal securities laws against them. In
addition, investors may not be able to commence an action in a Canadian court
predicated upon the civil liability provisions of the securities laws of the
United States. The foregoing risks also apply to those experts identified in
this Annual Report that are not residents of the United States.
Our
substantial indebtedness and related interest payments could adversely affect
our operations.
Since
November 2007, we have issued convertible promissory notes with warrants. Our
related interest payments on such convertible promissory notes could impose
financial burdens on us. If further new debt is added to our consolidated debt
level, the related risks that we now face could intensify. Covenants in the
convertible notes and warrants agreements governing our existing convertible
notes, and debt we may incur in the future, may materially restrict our
operations, including our ability to incur debt, pay dividends, make certain
investments and payments, and encumber or dispose of assets. In addition,
financial covenants contained in agreements relating to our existing and future
debt could lead to a default in the event our results of operations do not meet
our plans and we are unable to amend such financial covenants prior to default.
An event of default under any debt instrument, if not cured or waived, could
have a material adverse effect on us, our financial condition and our capital
structure.
We
need additional funds to expand our business through company and project
acquisitions. If we are unable to raise additional funds, we would be restricted
from further business expansion.
Since we
are at the expansion stage of our business, we may require further funding for
capital investment in acquiring target companies and projects. To raise funds,
we may, upon having the consent from our investors,
need to issue new equities or bonds which could result in additional dilution to
our shareholders and in operating and financing covenants that would restrict
our operations and strategy. If we are unable to raise additional funds, our
business expansion would be hampered.
If
we issue additional shares, this may result in dilution to our existing
stockholders.
Our
Certificate of Incorporation authorizes the issuance of 800,000,000 shares of
common stock and 5,000,000 shares of preferred stock. Our Board of Directors has
the authority to issue additional shares up to the authorized capital stated in
the Certificate of Incorporation. Our Board of Directors may choose to issue
shares to acquire one or more businesses or to provide additional financing in
the future. The issuance of shares may result in a reduction of the book value
or market price of the outstanding shares of our common stock. If we issue
additional shares, there may be a reduction in the proportionate ownership and
voting power of all other stockholders. Further, any issuance may result in a
change of control of the Company.
The
authorized preferred stock constitutes what is commonly referred to as “blank
check” preferred stock. This type of preferred stock allows the Board of
Directors to designate the preferred stock into a series, and determine
separately for each series any one or more relative rights and preferences. The
Board of Directors may issue shares of any series without further stockholder
approval. Preferred stock authorized in series allows our Board of Directors to
hinder or discourage an attempt to gain control by a merger, tender offer at a
control premium price, or proxy contest. Consequently, the preferred stock could
entrench our management. In addition, the market price of our common stock could
be affected by the existence of the preferred stock.
If we or our independent registered
public accountants cannot attest to our adequacy of the internal control
measures over our financial reporting, as required by Section 404 of the U.S. Sarbanes-Oxley Act in
future, we may be adversely affected.
As a
public company, we are required to report our internal control structure and
procedures for financial reporting in our Annual Report on Form 10-KSB under
Section 404 of the U.S. Sarbanes-Oxley Act of 2002 by the SEC. The report
must contain an assessment by management about the effectiveness of our internal
controls over financial reporting. Additionally, our independent registered
public accounting firm will be required to issue reports on management’s
assessment of our internal control over financial reporting and their evaluation
of the operating effectiveness of our internal control over financial reporting.
Starting from 2008, the auditor’s report is required for every financial year
end.
The
Company has paid attention to its internal control procedures. In 2007 we
established an internal control working group to investigate and evaluate our
operations and improve procedures wherever necessary. With the participation and
guidance of management, we have evaluated our internal control systems such that
our management can report on, and our independent public accounting firm can
attest to our internal control system pursuant to the requirements under
Section 404 of the Sarbanes-Oxley Act of 2002.
The
Company believes that it has adequate internal control procedures in place.
However, we are still exposed to potential risks from Section 404 of the
Sarbanes-Oxley Act of 2002 that requiring companies to have high standard of
internal control procedures. It may be possible that our management cannot
attest to our effectiveness of internal controls over financial reporting.
Furthermore, even if our management attests to our internal control measures to
be effective, our independent registered public accountants may not be satisfied
with our internal control structure and procedures. If our management cannot
attest to our internal control measures at any time in the future, or if our
independent registered public accounting firm are not satisfied with our
internal control structure, it could result in an adverse impact on us in the
financial marketplace due to the loss of investor confidence in the reliability
of our financial statements, which could negatively impact our stock market
price.
Trading
may be restricted by the SEC, which may limit a stockholder’s ability to buy and
sell our stock.
The SEC
has adopted Rule 15g-9, which generally defines “penny stock” to be any equity
security that has a market price (as defined) less than $5.00 per share or an
exercise price of less than $5.00 per share. Our securities are covered by rules
that impose additional sales practice requirements on broker-dealers who sell to
persons other than established customers and “accredited investors”. The term
“accredited investor” refers generally to institutions with assets in excess of
$5,000,000 or individuals with a net worth in excess of $1,000,000 or annual
income exceeding $200,000 or $300,000 jointly with their spouse. The rules
require a broker-dealer, prior to a transaction in penny stock, to deliver a
standardized risk disclosure document in a form prepared by the SEC. This
provides information about the nature and level of risks in the penny stock
market. The broker-dealer must provide the customer with current bid and offer
quotations for the penny stock, the compensation of the broker-dealer and its
salesperson in the transaction and monthly account statements showing the market
value of each penny stock held in the customer’s account. The bid and offer
quotations, and the broker-dealer and salesperson compensation information, must
be given to the customer orally or in writing prior to effecting the transaction
and must be given to the customer in writing before or with the customer’s
confirmation. In addition, these rules require that prior to a transaction in a
penny stock not otherwise exempt from these rules; the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser’s written agreement to the transaction.
These disclosure requirements may have the effect of reducing the level of
trading activity in the secondary market for the stock that is subject to these
penny stock rules. Consequently, these penny stock rules may affect the ability
of broker-dealers to trade our securities. We believe that the penny stock rules
discourage investors’ interest in and limit the marketability of our common
stock.
NASD
sales practice requirements may also limit a stockholder’s ability to buy and
sell our stock.
In
addition to the “penny stock” rules described above, the National Association of
Securities Dealers (“NASD”) has adopted rules that require a broker-dealer, when
providing investment recommendations, must have reasonable grounds for believing
that the investment is suitable for that customer. Prior to recommending low
priced securities to their non-institutional customers, broker-dealers must make
reasonable efforts to obtain information about the customer’s financial status,
tax status and investment objectives. Under interpretations of these rules, the
NASD believes that there is a high probability that low priced securities will
not be suitable for at least some customers. The NASD requirements make it more
difficult for broker-dealers to recommend their customers buying our common
stock, which may limit ability of our investors to buy and sell our stock and
hence have an effect on the market for our shares.
Stockholders
should have no expectation of any dividends.
The
holders of our common stock are entitled to receive dividends, when, as and if
declared by the Board of Directors out of funds of the Company legally available
for the payment of dividends. To date, we have not declared nor paid any cash
dividends. The Board of Directors does not intend to declare any dividends in
the near future, but instead intends to retain all earnings, if any, for use in
our business operations.
The
Company’s convertible promissory notes and warrants, as well as the purchase
agreement, contain various provisions that protect the interests of the holders
of these securities in a manner that may be adverse to our Common Stock holders.
The 3% Convertible Promissory Notes bear interest at 3% per annum payable
semi-annually in arrears and mature on June 30, 2011. The 3% Convertible
Promissory Notes are convertible into shares of common stock at an initial
conversion price of $1.65 per share, subject to customary anti-dilution
adjustments. In addition, the conversion price will be adjusted downward on
an annual basis if the Company should fail to meet certain annual earnings per
share (“EPS”) targets described in the Purchase Agreement. In the event of a
default, or if the Company’s actual EPS for any fiscal year is less than 80% of
the respective EPS target, certain of the investors may require the Company to
redeem the 3% Convertible Promissory Notes at 100% of the principal amount, plus
any accrued and unpaid interest, plus an amount representing a 20% internal rate
of return on the then outstanding principal amount. The Warrants grant the
holders the right to acquire shares of common stock at $2.50 and $3.50 per
share, subject to customary anti-dilution adjustments. The exercise price of the
Warrants will also be adjusted downward whenever the conversion price of the 3%
Convertible Promissory Notes is adjusted downward in accordance with the
provisions of the Purchase Agreement.
Not
applicable.
Not
applicable.
Item
4. Submission of Matters to a Vote of Security Holders
Not
applicable.
Not
applicable.
Item
6. Exhibits
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Exhibit
No.
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Description
of Document
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31.1
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Certification
of Chief Executive Officer pursuant to Securities Exchange Act Rules
13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes
Oxley Act of 2002
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31.2
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Certification
of Chief Financial Officer pursuant to Securities Exchange Act Rules
13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes
Oxley Act of 2002
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32.1
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Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
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32.2
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Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
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NETWORK
CN INC.
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Date: May
14, 2008
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By:
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/s/
GODFREY HUI
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Godfrey
Hui,
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Chief
Executive Officer
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Date:
May 14, 2008
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By:
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/s/
DALEY MOK
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Daley
Mok,
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Chief
Financial Officer
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